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BUSINESS OVERVIEW


OVERVIEW

Helix Energy Solutions Group, Inc. (“Helix”) is an international offshore energy company, incorporated in the state of Minnesota in 1979, that provides reservoir development solutions and other contracting services to the energy market as well as to our own oil and gas properties. Our Contracting Services segment utilizes our vessels, offshore equipment and proprietary technologies to deliver services that may reduce finding and development (“F&D”) costs and encompass the complete lifecycle of an offshore oil and gas field. Our Oil and Gas segment engages in prospect generation, exploration, development and production activities. Our primary operations are located in the Gulf of Mexico, North Sea, Asia Pacific and Middle East regions. Unless the context indicates otherwise, as used in this Annual Report, the terms “Company,” “we,” “us” and “our” refer collectively to Helix and its subsidiaries, including Cal Dive International, Inc. (collectively with its subsidiaries referred to as “Cal Dive” or “CDI”), a publicly traded majority-owned subsidiary.

In December 2008, we announced the intention to focus and shape the future of the Company around our deepwater construction and well intervention services. For additional information regarding this recent strategy announcement and about our deepwater construction and well intervention services see sections titled “Industry and Our Strategy,” “Contracting Services” and “Contracting Services Operations” all included elsewhere within Item 1. “Business” of this Annual Report.

Our principal executive offices are located at 400 North Sam Houston Parkway East, Suite 400, Houston, Texas 77060; phone number 281-618-0400. Our common stock trades on the New York Stock Exchange (“NYSE”) under the ticker symbol “HLX” and Cal Dive’s common stock also trades on the NYSE under the ticker symbol “DVR”. Our Chief Executive Officer submitted the annual CEO certification to the NYSE as required under the its listed Company Manual in April 2008. Our principal executive officer and our principal financial officer have made the certifications required under Section 302 of the Sarbanes-Oxley Act, which are included as exhibits to this report.

Please refer to the subsection “— Certain Definitions” on page 8 for definitions of additional terms commonly used in this Annual Report.


CONTRACTING SERVICES

We seek to provide services and methodologies which we believe are critical to finding and developing offshore reservoirs and maximizing production economics, particularly from marginal fields. By “marginal,” we mean reservoirs that are no longer wanted by major operators or are considered too small to be material to them. Our “life of field” services are organized in five disciplines: construction, well operations, reservoir and well technology services, drilling, and production facilities. We have disaggregated our contracting services operations into three reportable segments in accordance with Financial Accounting Standards Board (“FASB”) Statement No. 131 Disclosures about Segments of an Enterprise and Related Information (“SFAS No. 131”): Contracting Services (which includes subsea construction, well operations, reservoir and well technology services and drilling); Shelf Contracting; and Production Facilities.

Construction

For over 30 years, we have supported offshore oil and natural gas infrastructure projects by providing our services, which include the construction and maintenance of pipelines, production platforms, risers and subsea production systems primarily in the Gulf of Mexico, North Sea, Asia Pacific and Middle East regions. Our subsea construction services include pipelay and robotics in water depths exceeding 1,000 feet. We also provide construction services periodically from our well intervention vessels. We perform traditional subsea services, including air and saturation diving, salvage work and shallow water pipelay on the Outer Continental Shelf (“OCS”) of the Gulf of Mexico in water depths up to 1,000 feet through Cal Dive, a majority-owned subsidiary in which we currently own approximately 51%. The financial results of Cal Dive are consolidated in our accompanying financial statements as of December 31, 2008 and 2007 and for each of the years in the three-year period ending December 31, 2008 (see Item 8. Financial Statements and Supplementary Data ”).

Well Operations

We engineer, manage and conduct well construction, intervention and decommissioning operations in water depths ranging from 200 to 10,000 feet. Over the long term, we expect an increased demand for these services caused by the growing number of subsea tree installations, coupled with our lower cost solutions as compared to a deepwater rig. Accordingly, we are constructing a newbuild vessel (the “ Well Enhancer ”) and have expanded geographically in Australia and Asia in 2007 with the acquisition of Seatrac Pty Ltd. (“Seatrac”), an established Australian well operations company now called Well Ops SEA Pty Limited (“WOSEA”).

Reservoir and Well Technology Services

Our ownership of Helix RDS Limited (“Helix RDS”) makes us one of the largest outsource providers of sub-surface technology skills in the North Sea. With a staff base of over 120 employees, we have the resources to provide valuable well enhancement services, which typically increase production or extend the life of a reservoir, to our own oil and natural gas projects as well as to our clients. Each team we assign to a specific client comprises a diverse set of skills, including reservoir engineering, geology, modeling, flow assurance, completions, well design and production enhancement. Helix RDS has an established market presence in regions that we have identified as strategically important to future growth, including offices in Aberdeen and London in the United Kingdom, Kuala Lumpur, Malaysia and Perth, Australia.

Drilling

Contract drilling is a service we have not historically provided but have been contemplating since the construction of our Q4000 vessel over eight years ago. We added drilling capability to the Q4000 in 2008. The fundamentals for deepwater rigs have been favorable in recent years, reflecting significant demand and a limited availability of such rigs. Although the deterioration in the worldwide capital markets has led a number of oil and gas companies to recently curtail or to announce anticipated reductions in their near-term capital expenditure budgets, we believe that the long-term deepwater projects will be less affected because of the significant oil and gas reserves associated with such projects and the relatively long lead times required to develop these fields for production. The drilling and completion cost of a subsea development can be as much as 50% of the total F&D costs for a deepwater prospect. The Q4000’s drilling capability primarily focuses on the use of hybrid slim-bore technology capable of drilling and completing 6-inch slimbore wells to 22,000 feet total depth and operating in up to 6,000 feet of water, which will allow us to drill many of our own deepwater prospects and support the exploration and appraisal efforts of our clients. We expect approval from the MMS in 2009 for cased well services, including completions, and approval for drilling once we have satisfied MMS requirements.

Production Facilities

We own interests in certain production facilities in hub locations where there is potential for significant subsea tieback activity. Ownership of production facilities enables us to earn a transmission company type return through tariff charges while providing construction work for our vessels. We own a 50% interest in the Marco Polo tension leg platform (“TLP”), which was installed in 4,300 feet of water in the Gulf of Mexico, through Deepwater Gateway, L.L.C. (“Deepwater Gateway”). We also own a 20% interest in Independence Hub, L.L.C. (“Independence Hub”), an affiliate of Enterprise Products Partners L.P. Independence Hub owns a 105-foot deep draft, semi-submersible platform, which was installed during 2007. The Independence Hub platform is located in a water depth of 8,000 feet and serves as a regional hub for up to 1 billion cubic feet of natural gas production per day from multiple ultra-deepwater fields in the eastern Gulf of Mexico. Finally, through a consolidated 50% owned entity, we are actively converting a vessel into a floating production unit, which we intend to initially use to handle the future oil and gas production from our Phoenix field in the Gulf of Mexico (see Item 2. Properties – Significant Oil and Gas Properties).


OIL AND GAS

We formed our oil and gas operations in 1992 to develop and provide more efficient solutions for the abandonment requirements of companies operating offshore, to expand the asset utilization of our contracting services assets and to achieve incremental returns for our contracting services. We have evolved this business model to include not only mature oil and gas properties but also proved and unproved reserves yet to be developed and explored. In July 2006, we acquired Remington Oil and Gas Corporation (“Remington”), an exploration, development and production company with operations located primarily in the Gulf of Mexico. This acquisition has led to the assembly of services that allows us to create value at key points in the life of a reservoir from exploration through development and operating through the field’s final abandonment. As of December 31, 2008, we had 665 Bcfe of estimated proved reserves with approximately 98% associated with properties located in the Gulf of Mexico. As discussed in “The Industry and Our Strategy” below, in December 2008, we announced that we intend to seek the potential sale of part or all of our oil and gas operations, however; until any potential disposition occurs, we believe that owning interests in reservoirs, particularly in deepwater, provides the following:

•

a potential backlog for our service assets as a hedge against cyclical service asset utilization;

•

potential utilization for new non-conventional applications of service assets to hedge against lack of initial market acceptance and utilization risk; and

•

incremental returns.

Our oil and gas operations include an experienced team of personnel providing services in geology, geophysics, reservoir engineering, drilling, production engineering, facilities management, lease operations and petroleum land management. We seek to maximize returns on our oil and gas investments by lowering F&D costs, reducing development time, operating our fields more effectively, and extending the reservoir life through well exploitation operations. Our reservoir engineering and geophysical expertise, along with our access to contracting services assets that may positively impact a project’s development costs, have enabled us to partner with many other oil and gas companies in offshore development projects.

Our contracting services includes three of our business segments, Contracting Services, Shelf Contracting and Production Facilities. Our fourth business segment is Oil and Gas. Significant financial information relating to our operations by segments and by geographic areas for the last three years is contained in Item 8. Financial Statements and Supplementary Data “— Note 19 — Business Segment Information.”

THE INDUSTRY AND OUR STRATEGY

In December 2008, we announced our intention to focus and shape the future direction of the Company around our deepwater construction and well intervention services. We intend to achieve this strategic focus by seeking and evaluating strategic opportunities to:

1)

Divest all or a portion of our oil and gas assets;
2)

Divest our ownership interests in one or all production facilities; and
3)

Dispose of our remaining 51% interest in our majority owned subsidiary, CDI.

We have engaged financial advisors to assist us in these efforts. The current economic and financial market conditions may affect the timing of any strategic dispositions by us and will require a degree of patience in order to execute any transactions. As a result, we are unable to be specific with respect to a timetable for any disposition, but we intend to aggressively focus on reducing our indebtedness through monetization of non-core assets and allocation of free cash flow in order to accelerate our strategic goals. We cannot assure you that any or all of the proposed strategic dispositions will be completed or that we will be able to negotiate a favorable price and/or terms. Dispositions of any material assets and/or investments in our non-core businesses will require obtaining approval from our Board of Directors before consummation.

Consistent with this strategy, in December 2008 we announced the sale of our 17.5% non-operating working interest in the Bass Lite oil and gas field for $49 million in gross proceeds and in January 2009 we entered into a stock repurchase agreement with CDI that resulted in us selling approximately 13.6 million shares of CDI common stock held by us to CDI for $86 million in gross proceeds. The sale reduced our ownership of CDI from approximately 57% to our current approximate 51% ownership position.

Demand for our contracting services operations is primarily influenced by the condition of the oil and gas industry, and in particular, the willingness of oil and gas companies to make capital expenditures for offshore exploration, drilling and production operations. Generally, spending for our contracting services fluctuates directly with the direction of oil and natural gas prices. The performance of our oil and gas operations is also largely dependent on the prevailing market prices for oil and natural gas, which are impacted by global economic conditions, hydrocarbon production and excess capacity, geopolitical issues, weather and several other factors.

The global economic conditions deteriorated significantly over the past year with declines in the oil and gas market accelerating during the fourth quarter of 2008. Although we currently are experiencing a current market downturn, we believe that the long-term industry fundamentals are positive based on the following factors: (1) long term increasing world demand for oil and natural gas; (2) peaking global production rates; (3) globalization of the natural gas market; (4) increasing number of mature and small reservoirs; (5) increasing ratio of contribution to global production from marginal fields; (6) increasing offshore activity, particularly in Deepwater; and (7) increasing number of subsea developments. Our current strategy of combining contracting services operations and oil and gas operations allows us to focus on trends (4) through (7) in that we pursue long-term sustainable growth by applying specialized subsea services to the broad external offshore market but with a complementary focus on marginal fields and new reservoirs in which we have an equity stake.

Our primary goal is to provide services and methodologies to the industry which we believe are critical to finding and developing offshore reservoirs and maximizing the economics from marginal fields. A secondary goal is for our oil and gas operations to generate prospects and find and develop oil and gas employing our key services and methodologies resulting in a reduction in F&D costs. Meeting these objectives drives our ability to achieve our primary goal of maximizing the value for our shareholders. In order to achieve these goals we will:

Continue Expansion of Contracting Services Capabilities. We will focus on providing offshore services that deliver the highest financial return to us. We may make strategic investments in capital projects that expand our service capabilities or add capacity to existing services in our key operating regions. Our capital investments have included adding offshore drilling capability to our Q4000 vessel, converting a vessel into a dynamically positioned floating production unit ( Helix Producer I), converting a former dynamically positioned cable lay vessel into a deepwater pipelay vessel (the Caesar), and constructing the Well Enhancer vessel with greater well servicing capabilities in the North Sea.

Monetize Oil and Gas Reserves and Non-Core Assets. We intend to sell down interests in oil and gas reserves once value has been created via prospect generation, discovery and/or development engineering. Through this approach we seek to lower reservoir and commodity risk, lower capital expenditures and increase third party contracting services profits. We may sell interests in oil and gas reserves at any time during the life of the properties.

As stated previously, we will focus on services which are critical to lowering F&D costs, particularly on marginal fields in the deepwater. As the strategy of our Shelf Contracting segment does not focus on minimizing F&D cost, in December 2006, a minority stake (26.5%) in this business was sold through a carve-out initial public offering. Our interest in CDI was further reduced through CDI’s acquisition of Horizon Offshore, Inc. (“Horizon”) in December 2007 and was 57.2% at December 31, 2008. In January 2009, CDI acquired 13.6 million shares of its outstanding common shares from us reducing our current ownership in CDI to approximately 51%. See Item 8. Financial Statements and Supplementary Data “— Note 5 — Acquisition of Horizon Offshore, Inc.” We believe the Shelf Contracting segment, CDI, is better positioned for growth as a stand-alone entity.

Generate Prospects and Focus Exploration Drilling on Select Deepwater Prospects. Our oil and gas operations continue to function normally following our December 2008 announcement that all or a portion of such properties may be sold. This means we will continue to generate prospects and drill in areas where we believe our contracting services assets can be utilized and incremental returns will be achieved through control of and application of our development services and methodologies. To minimize our F&D costs, we expect to utilize the Q4000 for many of our deepwater drilling needs once regulatory approval has been obtained. Additionally, we plan to seek partners on these prospects to mitigate risk associated with the cost of drilling and development work.

Continue Exploitation Activities and Converting PUD/PDNP Reserves into Production. Over the years, our oil and gas operations have been able to achieve a significant return on capital due in part to our ability to convert proved undeveloped reserves (“PUD”) and proved developed non-producing reserves (“PDNP”) into producing assets through successful exploitation drilling and well work. As of December 31, 2008, the PUD category for our U.S Gulf of Mexico properties, totaled approximately 319 Bcfe or 49% of our total domestic estimated proved reserves. All of our U.K proved reserves are considered to be PUD at December 31, 2008. We will focus on cost effectively developing these reserves to generate oil and gas production, or alternatively, selling full or partial interests in them to fund our core service business and/or retire outstanding debt.


Certain Definitions

Defined below are certain terms helpful to understanding our business:

Bcfe: One billion cubic feet equivalent, with one barrel of oil being equivalent to six thousand cubic feet of natural gas.

Deepwater: Water depths exceeding 1,000 feet.

Dive Support Vessel (DSV): Specially equipped vessel that performs services and acts as an operational base for divers, remotely operated vehicles (“ROV”) and specialized equipment.

Dynamic Positioning (DP): Computer-directed thruster systems that use satellite-based positioning and other positioning technologies to ensure the proper counteraction to wind, current and wave forces enabling the vessel to maintain its position without the use of anchors.

DP-2: Two DP systems on a single vessel pursuant to which the redundancy allows the vessel to maintain position even with the failure of one DP system, required for vessels which support both manned diving and robotics and for those working in close proximity to platforms. DP-2 are necessary to provide the redundancy required to support safe deployment of divers, while only a single DP system is necessary to support ROV operations.

EHS: Environment, Health and Safety programs to protect the environment, safeguard employee health and eliminate injuries.

E&P: Oil and gas exploration and production activities.

F&D: Total cost of finding and developing oil and gas reserves.

G&G: Geological and geophysical.

IMR: Inspection, maintenance and repair activities.

Life of Field Services: Services performed on offshore facilities, trees and pipelines from the beginning to the end of the economic life of an oil field, including installation, inspection, maintenance, repair, contract operations, well intervention, recompletion and abandonment.

MBbl: When describing oil or other natural gas liquid, refers to 1,000 barrels containing 42 gallons each.

Minerals Management Service (MMS): The federal regulatory body for the United States having responsibility for the mineral resources of the United States OCS.

Mcf: When describing natural gas, refers to 1 thousand cubic feet.

MMcf: When describing natural gas, refers to 1 million cubic feet.

Moonpool: An opening in the center of a vessel through which a saturation diving system or ROV may be deployed, allowing safe deployment in adverse weather conditions.

MSV: Multipurpose support vessel.

Outer Continental Shelf (OCS): For purposes of our industry, areas in the Gulf of Mexico from the shore to 1,000 feet of water depth.

Peer Group-Contracting Services: Defined in this Annual Report as comprising FMC Technologies, Inc. (NYSE: FTI), Global Industries, Ltd. (NASDAQ: GLBL), McDermott International, Inc. (NYSE: MDR), Oceaneering International, Inc. (NYSE: OII), Cameron International Corporation (NYSE: CAM), Pride International, Inc. (NYSE: PDE), Oil States International, Inc. (NYSE: OIS), Rowan Companies, Inc. (NYSE: RDC), and Tidewater Inc. (NYSE: TDW).

Peer Group-Oil and Gas: Defined in this Annual Report as comprising ATP Oil & Gas Corp (NASDAQ: ATPG), W&T Offshore, Inc. (NYSE: WTI), and Mariner Energy, Inc. (NYSE: ME).

Proved Developed Non-Producing (PDNP): Proved developed oil and gas reserves that are expected to be recovered from (1) completion intervals which are open at the time of the estimate but which have not started producing, or (2) wells that require additional completion work or future recompletion prior to the start of production.

Proved Developed Shut-In (PDSI): Proved developed oil and gas reserves associated with wells that exhibited calendar year production, but were not online January 1, 2009.

Proved Developed Reserves: Reserves that geological and engineering data indicate with reasonable certainty to be recoverable today, or in the near future, with current technology and under current economic conditions.

Proved Undeveloped Reserves (PUD): Proved undeveloped oil and gas reserves that are expected to be recovered from a new well on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion.

Remotely Operated Vehicle (ROV): Robotic vehicles used to complement, support and increase the efficiency of diving and subsea operations and for tasks beyond the capability of manned diving operations.

ROVDrill: ROV deployed coring system developed to take advantage of existing ROV technology. The coring package, deployed with the ROV system, is capable of taking cores from the seafloor in water depths up to 3000m. Because the system operates from the seafloor there is no need for surface drilling strings and the larger support spreads required for conventional coring.

Saturation Diving: Saturation diving, required for work in water depths between 200 and 1,000 feet, involves divers working from special chambers for extended periods at a pressure equivalent to the pressure at the work site.

Spar: Floating production facility anchored to the sea bed with catenary mooring lines.

Spot Market: Prevalent market for subsea contracting in the Gulf of Mexico, characterized by projects that are generally short in duration and often on a turnkey basis. These projects often require constant rescheduling and the availability or interchangeability of multiple vessels.

Stranded Field: Smaller PUD reservoir that standing alone may not justify the economics of a host production facility and/or infrastructure connections.


CEO BACKGROUND

T. William Porter Director since 2004 Chairman age 67 Porter & Hedges, L.L.P.

Mr. Porter has served as a director since March 2004. He is the Chairman and a founding partner of Porter & Hedges, L.L.P., a Houston law firm formed in 1981. Mr. Porter also serves as a director of Copano Energy L.L.C., a midstream energy company with networks of natural gas gathering and intrastate transmission pipelines in the Texas Gulf Coast and Oklahoma mid-continent regions, and U.S. Concrete, Inc., a value-added provider of ready-mixed concrete and related products and services to the construction industry in several major markets in the United States. Mr. Porter graduated with a B.B.A. in finance from Southern Methodist University in 1963 and received his law degree from Duke University in 1966.

William L. Transier Director since 2000 Chief Executive Officer and President age 54
Endeavour International Corporation

Mr. Transier has served as a director since October 2000. He is Chief Executive Officer and President, and serves as Chairman of the Board, of Endeavour International Corporation, an international oil and gas exploration and production company. He served as Co-Chief Executive Officer of Endeavour from its formation in February 2004 through September 2006. Mr. Transier served as Executive Vice President and Chief Financial Officer of Ocean Energy, Inc. from March 1999 to April 2003, when Ocean Energy merged with Devon Energy Corporation. From September 1998 to March 1999, Mr. Transier served as Executive Vice President and Chief Financial Officer of Seagull Energy Corporation when Seagull Energy merged with Ocean Energy. From May 1996 to September 1998, he served as Senior Vice President and Chief Financial Officer of Seagull Energy Corporation. Prior thereto, Mr. Transier served in various roles including partner from June 1986 to April 1996 in the audit department of KPMG LLP. Mr. Transier graduated from the University of Texas with a B.B.A. in accounting and has an M.B.A. from Regis University. In addition to serving on our Board of Directors and the Board of Endeavour, he is also a director of Reliant Energy, Inc., a provider of electricity and energy services to retail and wholesale customers in the United States and Cal Dive International, Inc., our majority owned subsidiary. Mr. Transier has indicated his intention not to stand for re-election to the Reliant Energy board at its 2009 annual meeting.


James A. Watt Director since 2006 Chief Executive Officer and President age 59
Dune Energy, Inc.

Mr. Watt has served as a director since July 2006. Mr. Watt has been Chief Executive Officer and President of Dune Energy, Inc., an oil and gas exploration and development company since April 2007. He served as Chairman and Chief Executive Officer of Maverick Oil and Gas, Inc., an independent oil and gas exploration and production company from August 2006 until March 2007. Mr. Watt was the Chief Executive Officer of Remington Oil and Gas Corporation from February of 1998 and the Chairman of Remington from May 2003, until Helix acquired Remington in July 2006. Mr. Watt also served on Remington’s Board of Directors from September 1997 to July 2006. Mr. Watt was Vice President/Exploration of Seagull E & P, Inc., from 1993 to 1997, and Vice President/Exploration and Exploitation of Nerco Oil & Gas, Inc. from 1991 to 1993. Mr. Watt is also a director of Pacific Energy Resources, Ltd., an exploration and development company with offshore and onshore operations primarily in California and Alaska. He graduated from Rensselaer Polytechnic Institute with a Bachelor of Science in physics.

Gordon F. Ahalt Director since 1990 Retired Consultant age 81

Mr. Ahalt has served as a director since July 1990. Since 1982, Mr. Ahalt has been the President of GFA, Inc., a petroleum industry management and financial consulting firm. From 1977 to 1980, he was President of the International Energy Bank, London, England. From 1980 to 1982, he served as Senior Vice President and Chief Financial Officer of Ashland Oil Company. Prior thereto, he spent a number of years in executive positions with Chase Manhattan Bank. Mr. Ahalt also serves as a director of Bancroft & Elsworth Convertible Funds and other private investment funds. Mr. Ahalt received a B.S. Degree in Petroleum Engineering in 1951 from the University of Pittsburgh.

Nancy K. Quinn Director since 2009 Co-Owner, Principal age 55 Hanover Capital, LLC


Ms. Quinn has served as a director since February 2009. Ms. Quinn is a principal of Hanover Capital LLC, a privately-owned advisory firm that provides financial and strategic services primarily to clients in the energy and natural resources industries. She has served as Executive Director of The Beacon Group, LP. (now a part of JP Morgan Chase) from 1996 to 2000, as Managing Director of PaineWebber Incorporated from 1994 to 1995, and as co-head of the natural resources and energy investment banking section of Kidder, Peabody & Co. from 1982 to 1992. Ms. Quinn currently serves on the board of directors of Endeavour International Corporation, an international oil and gas exploration and production company, and Atmos Energy Corporation, a distributer of natural gas. Ms. Quinn graduated with a Bachelor of Fine Arts degree from Louisiana State University and an M.B.A. from the University of Arkansas.

Owen Kratz Director since 1990 President and Chief Executive Officer age 54
Helix Energy Solutions Group, Inc.

Mr. Kratz is our President and Chief Executive Officer. He was named Executive Chairman in October 2006 and served in that capacity until February 2008 when he resumed the position of President and Chief Executive Officer of the Company. He was appointed Chairman in May 1998 and served as the Company’s Chief Executive Officer since April 1997 until October 2006. Mr. Kratz served as President from 1993 until February 1999, and has served as a director since 1990. He served as Chief Operating Officer from 1990 through 1997. Mr. Kratz joined Cal Dive International, Inc. (now known as Helix) in 1984 and held various offshore positions, including saturation (SAT) diving supervisor, and had management responsibility for client relations, marketing and estimating. From 1982 to 1983, Mr. Kratz was the owner of an independent marine construction company operating in the Bay of Campeche. Prior to 1982, he was a superintendent for Santa Fe and various international diving companies, and a diver in the North Sea. Mr. Kratz is also a Director of Cal Dive International, Inc. Mr. Kratz has a Bachelor of Science degree from State University of New York.


Bernard J. Duroc-Danner Director since 1999 Chairman of the Board, President and Chief Executive Officer age 55 Weatherford International Ltd.

Mr. Duroc-Danner has served as a director since February 1999. He has been Chairman of the Board, President and Chief Executive Officer of Weatherford International Ltd. since May 1998. Weatherford is one of the largest global providers of innovative mechanical solutions, technology and services for the drilling and production sectors of the oil and gas industry. Mr. Duroc-Danner also serves as a director of LMS, a London investment company. Mr. Duroc-Danner is also a member of the National Petroleum Council and the Society of Petroleum Engineers. Mr. Duroc-Danner holds a Ph.D. in economics from The Wharton School of the University of Pennsylvania.


John V. Lovoi Director since 2003 Principal age 48 JVL Partners

Mr. Lovoi has served as a director since February 2003. He is a founder and Managing Partner of JVL Partners, a private oil and gas investment partnership. Mr. Lovoi served as head of Morgan Stanley’s global oil and gas investment banking practice from 2000 to 2002 and was a leading oilfield services and equipment research analyst for Morgan Stanley from 1995 to 2000. Prior to joining Morgan Stanley in 1995, he spent two years as a senior financial executive at Baker Hughes and four years as an energy investment banker with Credit Suisse First Boston. Mr. Lovoi also serves as a director of Evergreen Energy, Inc., a clean energy technology company providing technology and service solutions to the power generation industry and Dril-Quip, Inc., a provider of offshore drilling and production equipment to the global oil and gas business. Mr. Lovoi graduated from Texas A&M University with a Bachelor of Science degree in chemical engineering and received an M.B.A. from the University of Texas.

MANAGEMENT DISCUSSION FROM LATEST 10K

Our Business

We are an international offshore energy company that provides reservoir development solutions and other contracting services to the energy market as well as to our own oil and gas properties. Our oil and gas business is a prospect generation, exploration, development and production company. Employing our own key services and methodologies, we seek to lower finding and development costs, relative to industry norms.

Our Strategy

In December 2008, we announced the intention to focus and shape the future direction of the Company around our deepwater construction and well intervention services. We intend to achieve this strategic focus by seeking and evaluating strategic opportunities to:

1)

Divest all or a portion of our oil and gas assets;
2)

Divest our ownership interests in one or more of our production facilities; and
3)

Dispose of our remaining interest in our majority owned subsidiary, CDI.

We have engaged financial advisors to assist us in these efforts. The current economic and financial market conditions may affect the timing of any strategic dispositions by us and will require a degree of patience in order to execute any transactions. As a result, we are unable to be specific with respect to a timetable for any disposition, but we intend to aggressively focus on reducing debt levels through monetization of non-core assets and allocation of free cash flow in order to accelerate our strategic goals.

Consistent with this strategy, in December 2008 we announced the sale of our 17.5% non-operating working interest in the Bass Lite oil and gas field for $49 million in gross proceeds and in January 2009 we entered into a stock repurchase agreement with Cal Dive that resulted in us selling CDI approximately 13.6 million of CDI common shares held by us for $86 million in gross proceeds. This sale reduced our ownership interest in CDI to the current approximate 51%. We owned approximately 57% of CDI at December 31, 2008.

Demand for our contracting services operations is primarily influenced by the condition of the oil and gas industry, and in particular, the willingness of oil and gas companies to make capital expenditures for offshore exploration, drilling and production operations. Generally, spending for our contracting services fluctuates directly with the direction of oil and natural gas prices. The performance of our oil and gas operations is also largely dependent on the prevailing market prices for oil and natural gas, which are impacted by global economic conditions, hydrocarbon production and excess capacity, geopolitical issues, weather and several other factors.

Economic Outlook and Industry Influences

The recent economic downturn and weakness in the equity and credit capital markets has led to increased uncertainty regarding the outlook of the global economy. This uncertainty coupled with the probable decrease in the near-term global demand for oil and gas has resulted in commodity price declines over the second half of 2008, with significant declines occurring in the fourth quarter of 2008. Declines in oil and gas prices negatively impact our operating results and cash flow. We believe that these events have contributed to the significant decline in our stock price and corresponding market capitalization. In the fourth quarter of 2008, the declines in our stock price and the prices of oil and natural gas, were considered in association with our annual impairment assessment of goodwill as of November 1, 2008, at which time, we were required to assess the fair value of our goodwill, indefinite-lived intangible assets and certain of oil and gas properties that resulted in us recording an aggregate of $907.6 million of impairment charges ($715 million for goodwill and indefinite lived intangible assets and $192.6 million for oil and gas property impairments) (Note 2). The aggregate of all impairment charges for 2008 was $930.6 million. Further, our contracting services also may be negatively impacted by declining commodity prices as such may cause our customers, primarily oil and gas companies, to curtail or eliminate capital spending. At the moment, it is still too soon to predict to what extent current events may affect our overall activity levels in 2009 and beyond. The long-term fundamentals for our business remain generally favorable as the need for the continual replenishment of oil and gas production should drive the demand for our services. In addition, as our subsea construction operations primarily support capital projects with long lead times, that are less likely to be impacted by temporary economic downturns. We have hedged approximately 73% of our anticipated production for 2009 with a combination of forward sale and financial hedge contracts. The prices for these contracts are significantly higher than the prices for both crude oil and natural gas as of December 31, 2008 and as of the time of this filing on March 2, 2009. If the prices for crude oil and natural gas do not increase from current levels, and we have not entered into additional forward sale or financial hedge contracts to stabilize our cash flows, our oil and gas revenues may decrease in 2010 and beyond, perhaps significantly, absent offsetting increases in production amounts.

In light of the current credit crisis, in October 2008, we drew down an additional $175 million on our Revolving Credit Facility to ensure adequate and readily available liquidity to mitigate the cash flow impacts of production shut-in from Hurricanes Gustav and Ike , to fund ongoing capital projects and for hurricane remediation and repair costs. After this draw down, we had approximately $44 million (approximately $59 million as of February 27, 2009) of additional capacity remaining under our Revolving Credit Facility (including letters of credit). Further, we have reduced our planned capital expenditures for 2009 to include primarily the completion of major vessel construction projects and limited oil and gas expenditures. If we successfully implement the business plan outlined above, we believe we have sufficient liquidity without incurring additional indebtedness beyond the existing capacity under the Revolving Credit Facility.

Our business is substantially dependent upon the condition of the oil and natural gas industry and, in particular, the willingness of oil and natural gas companies to make capital expenditures for offshore exploration, drilling and production operations. The level of capital expenditures generally depends on the prevailing views of future oil and natural gas prices, which are influenced by numerous factors, including but not limited to:

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worldwide economic activity, including available access to global capital and capital market;

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demand for oil and natural gas, especially in the United States, Europe, China and India;

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economic and political conditions in the Middle East and other oil-producing regions;

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actions taken by the OPEC;

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the availability and discovery rate of new oil and natural gas reserves in offshore areas;

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the cost of offshore exploration for and production and transportation of oil and gas;

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the ability of oil and natural gas companies to generate funds or otherwise obtain external capital for exploration, development and production operations;

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the sale and expiration dates of offshore leases in the United States and overseas;

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technological advances affecting energy exploration production transportation and consumption;

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weather conditions;

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environmental and other governmental regulations; and

•

tax policies.

Global economic conditions have deteriorated significantly over the past year with declines in the oil and gas market accelerating during the fourth quarter of 2008. Predicting the timing of any recovery is subjective and highly uncertain. Although we are currently is a recession, we believe that the long-term industry fundamentals are positive based on the following factors: (1) long term increasing world demand for oil and natural gas; (2) peaking global production rates; (3) globalization of the natural gas market; (4) increasing number of mature and small reservoirs; (5) increasing ratio of contribution to global production from marginal fields; (6) increasing offshore activity, particularly in Deepwater; and (7) increasing number of subsea developments. Our strategy of combining contracting services operations and oil and gas operations allows us to focus on trends (4) through (7) in that we pursue long-term sustainable growth by applying specialized subsea services to the broad external offshore market but with a complementary focus on marginal fields and new reservoirs in which we have an equity stake.

Activity Summary

Over the last few years we continued to evolve our model by completing a variety of transactions and events that have had, and we believe will continue to have, significant impacts on our results of operations and financial condition. In 2005, we substantially increased the size of our Shelf Contracting fleet and deepwater pipelay fleet through the acquisition of assets from Torch Offshore, Inc. and Acergy US Inc. for a combined purchase price of $210.2 million. We also acquired a significant mature property package in the Gulf of Mexico OCS from Murphy Oil Corporation for $163.5 million cash and assumption of abandonment liability of $32 million. Finally, we established our Reservoir and Well Technology Services group through the acquisition of Helix Energy Limited for $32.7 million and the assumption of $7.5 million of liabilities. In 2006, we acquired Remington, an exploration, development and production company, for approximately $1.4 billion in cash and Helix common stock and the assumption of $358.4 million of liabilities. In March 2006m, we changed our name from Cal Dive International, Inc. to Helix Energy Solutions Group, Inc., leaving the “Cal Dive” name to our Shelf Contracting subsidiary, and in December 2006 completed a carve-out initial public offering of Cal Dive, selling a 26.5% stake and receiving pre-tax net proceeds of $264.4 million and a pre-tax dividend of $200 million from additional borrowings under the Cal Dive revolving credit facility.

During 2006 we committed to four capital projects which will significantly expand our contracting services capabilities: conversion of the Caesar into a deepwater pipelay vessel, upgrading of the Q4000 to include drilling capability, conversion of a ferry vessel into a DP floating production unit ( Helix Producer I ) and construction of a multi-service DP dive support/well intervention vessel ( Well Enhancer ). During 2007, we successfully completed the drilling of exploratory wells in our Bushwood prospect located in Garden Banks Blocks 462, 463, 506 and 507 in the Gulf of Mexico. In January 2009, we announced an additional discovery at the Bushwood field (see “Oil and Gas Operations” in Item 2. “Properties” elsewhere in this Annual Report). Initial sustained production from Bushwood commenced in January 2009.

In December 2007, Cal Dive acquired Horizon for approximately $650 million. CDI issued an aggregate of approximately 20.3 million shares of its common stock and paid approximately $300 million in cash in the merger. The cash portion of the merger consideration was paid from CDI’s cash on hand and from borrowings under its $675 million credit facility consisting of a $375 million senior secured term loan and a $300 million senior secured revolving credit facility, each of which is non-recourse to Helix. As a result of CDI’s equity issued, we recorded a $98.6 million gain, net of $53.1 million of taxes. The non-cash gain was calculated as the difference in the value of our investment in CDI immediately before and after CDI’s stock issuance.

Results of Operations

Our business consists of contracting services and oil and gas operations. We have disaggregated our contracting services operations into three reportable segments in accordance with SFAS No. 131 “ Disclosures about Segments of an Enterprise and Related Information ”. As a result, our reportable segments consist of the following: Contracting Services, Shelf Contracting, Production Facilities, and Oil and Gas. The Contracting Services segment includes operations such as deepwater pipelay, well operations, robotics and reservoir and well technology services. The Shelf Contracting segment represent the results and operations of Cal Dive, in which we owned 57.2% at December 31, 2008 and currently own approximately 51%. All material intercompany transactions between the segments have been eliminated in our consolidated financial statements, including our consolidated results of operations.

Gross revenues for our Shelf Contracting business increased 37% in 2008 compared to 2007 primarily reflecting the revenue contribution of the Horizon assets that were acquired in December 2007 partially offset by lower vessel utilization related to winter seasonality and harsh weather conditions which continued into May 2008, and weather downtime associated with Hurricanes Gustav and Ike. Following the storm, our Shelf Contracting revenues benefitted from the increased scope of work associated with the storms including inspections, repairs and reclamation projects.

Oil and Gas revenues decreased 7% during 2008 as compared to the prior year. The decrease is primarily associated with the loss of production following the shut-in of many of our oil and gas properties following Hurricanes Gustav and Ike. Our production rates in 2008 were 27% lower than the same period last year; however our current net daily production is approximately 90% of pre-storm production volumes after adjusting for the sale of one major deepwater property in December 2008. The decrease in our revenues was partially offset by substantially higher oil and natural gas prices realized over the amounts received in 2007, which reflects near historical high prices for both oil and natural gas over the first half of 2008. Prices of both oil and natural gas decreased significantly during the second half of 2008, with price reductions accelerating in the fourth quarter of 2008.

Gross Profit. The Contracting Services gross profit increase was primarily attributable to improved contract pricing for the well operations and ROV divisions. These increases were partially offset by lower margins realized on certain longer term deepwater pipelay projects reflecting the delays in delivery of the Ceasar and processing of certain change orders which prevented revenue recognition under the percentage-of-completion method (Note 2). We also recorded approximately $9.8 million of estimated losses on two contracts in which we believe the future revenue benefits will be exceeded by the estimated future costs to service the contracts (Note 2). The gross profit increase within Shelf Contracting was primarily attributable to the initial deployment of Horizon’s assets that were acquired in December 2007 and additional work following Hurricanes Gustav and Ike , offset by increased depreciation associated with Horizon assets and weather-related delays over the first five months of 2008 and during Hurricanes Gustav and Ike . Our 2007 Shelf Contracting operations were adversely effected by an higher number of out-of-service days referred to above, lower vessel utilization as a result of seasonal weather in the fourth quarter 2007, and increased depreciation and deferred drydock amortization.

The decrease in the gross profit for our oil and gas operations in 2008 as compared to 2007 reflects the following key factors :

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impairment expense of approximately $215.7 million ($192.6 million recorded in the fourth quarter of 2008) related to our proved oil and gas properties primarily as a result of downward reserve revisions reflecting lower oil and natural gas prices, weak end of life well performance for some of our domestic properties, fields lost as a result of Hurricanes Gustav and Ike and the reassessment of the economics of some of our marginal fields in light of our announced business strategy to exit the oil and gas exploration and production business; we also recorded a $14.6 million asset impairment charge associated with the Devil’s Island Development well (Garden Banks Block 344) that was determined to be non-commercial in January 2008. Asset impairment expense in 2007 totaled $64.1 million, which included $20.9 million for the costs incurred on the Devil’s Island well through December 31, 2007.

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an increase of $32.0 million in depletion expense in 2008 because of lower production which is primarily attributed to the effects Hurricanes Gustav and Ike had on our production during the latter part of the yea. This decrease was partially offset by higher rates resulting from a reduction in estimated proved reserves for a number of or producing fields at December 31, 2008.

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approximately $8.8 million of exploration expense (all in fourth quarter of 2008) compared to $9.0 million in 2007 related to reducing the carrying value of our unproved properties primarily due to management’s assessment that exploration activities for certain properties will not commence prior to the respective lease expiration dates;

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approximately $16.0 million of plug and abandonment overruns primarily related to properties damaged by the hurricanes, partially offset by insurance recoveries of $7.8 million; and

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approximately $18.8 million of dry hole exploration expense reflecting the conclusion that two exploratory wells previously classified as suspended wells (Note 7) no longer met the requirements to continue to be capitalized primarily as a result of the
discontinuing of plans to progress the development of these wells in light of our announcement in December 2008 of our intention to pursue a sale of all or a portion of our oil and gas assets. In 2007, our dry hole expense totaled $10.3 million, of which $5.9 million was related to our South Marsh Island Block 123 #1 well.

Goodwill and other intangible asset impairments. In the fourth quarter of 2008 we recorded a $704.3 million of impairment charge to eliminate our remaining oil and gas goodwill following our annual assessment of goodwill, which took into account the significant decrease in our common stock price as well as the stock prices of our identified peers and the rapid reduction in oil and natural gas commodity prices. For our Contracting Services segment, we recorded an $8.3 million impairment charge to eliminate the goodwill for one of our reporting units and a related $2.4 million impairment charge for an indefinite life asset (trademark). We separately recorded $8.1 million of reductions of goodwill associated with dispositions of oil and gas properties in 2008, which are included as a component of the gain or loss on sale of assets, net as discussed below.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Our Business

We are an international offshore energy company that provides reservoir development solutions and other contracting services to the energy market as well as to our own oil and gas properties. Our oil and gas business is a prospect generation, exploration, development and production company. Employing our own key services and methodologies, we seek to lower finding and development costs, relative to industry norms.

Our Strategy

In December 2008, we announced the intention to focus and shape the future direction of the Company around our deepwater construction and well intervention services. We intend to achieve this strategic focus by seeking and evaluating strategic opportunities to:

1)

Divest all or a portion of our oil and gas assets;
2)

Divest our ownership interests in one or more of our production facilities; and
3)

Dispose of our remaining interest in our majority owned subsidiary, CDI.

We have engaged financial advisors to assist us in these efforts. The current economic and financial market conditions may affect the timing of any strategic dispositions by us and will require a degree of patience in order to execute any transactions. As a result, we are unable to be specific with respect to a timetable for any disposition, but we intend to aggressively focus on reducing debt levels through monetization of non-core assets and allocation of free cash flow in order to accelerate our strategic goals.

Since the announcement of our strategy to monetize certain of our non core business assets, we have:

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Sold two oil and gas properties for $67 million in gross proceeds;
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Sold CDI approximately 13.6 million shares of its common stock held by us for $86 million; and
•

Sold Helix RDS Limited, our subsurface reservoir consulting business for $25 million.

Demand for our contracting services operations is primarily influenced by the condition of the oil and gas industry, and in particular, the willingness of oil and gas companies to make capital expenditures for offshore exploration, drilling and production operations. Generally, spending for our contracting services fluctuates directly with the direction of oil and natural gas prices. The performance of our oil and gas operations is also largely dependent on the prevailing market prices for oil and natural gas, which are impacted by global economic conditions, hydrocarbon production and excess capacity, geopolitical issues, weather and several other factors.

Economic Outlook and Industry Influences

The continuing economic downturn and weakness in the equity and credit capital markets has led to increased uncertainty regarding the outlook of the global economy. This uncertainty coupled with the probable decrease in the near-term global demand for oil and gas has resulted in commodity price declines over the second half of 2008, with significant declines occurring in the fourth quarter of 2008. Prices for oil remained relatively flat in first quarter of 2009 compared with prices at year end 2008 while natural gas prices continued to decrease to levels last seen in 2004. Declines in oil and gas prices negatively impact our operating results and cash flow. Further, our contracting services are negatively impacted by declining commodity prices, which has resulted in some of our customers, primarily oil and gas companies, to curtail capital spending. The long-term fundamentals for our business remain generally favorable as the need for the continual replenishment of oil and gas production should drive the demand for our services. In addition, as our subsea construction operations primarily support capital projects with long lead times that are less likely to be impacted by temporary economic downturns. We have economically hedged approximately 80% of our anticipated production for the remainder of 2009 with a combination of forward sale and financial hedge contracts. We have also hedged a portion of our anticipated natural gas production for 2010 through the placement of additional swap financial hedge contracts. The prices for these contracts are significantly higher than the prices for both crude oil and natural gas as of March 31, 2009 and as of the time of this filing on May 8, 2009. If the prices for crude oil and natural gas do not increase from current levels, and we have not entered into additional forward sale or financial hedge contracts to stabilize our cash flows, our oil and gas revenues may decrease in 2010 and beyond, perhaps significantly, absent offsetting increases in production amounts.

At March 31, 2009, we had cash on hand of $251.6 million and $346.1 million available for borrowing under our revolving credit facilities, of which $186.7 million relates to CDI. We have reduced our planned capital expenditures for 2009 to include primarily the completion of major vessel construction projects and limited oil and gas expenditures. If we successfully implement the business plan outlined above, we believe we have sufficient liquidity without incurring additional indebtedness beyond the existing capacity under the Helix Revolving Credit Facility.

Our operations are conducted through two lines of business: contracting services and oil and gas. We have disaggregated our contracting services operations into three reportable segments in accordance with SFAS No. 131. As a result, our reportable segments consist of the following: Contracting Services, Shelf Contracting, and Production Facilities as well as Oil and Gas.

Contracting Services Operations

We seek to provide services and methodologies which we believe are critical to finding and developing offshore reservoirs and maximizing production economics, particularly from marginal fields. Our “life of field” services are organized in five disciplines: construction, well operations, production facilities, reservoir and well tech services, and drilling. The Contracting Services segment includes operations such as subsea construction, well operations, robotics and drilling. The Shelf Contracting segment represents the results and operations of Cal Dive, of which the assets are deployed primarily for diving-related activities and shallow water construction. We owned approximately 51% of Cal Dive through shares of its outstanding common stock at March 31, 2009. Our contracting services business operates primarily in the Gulf of Mexico, the North Sea, Asia/Pacific and Middle East regions, with services that cover the lifecycle of an offshore oil or gas field. As of March 31, 2009, our contracting services operations had backlog of approximately $0.9 billion, with $0.4 billion associated with Cal Dive. We expect that approximately $0.7 billion of our backlog will be completed over the remainder of 2009. These backlog contracts are cancellable without penalty in many cases. Backlog is not a reliable indicator of total annual revenue for our Contracting Services businesses as contracts may be added, cancelled and in many cases modified while in progress.

Oil and Gas Operations

In 1992 we began our oil and gas operations to provide a more efficient solution to offshore abandonment, to expand our off-season asset utilization of our contracting services business and to achieve incremental returns to our contracting services. We have evolved this business model to include not only mature oil and gas properties but also proved and unproved reserves yet to be developed and explored. By owning oil and gas reservoirs and prospects, we are able to utilize the services we otherwise provide to third parties to create value at key points in the life of our own reservoirs including during the exploration and Revenues. During the three months ended March 31, 2009, our total revenues increased by 29% as compared to the same period in 2008. Contracting Services revenues increased 32% for the three months ended March 31, 2009 as compared to the same period in 2008 primarily reflecting the placing in service two new trenchers in our ROV business since first quarter of 2008. Overall utilization levels for well operations and ROVs increased while utilization for our subsea construction vessels decreased. The increase also reflects a decrease in the number of out-of-service days for the drilling upgrade and regulatory drydock for the Q4000 . Shelf Contracting revenues reflect higher vessel utilization rates in the first quarter of 2009 as a result of increased diving activity in international markets and increased demand for hurricane-related repair activity following Hurricanes Gustav and Ike that passed through the Gulf of Mexico in the third quarter of 2008.

Oil and Gas revenues decreased 6% during the three months ended March 31, 2009 as compared to the same period in 2008. The decrease reflects lower oil and natural gas production associated with damages sustained to certain third party pipelines and infrastructure during Hurricanes Gustav and Ike as well as significantly lower oil and natural gas prices received for our sales volumes in the first quarter of 2009 as compared to the first quarter of 2008. Currently our oil and natural gas production has attained approximately the same levels that were achieved prior to the storms. However, our production is still constrained by certain third party pipeline repairs that are still in progress. Our oil and gas revenues included $73.5 million of previously accrued royalty payments that were in dispute. Following a favorable judicial ruling we have reversed these amounts as oil and gas revenues and have begun accounting for the additional oil and gas revenues associated with the previously disputed royalty net revenue interest and we are no longer accruing any additional royalty reserves as we believe it is remote that we will be liable for such amounts.

Gross Profit. Gross profit in the first quarter of]]>Tue, 30 Jun 2009 04:09:35 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/2875/http://www.dailystocks.com/forum/showtopic.php?tid/2875/
BUSINESS OVERVIEW

Overview

We are a blank check company organized under the laws of the State of Delaware on November 2, 2007. We were formed for the purpose of effecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or other similar business combination with one or more businesses or assets. Prior to executing the transaction agreement with Iridium Holdings LLC (“Iridium Holdings”) as described below in “Proposed Initial Business Combination,” our activities were limited to organization matters, completing our initial public offering and identifying and evaluating possible business combination opportunities.

On February 21, 2008, we completed our initial public offering of 40,000,000 units at a price of $10.00 per unit, with each unit consisting of one share of common stock and one warrant exercisable for one share of common stock at an initial exercise price of $7.00. On February 21, 2008, we also consummated a private placement of warrants, to Greenhill, our founding stockholder, for an aggregate purchase price of $8.0 million. Our common stock and warrants began trading separately on the NYSE Amex (formerly the American Stock Exchange) on March 20, 2008.

We generated gross proceeds of $408.0 million from our initial public offering and the concurrent private placement of warrants. Of the gross proceeds, (i) we deposited $400.0 million into a trust account being maintained by American Stock Transfer & Trust Company, as trustee (which included approximately $16.4 million of deferred underwriting discounts and commissions), (ii) the underwriters received $6.9 million as underwriting fees (excluding the deferred underwriting fees), (iii) we retained $0.9 million to pay offering expenses and (iv) we also retained $0.2 million to fund expenses relating to our initial public offering and to fund a portion of our working capital. Up to $5.0 million of the interest earned on the trust account may be released to us to fund our working capital requirements; through December 31, 2008, approximately $1.2 million of such interest had been released to us for working capital. We are entitled to make additional withdrawals from earnings to the extent necessary for the payment of federal, state and local income taxes resulting on income earned on the trust account and for the payment of franchise taxes.

Our initial business combination must be with a target business or businesses with a fair market value of at least 80% of the balance in the trust account at the time of such business combination (less deferred underwriting discounts and commissions payable upon consummation of a business combination to the underwriters of our initial public offering). In addition, we may only consummate an initial business combination in which we acquire control of the target business or businesses.

Proposed Initial Business Combination

On September 22, 2008, we entered in a transaction agreement among Iridium Holdings, us and the sellers named therein, pursuant to which we agreed to acquire Iridium Holdings from such sellers on the terms and subject to the conditions set forth therein.

Under the terms of the transaction agreement, we agreed to pay for the purchase of 100% of Iridium Holdings’ equity, $77.1 million in cash, subject to certain adjustments, issue to the sellers 36,000,000 shares of our common stock (which stock would have a value of approximately $337.0 million based on a closing price per share of $9.36 on March 20, 2009 on the NYSE Amex) and assume approximately $130.8 million of net debt of Iridium Holdings. In addition, 90 days following the closing of the acquisition, if Iridium Holdings has in effect a valid election under Section 754 of the Internal Revenue Code of 1986, as amended (the “Code”) with respect to the taxable year in which the closing of the acquisition occurs, we will make a tax benefit payment of up to $30.0 million in aggregate to certain sellers to compensate them for the tax basis step-up. Following the acquisition, we will rename ourselves “Iridium Communications Inc.”

Separately, on September 22, 2008, we entered into an agreement with Greenhill whereby Greenhill has agreed to forfeit at the closing of the proposed initial business combination with Iridium Holdings the following of our securities which it currently owns: (1) 1,441,176 common shares; (2) 8,369,563 founder warrants; and (3) 2,000,000 private placement warrants, all of which will be cancelled by us. These forfeitures will reduce our shares and warrants outstanding immediately after the closing of the initial business combination.

The transaction agreement and related documents have been unanimously approved by our board of directors and the board of directors of Iridium Holdings. The closing of the transaction is subject to customary closing conditions including the expiration or termination of waiting periods under the Hart-Scott-Rodino Act, Federal Communications Commission approval, other regulatory approvals and the approval by our stockholders as set forth in the next section (“Opportunity for Stockholder Approval of Business Combination”). The waiting period under the Hart-Scott-Rodino Act was terminated on October 8, 2008. The transaction is expected to close in the first half of 2009. Additional information regarding the proposed transaction can be found in our preliminary proxy statement filed with the Securities and Exchange Commission.

We have filed with the Securities Exchange Commission (“SEC”) a preliminary proxy statement which contains additional information about the proposed initial business combination. A copy of the preliminary proxy statement is available at the SEC’s web site at http://www.sec.gov.

Opportunity For Stockholder Approval of Business Combination

Prior to the completion of our proposed initial business combination, we will submit the transaction to our stockholders for approval, even if the nature of the transaction is such as would not ordinarily require stockholder approval under applicable state law. At the same time, we will submit to our stockholders for approval a proposal to amend our amended and restated certificate of incorporation to provide for our perpetual existence if the initial business combination is approved and consummated. The quorum required to constitute this meeting, as for all meetings of our stockholders in accordance with our bylaws, is a majority of our issued and outstanding common stock (whether or not held by public stockholders). We will consummate our initial business combination only if (i) the initial business combination is approved by a majority of votes cast by our public stockholders in person or by proxy at a duly held stockholders meeting, (ii) an amendment to our amended and restated certificate of incorporation to provide for our perpetual existence is approved by holders of a majority of our outstanding shares of common stock and (iii) public stockholders owning no more than 30% (minus one share) of our outstanding shares of common stock sold in our initial public offering both vote against the business combination and exercise their conversion rights.

Under the terms of our amended and restated certificate of incorporation, this provision may not be amended without the unanimous consent of our stockholders before consummation of an initial business consummation. Even though the validity of unanimous consent provisions under Delaware General Corporation Law has not been settled, neither we nor our board of directors will propose any amendment to this 30% threshold, or support, endorse or recommend any proposal that stockholders amend this threshold (subject to any fiduciary obligations our management or board of directors may have). In addition, we believe we have an obligation in every case to structure our initial business combination so that not less than 30% of the shares sold in our initial public offering (minus one share) have the ability to be converted to cash by public stockholders exercising their conversion rights and the initial business combination will still go forward. Provided that a quorum is in attendance at the meeting, in person or by proxy, a failure to vote on the initial business combination at the stockholders’ meeting will have no outcome on the transaction. Voting against our initial business combination alone will not result in conversion of a stockholder’s shares into a pro rata share of the trust account. In order to convert its shares, a stockholder must have also exercised the conversion rights described below.

If a majority of the shares of common stock voted by the public stockholders are not voted in favor of a proposed initial business combination, we may continue to seek other target businesses with which to effect our initial business combination until February 14, 2010. In connection with seeking stockholder approval of our initial business combination, we will furnish our stockholders with proxy solicitation materials prepared in accordance with the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which, among other matters, will include a description of the operations of the target business and audited historical financial statements of the target business based on U.S. generally accepted accounting principles or prepared in accordance with International Financial Reporting Standards as approved by the International Accounting Standards Board.

Our initial stockholders have agreed, in connection with the stockholder vote required to approve our initial business combination, to vote the founder’s shares in accordance with the majority of the shares of common stock voted by the public stockholders. Our founding stockholder and each of our executive officers and directors have also agreed that any shares of common stock acquired in or following our initial public offering, will all be voted in favor of our initial business combination. As a result, neither our initial stockholders, nor our executive officers or directors will be able to exercise conversion rights with respect to any of our shares.

Conversion Rights

At the time we seek stockholder approval of our initial business combination, we will offer our public stockholders the right to have their shares of common stock converted to cash if they vote against the business combination and the business combination is approved and consummated. Notwithstanding the foregoing, a public stockholder, together with any affiliate of his, her or it or any other person with whom he, she or it is acting in concert or as a partnership, syndicate or other group for the purpose of acquiring, holding or disposing of our securities, will be restricted from seeking conversion rights with respect to more than 10% of the shares sold in our initial public offering. Such a public stockholder would still be entitled to vote against a proposed business combination with respect to all shares owned by him, her or it or his, her or its affiliates. We believe this restriction will prevent stockholders from accumulating large blocks of stock before the vote held to approve a proposed initial business combination and attempting to use the conversion right as a means to force us or our management to purchase their stock at a significant premium to the then current market price. Absent this provision, for example, a public stockholder who owns 15% of the shares sold in our initial public offering could threaten to vote against a proposed business combination and seek conversion, regardless of the merits of the transaction, if his, her or its shares are not purchased by us or our management at a premium to the then current market price. By limiting each stockholder’s ability to convert only up to 10% of the shares sold in our initial public offering, we believe we have limited the ability of a small group of stockholders to unreasonably attempt to block a transaction which is favored by our other public stockholders. However, we are not restricting the stockholders’ ability to vote all of their shares against the business combination.

The actual per-share conversion price will be equal to the aggregate amount then on deposit in the trust account (before payment of deferred underwriting discounts and commissions and including accrued interest, net of any income taxes payable on such interest and net of franchise taxes, which shall be paid from the trust account, and net of interest income previously released to us to fund our working capital requirements), calculated as of two business days before the consummation of the proposed initial business combination, divided by the number of shares sold in our initial public offering. The underwriters of our initial public offering have agreed that upon the consummation of our initial business combination, the deferred underwriting discounts and commissions released to them from the trust account will be net of the pro rata amount of deferred underwriting discounts and commissions paid to stockholders who properly exercise their conversion rights.

An eligible public stockholder who wishes to exercise its conversion rights may request conversion of its shares at any time after the mailing to our stockholders of the proxy statement and before the vote taken with respect to a proposed business combination at a meeting held for that purpose, but the request will not be granted unless the public stockholder votes against a initial business combination, our initial business combination is approved and completed, the public stockholder holds its shares through the closing of our initial business combination and the public stockholder follows the specific procedures for conversion that will be set forth in the proxy statement relating to the stockholder vote on a proposed initial business combination. Following the approval of our initial business combination by our stockholders and until the completion of such initial business combination (or termination of the definitive agreement relating to the proposed initial business combination), any transfer of shares owned by a public stockholder who has requested to exercise its conversion rights will be blocked. If a public stockholder votes against our initial business combination but fails to properly exercise its conversion rights, such public stockholder will not have its shares of common stock converted. Any request for conversion, once made, may be withdrawn at any time up to the date of the meeting of stockholders being held for the purpose of approving the initial business combination. It is anticipated that the funds to be distributed to public stockholders who elect conversion will be distributed promptly after completion of our initial business combination. Public stockholders who exercise their conversion rights will still have the right to exercise any warrants they still hold.

We may require public stockholders to tender their certificates to our transfer agent before the meeting or to deliver their shares to the transfer agent electronically using the Depository Trust Company’s DWAC (Deposit/Withdrawal At Custodian) System. We will notify investors on a current report on Form 8-K and in our proxy statement related to the initial business combination if we impose this requirement. Traditionally, in order to perfect conversion rights in connection with a blank check company’s business combination, a stockholder could simply vote against a proposed business combination and check a box on the proxy card indicating such stockholder was seeking to exercise its conversion rights. After the business combination was approved, the company would contact such stockholder to arrange for him, her or it to deliver his, her or its certificate to verify ownership. As a result, the stockholder then had an “option window” after the consummation of the business combination during which he, she or it could monitor the price of the stock in the market. If the price rose above the conversion price, the stockholder could sell his, her or its shares in the open market before actually delivering his, her or its shares to the company for cancellation in consideration for the conversion price. Thus, the conversion right, to which stockholders were aware they needed to commit before the stockholder meeting, would become an option to convert surviving past the consummation of the business combination until the converting stockholder delivered his, her or its certificate. The requirement for physical or electronic delivery before the meeting ensures that a converting stockholder’s election to convert is irrevocable once the business combination is approved.

If we elect to require physical delivery of the share certificates, we would expect that stockholders would have to comply with the following steps. If the shares are held in street name, stockholders must instruct their account executive at the stockholders’ bank or broker to withdraw the shares from the stockholders’ account and request that a physical certificate be issued in the stockholders’ name. Our transfer agent will be available to assist with the process. No later than the day before the stockholder meeting, the written instructions stating that the stockholder wishes to convert his or her shares into a pro rata share of the trust account and confirming that the stockholder has held the shares since the record date and will continue to hold them through the stockholder meeting and the closing of our business combination must be presented to our transfer agent. Certificates that have not been tendered in accordance with these procedures by the day before the stockholder meeting will not be converted into cash. In the event that a stockholder tenders his or her shares and decides before the stockholder meeting that he or she does not want to convert his or her shares, the stockholder may withdraw the tender. In the event that a stockholder tenders shares and our business combination is not completed, these shares will not be converted into cash and the physical certificates representing these shares will be returned to the stockholder.

In connection with a vote to approve our initial business combination, public stockholders may elect to vote a portion of their shares for and a portion of their shares against such proposal. If the initial business combination is approved and consummated, public stockholders who elected to convert the portion of their shares voted against the initial business combination will receive the conversion price with respect to those shares (subject to the 10% limitation discussed above) and may retain any other shares they own.

If the per share conversion price is lower than the $10.00 per unit initial public offering price or less than the market price of a share of our common stock on the date of conversion, there may be a disincentive to public stockholders to exercise their conversion rights.

If a vote on an initial business combination is held and the business combination is not approved, we may continue to try to consummate an initial business combination with a different target until February 14, 2010. If the initial business combination is not approved or completed for any reason, then public stockholders voting against our initial business combination who exercised their conversion rights would not be entitled to convert their shares of common stock into a pro rata share of the aggregate amount then on deposit in the trust account. Those public stockholders would be entitled to receive their pro rata share of the aggregate amount on deposit in the trust account only if the initial business combination they voted against was duly approved and subsequently completed, or in connection with our liquidation.

Liquidation If No Business Combination

Our amended and restated certificate of incorporation provides that we will continue in existence only until February 14, 2010. If we consummate our initial business combination before February 14, 2010, we will seek to amend this provision to provide for our perpetual existence. If we have not completed our initial business combination by February 14, 2010, our corporate existence will cease except for the purposes of winding up our affairs and liquidating pursuant to Section 278 of the Delaware General Corporation Law. Because of this provision in our amended and restated certificate of incorporation, no resolution by our board of directors and no vote by our stockholders to approve our dissolution would be required for us to dissolve and liquidate. Instead, we will notify the Delaware Secretary of State in writing on the termination date that our corporate existence is ceasing, and include with such notice payment of any franchise taxes then due to or assessable by the state.

If we are unable to complete a business combination by February 14, 2010, our existence will automatically terminate and as promptly as practicable thereafter we will adopt a plan of distribution that makes reasonable provision for claims against us in accordance with Section 281(b) of the Delaware General Corporation Law. Upon our plan of distribution, the trustee will commence liquidating the investments constituting the trust account and distribute the proceeds to our public stockholders.

Section 278 provides that even after we cease our business activities and distribute the balance of the trust account to our public stockholders, our existence will continue for at least three years after our termination for the purpose of prosecuting and defending suits, whether civil, criminal or administrative, by or against us, and of enabling us gradually to settle and close our business, to dispose of and convey our property, to discharge our liabilities and to distribute to our stockholders any remaining assets, but not for the purpose of continuing the business for which we were organized. Our existence will continue automatically even beyond the three-year period for the purpose of completing the prosecution or defense of suits begun before the expiration of the three-year period, until such time as any judgments, orders or decrees resulting from such suits are fully executed. Section 281(b) will require us to pay or make reasonable provision for all then-existing claims and obligations, including all contingent, conditional, or unmatured contractual claims known to us, and to make such provision as will be reasonably likely to be sufficient to provide compensation for any then-pending claims and for claims that have not been made known to us or that have not arisen but that, based on facts known to us at the time, are likely to arise or to become known to us within 10 years after the date of dissolution. Under Section 281(b), the plan of distribution must provide for all of such claims to be paid in full or make provision for payments to be made in full, as applicable, if there are sufficient assets. If there are insufficient assets, the plan must provide that such claims and obligations be paid or provided for according to their priority and, among claims of equal priority, ratably to the extent of legally available assets. Any remaining assets will be available for distribution to our stockholders.

We expect that all costs and expenses associated with implementing our plan of distribution, as well as payments to any creditors, will be funded from amounts remaining out of the $0.2 million of proceeds from our initial public offering, held outside the trust account and from interest income on the balance of the trust account that may be released to us, in an amount up to $5.0 million, to fund our working capital requirements. We are also entitled to make additional withdrawals from earnings on the amounts held in the trust account to the extent necessary for the payment of federal, state and local income taxes resulting on income earned on the trust account and to pay franchise taxes. During 2008 we earned approximately $5.6 million of interest income from the trust account of which we have withdrawn approximately $1.2 million for working capital purposes and approximately $2.5 million for the payment of federal, state and local income taxes. At December 31, 2008, we had the right to withdraw from the trust account approximately $1.8 million to fund working capital.

However, if those funds are not sufficient to cover the costs and expenses associated with implementing our plan of distribution, to the extent that there is any interest accrued in the trust account not required to pay income taxes on interest income earned on the trust account balance, we may request that the trustee release to us an additional amount of up to $0.1 million of such accrued interest to pay those costs and expenses.

Our initial stockholders have waived their right to participate in any liquidation distribution with respect to the founder’s shares, but not with respect to any shares of our common stock they may have purchased in our initial public offering or may purchase in the secondary market. Additionally, if we do not complete an initial business combination and the trustee must distribute the balance of the trust account, the underwriters of our initial public offering have agreed to forfeit any rights or claims to their deferred underwriting discounts and commissions then in the trust account, and those funds will be included in the pro rata liquidation distribution to the public stockholders. There will be no distribution from the trust account with respect to any of our warrants, which will expire worthless if we are liquidated, and as a result purchasers of our units will have paid the full unit purchase price solely for the share of common stock included in each unit.

If we are unable to conclude an initial business combination and expend all of the net proceeds of our initial public offering and the founding stockholder’s investment, other than the proceeds deposited in the trust account, the per-share liquidation price will be at least $10.00, which equals the per-unit initial public offering price of $10.00. In addition, the proceeds deposited in the trust account could become subject to claims of our creditors that are in preference to the claims of our stockholders, and we therefore cannot assure you that the actual per-share liquidation price will not be less than $10.00.

Our founding stockholder has agreed that it will be liable to us if and to the extent claims by third parties reduce the amounts in the trust account available for payment to our stockholders in the event of a liquidation and the claims are made by a vendor for services rendered or products sold to us, by a third party with which we entered into a contractual relationship following consummation of our initial public offering or by a prospective target business. However, the agreement entered into by our founding stockholder specifically provides for two exceptions to the indemnity given: there will be no liability (1) as to any claimed amounts owed to a third party who executed a valid and enforceable waiver or (2) as to any claims under our indemnity of the underwriters of our initial public offering against certain liabilities, including liabilities under the Securities Act of 1933, as amended (the “Securities Act”). Furthermore, there could be claims from parties other than vendors or target businesses that would not be covered by the indemnity from our founding stockholder, such as stockholders and other claimants who are not parties in contract with us who file a claim for damages against us. Based on a review of publicly available financial statements, we believe that our founding stockholder is capable of funding its indemnity obligations, even though we have not asked them to reserve for such an eventuality. We cannot assure you, however, that our founding stockholder would be able to satisfy those obligations.

Under Delaware General Corporation Law, creditors of a corporation have a superior right to stockholders in the distribution of assets upon liquidation. Consequently, if the trust account is liquidated and paid out to our public stockholders before satisfaction of the claims of all of our creditors, it is possible that our stockholders may be held liable for third parties’ claims against us to the extent of the distributions received by them.

If we are forced to file a bankruptcy case or an involuntary bankruptcy case is filed against us that is not dismissed, the proceeds held in the trust account could be subject to applicable bankruptcy law, and may be included in our bankruptcy estate and subject to the claims of third parties with priority over the claims of our stockholders. To the extent any bankruptcy claims deplete the trust account, we cannot assure you that we will be able to pay at least $10.00 per share to our public stockholders.

A public stockholder will be entitled to receive funds from the trust account only if we do not consummate an initial business combination by February 14, 2010 or if the stockholder converts its shares into cash after voting against an initial business combination that is actually completed by us and exercising its conversion rights. In no other circumstances will a stockholder have any right or interest of any kind to or in the trust account. Before our completing an initial business combination or liquidating, we are permitted to have released from the trust account only (i) interest income to pay income taxes on interest income earned on the trust account balance and to pay franchise taxes and (ii) interest income earned of up to $5.0 million, to fund our working capital requirements.

Competition

If we are not successful in consummating the proposed transaction with Iridium Holdings, and if sufficient time prior to February 14, 2010 remains, we may seek to identify another target for a business combination. In identifying, evaluating and selecting any such target business, we may encounter intense competition from other entities having a business objective similar to ours, including other blank check companies, private equity groups and leveraged buyout funds, as well as operating businesses seeking acquisitions. Many of these entities are well established and have extensive experience identifying and effecting business combinations directly or through affiliates. Moreover, many of these competitors possess greater financial, technical, human and other resources than us. While we believe there should be numerous potential target businesses with which we could combine, our ability to acquire larger target businesses will be limited by our available financial resources. This inherent limitation gives others an advantage in pursuing the acquisition of a target business. Furthermore:


• our obligation to seek stockholder approval of our initial business combination or obtain necessary financial information may delay the completion of a transaction;

• our obligation to convert into cash shares of common stock held by our public stockholders who vote against the initial business combination and exercise their conversion rights may reduce the resources available to us for an initial business combination;

• our outstanding warrants and the future dilution they potentially represent may not be viewed favorably by certain target businesses; and

• the requirement to acquire an operating business that has a fair market value equal to at least 80% of the balance of the trust account at the time of the acquisition (less deferred underwriting discounts and commissions of approximately $16.4 million) could require us to acquire the assets of several operating businesses at the same time, all of which sales would be contingent on the closings of the other sales, which could make it more difficult to consummate the business combination.

Any of these factors may place us at a competitive disadvantage in successfully negotiating a business combination.

Facilities

Our executive offices are currently located at 300 Park Avenue, 23 rd Floor, New York, New York 10022. The cost for this space is included in a $10,000 per-month fee that our founding stockholder charges us for general and administrative services. We believe, based on rents and fees for similar services in the New York City area, that the fee charged by our founding stockholder is at least as favorable as we could obtain from an unaffiliated person. We consider our current office space adequate for our current operations.

Employees

We currently have four officers. These individuals are not obligated to devote any specific number of hours to our business and intend to devote only as much time as they deem necessary to our business. We currently have no full-time employees.


MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

We are a blank check company organized under the laws of the State of Delaware on November 2, 2007. We were formed for the purpose of effecting a merger, capital stock exchange, asset acquisition or other similar business combination with one or more businesses or assets, which we refer to as our “initial business combination.” We intend to utilize cash derived from the proceeds of our initial public offering, our private placement of warrants, our capital stock, debt or a combination of cash, capital stock and debt, in effecting a business combination. We completed our initial public offering in February 2008.

We have neither engaged in any operations nor generated any revenues from operations to date. Our entire activity since inception has been to prepare for and consummate our initial public offering and thereafter to identify and investigate potential targets for a business combination. We will not generate any operating revenues until completion of an initial business combination. We will generate, and have generated, non-operating income in the form of interest income on cash and cash equivalents.

From the initial public offering through December 31, 2008, we earned approximately $5.6 million of interest income. For the year ended December 31, 2008, net income amounted to approximately $1.7 million, which consisted of approximately $5.6 million of interest income primarily from the trust account offset by approximately $2.3 million of professional fees related to due diligence work incurred in conjunction with our proposed business combination, as well as operating expenses of $0.3 million and a provision for income taxes of approximately $1.4 million.

Following the closing of the acquisition, we will record a compensation charge in the amount of approximately $1.3 million and a capital contribution related to the transfer at cost of founding stockholder’s units to certain of our directors.

On September 22, 2008, we entered in a transaction agreement among Iridium Holdings LLC, us and the sellers named herein, pursuant to which we agreed to acquire Iridium Holdings from such sellers on the terms and subject to the conditions set forth therein.

Under the terms of the transaction agreement, we agreed to pay for the purchase of 100% of Iridium Holdings’ equity, $77.1 million in cash, subject to certain adjustments, issue to the sellers 36,000,000 shares of our common stock (which stock would have a value of approximately $337.0 million based on a closing price per share of $9.36 on March 20, 2009 on the NYSE Amex) and assume approximately $130.8 million of net debt of Iridium Holdings. In addition, 90 days following the closing of the acquisition, if Iridium Holdings has in effect a valid election under Section 754 of the Code with respect to the taxable year in which the closing of the acquisition occurs, we will make a tax benefit payment of up to $30.0 million in aggregate to certain sellers to compensate them for the tax basis step-up.

On September 22, 2008, we entered into an agreement with Greenhill whereby Greenhill has agreed to forfeit at the closing of the proposed business combination with Iridium Holdings the following of our securities which it currently owns: (1) 1,441,176 common shares; (2) 8,369,563 founder warrants; and (3) 2,000,000 private placement warrants all of which will be cancelled by us. These forfeitures will reduce our shares and warrants outstanding immediately after the closing of the proposed initial business combination.

The transaction agreement and related documents have been unanimously approved by our board of directors and that of Iridium Holdings. The closing of the transaction is subject to customary closing conditions including the expiration or termination of waiting periods under the Hart-Scott-Rodino Act, Federal Communications Commission approval, other regulatory approvals and the approval of our stockholders as described in greater detail under “Item 1. Business – Opportunity for Stockholder Approval of Business Combination.” The transaction is expected to close in the first half of 2009.

The transaction agreement may be terminated at any time prior to the closing, under the following circumstances: (i) by mutual written consent of us and Iridium Holdings; (ii) by either us or Iridium Holdings if (a) the transaction has not been consummated by June 29, 2009 (if all regulatory approvals required to consummate the closing have been obtained prior to such date) or February 14, 2010 (if the only condition to closing unfulfilled as of June 29, 2009 is the obtaining of all regulatory approvals required to consummate the closing), (b) there is any material law or judgment that makes consummation of the closing illegal or otherwise prohibited or enjoins the parties to the transaction agreement from consummating the closing and such injunction shall have become final and nonappealable, or (c) our stockholder approval is not obtained at the stockholder meeting; (iii) by us, in the event of certain breaches of representations or warranties or certain failures to perform the covenants or agreements by Iridium Holdings or a seller set forth in the transaction agreement; or (iv) by Iridium Holdings, (a) in the event of certain breaches of the representations or warranties by us or certain failures by us to perform any covenant or agreement occur; or (b) if our stockholder meeting has not been held within 90 days of our proxy statement being cleared by the SEC.

If (i) the transaction agreement is terminated by us or Iridium Holdings due to our stockholder approval not being obtained, (ii) we breach our obligation to hold a stockholder meeting and obtain our stockholder approval or to use our reasonable best efforts to consummate the transactions contemplated by the transaction agreement and (iii) we consummate an initial business combination (other than with Iridium Holdings), we will be obligated to pay to Iridium Holdings a break-up fee consisting of $5.0 million in cash, shares of our common stock or a combination thereof, at our election (the “Termination Fee”). The Termination Fee will be the exclusive remedy of Iridium Holdings, the sellers and their respective affiliates with respect to any such breach except in the case where, prior to 10 business days immediately following the termination of the transaction agreement, Iridium Holdings notifies us in writing that it believes in good faith we have committed a willful breach of the transaction agreement, and in such case Iridium Holdings shall have the right to pursue its remedies for willful breach against us, subject to other limitations set forth in the transaction agreement.

Information on Iridium Holdings is contained in our preliminary proxy on file with the SEC.

Liquidity and Capital Resources

On February 21, 2008, we completed our initial public offering of 40,000,000 units, each consisting of one share of common stock and one warrant exercisable for an additional share of common stock and received proceeds of approximately $393.1 million, net of underwriting discounts and commissions payable at that time of approximately $6.9 million. On February 21, 2008, we issued in a private placement warrant to Greenhill exercisable for our common stock for a purchase price of $8.0 million. Proceeds of $400.0 million from our initial public offering and the concurrent sale of the private placement warrants were placed in a trust account with the remaining $1.1 million being held outside of the trust and used to pay other costs and expenses related to our initial public offering. A portion of the underwriting fees related to our initial public offering have been deferred until the consummation of a business combination. At that time, we will incur additional underwriting fees of approximately $16.4 million, which are payable out of the trust account.

We expect to use substantially all of the net proceeds of our initial public offering not in the trust account as well as certain interest income we may withdraw from the trust account, to pay expenses in locating and acquiring a target business, including identifying and evaluating prospective acquisition candidates, selecting the target business, and structuring, negotiating and consummating our initial business combination. To the extent that our capital stock or debt financing is used in whole or in part as consideration to effect our initial business combination, any proceeds held in the trust account, as well as any other net proceeds, not expended in the acquisition will be used to finance the operations of the target business.

We are permitted to release from the trust account (i) interest income to pay income taxes on interest income earned on the trust account balance as well as to pay franchise taxes and (ii) interest income earned up to $5.0 million to fund our working capital requirements. During 2008 we earned approximately $5.6 million of interest income from the trust account of which we have withdrawn approximately $1.2 million for working capital purposes related to an initial business combination and approximately $2.5 million for the payment of federal, state and local income taxes as well as franchise taxes.

At December 31, 2008, approximately $401.8 million was held in trust, of which we had the right to withdraw approximately $1.8 million to fund working capital needs relating to an initial business combination and/or withdraw as needed for the payment of federal, state and local income taxes and franchise taxes. From January 2009 through March 20, 2009 we withdrew approximate $0.5 million from the trust; approximately $0.2 million of which was used for additional working capital purposes and approximately $0.3 million for the payment of federal, state and local income taxes and franchise taxes.

Although we have remaining authority to withdraw approximately $3.6 million of future earnings from the trust account for working capital purposes and to consummate the purchase of our initial business we do not expect that our earnings on the trust account will be sufficient enough to enable us to withdraw this amount. As of March 20, 2009 we have approximately $1.8 million of interest income available to fund our working capital needs and income tax obligations. We are currently earning approximately $0.2 million per month from the trust account.

As a result of the significant decline in interest rates since our initial public offering our earnings on the trust account may be insufficient to operate our business prior to our initial business combination. We are monitoring our cash position to minimize our expenditures. In the event we do not consummate the proposed transaction with Iridium Holdings, we may not have sufficient cash to pursue other business combination opportunities.

Under the terms of the transaction agreement, we agreed to pay for the purchase of 100% of Iridium Holdings’ equity, $77.1 million in cash, subject to certain adjustments, issue to the sellers 36,000,000 shares of our common stock (which stock would have a value of approximately $337.0 million based on a closing price per share of $9.36 on March 20, 2009 on the NYSE Amex) and assume approximately $130.8 million of net debt of Iridium Holdings. Upon completion of the acquisition of Iridium Holdings, any funds remaining in the trust account after payment of amounts, if any, to our stockholders exercising their conversion rights or tendering their shares, will be used for the prepayment of all or a portion of Iridium Holdings’ debt, payment of transaction expenses and to fund Iridium Holdings’ working capital after the closing of the acquisition.

Controls and Procedures of Target Business

We expect to assess the internal controls of our target business or businesses by the compliance date and, if necessary, to implement and test additional controls as we may determine are necessary to state that we maintain an effective system of internal controls. A target business may not be in compliance with the provisions of the Sarbanes-Oxley Act regarding the adequacy of internal controls. Many small and mid-sized target businesses we may consider for a business combination may have internal controls that need improvement in areas such as:


• staffing for financial, accounting and external reporting areas, including segregation of duties;

• reconciliation of accounts;

• proper recording of expenses and liabilities in the period to which they relate;

• evidence of internal review and approval of accounting transactions;

• documentation of processes, assumptions and conclusions underlying significant estimates; and

• documentation of accounting policies and procedures.

Because it will take time, management involvement and perhaps outside resources to determine what internal control improvements are necessary for us to meet regulatory requirements and market expectations for our operation of a target business, we may incur significant expense in meeting our public reporting responsibilities, particularly in the areas of designing, enhancing, or remediating internal and disclosure controls. Doing so effectively may also take longer than we expect, thus increasing our potential exposure to financial fraud or erroneous financing reporting.

Once our management’s report on internal controls is complete, we will retain our independent auditors to audit and render an opinion on such report when required by Section 404. The independent auditors may identify additional issues concerning a target business’s internal controls while performing their audit of internal control over financial reporting.

Market Risk

The approximately $401.8 million in the trust account as of December 31, 2008 is invested in government securities (as defined in Section 2(a)(16) of the Investment Company Act of 1940) or in assets which all meet the conditions under Rule 2a-7 promulgated under the Investment Company Act of 1940 with financial institutions with high credit ratings. However, in light of the overall instability of the markets, we can not assure you that the funds in the trust account are not subject to market risk.

Related Party Transactions

On November 19, 2007, we issued a promissory note in the aggregate principal amount of $0.3 million to Greenhill, which accrued interest at the rate of 8.5% per annum, was unsecured and was due at the earlier of (i) December 30, 2008, or (ii) the consummation of our initial public offering.

The note was repaid on February 26, 2008 out of the proceeds of our initial public offering not being placed in the trust account. See also “Item 13. Certain Relationships and Related Transactions and Director Independence” for information on this note.

On February 1, 2008, the founding stockholder transferred at cost an aggregate of 150,000 founder’s units (of which 19,563 were forfeited because Banc of America Securities LLC did not exercise the over-allotment option) to certain of our directors in connection with their agreement to serve as directors. These transferred units have the same terms and are subject to the same restrictions on transfer as the founder’s units. The restrictions on transfer on these units will lapse 180 days after the consummation of an initial business combination (if any) (considered a performance condition). In accordance with the Statement of Financial Accounting Standards No. 123 (Revised 2004) “Share Based Payments”, the restrictions are not being taken into account for purposes of determining the value of the transferred units and we will record a compensation charge and a related capital contribution (at the time a business combination is consummated) for the difference between the consideration received by the founding stockholder in the transfer and the price of $10.00 per unit paid by the stockholders which acquired units in our initial public offering.

We have agreed to pay Greenhill a monthly fee of $10,000 for general and administrative services, including office space and secretarial support. We believe that such fees are at least as favorable as we could obtain from an unaffiliated third party.

Greenhill purchased an aggregate of 8,000,000 private placement warrants at $1.00 per warrant (for a total purchase price of $8.0 million) from us in a private placement simultaneously with the consummation of our initial public offering. We believe that the purchase price of the private placement warrants approximated the fair value of such warrants.

Off-Balance Sheet Arrangements; Commitments and Contractual Obligations; Quarterly Results

As of December 31, 2008, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K and did not have any commitments or contractual obligations.

Critical Accounting Policies and Estimates

Cash and Cash Equivalents

The Company considers all highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents.

Fair Value of Financial Instruments

Cash, investments held in trust at broker and notes payable are carried at cost, which approximates fair value due to the short-term nature of these investments.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ materially from those estimates.

Earnings per Share

The Company calculates earnings per share (“EPS”) in accordance with FASB Statement No. 128, “Earnings per Share” (“SFAS 128”). Basic and diluted EPS is calculated by dividing net income by the weighted-average number of shares of common stock outstanding during the period. Warrants issued by the Company in the initial public offering and private placement are contingently exercisable at the later of one year from the date of the offering and the consummation of a business combination, provided, in each case, there is an effective registration statement covering the shares issuable upon exercise of the warrants. Hence, the shares of common stock underlying the warrants are excluded from basic and diluted EPS.

Income Taxes

The Company accounts for taxes in accordance with FASB Statement No. 109, “Accounting for Income Taxes” (“SFAS 109”), which requires the recognition of tax benefits or expenses on the temporary differences between the financial reporting and tax bases of its assets and liabilities. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized. The Company also complies with FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” an interpretation of FASB Statement No. 109 (“FIN 48”), which provides criteria for the recognition, measurement, presentation and disclosure of uncertain tax position. A tax benefit from an uncertain position may be recognized only if it is “more likely than not” that the position is sustainable based on its technical merits.

New Accounting Pronouncements

Effective January 1, 2008, the Company adopted FASB Statement No. 157, “Fair Value Measurements” (“SFAS 157”), for assets and liabilities measured at fair value on a recurring basis. SFAS 157 accomplished the following key objectives:


• Defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date;

• Establishes a three-level hierarchy (“valuation hierarchy”) for fair value measurements;

• Requires consideration of the Company’s creditworthiness when valuing liabilities; and

• Expands disclosures about instruments measured at fair value.

The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of the valuation hierarchy and the distribution of the Company’s financial assets within it are as follows:


• Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

• Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instrument.

• Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.

In February 2007, FASB Statement No. 159, “Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115” (“SFAS 159”) was issued. SFAS 159 permits an entity to elect fair value as the initial and subsequent measurement attribute for many financial assets and liabilities. Entities electing the fair value option would be required to recognize changes in fair value in earnings. Entities electing the fair value option would be required to distinguish, on the face of the balance sheet, the fair value of assets and liabilities for which the fair value option has been elected and similar assets and liabilities measured using another measurement attribute. SFAS 159 became effective beginning January 1, 2008. The Company did not elect the fair value measurement option for financial instruments or other items upon adoption of SFAS 159 and therefore, SFAS 159 did not have an impact on the Company’s financial statements.

In December 2007, FASB Statement No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”) was issued. SFAS 141R provides revised guidance on how acquirers recognize and measure the consideration transferred, identifiable assets acquired, liabilities assumed, noncontrolling interests, and goodwill acquired in a business combination. SFAS 141R also expands required disclosures surrounding the nature of financial effects of business combinations. SFAS 141R is effective, on a prospective basis, for companies for fiscal years beginning January 1, 2009. The Company is currently applying the transitional guidance, which allows transactional costs to be expensed when it becomes probable that the acquisition will not close until after the effective date of SFAS 141R.

In April 2008, FASB Staff Position No. FSP FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP FAS 142-3”) was issued. FSP FAS 142-3 amends the factors that should be considered in developing a renewal or extension assumptions used for purposes of determining the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). FSP FAS 142-3 is intended to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141R and other U.S. generally accepted accounting principles. FSP FAS 142-3 is effective for fiscal years beginning after December 15, 2008. Earlier application is not permitted. The Company will be assessing the potential effect of FSP FAS 142-3, if applicable, once the Company enters into a business combination.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Overview
We are a blank check company organized under the laws of the State of Delaware on November 2, 2007. We were formed for the purpose of effecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or other similar business combination with one or more businesses or assets. Prior to executing the transaction agreement with Iridium Holdings LLC (“Iridium Holdings”) as described below in “Proposed Initial Business Combination,” our activities were limited to organization matters, completing our initial public offering and identifying and evaluating possible business combination opportunities.
On February 21, 2008, we completed our initial public offering of 40,000,000 units at a price of $10.00 per unit, with each unit consisting of one share of common stock and one warrant exercisable for one share of common stock at an initial exercise price of $7.00. On February 21, 2008, we also consummated a private placement of warrants, to Greenhill, our founding stockholder, for an aggregate purchase price of $8.0 million. Our common stock and warrants began trading separately on the NYSE Amex (formerly the American Stock Exchange) on March 20, 2008.
We generated gross proceeds of $408.0 million from our initial public offering and the concurrent private placement of warrants. Of the gross proceeds, (i) we deposited $400.0 million into a trust account being maintained by American Stock Transfer & Trust Company, as trustee (which included approximately $16.4 million of deferred underwriting discounts and commissions), (ii) the underwriters received $6.9 million as underwriting fees (excluding the deferred underwriting fees), (iii) we retained $0.9 million to pay offering expenses and (iv) we also retained $0.2 million to fund expenses relating to our initial public offering and to fund a portion of our working capital. Up to $5.0 million of the interest earned on the trust account may be released to us to fund our working capital requirements; through March 31, 2009, approximately $1.5 million of such interest had been released to us for working capital. We are entitled to make additional withdrawals from earnings to the extent necessary for the payment of federal, state and local income taxes resulting on income earned on the trust account and for the payment of franchise taxes.
Our initial business combination must be with a target business or businesses with a fair market value of at least 80% of the balance in the trust account at the time of such business combination (less deferred underwriting discounts and commissions payable upon consummation of a business combination to the underwriters of our initial public offering). In addition, we may only consummate an initial business combination in which we acquire control of the target business or businesses.
Proposed Initial Business Combination
On September 22, 2008, we entered in a transaction agreement among Iridium Holdings, us and the sellers named therein, pursuant to which we agreed to acquire Iridium Holdings from such sellers on the terms and subject to the conditions set forth therein.
On April 28, 2009, the Company and Iridium Holdings announced the signing of an amendment to the Transaction Agreement. Under the terms of the amendment, the aggregate consideration payable by the Company to Iridium Holdings’ existing shareholders will be reduced by 15%. The amended agreement, unanimously approved by the Board of Directors of the Company and Iridium Holdings, as well as Iridium Holdings’ major shareholders, values Iridium Holdings at an enterprise value of approximately $517.3 million. The Company will acquire Iridium Holdings in exchange for 29,400,000 shares of its common stock (36,000,000 shares under the original Transaction Agreement), $77.1 million of cash, subject to adjustment and assume approximately $145.8 million of net debt of Iridium Holdings ($130.8 million of net debt under the original agreement). In addition, 90 days following the closing of the acquisition, if Iridium Holdings has in effect a valid election under Section 754 of the Internal Revenue Code of 1986, as amended (the “Code”) with respect to the taxable year in which the closing of the acquisition occurs, we will make a tax benefit payment of $25.5 million (up to $30.0 million under the original agreement) in aggregate to certain sellers to compensate them for the tax basis step-up. Following the acquisition, we will rename ourselves “Iridium Communications Inc.”
Effective upon completion of the Proposed Business Combination, the Founder has agreed to forfeit the following securities of the Company which it currently owns: (1) 1,441,176 common shares; (2) 8,369,563 founder warrants; and (3) 4,000,000 private placement warrants. These forfeitures will reduce the Company’s shares and warrants outstanding immediately post-closing.
The closing of the transaction is subject to customary closing conditions including the expiration or termination of waiting periods under the Hart-Scott-Rodino Act, Federal Communications Commission approval, other regulatory approvals and the approval by our stockholders as set forth in the next section (“Opportunity for Stockholder Approval of Business Combination”). The waiting period under the Hart-Scott-Rodino Act was terminated on October 8, 2008. The transaction is expected to occur during the summer of 2009.
We have filed with the Securities Exchange Commission (“SEC”) a proxy statement which contains additional information about the proposed initial business combination. A copy of the proxy statement is available at the SEC’s web site at http://www.sec.gov.
Liquidity and Capital Resources
On February 21, 2008, we completed our initial public offering of 40,000,000 units, each consisting of one share of common stock and one warrant exercisable for an additional share of common stock and received proceeds of approximately $393.1 million, net of underwriting discounts and commissions payable at that time of approximately $6.9 million. On February 21, 2008, we issued in a private placement warrant to Greenhill exercisable for our common stock for a purchase price of $8.0 million. Proceeds of $400.0 million from our initial public offering and the concurrent sale of the private placemen]]>Mon, 29 Jun 2009 05:33:28 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/2831/http://www.dailystocks.com/forum/showtopic.php?tid/2831/
BUSINESS OVERVIEW

A. General

We are an integrated multi-channel retailer that markets, sells and distributes our products directly to consumers through various forms of electronic media. Our operating strategy incorporates distribution from television, internet and mobile devices. Our principal electronic media activity is our television home shopping business, which uses on-air spokespersons to market brand name and private label consumer products at competitive prices. Our live 24-hour per day television home shopping programming is distributed primarily through cable and satellite affiliation agreements and the purchase of month-to-month full- and part-time lease agreements of cable and broadcast television time. In addition, we distribute our programming through a company-owned full power television station in Boston, Massachusetts and through leased carriage on full power television stations in Pittsburgh, Pennsylvania and Seattle, Washington. We also market a broad array of merchandise through our internet retailing websites, www.ShopNBC.com and www.ShopNBC.TV.

We have an exclusive license from NBC Universal, Inc., known as NBCU, for the worldwide use of an NBC-branded name and the peacock image through May 2011. Pursuant to the license, we operate our television home shopping network under the ShopNBC brand name and operate our internet website under the ShopNBC.com and ShopNBC.TV brand name.

Television and Internet Retailing

Our principal electronic media activity is our live 24-hour per day television home shopping network program. Our home shopping network is the third largest television home shopping retailer in the United States. Through our merchandise-focused television programming, we sell a wide variety of products and services directly to consumers. Net sales from our television and companion internet website business, including shipping and handling revenues, totaled $565.4 million, $767.3 million and $755.3 million for fiscal 2008, fiscal 2007 and fiscal 2006, respectively. Products are presented by on-air television home shopping sales persons and guests; viewers may then call a toll-free telephone number and place orders directly with us or enter an order on the ShopNBC.com website. Our television programming is produced at our Eden Prairie, Minnesota facility and is transmitted nationally via satellite to cable system operators, satellite dish owners, broadcast television station operators and to our owned full power broadcast television station WWDP TV-46 in Boston, Massachusetts.

Products and Product Mix

Products sold on our television network and internet shopping website include jewelry, watches, consumer electronics, housewares, apparel, cosmetics, seasonal items and other merchandise. We believe that having a broad diversity of products appeals to a larger segment of potential customers and is important to our growth. Our product diversification strategy is to continue to develop new product offerings across multiple merchandise categories as needed in response to both customer demand and in order to maximize margin dollars per hour in our television home shopping operation.

B. Business Strategy

We endeavor to be the premium lifestyle brand in the TV shopping and internet retailing industry. As an integrated, multi-channel retailer, our strategy is to offer our current and new customers brands and products that are meaningful, unique and relevant. Our merchandise brand positioning aims to be the destination and authority for home, fashion and jewelry shoppers. We focus on creating a customer experience that builds strong loyalty and a growing customer base.

In support of this strategy, we are pursuing the following actions in our ongoing efforts to improve the operational and financial performance of our company: (i) materially reduce the cost of our current distribution agreements for our television programming with cable and satellite operators, as well as pursuing other means of reaching customers such as through webcasting, internet videos and mobile devices, (ii) broaden and optimize our mix of product categories offered on television and the internet in order to appeal to a broader population of potential customers, (iii) lower the average selling price of our products in order to increase the size and purchase frequency of our customer base, (iv) grow our internet business by providing a broader, internet-only merchandise offering, and (v) improve the shopping experience and customer service in order to retain and attract more customers.

We are currently in a transition period as we implement our new strategic vision. During this transition, we will work to implement the actions outlined in the paragraph above as well as work through several transition issues including: (i) liquidating our existing inventory of merchandise that is not consistent with our strategy, (ii) continue to renegotiate cable and satellite carriage contracts where we have cost savings opportunities, (iii) aggressively reduce our operating expenses to reverse our operating losses and (iv) grow new and active customers while improving household penetration.


C. Television Program Distribution and Internet Operations

Television Home Shopping Network

Satellite Delivery of Programming. Our programming is presently distributed via a leased communications satellite transponder to cable systems, a full power television station in Boston, two other leased broadcast stations, and satellite dish operators. On January 31, 2005, we entered into a new long-term satellite lease agreement with our present provider of satellite services. Pursuant to the terms of this agreement, we distribute our programming through a satellite that was launched in February 2006. The agreement provides us with preemptible back-up services if satellite transmission is interrupted.

Cable Affiliation Agreements. As of January 31, 2009, we have entered into affiliation agreements with parties representing approximately 1,400 cable systems that require each operator to offer our television home shopping programming substantially on a full-time basis over their systems. The terms of the affiliation agreements typically range from one to four years. Under certain circumstances, the system operators or we may cancel the agreements prior to their expiration. The affiliation agreements generally provide that we will pay each operator a monthly access fee and in some cases marketing support payments based on the number of homes receiving our programming. We are seeking to enter into affiliation agreements with additional cable system operators and broadcast stations providing for full- or part-time carriage of our programming.

Cable operators serving a large majority of cable households now offer cable programming on a digital basis. The use of digital compression technology provides cable companies with greater channel capacity. While greater channel capacity increases the opportunity for distribution and, in some cases, reduces access fees paid by us, it also may adversely impact our ability to compete for television viewers to the extent it results in higher channel position for us, placement of our programming in separate programming tiers, the broadcast of additional competitive channels or viewer fragmentation due to a greater number of programming alternatives.

During 2008, there were approximately 123 million homes in the United States with at least one television set. Of those homes, there were approximately 65 million basic cable television subscribers and approximately 29 million direct-to-home satellite subscribers or DTH. Homes that receive our television home shopping programming 24 hours per day are each counted as one full-time equivalent, or FTE, and homes that receive our programming for any period less than 24 hours are counted based upon an analysis of time of day and day of week that programming is received. We have continued to experience growth in the number of FTE subscriber homes that receive our programming.

As of January 31, 2009, we served approximately 74.1 million subscriber homes, or approximately 71.7 million average FTEs, compared with approximately 72.4 million subscriber homes, or approximately 68.9 million average FTEs, as of February 2, 2008. As of January 31, 2009, our television home shopping programming was carried by approximately 1,400 broadcasting systems on a full-time basis, compared to approximately 1,450 broadcasting systems on February 2, 2008, and 45 broadcasting systems on a part-time basis, compared to 60 broadcasting systems on February 2, 2008. The total number of cable homes that presently receive our television home shopping programming represents approximately 69% of the total number of cable subscribers in the United States.

Direct Satellite Service Agreements. Our programming is carried on the direct-to-home, or DTH satellite services DIRECTV and DISH Network. Carriage is full-time and we pay each operator a monthly access fee based upon the number of subscribers receiving our programming. As of January 31, 2009, our programming reached approximately 29 million DTH subscribers on a full-time basis representing approximately 100% of the total number of DTH satellite subscribers in the United States.

Other Methods of Program Distribution. Our programming is also made available full-time to “C”-band satellite dish owners nationwide and is made available to homes in the Boston, Pittsburgh and Seattle markets over the air via television broadcast stations owned by us or where we lease their access. In fiscal 2008 and fiscal 2007, our Boston, leased access Pittsburgh and Seattle stations and “C”-band satellite dish transmissions were responsible for approximately 5% of our total consolidated net sales. In addition, our programming is also available through our internet retailing websites, www.ShopNBC.com and www.ShopNBC.TV.

Internet Website

Our website, ShopNBC.com, provides customers with a broad array of consumer merchandise, including all products being featured on our television programming. The website includes a live webcast feed of our television programming, an archive of recent past programming, videos of many individual products that the customer can view on demand and clearance and auction pages.

Net sales from our internet website business, inclusive of shipping and handling revenues, totaled $181.2 million, $217.9 million and $184.1 million, representing 32%, 28% and 24% of consolidated net sales for fiscal 2008, fiscal 2007 and fiscal 2006, respectively. We believe that our internet business represents an important component of our future growth opportunities, and we will continue to invest in and enhance our internet-based capabilities.

Our e-commerce activities are subject to a number of general business regulations and laws regarding taxation and online commerce. As the role and importance of e-commerce has grown in the United States in recent years, there have been continuing efforts to increase the legal and regulatory obligations and restrictions on companies conducting commerce through the internet, primarily in the areas of taxation, consumer privacy and protection of consumer personal information. These laws and regulations could increase the costs and liabilities associated with our e-commerce activities and increase the price of our products to consumers, without an increase in our revenue or net income. The Commonwealth of Massachusetts has promulgated regulations that are scheduled to take effect on January 1, 2010, that impose a number of data security requirements on companies that collect certain types of information concerning Massachusetts residents. There are indications that other states may adopt similar requirements in the future. A patchwork of state laws imposing differing security requirements depending on the residence of our customers could impose added compliance costs without a compensating increase in income.

On October 31, 2007, the United States enacted a seven-year moratorium on internet access taxes extending a ban on internet taxes that is set to expire in 2014. In addition, in November 2002, a number of states approved a multi-state agreement to simplify state sales tax laws by establishing one uniform system to administer and collect sales taxes on traditional retailers and electronic commerce merchants. The agreement became effective on October 3, 2005, although fewer than half of the states have become members by enacting implementation legislation. Despite the moratorium mentioned above, a number of states and the US Congress are considering legislative initiatives that would impose tax collection obligations on sales made through the internet. No prediction can be made as to whether individual states will enact legislation requiring retailers such as us to collect and remit sales taxes on transactions that occur over the internet. Adding sales tax to our internet transactions could negatively impact consumer demand. ShopNBC partners with numerous affiliate companies across the country to publicize our through links from different websites to our website, ShopNBC.com. In 2008, the state of New York enacted legislation which required certain sellers like us to collect sales tax from New York “resident representatives”, which term was intended to include internet companies that publicize e-commerce retailers through links from different websites to the e-commerce retailer’s website. As a result of this legislation and to avoid the possible taxation of sales in the state of New York, we ceased transacting with affiliates who were “resident representatives” of the state of New York. During 2009, several other state legislatures are considering similar legislation. If such legislation is adopted by numerous states, it could adversely affect a portion of the e-commerce sales or sales growth of the Company in the coming years or could result in a requirement to begin charging state sales tax in numerous jurisdictions.

The federal Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003, or the CAN-SPAM Act, was signed into law on December 16, 2003 and went into effect on January 1, 2004. The CAN-SPAM Act pre-empts similar laws passed by over thirty states, some of which contain restrictions or requirements that are viewed as stricter than those of the CAN-SPAM Act. The CAN-SPAM Act is primarily an opt-out type law; that is, prior permission to send e-mail solicitations to a recipient is not required, but a recipient may affirmatively opt out of such future e-mail solicitations. The CAN-SPAM Act requires commercial e-mails to contain a clear and conspicuous identification that the message is an advertisement or solicitation for goods or services (unless the sender obtains prior affirmative consent from the recipient to receive such messages), as well as a clear and conspicuous unsubscribe function that allows recipients to alert the sender that they do not desire to receive future e-mail solicitation messages. In addition, the CAN-SPAM Act requires that all commercial e-mail messages include a valid physical postal address. CAN-SPAM was amended in 2008 to include, among other things, a prohibition that e-mail senders make it difficult for a recipient to opt-out of receiving future emails from the sender. We believe the CAN-SPAM Act limits our ability to pursue certain direct marketing activities, thus limiting our sales and potential customers.

Changes in consumer protection laws also may impose additional burdens on those companies conducting business online. The adoption of additional laws or regulations may decrease the growth of the internet or other online services, which could, in turn, decrease the demand for our products and services and increase our cost of doing business through the internet.

In addition, since our website is available over the internet in all states, various states may claim that we are required to qualify to do business as a foreign corporation in such state, a requirement that could result in fees and taxes as well as penalties for the failure to qualify. Any new legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently apply to our business or the application of existing laws and regulations to the internet and other online services could have a material adverse effect on the growth of our business in this area.

D. Strategic Relationships

Strategic Alliance with GE Equity and NBCU

In March 1999, we entered into a strategic alliance with GE Capital Equity Investments, Inc. (“GE Equity”) and NBC Universal, Inc. (“NBCU”) pursuant to which we issued Series A Redeemable Convertible Preferred Stock and common stock warrants, and entered into a shareholder agreement, a registration rights agreement, a distribution and marketing agreement and, the following year, a trademark license agreement. On February 25, 2009, we entered into an exchange agreement with the same parties, pursuant to which GE Equity exchanged all outstanding shares of our Series A Preferred Stock for (i) 4,929,266 shares of our Series B Redeemable Preferred Stock, (ii) warrants to purchase up to 6,000,000 shares of our common stock at an exercise price of $0.75 per share and (iii) a cash payment in the amount of $3.4 million. Immediately after the exchange, the aggregate equity ownership of GE Equity and NBCU in our company was as follows: (i) 6,452,194 shares of common stock, (ii) warrants to purchase up to 6,029,487 shares of common stock and (iii) 4,929,266 shares of Series B Preferred Stock. In connection with the exchange, the parties also amended and restated both the shareholder agreement and the registration rights agreement. The outstanding agreements with GE Equity and NBCU are described in more detail below.

Series B Preferred Stock

On February 25, 2009, we issued 4,929,266 shares of Series B Preferred Stock to GE Equity. The shares of Series B Preferred Stock are redeemable at any time by us for the initial redemption amount of $40.9 million, plus accrued dividends. The Series B Preferred Stock accrues cumulative dividends at a base annual rate of 12%, subject to adjustment. All payments on the Series B Preferred Stock will be applied first to any accrued but unpaid dividends, and then to redeem shares.

30% of the Series B Preferred Stock (including accrued but unpaid dividends) is required to be redeemed on February 25, 2013, and the remainder on February 25, 2014. In addition, the Series B Preferred Stock includes a cash sweep mechanism that may require accelerated redemptions if we generate excess cash above agreed upon thresholds. Specifically, our excess cash balance at the end of each fiscal year, and at the end of any fiscal quarter during which we sell our auction rate securities or dispose of assets or incur indebtedness above agreed upon thresholds, must be used to redeem the Series B Preferred Stock and pay accrued and unpaid dividends thereon. Excess cash balance is defined as our company’s cash and cash equivalents and marketable securities, adjusted to (i) exclude auction rate securities, (ii) exclude cash pledged to vendors to secure purchase price of inventory, (iii) account for variations that are due to our management of payables, and (iv) provide us a cash cushion of at least $20 million. Any redemptions as a result of this cash sweep mechanism will reduce the amounts required to be redeemed on February 25, 2013 and February 25, 2014. The Series B Preferred Stock (including accrued but unpaid dividends) is also required to be redeemed, at the option of the holders, upon a change in control.

The Series B Preferred Stock is not convertible into common stock or any other security, but initially will vote with the common stock on a one-for-one basis on general corporate matters other than the election of directors. In addition, the holders of the Series B Preferred Stock have certain class voting rights, including the right to elect the GE Equity director-designees described below.

Amended and Restated Shareholder Agreement

On February 25, 2009, we entered into an amended and restated shareholder agreement with GE Equity and NBCU, which provides for certain corporate governance and standstill matters. The amended and restated shareholder agreement provides that GE Equity is entitled to designate nominees for three out of nine members of our board of directors so long as the aggregate beneficial ownership of GE Equity and NBCU (and their affiliates) is at least equal to 50% of their beneficial ownership as of February 25, 2009 (i.e. beneficial ownership of approximately 8.75 million common shares), and two out of nine members so long as their aggregate beneficial ownership is at least 10% of the “adjusted outstanding shares of common stock,” as defined in the amended and restated shareholder agreement. In addition, the amended and restated shareholder agreement provides that GE Equity may designate any of its director-designees to be an observer of the Audit, Human Resources and Compensation, and Corporate Governance and Nominating Committees.

The amended and restated shareholder agreement requires the consent of GE Equity prior to our entering into any material agreements with any of CBS, Fox, Disney, Time Warner or Viacom, provided that this restriction will no longer apply when either (i) our trademark license agreement with NBCU (described below) has terminated or (ii) GE Equity is no longer entitled to designate at least two director nominees. In addition, the amended and restated shareholder agreement requires the consent of GE Equity prior to our exceeding certain thresholds relating to the issuance of securities, the payment of dividends, the repurchase of common stock, acquisitions (including investments and joint ventures) or dispositions, and the incurrence of debt; provided, that these restrictions will no longer apply when both (i) GE Equity is no longer entitled to designate three director nominees and (ii) GE Equity and NBCU no longer hold any Series B Preferred Stock. We are also prohibited from taking any action that would cause any ownership interest by us in TV broadcast stations from being attributable to GE Equity, NBCU or their affiliates.

CEO BACKGROUND

Keith R. Stewart was named our president and chief executive officer in January 2009 after having joined ShopNBC as president and chief operating officer in August 2008. Mr. Stewart retired from QVC in July 2007 where he had served the majority of his retail career, most recently as vice president — merchandising of QVC (USA) and vice president — global sourcing of QVC (USA) from April 2004 to June 2007. Previously he was general manager of QVC’s German business unit from 1998 to March 2004. Mr. Stewart first joined QVC as a consumer electronics buyer in 1992 and was promoted through a series of progressively responsible positions through which he developed expertise in key areas of TV home shopping, including merchandising, programming, cable distribution, strategic planning, organizational development, and international sourcing.

John D. Buck currently serves as chairman of our board of directors. From October 25, 2007 to March 3, 2008, and again from August 22, 2008 through January 26, 2009, Mr. Buck served as our interim chief executive officer. His previous experience includes serving as chief executive officer of Medica (Minnesota’s second largest health insurer) from July 2001 to January 2003. He currently serves as non-executive chairman of the board of Medica, and serves on the board of directors of Patterson Companies, Inc. and Halo Innovations. Previously, Mr. Buck worked for Fingerhut Companies where he held several senior executive positions, including president and chief operating officer. He left Fingerhut in October 2000. Mr. Buck also previously held executive positions at Graco Inc., Honeywell Inc., and Alliant Techsystems Inc.

Joseph F. Berardino has served as a managing director at Alvarez & Marsal, a global professional services firm, since October 2008. Prior to joining Alvarez & Marsal, Mr. Berardino was chairman of the board of directors and chief executive officer of Profectus BioSciences, a biotechnology company, from October 2005 to January 2008. From February 2008 to September 2008 Mr. Berardino continued his service as a member of the board of directors of Porfectur BioSciences but was not an employee during that period. He previously served as vice- chairman of Sciens Capital Management, a New York-based alternative asset management firm, from mid-2004 to September 2005. Before Sciens, Mr. Berardino was chief executive officer of Andersen Worldwide, a global accounting and consulting firm. Mr. Berardino currently is the chairman of the finance committee for the board of trustees of Fairfield University. He has been a Certified Public Accountant since 1975.

Robert J. Korkowski , from 1989 until his retirement in 1996, was the senior vice president of finance and a director of Opus Corporation, a privately held real estate development and construction company. From 1986 to 1989, Mr. Korkowski was the vice president and chief financial officer of National Computer Systems, Inc., an information systems company. From 1974 to 1986, Mr. Korkowski was executive vice president and chief financial officer of G. Heileman Brewing Company. Mr. Korkowski served as a director of Redline Performance Products, Inc. beginning in 2003 until August 2004.

Randy S. Ronning served as executive vice president and chief merchandising officer of QVC, where he oversaw all merchandising, brand management, and merchandise analysis efforts of QVC and QVC.com, from June 2005 until his retirement in January 2007. He also was responsible for QVC.com operations during this period. Previously, Mr. Ronning was executive vice president over affiliate sales and marketing, information services, marketing, research and sales analysis, direct marketing, corporate marketing, public relations, and charitable giving at QVC, from 2001 to May 2005. Prior to joining QVC, Mr. Ronning spent 30 years with J.C. Penney Co., where he held executive positions including president of its catalog and internet divisions.

Catherine Dunleavy has served as executive vice president and chief financial officer, NBC Universal Cable, since March 2007. In her present role Ms. Dunleavy oversees the financial performance and strategic analysis of NBC Universal’s cable properties including USA, Sci Fi, Bravo, Oxygen, Universal HD, Sleuth, Chiller, i-Village and Cable Studio, as well as the financial performance of cable distribution. Previously Ms. Dunleavy held the role of senior vice president and chief financial officer of USA and Sci Fi from May 2004 to March 2007. In her prior roles at NBC Universal, Ms. Dunleavy was vice president of financial planning and analysis from January 2001 to May 2004. Before joining NBC Universal, Ms. Dunleavy worked for GE’s corporate audit staff from June 1995 to January 2001, where she was promoted to executive audit manager.

Patrick O. Kocsi was named a senior managing director of GE Equity in February 2009, where he leads the portfolio management team for the business. Previously, from June 2007 to January 2009, he was a managing director at GE Equity. Mr. Kocsi joined GE in 1991 in the Financial Management Program in GE Plastics. He worked in The Netherlands, France, and the US. In 1996, he joined GE Capital working on acquisitions in the US, Brazil, and Germany. In that role Mr. Kocsi began investing in industrial, media, transportation, and technology companies. Currently he serves as a director on the board of SecureWorks.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

Company Description

We are an integrated multi-channel retailer that markets our products directly to consumers through various forms of electronic media. Our operating strategy incorporates distribution from television, internet and mobile devices. Our live 24-hour per day television home shopping programming is distributed primarily through cable and satellite affiliation agreements and on-line through ShopNBC.com and ShopNBC.TV. We have an exclusive license from NBC Universal, Inc., known as NBCU, for the worldwide use of an NBC-branded name and the peacock image for a period ending in May 2011. Pursuant to the license, we operate our television home shopping network under the ShopNBC brand name and operate our internet website under the ShopNBC.com and ShopNBC.TV brand names.

In support of this strategy, we are pursuing the following actions in our ongoing efforts to improve the operational and financial performance of our company: (i) materially reduce the cost of our current distribution agreements for our television programming with cable and satellite operators, as well as pursuing other means of reaching customers such as through webcasting, internet videos and mobile devices, (ii) broaden and optimize our mix of product categories offered on television and the internet in order to appeal to a broader population of potential customers, (iii) lower the average selling price of our products in order to increase the size and purchase frequency of our customer base, (iv) grow our internet business by providing a broader, internet-only merchandise offering, and (v) improve the shopping experience and customer service in order to retain and attract more customers.

Primary Challenge

Our television home shopping business operates with a high fixed cost base, which is primarily due to fixed contractual fees paid to cable and satellite operators to carry our programming. In order to attain profitability, we must achieve sufficient sales volume through the acquisition of new customers and the increased retention of existing customers to cover our high fixed costs or reduce the fixed cost base for our cable and satellite distribution. Our growth and profitability could be adversely impacted if sales volume decreases, as we have limited capability to reduce our fixed cable and satellite distribution operating expenses to mitigate a sales shortfall. Our near-term primary challenge is to successfully execute our plan to significantly reduce our cable and satellite distribution costs and achieve other cost-saving initiatives in an effort to return to profitability.

Our Competition

The direct marketing and retail businesses are highly competitive. In our television home shopping and e-commerce operations, we compete for customers with other television home shopping and e-commerce retailers; infomercial companies; other types of consumer retail businesses, including traditional “brick and mortar” department stores, discount stores, warehouse stores and specialty stores; catalog and mail order retailers and other direct sellers.

In the competitive television home shopping sector, we compete with QVC Network, Inc. and HSN, Inc., both of whom are substantially larger than we are in terms of annual revenues and customers, and whose programming is carried more broadly to U.S. households than is our programming. The American Collectibles Network, which operates Jewelry Television, also competes with us for television home shopping customers in the jewelry category. In addition, there are a number of smaller niche players and startups in the television home shopping arena who compete with our company. We believe that QVC and HSN incur cable and satellite distribution fees representing a significantly lower percentage of their sales attributable to their television programming than do we; and that their fee arrangements are substantially on a commission basis (in some cases with minimum guarantees) rather than on the predominantly fixed-cost basis that we currently have. This difference in programming distribution fee structures represents a material competitive disadvantage for our company.

The e-commerce sector also is highly competitive, and we are in direct competition with numerous other internet retailers, many of whom are larger, better financed and/or have a broader customer base. Certain of our competitors in the television home shopping sector have acquired internet businesses complementary to their existing internet sites, which poses additional competitive challenges for our company.

We anticipate continuing competition for viewers and customers, for experienced home shopping personnel, for distribution agreements with cable and satellite systems and for vendors and suppliers — not only from television home shopping companies, but also from other companies that seek to enter the home shopping and internet retail industries, including telecommunications and cable companies, television networks, and other established retailers. We believe that our ability to be successful in the television home shopping and e-commerce sectors will be dependent on a number of key factors, including (i) obtaining more favorable terms in our cable and satellite distribution agreements, (ii) increasing the number of customers who purchase products from us and (iii) increasing the dollar value of sales per customer from our existing customer base.

Results for Fiscal 2008

Consolidated net sales from continuing operations in fiscal 2008 were $567.5 million compared to $781.6 million in fiscal 2007, a 27% decrease. We reported an operating loss of $88.5 million and net loss of $97.8 million for fiscal 2008, which included a pretax loss of $11.1 million related to an other-than-temporary impairment write-down of our auction rate securities. Operating expenses in fiscal 2008 included $4.3 million of additional restructuring charges, an $8.8 million FCC license intangible asset write-down and CEO transition costs of $2.7 million. We reported an operating loss of $23.1 million and net income of $22.5 million in fiscal 2007, which included a pretax gain of $40.2 million from the sale of RLM. Operating expenses in fiscal 2007 included a $5.0 million restructuring charge and CEO termination costs of $2.5 million. We reported an operating loss of $9.5 million and a net loss of $2.4 million in fiscal 2006.

Strategic Alternatives

On September 11, 2008, our board of directors announced that it had appointed a special committee of independent directors to review strategic alternatives to maximize shareholder value. The special committee retained Piper Jaffray & Co., a nationally-recognized investment banking firm, as its financial advisor. The special committee, with the assistance of Piper Jaffray, broadly solicited expressions of interest in a purchase of or strategic relationship with our company and also evaluated several other strategic alternatives, including a distribution to shareholders through a sale of assets and liquidation of our company. While a number of parties engaged in the process and conducted due diligence, the special committee did not receive any final bids from any of the parties involved. In addition, the special committee concluded that a liquidation of our company would not likely result in any distribution to our shareholders. Therefore, at the recommendation of the special committee, the board of directors concluded the strategic alternatives review process in January 2009. Notwithstanding the formal termination of the strategic alternatives process, the special committee and board of directors remain committed to maximizing shareholder value and will pursue any reasonable alternatives that present themselves.

Intangible and Long-lived Asset Impairment

In accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets and No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we review intangible and long-lived assets for impairment on an annual basis during the fourth quarter, or when events or changes in circumstances indicate that it is more likely than not that the assets might be impaired. During the third and fourth quarters of fiscal 2008, we experienced a significant decline in the price of our publicly-traded common stock and, accordingly, a significant decline in our market capitalization. In the fourth quarter, we evaluated whether the decline in our market capitalization resulting from a record low market value of our common stock was an indicator of impairment. We performed an undiscounted cash flow analysis based on a forecasted cash flow model that included certain significant cost saving assumptions with respect to our cable and satellite distribution cost structure as well as other cost-saving initiatives and based on that analysis concluded there had not been an impairment as of January 31, 2009. However, if we are unable to successfully execute our plans to significantly reduce our cable and satellite distribution costs, achieve other cost-saving initiatives and successfully meet our fiscal 2009 operating plan, we may be required to write down the carrying amount of some or all of our intangible and other long-lived assets to fair value in a future period.

Restructuring Costs

On May 21, 2007, we announced the initiation of a restructuring of our operations that included a 12% reduction in the salaried workforce in the second quarter of fiscal 2007, a consolidation of our distribution operations into a single warehouse facility, the exit and closure of a retail outlet store and other cost saving measures. On January 14, 2008, we announced additional organizational changes and cost-saving measures following a formal business review conducted by management and an outside consulting firm and further reduced our headcount in the fourth quarter of fiscal 2007. Our organizational structure was simplified and streamlined to focus on profitability. As a result of these restructuring initiatives, we recorded a $5.0 million restructuring charge for fiscal 2007 and additional restructuring charges totaling $4.3 million for fiscal 2008. Restructuring costs charged in fiscal 2008 and 2007 primarily include employee severance and retention costs associated with the consolidation and elimination of approximately 300 positions including ten officers. In addition, restructuring costs also include incremental charges associated with the consolidation of our distribution and fulfillment operations into a single warehouse facility, the closure of a retail outlet store, fixed asset impairments incurred as a direct result of the operational consolidation and closures, restructuring advisory service fees and costs associated with our strategic alternative initiative.

Chief Executive Officer Transition Costs

On October 26, 2007, we announced that William Lansing, at the request of the board of directors, had stepped down as president and chief executive officer and had left our board of directors. In conjunction with Mr. Lansing’s resignation, we recorded a charge to income of $2.5 million during fiscal 2007 relating primarily to severance payments to Mr. Lansing and incurred additional costs of $1.1 million during fiscal 2008 associated with the hiring of Rene Aiu in March 2008 as our chief executive officer.

On August 22, 2008, our board of directors terminated Ms. Aiu’s employment with the Company. Our board appointed Keith Stewart to serve as ShopNBC’s president and chief operating officer. We also announced the departures of three other senior officers who had been named to their positions in April 2008 by Ms. Aiu. During the third and fourth quarters of fiscal 2008, we recorded costs totaling $1.6 million relating primarily to accrued severance and other costs associated with the departures of the three senior officers and costs associated with hiring Mr. Stewart.

On November 21, 2008, a lawsuit against our company was filed by Ms. Aiu. Her claims include money damages for breach of contract for nonpayment of severance equal to two years of salary and of targeted incentive compensation, fraud and misrepresentation, and violation of certain Minnesota statutes. We filed a response on November 25, 2008 denying Ms. Aiu’s claims. Discovery has commenced and the Court has set the trial to commence in 2010. We believe that Ms. Aiu was properly dismissed for “cause” as defined in her employment agreement, intend to defend the suit vigorously and at this time cannot estimate a dollar amount of liability, if any.

Limitation on Must-Carry Rights

The Federal Communications Commission, known as the FCC, issued a public notice on May 4, 2007 stating that it was updating the public record for a petition for reconsideration filed in 1993 and still pending before the FCC. The petition challenges the FCC’s prior determination to grant the same mandatory cable carriage (or “must-carry”) rights for TV broadcast stations carrying home shopping programming that the FCC’s rules accord to other TV stations. The time period for comments and reply comments regarding the reconsideration closed in August 2007, and we submitted comments supporting the continuation of must-carry rights for home shopping stations. If the FCC decides to change its prior determination and withdraw must-carry rights for home shopping stations as a result of this updating of the public record, we could lose our current carriage distribution on cable systems in three markets: Boston, Pittsburgh and Seattle, which currently constitute approximately 3.2 million full-time equivalent households, or FTE’s, receiving our programming. We own the Boston television station and have carriage contracts with the Pittsburgh and Seattle television stations. In addition, if must-carry rights for home shopping stations are withdrawn, it may not be possible to replace these FTE’s on commercially reasonable terms and the carrying value of our Boston FCC license ($23.1 million) may become further impaired. At this time, we cannot predict the timing or the outcome of the FCC’s action to update the public record on this issue.

Preferred Stock Exchange (Subsequent Event)

On February 25, 2009, GE Equity exchanged all outstanding shares of our Series A Preferred Stock for (i) 4,929,266 shares of our Series B Redeemable Preferred Stock, (ii) warrants to purchase up to 6,000,000 shares of our common stock at an exercise price of $0.75 per share and (iii) a cash payment in the amount of $3.4 million.

The shares of Series B Preferred Stock are redeemable at any time by us for the initial redemption amount of $40.9 million, plus accrued dividends. The Series B Preferred Stock accrues cumulative dividends at a base annual rate of 12%, subject to adjustment. All payments on the Series B Preferred Stock will be applied first to any accrued but unpaid dividends, and then to redeem shares. 30% of the Series B Preferred Stock (including accrued but unpaid dividends) is required to be redeemed on February 25, 2013, and the remainder on February 25, 2014. In addition, the Series B Preferred Stock includes a cash sweep mechanism that may require accelerated redemptions if we generate excess cash above agreed upon thresholds. Specifically, our excess cash balance at the end of each fiscal year, and at the end of any fiscal quarter during which we sell auction rate securities or dispose of assets or incur indebtedness above agreed upon thresholds, must be used to redeem the Series B Preferred Stock and pay accrued and unpaid dividends thereon. Excess cash balance is defined as our cash and cash equivalents and marketable securities, adjusted to (i) exclude auction rate securities, (ii) exclude cash pledged to vendors to secure purchase price of inventory, (iii) account for variations that are due to our management of payables, and (iv) provide us a cash cushion of at least $20 million. Any redemption as a result of this cash sweep mechanism will reduce the amounts required to be redeemed on February 25, 2013 and February 25, 2014. The Series B Preferred Stock (including accrued but unpaid dividends) is also required to be redeemed, at the option of the holders, upon a change in control. The Series B Preferred Stock is not convertible into common stock or any other security, but initially will vote with the common stock on a one-for-one basis on general corporate matters other than the election of directors. In addition, the holders of the Series B Preferred Stock have the class voting rights and rights to designate members of our board of directors previously held by the holders of the Series A Preferred Stock.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Overview
Company Description

We are an integrated multi-channel retailer that markets our products directly to consumers through various forms of electronic media. Our operating strategy incorporates distribution from television, internet and mobile devices. Our live 24-hour per day television home shopping programming is distributed primarily through cable and satellite affiliation agreements and on-line through ShopNBC.com and ShopNBC.TV. We have an exclusive license from NBC Universal, Inc., known as NBCU, for the worldwide use of an NBC-branded name and the peacock image for a period ending in May 2011. Pursuant to the license, we operate our television home shopping network under the ShopNBC brand name and operate our internet website under the ShopNBC.com and ShopNBC.TV brand names.

Company Strategy
We endeavor to be the premium lifestyle brand in the TV shopping and internet retailing industry. As an integrated, multi-channel retailer, our strategy is to offer our current and new customers brands and products that are meaningful, unique and relevant. Our merchandise brand positioning aims to be the destination and authority for home, fashion and jewelry shoppers. We focus on creating a customer experience that builds strong loyalty and a growing customer base.
In support of this strategy, we are pursuing the following actions in our ongoing efforts to improve the operational and financial performance of our company: (i) materially reduce the cost of our current distribution agreements for our television programming with cable and satellite operators, as well as pursuing other means of reaching customers such as through webcasting, internet videos and mobile devices, (ii) broaden and optimize our mix of product categories offered on television and the internet in order to appeal to a broader population of potential customers, (iii) lower the average selling price of our products in order to increase the size and purchase frequency of our customer base, (iv) grow our internet business by providing a broader, internet-only merchandise offering, and (v) improve the shopping experience and customer service in order to retain and attract more customers.
Primary Challenge
Our television home shopping business operates with a high fixed cost base, which is primarily due to fixed contractual fees paid to cable and satellite operators to carry our programming. In order to attain profitability, we must achieve sufficient sales volume through the acquisition of new customers and the increased retention of existing customers to cover our high fixed costs or reduce the fixed cost base for our cable and satellite distribution. Our growth and profitability could be adversely impacted if sales volume decreases, as we have limited capability to reduce our fixed cable and satellite distribution operating expenses to mitigate a sales shortfall. Our near-term primary challenge is to continue our cost-control efforts while growing margins and sales in order to reach profitability.
Our Competition
The direct marketing and retail businesses are highly competitive. In our television home shopping and e-commerce operations, we compete for customers with other television home shopping and e-commerce retailers; infomercial companies; other types of consumer retail businesses, including traditional “brick and mortar” department stores, discount stores, warehouse stores and specialty stores; catalog and mail order retailers and other direct sellers.
In the competitive television home shopping sector, we compete with QVC Network, Inc. and HSN, Inc., both of whom are substantially larger than we are in terms of annual revenues and customers, and whose programming is carried more broadly to U.S. households than is our programming. The American Collectibles Network, which operates Jewelry Television, also competes with us for television home shopping customers in the jewelry category. In addition, there are a number of smaller niche players and startups in the television home shopping arena who compete with our company. We believe that QVC and HSN incur cable and satellite distribution fees representing a significantly lower percentage of their sales attributable to their television programming than do we; and that their fee arrangements are substantially on a commission basis (in some cases with minimum guarantees) rather than on the predominantly fixed-cost basis that we currently have. This difference in programming distribution fee structures represents a material competitive disadvantage for our company.

The e-commerce sector also is highly competitive, and we are in direct competition with numerous other internet retailers, many of whom are larger, better financed and/or have a broader customer base. Certain of our competitors in the television home shopping sector have acquired internet businesses complementary to their existing internet sites, which poses additional competitive challenges for our company.
We anticipate continuing competition for viewers and customers, for experienced home shopping personnel, for distribution agreements with cable and satellite systems and for vendors and suppliers — not only from television home shopping companies, but also from other companies that seek to enter the home shopping and internet retail industries, including telecommunications and cable companies, television networks, and other established retailers. We believe that our ability to be successful in the television home shopping and e-commerce sectors will be dependent on a number of key factors, including (i) obtaining more favorable terms in our cable and satellite distribution agreements, (ii) increasing the number of customers who purchase products from us and (iii) increasing the dollar value of sales per customer from our existing customer base.
Results for the First Quarter of Fiscal 2009
Consolidated net sales for the fiscal 2009 first quarter were $133,802,000 compared to $156,288,000 for the 2008 first quarter, a 14% decrease. We reported an operating loss of ($11,647,000) and a net loss of ($12,012,000) for the 2009 first quarter. We reported an operating loss of ($18,388,000) and a net loss of ($17,578,000) for the 2008 first quarter.
Preferred Stock Exchange
On February 25, 2009, GE Equity exchanged all outstanding shares of our Series A Preferred Stock for (i) 4,929,266 shares of our Series B Redeemable Preferred Stock, (ii) warrants to purchase up to 6,000,000 shares of our common stock at an exercise price of $0.75 per share and (iii) a cash payment in the amount of $3.4 million.
The shares of Series B Preferred Stock are redeemable at any time by us for the initial redemption amount of $40.9 million, plus accrued dividends. The Series B Preferred Stock accrues cumulative dividends at a base annual rate of 12%, subject to adjustment. All payments on the Series B Preferred Stock will be applied first to any accrued but unpaid dividends, and then to redeem shares. 30% of the Series B Preferred Stock (including accrued but unpaid dividends) is required to be redeemed on February 25, 2013, and the remainder on February 25, 2014. In addition, the Series B Preferred Stock includes a cash sweep mechanism that may require accelerated redemptions if we generate excess cash above agreed upon thresholds. Specifically, our excess cash balance at the end of each fiscal year, and at the end of any fiscal quarter during which we sell auction rate securities or dispose of assets or incur indebtedness above agreed upon thresholds, will trigger a calculation to determine whether the Company needs to redeem a portion of the Series B Preferred Stock and pay accrued and unpaid dividends thereon. Excess cash balance is defined as our cash and cash equivalents and marketable securities, adjusted to (i) exclude auction rate securities, (ii) exclude cash pledged to vendors to secure purchase price of inventory, (iii) account for variations that are due to our management of payables, and (iv) provide us a cash cushion of at least $20 million. Any redemption as a result of this cash sweep mechanism will reduce the amounts required to be redeemed on February 25, 2013 and February 25, 2014. The Series B Preferred Stock (including accrued but unpaid dividends) is also required to be redeemed, at the option of the holders, upon a change in control. The Series B Preferred Stock is not convertible into common stock or any other security, but initially will vote with the common stock on a one-for-one basis on general corporate matters other than the election of directors. In addition, the holders of the Series B Preferred Stock have the class voting rights and rights to designate members of our board of directors previously held by the holders of the Series A Preferred Stock. In addition, as a result of the preferred stock exchange transaction, we recorded the excess of the carrying amount of the Series A Preferred Stock over the fair value of the Series B Preferred Stock as an addition to earnings to arrive at net earnings available to common shareholders. Due to the mandatory redemption feature of the preferred stock, the Company has classified the carrying value of the Series B Preferred Stock, and related accrued dividends, as long-term liabilities on its consolidated balance sheet.

Program Distribution
Our television home shopping programming was available to approximately 72.9 million average full time equivalent, or FTE, households for the first quarter of fiscal 2009 and approximately 70.8 million average FTE households for the first quarter of fiscal 2008. Average FTE subscribers grew 3% in the first quarter of fiscal 2009, resulting in a 2.1 million increase in average FTE’s versus the prior year comparable quarter. The increase was driven by continued strong growth in satellite distribution of our programming and increased distribution of our programming on digital cable. We anticipate that our cable programming distribution will increasingly shift towards a greater mix of digital as opposed to analog cable tiers, both through growth in the number of digital subscribers and through cable system operators moving programming that is carried on analog channels over to digital channels. Nonetheless, because of the broader universe of programming choices available for viewers in digital systems and the higher channel placements commonly associated with digital tiers, the shift towards digital systems may adversely impact our ability to compete for television viewers even if our programming is available in more homes. Our television home shopping programming is also simulcast live 24 hours a day, 7 days a week through our internet websites, www.ShopNBC.com and www.ShopNBC.TV, which is not included in total FTE households.
Cable and Satellite Distribution Agreements
We have entered into cable and satellite distribution agreements that represent approximately 1,400 cable systems that require each operator to offer our television home shopping programming substantially on a full-time basis over their systems. The terms of these existing agreements typically range from one to four years. Under certain circumstances, the television operators or we may cancel the agreements prior to their expiration. If certain of these agreements are terminated, the termination may materially or adversely affect our business. Cable and satellite distribution agreements representing a majority of the total cable and satellite households who currently receive our television programming were scheduled to expire at the end of the 2008 calendar year. Most of the major agreements have been renegotiated and renewed at this time; and for other of the major agreements, we have obtained temporary extensions while we continue our negotiations. We expect to preserve all of our distribution footprint and with regard to negotiations completed to date, we expect to realize a 33% rate reduction which will result in a cost savings in the range of $22 million to $25 million in fiscal 2009. Failure to successfully renew remaining cable agreements covering a material portion of our existing cable households on acceptable financial and other terms could adversely affect our future growth, sales revenues and earnings unless we are able to arrange for alternative means of broadly distributing our television programming. In addition, many cable operators are moving to transition our programming (and other cable content providers as well) in many of their local cable systems to digital instead of analog programming tiers. As this occurs, we may experience temporary reductions in cable households in certain markets.
Customer Counts
During the first quarter of fiscal 2009, customer trends improved with new and active customers up 60% and 23%, respectively over the prior year first quarter. We attribute the increase in new and active customers during the quarter to our merchandise strategy of lower price points and new products, brands and concepts that proved successful in driving increased customer activity.
Net Shipped Units
The number of net shipped units during the fiscal 2009 first quarter increased 10% from the prior year’s comparable quarter to 852,000 from 774,000. The increase in net shipped units was directly related to an increase in unit sales to customers during the first quarter of fiscal 2009. We believe that the decline in average selling prices, discussed below, was a major contributing factor to the increase in unit sales.
Average Selling Price
The average selling price, or ASP, per net unit was $144 in the 2009 first quarter, a 26% decrease from the comparable prior year quarter. The quarter decrease in the fiscal 2009 ASP was driven primarily by unit selling price decreases within the jewelry and across almost all other product categories. We have intentionally made an effort to reduce our average selling price points in order to reduce our return rates, to appeal to a broader audience and to allow for a broader merchandise assortment.
Return Rates
Our return rate was 21.7% in the fiscal 2009 first quarter as compared to 36.0% for the comparable prior year quarter, a 14.3 percentage point decrease. We attribute the decrease in the 2009 quarterly return rate primarily to operational improvements in our delivery time and customer service, a change in our merchandise mix, our overall product quality and our lower price points.

Net Sales
Consolidated net sales for the fiscal 2009 first quarter were $133,802,000 as compared with consolidated net sales of $156,288,000 for the fiscal 2008 first quarter, a 14% decrease. The decrease in consolidated net sales from prior year is directly attributed to decreases experienced in net sales from of our television home shopping and internet operations. These declines in consolidated net sales are directly attributed to an approximate 26% decline in our average selling price offset by a 10% increase in net shipped units. The remaining change in net sales is attributable to an increase in shipping and handling revenue and a decrease in promotional discounts offered over prior year. Our consolidated net sales are still feeling the effect of the continued challenging overall environment experienced by retailers. From a product category perspective, our gemstone and gold categories experienced significant declines as these businesses are being repositioned at lower price points in order to broaden their appeal and reduce return rates. Our watch and consumer electronics sales off-set some of the decline experienced in our jewelry business. As part of our strategic merchandise transition, we have also been working through a significant amount of aged and lower-performing inventory which has contributed to the sales decreases experienced during the first quarter of fiscal 2009. In addition, television and internet net sales decreased due to reduced total revenues associated with our discontinued polo.com fulfillment operations.
Cost of Sales (exclusive of depreciation and amortization)
Cost of sales (exclusive of depreciation and amortization) for the fiscal 2009 first quarter and fiscal 2008 first quarter was $91,613,000 and $106,332,000, respectively, a decrease of $14,719,000, or 14%. The decrease in cost of sales is directly attributable to decreased costs associated with decreased sales volume from our television home shopping and internet businesses. Net sales less cost of sales (exclusive of depreciation and amortization) as a percentage of sales for the first quarters of fiscal 2009 and fiscal 2008 quarters were 31.5% and 32.0%, respectively. The decrease in gross margins experienced during the quarter was driven primarily by a negative mix impact from increased sales in lower margin consumer electronics and lower margin rates achieved across all major product categories during the current fiscal year. Margin decreases also resulted from our effort to reduce aged inventory levels by taking aggressive markdowns during the first quarter of fiscal 2009 as we reposition our mix of new inventory purchases. We expect our margins to gradually improve as we shift and grow our merchandise mix in the key product categories of home, fashion and health & beauty. We will also continue to reposition our core jewelry business with more moderate price points and higher margins. First quarter fiscal 2008 margins were impacted by a non-cash inventory write down of $3.8 million recorded as a result of strategic decisions made in prior year to significantly reduce our product’s on-air life cycle.
Operating Expenses
Total operating expenses for the fiscal 2009 first quarter were $53,836,000 compared to $68,344,000 for the comparable prior year period, a decrease of 21%. Distribution and selling expense decreased $11,844 , 000, or 21%, to $45,239,000, or 34% of net sales during the 2009 first quarter compared to $57,083,000 or 37% of net sales for the comparable prior year quarter. Distribution and selling expense decreased on a year-to-date basis over the prior year primarily due to a $6,298,000 first quarter savings resulting from decreases in net cable and satellite rates in the first quarter due to the successful renegotiating of our cable and satellite contracts; a decrease in telemarketing, customer service and fulfillment variable costs of $777,000 associated with decreased sales volume and efficiency gains; decreases in salaries, headcount and other related personnel costs associated with merchandising, television production and show management per]]>Tue, 23 Jun 2009 04:52:01 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/2811/http://www.dailystocks.com/forum/showtopic.php?tid/2811/
BUSINESS OVERVIEW

Overview

We are an independent crude oil refiner and marketer of refined products and also operate service stations and convenience stores. We own and operate four refineries with a total crude oil throughput capacity of approximately 238,000 barrels per day, or bpd. In addition to our 128,000 bpd refinery in El Paso, Texas, we also own and operate a 70,000 bpd refinery on the East Coast of the United States near Yorktown, Virginia and two refineries in the Four Corners region of Northern New Mexico with a combined throughput capacity of 40,000 bpd. Our primary operating areas encompass West Texas, Arizona, New Mexico, Utah, Colorado, and the Mid-Atlantic region. In addition to the refineries, we also own and operate stand-alone refined products terminals in Flagstaff, Arizona and Albuquerque, New Mexico, as well as asphalt terminals in Phoenix and Tucson, Arizona, Albuquerque and El Paso. As of February 27, 2009, we also own and operate 153 retail service stations and convenience stores in Arizona, Colorado and New Mexico, a fleet of crude oil and finished product truck transports, and a wholesale petroleum products distributor that operates in Arizona, California, Colorado, Nevada, New Mexico, Texas, and Utah.

We were incorporated in September 2005 under Delaware law. In January 2006, we completed an initial public offering and our stock began trading on the New York Stock Exchange, or NYSE, under the symbol “WNR.” Also in connection with our initial public offering, pursuant to a contribution agreement, a reorganization of entities under common control was consummated whereby Western Refining, Inc. became the indirect owner of the historical operating subsidiary, Western Refining LP and all of its refinery assets.

On May 31, 2007, we completed the acquisition of Giant. Under the terms of the merger agreement, we acquired 100% of Giant’s 14,639,312 outstanding shares for $77.00 per share in cash. The purchase price of $1,149.2 million was funded through a combination of cash on hand, proceeds from an escrow deposit, and a $1,125.0 million secured term loan. In connection with the acquisition, we borrowed an additional $275.0 million in July 2007, when we paid off and retired Giant’s 8% and 11% Senior Subordinated Notes. Prior to the acquisition of Giant, we generated substantially all of our revenues from our refining operations in El Paso.

Following the acquisition of Giant, we began reporting our operating results in three business segments: the refining group, the retail group, and the wholesale group. Our refining group operates the four refineries and related refined products terminals and asphalt terminals. At the refineries, we refine crude oil and other feedstocks into finished products such as gasoline, diesel fuel, jet fuel, and asphalt. Our refineries market finished products to a diverse customer base including wholesale distributors and retail chains. Our retail group operates service stations and convenience stores and sells gasoline, diesel fuel, and merchandise. Our wholesale group distributes gasoline, diesel fuel, and lubricant products. See Note 4, “Segment Information” in the Notes to Consolidated Financial Statements included in this annual report for detailed information on our operating results by segment.

Refining Segment

Our refining group operates four refineries: one in El Paso, Texas (the El Paso refinery), two in the Four Corners region of Northern New Mexico, one near Gallup and one in Bloomfield, (the Four Corners refineries), and one near Yorktown, Virginia (the Yorktown refinery). Each of these refineries has its own product distribution terminal. Our refining group also operates a crude oil transportation and gathering pipeline system in the Four Corners region of New Mexico, an asphalt plant in El Paso, two finished stand-alone products distribution terminals in Flagstaff and Albuquerque, and four asphalt distribution terminals in El Paso, Phoenix, Tucson and Albuquerque.

We also purchase additional refined products from other refiners to supplement supply to our customers. These products are similar to the products that we currently manufacture.

Competition. We operate primarily in West Texas, Arizona, New Mexico, Utah, Colorado, and the Mid-Atlantic region. Refined products are supplied to these areas from our refineries, from other refineries in these regions and from refineries located in other regions via interstate pipelines. These areas have substantial refining capacity.

Petroleum refining and marketing is highly competitive. The principal competitive factors affecting us are costs of crude oil and other feedstocks, refinery efficiency, operating costs, refinery product mix, and costs of product distribution and transportation. Because of their geographic diversity, larger and more complex refineries, integrated operations, and greater resources, some of our competitors may be better able to withstand volatile market conditions, to compete on the basis of price, to obtain crude oil in times of shortage, and to bear the economic risk inherent in all phases of the refining industry.

In the Southwest, the El Paso and the Four Corners refineries primarily compete with Valero Energy Corp., ConocoPhillips Company, Alon USA Energy, Inc., Holly Corporation, Flying J, Inc., Tesoro Corporation, Chevron Products Company, or Chevron, and Suncor Energy, Inc. as well as refineries in other regions of the country that serve the regions we serve through pipelines.

The Longhorn refined products pipeline runs approximately 700 miles from the Houston area of the Gulf Coast to El Paso and has an estimated maximum capacity of 225,000 bpd. This pipeline provides Gulf Coast refiners and other shippers with improved access to West Texas and New Mexico. Any additional supply provided by this pipeline or by the Kinder Morgan Energy Partners, LP, or Kinder Morgan, pipeline expansion could lower prices and increase price volatility in areas that we serve and could adversely affect our sales and profitability. The entity that owns the Longhorn pipeline recently filed for bankruptcy and the impact of this bankruptcy filing on the future operations of this pipeline is uncertain.

In the Mid-Atlantic region, our Yorktown refinery primarily competes with Sunoco, Inc., Valero Energy Corp., ConocoPhillips Company, Hess Corporation and other refineries in the Gulf Coast via the Colonial Pipeline, which runs from the Gulf Coast area to New Jersey. We also compete with offshore refiners that deliver product by water transport.

Southwest

El Paso Refinery

Our El Paso refinery has a crude oil throughput capacity of 128,000 bpd with approximately 4.3 million barrels of storage capacity, a finished products terminal and asphalt plant and terminal.

This refinery is well-situated to serve two separate geographic areas, which allows us to diversify our market pricing exposure. Tucson and Phoenix reflect a West Coast market pricing structure, while El Paso, Albuquerque and Juarez typically reflect a Gulf Coast market pricing structure.

Process Summary. Our El Paso refinery is a nominal 128,000 bpd crude oil throughput cracking facility that has historically run WTI crude oil to optimize the yields of higher-value refined products, which currently account for over 90% of our production output. The completion of our gasoline desulfurization project in mid-2009 will give us the flexibility to process more West Texas Sour, or WTS, crude oil, which typically is less expensive than WTI crude oil.

In June 2005, Western Refining LP entered into a sulfuric acid regeneration and sulfur gas processing agreement with E.I. du Pont de Nemours, or DuPont. Under the agreement, Western Refining LP has a long-term commitment to purchase services for use by its El Paso refinery. In exchange for this commitment, DuPont agreed to design, construct, and operate two sulfuric acid regeneration plants on property we lease to DuPont within our El Paso refinery. In November 2008, we began processing all sulfur gas from the north side of the El Paso refinery at the DuPont facility. In January 2009, we began processing all sulfur gas from the south side of the El Paso refinery at the DuPont facility.

Power Supply. Electricity is supplied to our refinery by a regional electric company via two separate feeders to both the north and south sides of our refinery. We have an electrical power curtailment plan to conserve power in the event of a partial outage. In addition, we have multiple small, automatic-starting emergency generators to supply electricity for essential lighting and controls in the event of a power outage.

Natural gas is supplied to our refinery via pipeline under two transportation agreements. One transportation agreement is on an interruptible basis while the other is on an uninterruptible basis. We purchase our natural gas at market rates or under fixed-price agreements.

(WTI) and sour (WTS) crude oil. The main trunkline into El Paso is used solely for the supply of crude oil to us, on a published tariff. The crude oil pipeline has access to the majority of the producing fields in the Permian Basin, which gives us access to a plentiful supply of WTI and WTS crude oil from fields with long reserve lives. We generally buy our crude oil under contracts with various crude oil providers, including a contract with Kinder Morgan that expires in 2020 and shorter-term contracts with other suppliers, at market-based rates.

We also have access to blendstocks and refined products from the Gulf Coast through the Magellan South System pipeline that runs from the Gulf Coast to our refinery.

Refined Products Transportation. Outside of the El Paso area, which is supplied via our El Paso refinery product terminal, we provide refined products to other areas, including Tucson, Phoenix, Albuquerque and Juarez, Mexico. Supply to these areas is achieved through pipeline systems that are linked to our refinery. Our refined products are delivered to Tucson and Phoenix through the Kinder Morgan East Line, which was expanded to over 200,000 bpd in the fourth quarter of 2007, and to Albuquerque and Juarez, Mexico through pipelines owned by Plains All American Pipeline L.P., or Plains. We also sell our refined products at our product marketing terminal and rail loading facilities in El Paso. Another pipeline owned by Kinder Morgan provides diesel fuel to the Union Pacific railway in El Paso.

Both Kinder Morgan’s East Line and the Plains pipeline to Albuquerque are interstate pipelines regulated by the Federal Energy Regulatory Commission, or FERC, and have historically operated near 100% capacity year-round. The tariff provisions for these pipelines include prorating policies that grant historical shippers line space that is consistent with their prior activities as well as a prorated portion of any expansions.

Four Corners Refineries

Our refining group operates two refineries in the Four Corners region of Northern New Mexico. We operate the two refineries in an integrated fashion. Our Gallup refinery has a crude oil throughput capacity of 23,000 bpd. It is located on approximately 810 acres near Gallup, New Mexico. Our Bloomfield refinery has a crude oil throughput capacity of 17,000 bpd. It is located on 305 acres near Farmington, New Mexico. We typically have not operated these refineries at these capacity levels.

Arizona, Colorado, New Mexico and Utah are the primary areas for the refined products and also are the primary source of crude oil and natural gas liquid supplies for both refineries.

Process Summary. The Four Corners refineries produce a high percentage of high-value products. Each barrel of raw materials processed by our Four Corners refineries has resulted in approximately 90% of high-value finished products, including gasoline and diesel fuel during the past five years.

Power Supply. Electrical power is supplied to the Gallup Refinery by a regional electric cooperative. There are several uninterruptible power supply units throughout the plant to maintain computers and controls in the event of a power outage. The Gallup refinery has a natural gas operated cogeneration unit that provides partial backup electrical power to the refinery. Natural gas is supplied to our refinery via pipeline from a single supplier.

Electricity is supplied to our Bloomfield refinery by the local electric company via one 69 KV line through two separate step down transformers that feed the plant. There is no backup electric generation. Natural gas is supplied to this refinery via pipeline. The transportation contract for this natural gas supply is on an interruptible basis.

Raw Material Supply. The feedstocks for our Four Corners refineries are Four Corners Sweet and West Texas Super Sweet crude oil. The Four Corners Sweet comes from the Four Corners area and is delivered by pipelines, including pipelines we own, connected to our refineries, or delivered by our trucks to pipeline injection points or refinery tankage. Our pipeline system reaches into the San Juan Basin, located in the Four Corners area, and connects with local common carrier pipelines. We currently own approximately 250 miles of pipeline for gathering and delivering crude oil to the refineries. Our Gallup refinery receives natural gas liquids primarily through a 13-mile pipeline we own that is connected to a natural gas liquids processing plant.

The West Texas Super Sweet crude oil comes from the Permian Basin region of West Texas and Southeast New Mexico and is delivered via a 16-inch pipeline system operated as a common carrier line with FERC tariffs by our wholly-owned subsidiary, Western Refining Pipeline Company. This pipeline runs from Lynch to Bisti, New Mexico and began delivering crude oil to our Four Corners refineries in August 2007. This pipeline, combined with rail deliveries, is capable of providing enough feedstock for our two Four Corners refineries to run at full capacity rates (40,000 bpd). Based on seasonally lower product demand in the Four Corners area in the winter months and to manage our working capital, we have removed the crude oil from this pipeline. We will continue to evaluate future demand and alternative sources of crude oil to determine when this pipeline will be returned to service. See Item 1A, “Risk Factors — We may not be able to run our Four Corners refineries at increased rates. ”

We purchase crude oil from a number of sources, including major oil companies and independent producers, under arrangements that contain market-responsive pricing provisions. Many of these arrangements are subject to cancellation by either party or have terms of one year or less. In addition, these arrangements are subject to periodic renegotiation, which could result in our paying higher or lower relative prices for crude oil.

Terminal Operations. Each of our Four Corners refineries has its own products distribution terminal. We own a stand-alone finished products terminal near Flagstaff which is permitted to operate at 12,000 bpd. This terminal has approximately 65,000 barrels of finished product tankage and a truck loading rack with three loading spots. Product deliveries to this terminal are made by truck from our Four Corners refineries.

We also own a stand-alone finished products terminal in Albuquerque which is permitted to operate at 27,500 bpd. This terminal has approximately 170,000 barrels of finished product tankage and a truck loading rack with two loading spots. Product deliveries to this terminal are made by truck or by pipeline, including deliveries from our El Paso, Gallup and Bloomfield refineries.

Refined Products Transportation. Our Four Corners gasoline and diesel fuel production is distributed in Arizona, Colorado, New Mexico and Utah, primarily via a fleet of finished product trucks operated by our wholesale group.

Mid-Atlantic

Yorktown Refinery

Our Yorktown refinery is located on 676 acres of land known as Goodwin’s Neck, located on the York River in York County, Virginia. The Yorktown refinery has its own deep-water port on the York River, close to the Norfolk military complex and the Hampton Roads shipyards. The Yorktown refinery primarily serves Yorktown, Virginia; Salisbury, Maryland; Norfolk, Virginia; North and South Carolina and the New York Harbor.

Process Summary. Our Yorktown refinery is a nominal 70,000 bpd heavy crude oil coking facility that can process a wide variety of crude oils, including certain lower quality crude oils, into high-value finished products, including both conventional and reformulated gasoline, ultra low sulfur diesel fuel, and heating oil. We also produce liquefied petroleum gases, or LPGs, fuel oil, and anode grade petroleum coke.

Power Supply. The Yorktown refinery’s electrical power is supplied by the regional electric company via two independent transformers. All process computers and controls are protected by various uninterruptible power supply systems.

Natural gas is supplied to our refinery via pipeline. The natural gas is used as a back-up to refinery produced fuel gas.

Raw Material Supply. Most of the crude oil for our Yorktown refinery currently comes from South America. Our Yorktown refinery’s strategic location on the York River and its own deep-water port access allow it to receive supply shipments from various regions of the world. Crude oil tankers deliver all of the crude oil supplied to our Yorktown refinery. The refinery can process a wide range of crude oils, including certain lower quality crude oils. The ability to process a wide range of crude oils allows our Yorktown refinery to vary its crude oil slate. Lower quality crude oils can typically be purchased at a lower cost, compared to higher quality crude oils. The Yorktown refinery also purchases other feedstocks and blendstocks to optimize refinery operations and blending operations.

Western Refining Yorktown, Inc., or Western Yorktown, our subsidiary we acquired in connection with the Giant acquisition, declared force majeure under its crude oil supply agreement with Statoil Marketing and Trading (USA), Inc., or Statoil, based on the effects of the Grane crude oil on its plant and equipment. Statoil filed a lawsuit against Western Yorktown on March 28, 2008, in the Superior Court of Delaware in and for New Castle County. The lawsuit alleges breach of contract and other related claims by Western Yorktown in connection with the crude oil supply agreement and alleges Statoil is entitled to recover damages in excess of $100 million. Western Yorktown believes its declaration of force majeure was in accordance with the contract, disputes Statoil’s claims and intends to vigorously defend against them.

Retail Segment

Our retail group operates service stations, which include convenience stores or kiosks. The service stations sell various grades of gasoline, diesel fuel, general merchandise, and beverage and food products to the general public. Our refining group or wholesale group supply substantially all the gasoline and diesel fuel that the retail group sells. We purchase general merchandise and food products from various suppliers. At February 27, 2009, our retail group operated 153 service stations with convenience stores or kiosks located in Arizona, New Mexico and Colorado.

The main competitive factors affecting our retail segment are the location of the stores, brand identification, and product price and quality. Our service stations compete with Valero Energy Corp., Alon Energy USA, K&G Markets (formerly ConocoPhillips), Maverick, Circle K, Brewer Oil Company and 7-2-11 food stores. Large chains of retailers like Costco Wholesale Corp. and Wal-Mart Stores Inc. have recently entered the motor fuel retail business. Many of these competitors are substantially larger than us and because of their integrated operations, may be better able to withstand volatile conditions in the fuel market and lower profitability in merchandise sales.

CEO BACKGROUND

Brian J. Hogan 47

Brian J. Hogan has served as one of our directors since January 2006. Since 1986, he has served as an officer of, and since 1990 as President of, Hogan Motor Leasing, Inc., a full-service regional truck leasing company. Mr. Hogan also serves as a director and Chairman of AmeriQuest Corp., a transportation and logistics resource company. In addition, he serves on various transportation and leasing industry professional association boards and charitable organization boards.

Scott D. Weaver 50

Scott D. Weaver has served as one of our directors and as one of our executive officers since September 2005. From 2000 to August 2005, he served as the Chief Financial Officer, Treasurer and Secretary of one of our affiliates. In September 2005, he resigned as Chief Financial Officer and Treasurer and became our Chief Administrative Officer. In November 2005, he resigned as Secretary and became our Assistant Secretary. In December 2007, he resigned as Chief Administrative Officer and became a Vice President. Mr. Weaver currently serves on the board of directors of Encore Wire Corporation, a publicly-traded copper wire manufacturing company, and on the board of directors of WIG Holdings, Inc.

MANAGEMENT DISCUSSION FROM LATEST 10K

Company Overview

We are an independent crude oil refiner and marketer of refined products and also operate service stations and convenience stores. We own and operate four refineries with a total crude oil throughput capacity of approximately 238,000 barrels per day, or bpd. In addition to our 128,000 bpd refinery in El Paso, Texas, we own and operate a 70,000 bpd refinery on the East Coast of the United States near Yorktown, Virginia and two refineries in the Four Corners region of Northern New Mexico with a combined throughput capacity of 40,000 bpd. Our primary operating areas encompass West Texas, Arizona, New Mexico, Utah, Colorado, and the Mid-Atlantic region. In addition to the refineries, we also own and operate stand-alone refined products terminals in Flagstaff, Arizona and Albuquerque, as well as asphalt terminals in Phoenix, Arizona; Tucson, Arizona; Albuquerque; and El Paso. As of December 31, 2008, we also own and operate 155 retail service stations and convenience stores in Arizona, Colorado and New Mexico, a fleet of crude oil and finished product truck transports, and a wholesale petroleum products distributor, that operates in Arizona, California, Colorado, Nevada, New Mexico, Texas, and Utah.

On May 31, 2007, we completed the acquisition of Giant. Under the terms of the merger agreement, we acquired 100% of Giant’s 14,639,312 outstanding shares for $77.00 per share in cash. The purchase price of $1,149.2 million was funded through a combination of cash on hand, proceeds from an escrow deposit, and a $1,125.0 million secured term loan. In connection with the acquisition, we borrowed an additional $275.0 million in July 2007, when we paid off and retired Giant’s 8% and 11% Senior Subordinated Notes.

Following the acquisition of Giant, we began reporting our operating results in three business segments: the refining group, the retail group, and the wholesale group. Our refining group operates the four refineries and related refined products terminals and asphalt terminals. At the refineries, we refine crude oil and other feedstocks into finished products such as gasoline, diesel fuel, jet fuel, and asphalt. Our refineries market finished products to a diverse customer base including wholesale distributors and retail chains. Our retail group operates service stations and convenience stores and sells gasoline, diesel fuel, and merchandise. Our wholesale group distributes gasoline, diesel fuel, and lubricant products. See Note 4, “Segment Information” in the Notes to Consolidated Financial Statements included elsewhere in this annual report for detailed information on our operating results by segment.

Prior to the acquisition of Giant, we generated substantially all of our revenues from our refining operations in El Paso. By expanding our refining operations from one to four facilities, we diversified our operations. In addition, we increased our sour and heavy crude oil processing capacity as a percent of our total crude oil capacity from 12% prior to the acquisition to approximately 38% as of December 31, 2008. Sour and heavy crude oil is generally less expensive to acquire. We expect our combined sour and heavy crude oil processing capability to reach up to 50% by the end of 2009, following the completion of our previously announced gasoline desulfurization project at our El Paso refinery. The Yorktown refinery also has the flexibility for future growth initiatives given its ability to process cost-advantaged feedstocks. With the acquisition, we also gained a diverse mix of complementary retail and wholesale businesses.

In 2005, Giant purchased an inactive pipeline running from Southeast New Mexico to Northwest New Mexico. The pipeline has been reversed and upgraded to transport crude oil from Southeast New Mexico to the Four Corners region. Crude oil began pumping into this pipeline in July 2007 and reached the Four Corners refineries in August 2007. This pipeline, combined with rail deliveries, is capable of providing enough feedstock for our two Four Corners refineries to run at increased capacity rates. Based on seasonally lower product demand in the Four Corners area in the winter months and to manage our working capital, we have removed the crude oil from this pipeline. We will continue to evaluate future demand and alternative sources of crude oil to determine when this pipeline will be returned to service. See Item 1A, “Risk Factors — We may not be able to run our Four Corners refineries at increased rates ” elsewhere in this annual report.

Major Influences on Results of Operations

Refining. Our earnings and cash flows from our refining operations are primarily affected by the difference between refined product prices and the prices for crude oil and other feedstocks, all of which are commodities. The cost to acquire feedstocks and the price of the refined products that we ultimately sell depend on numerous factors beyond our control. These factors include the supply of, and demand for, crude oil, gasoline and other refined products, which in turn depend on changes in domestic and foreign economies; weather conditions; domestic and foreign political affairs; production levels; the availability of imports; the marketing of competitive fuels; and government regulation. While our net sales fluctuate significantly with movements in crude oil and refined product prices, it is primarily the spread between crude oil and refined product prices that affects our earnings and cash flow from our operations. In particular, refining margins were extremely volatile in 2008. Our refining margins decreased during the first six months of 2008 due to substantial increases in crude oil costs and lower increases in gasoline and asphalt prices. In the third quarter of 2008, our crude oil costs declined faster than the prices of finished products leading to improved refining margins during the quarter. In the fourth quarter of 2008, our margins were lower primarily due to reduced gasoline prices compared to crude oil costs, and a non-cash adjustment of $61.0 million to value our Yorktown inventories to net realizable market values as a result of declining crude oil, blendstocks and finished products prices.

In addition, other factors that impact our overall refinery gross margins are the sale of lower value products such as residuum, petroleum coke and propane, particularly when crude costs are higher. In addition, our refinery gross margin is further reduced because our refinery product yield is less than our total refinery throughput volume.

Our results of operations are also significantly affected by our refineries’ direct operating expenses, especially the cost of natural gas used for fuel and the cost of electricity. Natural gas prices have historically been volatile. Typically, electricity prices fluctuate with natural gas prices.

Demand for gasoline is generally higher during the summer months than during the winter months. In addition, higher volumes of ethanol are blended with gasoline produced in the Southwest region during the winter months, thereby increasing the supply of gasoline. This combination of decreased demand and increased supply during the winter months can lower gasoline prices. As a result, our operating results for the first and fourth calendar quarters are generally lower than those for the second and third calendar quarters of each year. The effects of seasonal demand for gasoline are partially offset by increased demand during the winter months for diesel fuel in the Southwest and heating oil in the Northeast. During 2008, the volatility in crude oil prices and refining margins also contributed to the variability of our results of operations for the four calendar quarters.

Safety, reliability and the environmental performance of our refineries’ operations are critical to our financial performance. Unplanned downtime of our refineries generally results in lost refinery gross margin opportunity, increased maintenance costs and a temporary increase in working capital investment and inventory. We attempt to mitigate the financial impact of planned downtime, such as a turnaround or a major maintenance project, through a planning process that considers product availability, margin environment and the availability of resources to perform the required maintenance. Periodically we have planned maintenance turnarounds at our refineries, which are expensed as incurred.

During the fourth quarter of 2008, we performed a maintenance turnaround at the north side of the El Paso refinery at a total cost of $28.9 million, most of which was expensed during that quarter. During the third quarter of 2007, we performed a scheduled maintenance turnaround on the ultraformer unit at the Yorktown refinery at a cost of $13.2 million, most of which was expensed in the same quarter, and incurred costs of $2.7 million in anticipation of the 2008 turnaround at the north side of the El Paso refinery. We performed a planned maintenance turnaround at the El Paso refinery during the first quarter of 2006 at a cost of $22.2 million, which was expensed during that same quarter. We will have a maintenance turnaround during the fall of 2009 at the Yorktown refinery.

The nature of our business requires us to maintain substantial quantities of crude oil and refined product inventories. Because crude oil and refined products are commodities, we have no control over the changing market value of these inventories. Our inventory of crude oil and refined products is valued at the lower of cost or market value under the last-in, first-out, or LIFO, inventory valuation methodology. For periods in which the market price declines below our LIFO cost basis, we are subject to significant fluctuations in the recorded value of our inventory and related cost of products sold. As a result of declining market prices of crude oil, blendstocks and finished products, we recorded a non-cash adjustment of $61.0 million to value our Yorktown inventories to net realizable market values in the fourth quarter of 2008. In addition, due to recent volatility in the price of crude oil and other blendstocks, we have experienced fluctuations in our LIFO reserves during the year ended December 31, 2008. We also experienced LIFO liquidations during the same period based on permanent decreased levels in our inventories. These LIFO liquidations resulted in an increase in costs of products sold of $66.9 million in 2008. See Note 6, “Inventories” in the Notes to Consolidated Financial Statements included in this annual report for detailed information on the impact of LIFO inventory accounting.

Retail. Our earnings and cash flows from our retail business segment are primarily affected by the sales volumes and margins of gasoline and diesel fuel sold, and by the sales and margins of merchandise sold at our service stations and convenience stores. Margins for gasoline and diesel fuel sales are equal to the sales price less the delivered cost of the fuel and motor fuel taxes, and are measured on a cents per gallon, or cpg, basis. Fuel margins are impacted by local supply, demand, and competition. Margins for retail merchandise sold are equal to retail merchandise sales less the delivered cost of the merchandise, net of supplier discounts and inventory shrinkage, and are measured as a percentage of merchandise sales. Merchandise sales are impacted by convenience or location, branding, and competition. Our retail sales are seasonal. Our retail business segment operating results for the first and fourth calendar quarters are generally lower than those for the second and third calendar quarters of each year.

Wholesale. Our earnings and cash flows from our wholesale business segment are primarily affected by the sales volumes and margins of gasoline, diesel fuel and lubricants sold. Margins for gasoline, diesel fuel and lubricants sales are equal to the sales price less cost of sales. Margins are impacted by local supply, demand, and competition.

Factors Impacting Comparability of Our Financial Results

Our historical results of operations for the periods presented may not be comparable with prior periods or to our results of operations in the future for the reasons discussed below.

Acquisition of Giant

On May 31, 2007, we completed the acquisition of Giant. Under the terms of the merger agreement, Western acquired 100% of Giant’s 14,639,312 outstanding shares for $77.00 per share in cash. The transaction was funded through a combination of cash on hand, proceeds from an escrow deposit, and a $1,125.0 million secured term loan. In addition, in connection with the acquisition, we borrowed an additional $275.0 million on July 5, 2007, when we paid off and retired Giant’s 8% and 11% Senior Subordinated Notes. Our statements of operations for the year ended December 31, 2008, include interest expense of $90.1 million, net of $9.9 million of capitalized interest, associated with this term loan and the revolving credit facility, for the twelve months we operated Giant. Interest expense associated with this term loan and the revolving credit facility for the year ended December 31, 2007, was $47.9 million, net of $5.8 million of capitalized interest, for the seven months we operated Giant.

Prior to the acquisition of Giant on May 31, 2007, we generated substantially all of our revenues from our refining operations in El Paso. The financial information for the year ended December 31, 2008, includes the results of operations of the three refineries and the retail and wholesale operations acquired from Giant; however, the financial information for the year ended December 31, 2007, includes only seven months of operations from these assets acquired from Giant. The financial information for 2006 does not include the results of operations of the three refineries and the retail and wholesale operations acquired from Giant.

Write-off of Unamortized Loan Fees

On June 30, 2008, we entered into an amendment to our term loan credit agreement. As a result of such amendment, we recorded an expense of $10.9 million related to the write-off of deferred loan fees incurred in May 2007. See Note 14, “Long-Term Debt” to the Consolidated Financial Statements included in this annual report for detailed information on our long-term debt agreements.

At December 31, 2005, we had a balance of $149.5 million on a term loan facility. In January 2006, we paid off the term loan with proceeds from our initial public offering. In connection with such repayment, we recorded an expense in January 2006 of approximately $2.0 million related to the write-off of deferred financing costs. Our statements of operations for the twelve months ended December 31, 2006, included $0.7 million in interest expense related to this term loan facility.

Matters Arising from the Initial Public Offering

Prior to our initial public offering in January 2006, our operations were conducted by an operating partnership, Western Refining LP. Immediately prior to the closing of our initial public offering, Western Refining LP became an indirect, wholly-owned subsidiary of Western Refining as a result of a series of steps. As a result, we now report our results of operations and financial condition as a corporation on a consolidated basis rather than as an operating partnership.

Prior to the initial public offering, we did not incur income taxes because our operations were conducted by an operating partnership that was not subject to income taxes. Partnership capital distributions were made to our partners to fund the tax obligations resulting from the partners being taxed on their proportionate share of the partnership’s taxable income. As a consequence of our change in structure, we now recognize deferred tax assets and liabilities to reflect net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial and tax reporting purposes. In connection with the change to a corporate holding company structure immediately prior to the closing of our initial public offering, we recorded income tax expense of $8.3 million during 2006 for the cumulative effect of recording our initial net deferred tax liability. The impact of this adjustment decreased diluted earnings per share by $0.13 for the twelve months ended December 31, 2006.

In connection with our initial public offering, we assumed the obligations of one of the partners of Western Refining LP under an equity appreciation rights plan. We terminated such plan in exchange for a cash payment of $28.0 million to the participants in such plan immediately prior to the consummation of the offering. In addition, we granted such participants 1,772,041 restricted shares of our common stock, which vested ratably each quarter for two years, ending in the first quarter of 2008. The fair market value of the restricted stock, determined at the date of grant, was amortized over the vesting period as stock-based compensation expense included in selling, general and administrative expenses.

Planned Maintenance Turnaround

During 2008, we incurred costs of $28.9 million for a maintenance turnaround performed during the fourth quarter of 2008 at the north side of the El Paso refinery. During the third quarter of 2007, we performed a scheduled maintenance turnaround on the ultraformer unit at the Yorktown refinery at a cost of $13.2 million, most of which was expensed in the same quarter and incurred costs of $2.7 million in anticipation of the 2008 turnaround at the north side of the El Paso refinery. We performed a planned maintenance turnaround on the south side of the El Paso refinery during the first quarter of 2006 at a cost of $22.2 million, which was expensed during that same quarter. Most of our competitors, however, capitalize and amortize maintenance turnarounds.

Critical Accounting Policies and Estimates

We prepare our financial statements in conformity with U.S. GAAP. In order to apply these principles, we must make judgments, assumptions and estimates based on the best available information at the time. Actual results may differ based on the accuracy of the information utilized and subsequent events, some of which we may have little or no control over. Our critical accounting policies, which are discussed below, could materially affect the amounts recorded in our financial statements.

Purchase Accounting. We accounted for the acquisition of Giant under the purchase method as required by Statement of Financial Accounting Standard, or SFAS, No. 141, Business Combinations, with Western as the accounting acquirer. In accordance with the purchase method of accounting, the price paid by us for Giant was allocated to the assets acquired and liabilities assumed based upon their estimated fair values at the date of the acquisition. The excess of the purchase price over fair value of the net assets acquired represents goodwill that has been allocated to the reporting units and subject to annual impairment testing. We have performed a purchase price allocation for the acquisition of Giant on May 31, 2007. The fair values of the assets acquired and liabilities assumed were based on management’s evaluations of those assets and liabilities. Management obtained an independent appraisal to assist them in determining these values. See Note 3, “Acquisition of Giant Industries, Inc.” in the Notes to Consolidated Financial Statements included in this annual report for a summary of the purchase price allocation.

Inventories. Crude oil, refined product and other feedstock and blendstock inventories are carried at the lower of cost or market. Cost is determined principally under the LIFO valuation method to reflect a better matching of costs and revenues. Ending inventory costs in excess of market value are written down to net realizable market values and charged to cost of products sold in the period recorded. In subsequent periods, a new lower of cost or market determination is made based upon current circumstances. We determine market value inventory adjustments by evaluating crude oil, refined products and other inventories on an aggregate basis by geographic region. Aggregated LIFO costs exceeded the average cost of our crude oil, refined product and other feedstock and blendstock inventories by $25.6 million, net of a non-cash LCM write-down of $61.0 million, due to the current cost of our Yorktown inventory being lower than market value at December 31, 2008.

Retail refined product (fuel) inventory values are determined using the first-in, first-out, or FIFO, inventory valuation method. Retail merchandise inventory value is determined under the retail inventory method. Wholesale finished product, lubricant and related inventories are determined using the FIFO inventory valuation method. Finished product inventories originate from either our refineries or from third-party purchases.

Maintenance Turnaround Expense. The units at our refineries require regular major maintenance and repairs commonly referred to as “turnarounds.” The required frequency of the maintenance varies by unit but generally is every four years. We expense the cost of maintenance turnarounds when the expense is incurred. These costs are identified as a separate line item in our statement of operations.

Long-Lived Assets. We calculate depreciation and amortization on a straight-line basis over the estimated useful lives of the various classes of depreciable assets. When assets are placed in service, we make estimates of what we believe are their reasonable useful lives. We account for impairment of assets in accordance with SFAS No. 144, Accounting for the Impairment and Disposal of Long-Lived Assets, or SFAS No. 144. We review the carrying values of our long-lived assets for possible impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of assets held and used is measured by a comparison of the carrying value of an asset to future net cash flows expected to be generated by the asset. If the carrying value of an asset exceeds its expected future cash flows, an impairment loss is recognized based on the excess of the carrying value of the impaired asset over its fair value. These future cash flows and fair values are estimates based on our judgment and assumptions. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs of dispositions.

Goodwill and Other Intangible Assets. Goodwill represents the excess of the purchase price (cost) over the fair value of the net assets acquired and is carried at cost. We test goodwill for impairment at the reporting unit level annually. In addition, goodwill of a reporting unit is tested for impairment if any events and circumstances arise during a quarter that indicate goodwill of a reporting unit might be impaired. The reporting unit or units used to evaluate and measure goodwill for impairment are determined primarily from the manner in which the business is managed. A reporting unit is an operating segment or a component that is one level below an operating segment. Within our refining segment, we have determined that we have three reporting units for purposes of assigning goodwill and testing for impairment. Our retail and wholesale segments are considered reporting units for purposes of assigning goodwill and testing for impairment. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets , or SFAS No. 142, we do not amortize goodwill for financial reporting purposes.

We apply SFAS No. 142 in determining the useful economic lives of intangible assets that are acquired. SFAS No. 142 requires that we amortize intangible assets, such as rights-of-way, licenses, and permits over their economic useful lives, unless the economic useful lives of the assets are indefinite. If an intangible asset’s economic useful life is determined to be indefinite, then that asset is not amortized. We consider factors such as the asset’s history, our plans for that asset, and the market for products associated with the asset when the intangible asset is acquired. We consider these same factors when reviewing the economic useful lives of our existing intangible assets as well. We review the economic useful lives of our intangible assets at least annually.

The risk of goodwill and other intangible asset impairment losses may increase to the extent our market capitalization, results of operations, or cash flows decline. Impairment losses may result in a material, non-cash write-down of goodwill or other intangible assets. Furthermore, impairment losses could have a material adverse effect on our results of operations and shareholders’ equity. While we determined that our goodwill was not impaired at December 31, 2008, declines in our market capitalization could be an early indication that goodwill may become impaired in the future.

Environmental and Other Loss Contingencies. We record liabilities for loss contingencies, including environmental remediation costs, when such losses are probable and can be reasonably estimated. Environmental costs are expensed if they relate to an existing condition caused by past operations with no future economic benefit. Estimates of projected environmental costs are made based upon internal and third-party assessments of contamination, available remediation technology, and environmental regulations. Loss contingency accruals, including those for environmental remediation, are subject to revision as further information develops or circumstances change and such accruals can take into account the legal liability of other parties.

As a result of purchase accounting related to the Giant acquisition, the majority of our environmental obligations assumed in the acquisition of Giant are recorded on a discounted basis. Where the available information is sufficient to estimate the amount of liability, that estimate is used. Where the information is only sufficient to establish a range of probable liability and no point within the range is more likely than other, the lower end of the range is used. Possible recoveries of some of these costs from other parties are not recognized in the consolidated financial statements until they become probable. Legal costs associated with environmental remediation, as defined in Statement of Position 96-1, Environmental Remediation Liabilities, are included as part of the estimated liability.

Asset Retirement Obligations. We account for our AROs in accordance with SFAS No. 143, Accounting for Asset Retirement Obligations, or SFAS No. 143, and FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations — an interpretation of FASB Statement No. 143 , or FIN 47. The estimated fair value of the ARO is based on the estimated current cost escalated by an inflation rate and discounted at a credit adjusted risk-free rate. This liability is capitalized as part of the cost of the related asset and amortized using the straight-line method. The liability accretes until we settle the liability. Legally restricted assets have been set aside for purposes of settling certain of the ARO liabilities.

Financial Instruments and Fair Value. We are exposed to various market risks, including changes in commodity prices. We use commodity futures and swap contracts to reduce price volatility, to fix margins for refined products, and to protect against price declines associated with our crude oil and blendstock inventories. All derivatives entered into by us are recognized as either assets or liabilities on the balance sheet and those instruments are measured at fair value. We elected not to pursue hedge accounting treatment for these instruments for financial accounting purposes. Therefore, changes in the fair value of these derivative instruments are included in income in the period of change. Net gains or losses associated with these transactions are recognized in gain (loss) from derivative activities using mark-to-market accounting.

Pension and Other Postretirement Obligations. Pension and other postretirement plan expenses and liabilities are determined based on actuarial valuations. Inherent in these valuations are key assumptions including discount rates, future compensation increases, expected return on plan assets, health care cost trends and demographic data. Changes in our actuarial assumptions are primarily influenced by factors outside of our control and can have a significant effect on our pension and other postretirement liabilities and costs.

In December 2006, we adopted SFAS No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment to FASB Statements No. 87, 88, 106 and 132R , or SFAS No. 158, which requires companies to fully recognize the obligations associated with single-employer defined benefit pension, retiree healthcare, and other postretirement plans in their financial statements. Previous standards required an employer to disclose the complete funded status of its plan only in the notes to the financial statements. Under SFAS No. 158, a defined benefit postretirement plan sponsor must (a) recognize in its statement of financial position an asset for a plan’s overfunded status or liability for the plan’s underfunded status, (b) measure the plan’s assets and obligations that determine its funded status as of the end of the employer’s fiscal year, and (c) recognize, as a component of other comprehensive income, the changes in the funded status of the plan that arise during the year but are not recognized as components of net periodic benefit cost.

Stock-based Compensation. Concurrent with our initial public offering of common stock on January 24, 2006, we adopted SFAS No. 123 (revised), Share-Based Payment , or SFAS No. 123R, to account for stock awards granted under the Western Refining Long-Term Incentive Plan. Under SFAS No. 123R, the cost of the employee services received in exchange for an award of equity instruments is measured based on the grant-date fair value of the award. The fair value of each share of restricted stock awarded is measured based on the market price at closing as of the measurement date and is amortized on a straight-line basis over the respective vesting periods.

Recent Accounting Pronouncements

In September 2006, the FASB published SFAS No. 157, Fair Value Measurements , or SFAS No. 157. SFAS No. 157 is intended to eliminate the diversity in practice that exists due to the different definitions of fair value and the limited guidance for applying those definitions in GAAP that are dispersed among the many accounting pronouncements that require fair value measurements. SFAS No. 157 expands disclosures about the use of fair value to measure assets and liabilities in interim and annual periods subsequent to initial recognition. SFAS No. 157 was effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In February 2007, the FASB issued FASB Staff Position, or FSP, FAS 157-1, and FSP FAS 157-2. FSP FAS 157-1 amends the scope of SFAS No. 157 to exclude SFAS No. 13, Accounting for Leases and other accounting standards that address fair value measurements of leases from the provisions of SFAS No. 157. FSP FAS 157-2 delays the effective date of SFAS No. 157 for most nonfinancial assets and liabilities to fiscal years beginning after November 15, 2008 except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. In October 2008, the FASB issued FSP FAS 157-3. FSP FAS 157-3 clarifies the application of SFAS No. 157 in a market that is not active and key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. We adopted SFAS No. 157 for our financial assets and liabilities in the first quarter of 2008. We believe that FSP FAS 157-1, FSP FAS 157-2, and FSP FAS 157-3 will not have a significant impact on our financial position and results of operations.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations , or SFAS No. 141R, which replaces SFAS No. 141. SFAS No. 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. SFAS No. 141R also establishes disclosure requirements that will enable users to evaluate the nature and financial effects of the business combination. For us, SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after January 1, 2009. We believe SFAS No. 141R will not have a significant impact on our financial position and results of operations.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133 , or SFAS No. 161. The new standard requires additional disclosures regarding a company’s derivative instruments and hedging activities by requiring qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. It also requires disclosure of derivative features that are credit risk-related as well as cross-referencing within the notes to the financial statements to enable financial statement users to locate important information about derivative instruments, financial performance, and cash flows. The standard is effective for us beginning January 1, 2009. The principal impact from this standard will be to require us to expand our disclosures regarding our derivative instruments.

On April 25, 2008, the FASB issued or FSP FAS 142-3, Determination of the Useful Life of Intangible Assets, or FSP FAS 142-3. The guidance is intended to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141R, and other guidance under U.S. GAAP. FSP FAS 142-3 is effective for us beginning January 1, 2009. We are currently evaluating the potential impact, if any, of FSP FAS 142-3 on our financial position and results of operations.

On June 16, 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities or FSP EITF 03-6-1. The statement addresses unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents and states that they are participating securities and should be included in the computation of earnings per share pursuant to the two-class method. FSP EITF 03-6-1 is effective for us beginning January 1, 2009, and interim periods after that. We believe FSP EITF 03-6-1 will not have a significant impact on our determination of earnings per share.


MANAGEMENT DISCUSSION FOR LATEST QUARTER

Company Overview

We are an independent crude oil refiner and marketer of refined products and also operate service stations and convenience stores. We own and operate four refineries with a total crude oil throughput capacity of approximately 238,000 barrels per day, or bpd. In addition to our 128,000 bpd refinery in El Paso, Texas, we also own and operate a 70,000 bpd refinery on the East Coast of the United States near Yorktown, Virginia and two refineries in the Four Corners region of Northern New Mexico with a combined throughput capacity of 40,000 bpd. Our primary operating areas encompass West Texas, Arizona, New Mexico, Utah, Colorado, and the Mid-Atlantic region. In addition to the refineries, we also own and operate stand-alone refined products terminals in Flagstaff, Arizona and Albuquerque, New Mexico, as well as asphalt terminals in Phoenix, Arizona; Tucson, Arizona; Albuquerque; and El Paso. As of March 31, 2009, we also own and operate 152 retail service stations and convenience stores in Arizona, Colorado and New Mexico, a fleet of crude oil and refined product truck transports, and a wholesale petroleum products distributor, that operates in Arizona, California, Colorado, Nevada, New Mexico, Texas, and Utah.
We report our operating results in three business segments: the refining group, the retail group, and the wholesale group. Our refining group operates the four refineries and related stand-alone refined products terminals and asphalt terminals. At the refineries, we refine crude oil and other feedstocks into refined products such as gasoline, diesel fuel, jet fuel, and asphalt. Our refineries market refined products to a diverse customer base including wholesale distributors and retail chains. Our retail group operates service stations and convenience stores and sells gasoline, diesel fuel, and merchandise. Our wholesale group distributes gasoline, diesel fuel, and lubricant products. See Note 3, “Segment Information” in the Notes to Condensed Consolidated Financial Statements included in this quarterly report for detailed information on our operating results by segment.
Since the acquisition of Giant in 2007, we have increased our sour and heavy crude oil processing capacity as a percent of our total crude oil capacity from 12% prior to the acquisition to approximately 38% as of March 31, 2009. Sour and heavy crude oil is generally less expensive to acquire. We expect our combined sour and heavy crude oil processing capability to reach approximately 50% by the end of 2009, following the completion of our previously announced gasoline desulfurization project at our El Paso refinery. The Yorktown refinery also has the flexibility for future growth initiatives given its ability to process cost-advantaged feedstocks. With the acquisition, we also gained a diverse mix of complementary retail and wholesale businesses.
In 2005, Giant purchased an inactive pipeline running from Southeast New Mexico to Northwest New Mexico. The pipeline has been reversed and upgraded to transport crude oil from Southeast New Mexico to the Four Corners region. Crude oil began pumping into this pipeline in July 2007 and reached the Four Corners refineries in August 2007. This pipeline, combined with rail deliveries, is capable of providing enough feedstock for our two Four Corners refineries to run at increased capacity rates. Based on seasonally lower product demand in the Four Corners area in the winter months and to manage our working capital, we have removed the crude oil from the pipeline. We will continue to evaluate future demand and alternative sources of crude oil to determine when the pipeline will be returned to service. See Item 1A. “Risk Factors — We may not be able to run our Four Corners refineries at increased rates ” in our 2008 Form 10-K.

Major Influences on Results of Operations
Refining . Our earnings and cash flows from our refining operations are primarily affected by the difference between refined product prices and the prices for crude oil and other feedstocks, all of which are commodities. The cost to acquire feedstocks and the price of the refined products that we ultimately sell depend on numerous factors beyond our control. These factors include the supply of, and demand for, crude oil, gasoline and other refined products, which in turn depend on changes in domestic and foreign economies; weather conditions; domestic and foreign political affairs; production levels; the availability of imports; the marketing of competitive fuels; and government regulation. While our net sales fluctuate significantly with movements in crude oil and refined product prices, it is primarily the spread between crude oil and refined product prices that affects our earnings and cash flow from our operations. In particular, refining margins were extremely volatile in 2008. Our refining margins were lower during the first quarter of 2008 (as compared to the same period in 2009) due to substantial increases in crude oil costs and lower increases in gasoline and asphalt prices. Our refining margins were higher throughout much of the first quarter of 2009 as a result of refined product prices, particularly gasoline, increasing faster than the price of crude oil. In addition, we had a change in the LCM reserve from December 31, 2008 to March 31, 2009 of $11.0 million to value our Yorktown inventories to net realizable market values as a result of increasing crude oil, blendstocks and refined products prices, which also increased our refining margins.
In addition, other factors that impact our overall refinery gross margins are the sale of lower value products such as residuum, petroleum coke and propane, particularly when crude costs are higher. In addition, our refinery gross margin is further reduced because our refinery product yield is less than our total refinery throughput volume.
Our results of operations are also significantly affected by our refineries’ direct operating expenses, especially the cost of natural gas used for fuel and the cost of electricity. Natural gas prices have historically been volatile. Typically, electricity prices fluctuate with natural gas prices.
Demand for gasoline is generally higher during the summer months than during the winter months. In addition, higher volumes of ethanol are blended with gasoline produced in the Southwest region during the winter months, thereby increasing the supply of gasoline. This combination of decreased demand and increased supply during the winter months can lower gasoline prices. As a result, our operating results for the first and fourth calendar quarters are generally lower than those for the second and third calendar quarters of each year. The effects of seasonal demand for gasoline are partially offset by increased demand during the winter months for diesel fuel in the Southwest and heating oil in the Northeast.
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BUSINESS OVERVIEW

We are a biotechnology company focused on the development and commercialization of unique products to address the unmet medical needs of patients with chronic and life-threatening cardiovascular and infectious diseases and cancer.

Our key therapeutic platforms are:

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Prostacyclin Analogues , which are stable synthetic forms of prostacyclin, an important molecule produced by the body that has powerful effects on blood vessel health and function. Our lead prostacyclin analogue is Remodulin®, a treprostinil-based compound for the treatment of cardiovascular disease. Remodulin (treprostinil sodium) Injection has been approved by the U.S. Food and Drug Administration (FDA) for the treatment of pulmonary arterial hypertension (PAH) in patients with New York Heart Association (NYHA) Class II-IV (moderate to severe) symptoms to diminish symptoms associated with exercise. Remodulin has been approved in most of Europe for the treatment of NYHA Class III patients with idiopathic (familial) PAH and in other countries for use similar to that for which it is approved in the United States. Our inhaled and oral formulations of treprostinil are in the later stages of development. A New Drug Application (NDA) for our inhaled formulation is currently under review by the FDA and a Marketing Authorization Application (MAA) is currently under review by the European Medicines Agency (EMEA). We are also developing modified release beraprost (beraprost-MR), another prostacyclin analogue, for the treatment of PAH;

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Phosphodiesterase 5 (PDE5) inhibitors , which act to inhibit the degradation of cyclic guanosine monophosphate (cGMP) in cells. CGMP is activated by nitric oxide (NO) to signal relaxation of vascular smooth muscle. Our investigational therapy in this platform is tadalafil, a product developed by Eli Lilly and Company (Lilly). Lilly's NDA for tadalafil for the treatment of PAH is currently under review by the FDA. We entered into a license agreement with Lilly to obtain certain rights to tadalafil for PAH, effective December 18, 2008;

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Monoclonal Antibodies , which are antibodies that activate patients' immune systems to treat cancer. Our platform includes the 3F8 and 8H9 murine antibodies, which we are developing for the treatment of neuroblastoma and metastatic brain cancer, respectively. We expect to begin a Phase II clinical trial in the second quarter of 2009 of the 3F8 antibody in patients with neuroblastoma; and

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Glycobiology Antiviral Agents , which are a novel class of small, sugar-like molecules that have shown pre-clinical indications of efficacy against a broad range of viruses, such as hepatitis C.

We devote most of our resources to developing products within our key therapeutic platforms. We also devote resources to the commercialization and further development of telemedicine products and services, principally for the detection of cardiac arrhythmias (abnormal heart rhythms).

We generate revenues from the sale of Remodulin and telemedicine products and services. Our sales and marketing staff for Remodulin, which is supplemented by our specialty pharmaceutical distributors, supports the commercial availability of Remodulin in the United States, Canada, Europe and other countries.

United Therapeutics was incorporated in Delaware in June 1996. Our principal executive offices are located at 1110 Spring Street, Silver Spring, Maryland 20910. We also maintain executive offices at 55 T.W. Alexander Drive, Research Triangle Park, North Carolina 27709.

Remodulin

Our lead product for treating PAH is Remodulin (treprostinil sodium) Injection, the main ingredient of which is treprostinil sodium, a prostacyclin analogue. We sell Remodulin to our specialty pharmaceutical distributors in the United States at a discount from an average wholesale price recommended by us, and to our international distributors at a transfer price set by us. We recognized approximately $269.7 million, $200.9 million and $152.5 million in Remodulin revenues, representing 96%, 95% and 96% of our net revenues in 2008, 2007 and 2006, respectively. We obtained worldwide rights for all indications to Remodulin from GlaxoSmithKline PLC (formerly Glaxo Wellcome, Inc.) (Glaxo) in January 1997 and from Pfizer, Inc. (formerly Pharmacia & Upjohn Company)(Pfizer) in December 1996. In May 2002, Remodulin was approved by the FDA as a continuous subcutaneous (under the skin) infusion for the treatment of PAH in patients with NYHA Class II-IV (moderate to severe) symptoms. In November 2004, the FDA expanded its approval to permit continuous intravenous (through a vein) infusion for patients who cannot tolerate subcutaneous infusion. In March 2006, the FDA expanded its approval to include transition of patients to Remodulin from Flolan® (epoprostenol), the first FDA-approved prostacyclin for PAH. Remodulin is also approved as a continuous subcutaneous infusion treatment for various forms of PAH in 33 countries throughout the world, and as a continuous intravenous infusion treatment for various forms of PAH in Canada, Israel, Mexico, Peru and Argentina. Applications for approval for both subcutaneous and intravenous Remodulin infusion are under review in many other countries. We continue to work on expanding Remodulin commercialization to other new territories, including Japan.

PAH is a life-threatening disease that affects the blood vessels in the lungs and is characterized by increased blood pressure in the blood vessels leading from the heart to the lungs, known as the pulmonary arteries. The elevated pressure in the pulmonary arteries strains the right side of the heart as it pumps blood to the lungs leading to right heart failure and death. PAH is characterized by the disruption of blood vessel walls, the aggregation of platelets and the alteration of smooth muscle function. It is estimated that PAH affects between 100,000 and 200,000 individuals worldwide. In recent years, as awareness of PAH has grown, we have seen an increase in the number of people diagnosed with the disease. However, because of the rarity of PAH and the complexity of diagnosing it, only a small fraction of patients with PAH are being treated. There is scientific interest in identifying easier, less invasive methods of diagnosing PAH. If this research is successful, more patients could be diagnosed at an earlier stage of the disease.

The complexity of diagnosing PAH reflects in part the current uncertainties surrounding the etiology and pathophysiology of the condition. Currently, treatment of PAH focuses on three distinct molecular pathways that have been implicated in the disease process. These are the endothelin pathway, the NO pathway, and the prostacyclin pathway. Patients with PAH have been shown to have elevated levels of endothelin, a naturally occurring substance in the body that causes constriction of the pulmonary blood vessels. Therefore, one established therapeutic approach has been to block the action of endothelin with drugs that are known as endothelin receptor antagonists (ERAs). Patients with PAH have also been shown to have reduced levels of the enzyme responsible for producing NO, a naturally occurring substance in the body that has the effect of relaxing pulmonary blood vessels. NO produces this effect by increasing intracellular levels of an intermediary known as cGMP. Therefore, another established therapeutic approach has been to inhibit the degradation of cGMP, using drugs that are termed Phosphodiesterase 5 (PDE5) inhibitors. Finally, patients with PAH have been shown to have reduced levels of prostacyclin, a naturally occurring substance that has the effect of relaxing the pulmonary blood vessels, preventing platelet aggregation, and inhibiting the proliferation of smooth muscle cells in pulmonary vessels. Therefore, drugs that mimic the action of prostacyclin, termed prostacyclin analogues, are also established PAH treatments. Because any or all of these three pathways may be operative in a patient, these three classes of drugs are used alone or in combination to treat patients with PAH. We currently market Remodulin, a prostacyclin analogue, and are awaiting FDA approval to market tadalafil, a PDE5 inhibitor, for the treatment of pulmonary hypertension.

A long-term outcome study published in the European Respiratory Journal (vol. 28, Number 6; December 2006) demonstrated improved survival with Remodulin therapy when compared to predicted survival (NIH registry formula) over a four-year period. One-, two-, three- and four-year survival was 87%, 78%, 71%, and 68%, respectively, for all 860 patients in the study (including 130 patients who received Remodulin in combination with other PAH therapies) and 88%, 79%, 73%, and 70%, respectively, for 730 of the patients in the study who received only Remodulin. In patients with idiopathic PAH for whom baseline hemodynamics (measurement of bloodflow and pressures) were available (332 patients), survival was 91%, 82%, 76%, and 72% at years one through four, respectively. This compares to respective predicted survival estimates of 69%, 56%, 46%, and 38% over the four-year period based on the NIH registry formula.

Flolan, the first FDA-approved prostacyclin analogue for PAH, is delivered continuously through a surgically implanted intravenous catheter connected to an external pump. Flolan is approved for the treatment of patients with certain subsets of late-stage PAH. We believe Remodulin provides patients with a less invasive alternative to Flolan. In contrast to Flolan, Remodulin is stable at room temperature and lasts significantly longer inside the human body. These attributes allow for safer and more convenient drug delivery to patients. Unlike Flolan, Remodulin can be delivered by subcutaneous infusion with a pager-sized miniature pump device. Subcutaneous delivery of Remodulin also eliminates the risk of central venous catheter infection and the hospitalization required to begin intravenous infusion. Remodulin's extended presence in the body may also reduce the risk of rebound PAH, and possibly death, if treatment is abruptly interrupted. The stability of Remodulin also allows it to be packaged as an aqueous solution, so patients do not have to mix the drug, as they do with Flolan. Remodulin can be continuously infused for up to 48 hours before refilling the infusion pump, unlike Flolan, which must be mixed and refilled every 24 hours. Treprostinil sodium, the active ingredient in Remodulin, is highly soluble in an aqueous solution and therefore Remodulin can be manufactured at highly concentrated solutions. This allows therapeutic concentrations of Remodulin to be delivered at low flow rates via miniaturized infusion pumps for both subcutaneous and intravenous infusion. Lastly, Remodulin does not require the patient to continuously keep the drug cool even during infusion. This eliminates the need for cooling packs or refrigeration to keep it stable, as is required with Flolan due to Flolan's chemical instability at room temperature. In June 2008, the FDA approved a generic version of Flolan, developed by GeneraMedix, Inc., that is stable at room temperature, but still shares all of Flolan's other inconvenient attributes including, but not limited to, risk of central venous catheter infection, required hospitalization at the start of treatment, shorter half-life increasing risk of rebound PAH, mixing, greater frequency of pump refills and larger pump size.

There are noteworthy adverse events associated with Remodulin infusion. When infused subcutaneously, Remodulin causes infusion site pain and reaction (redness and swelling) in most patients to varying degrees. Patients who cannot tolerate subcutaneous Remodulin may instead use it intravenously. Intravenous Remodulin is delivered continuously by an external pump through a surgically implanted central venous catheter, similar to Flolan. When delivered intravenously, Remodulin bears the risk of a serious bloodstream infection known as sepsis, as does Flolan.

FDA Review of Subcutaneous Remodulin

In March 2000, we completed an international, randomized, placebo-controlled, double-blind study of subcutaneous Remodulin involving a total of 470 patients with PAH. Half of the patients received Remodulin subcutaneously for 12 weeks, while the other half received a placebo. The study data showed that patients who received Remodulin had significant improvement in important clinical endpoints. These clinical endpoints included a composite index that measured exercise capacity and shortness of breath, cardiopulmonary hemodynamics and the signs and symptoms of the disease. Based on the favorable results of this study, we filed an NDA with the FDA in late 2000. In May 2002, the FDA approved Remodulin, under Subpart H regulations, as a continuous subcutaneous infusion for the treatment of PAH in patients with NYHA class II-IV symptoms to diminish symptoms associated with exercise. Remodulin may be prescribed for all types of PAH and is the only PAH treatment approved for patients with NYHA class II-IV symptoms.

FDA Review of Intravenous Remodulin

In July 2003, the FDA accepted our Investigational NDA for the development of Remodulin by intravenous delivery for the treatment of PAH. A study in volunteers was performed in late 2003, which established that intravenous and subcutaneous Remodulin are bioequivalent (meaning that both routes of infusion result in comparable levels of Remodulin in the blood). In addition, animal toxicology studies were completed and indicated that there were no additional safety concerns associated with chronic intravenous infusion.

On January 30, 2004, we filed a supplemental NDA with the FDA to request approval for intravenous use of Remodulin for PAH. On November 24, 2004, based on data establishing intravenous Remodulin's bioequivalence with the previously approved subcutaneous administration of Remodulin, the FDA approved the intravenous use of Remodulin for those not able to tolerate subcutaneous infusion.

On March 20, 2006, the FDA approved a supplemental NDA that we filed to satisfy of our Subpart H commitment from our original May 2002 approval for subcutaneous Remodulin. This approval added language to Remodulin's package insert indicating patients can be transitioned from Flolan to Remodulin.

In January 2007, the results of a prospective, open-label study demonstrated that rapid transition from intravenous Flolan to intravenous Remodulin was achieved in 12 PAH patients with no serious adverse events and baseline clinical status was maintained over 12 weeks. The patients were transitioned from Flolan to intravenous Remodulin by a direct switch from a Flolan medication cassette to a Remodulin medication cassette. All patients reported fewer prostacyclin-related side effects with Remodulin and remained on Remodulin after study completion. The study demonstrated that stable patients with PAH can be safely transitioned from Flolan to intravenous Remodulin using a rapid switch protocol.

Although intravenous Remodulin does not possess all the safety and convenience benefits of subcutaneous Remodulin, it has one important advantage: it eliminates infusion site pain and reaction, a common side effect of subcutaneous Remodulin. Many patients are unsuccessful in managing their infusion site pain even when using available pain management techniques or medication. Intravenous Remodulin has many beneficial characteristics that differentiate it from intravenous Flolan. Intravenous Remodulin does not require refrigeration whereas Flolan must be refrigerated. Furthermore, Remodulin persists in the blood for a few hours, whereas Flolan is highly unstable and only remains active in the body for a few minutes. Because Remodulin persists in the body longer, it may reduce the risk of rebound PAH, a severe recurrence of the disease that can occur when therapy is abruptly interrupted. Intravenous Remodulin can be infused continuously for up to 48 hours once the administering pump has been filled, while Flolan can only be infused for 24 hours once the drug has been mixed and the administering pump filled. This allows patients to fill their pumps with medication every other day as opposed to daily. Also, because Remodulin can be made in highly concentrated solutions, a wide variety of pump options, including miniaturized pumps, is available to patients.

In February 2007, the Scientific Leadership Committee (SLC) of the Pulmonary Hypertension Association announced new guidelines related to the treatment of PAH patients on long-term intravenous therapy. The SLC guidelines were issued in response to the release of a slide presentation prepared by researchers with the U.S. Centers for Disease Control and Prevention (CDC) entitled, Bloodstream infections among patients treated with intravenous epoprostenol and intravenous treprostinil for pulmonary arterial hypertension, United States 2004—2006 . These slides accompanied a presentation to the SLC and were subsequently published in the March 2, 2007, issue of the CDC's Morbidity and Mortality Weekly Report . The slides and report were prepared in connection with a CDC retrospective inquiry at seven centers into a report of increased blood stream infections (sepsis), particularly gram-negative blood stream infections, among PAH patients treated with intravenous Remodulin as compared to intravenous Flolan. The SLC guidelines noted that the CDC observations were hypothesis-generating and did not permit definitive or specific conclusions. The SLC reminded physicians of the need to be aware of the range of possible gram-negative and gram-positive infectious organisms in patients with long-term central venous catheters and to treat them appropriately. The risk of sepsis was already noted in the Remodulin package insert. In February 2008, the FDA approved a revised package insert for Remodulin that more fully described the associated infection risk and appropriate techniques to be practiced when preparing and administering Remodulin for intravenous infusion.

International Regulatory Review of Subcutaneous and Intravenous Remodulin

Remodulin for subcutaneous use is approved in countries throughout the world. We used the mutual recognition process to obtain approval of subcutaneous Remodulin in the EU. The mutual recognition process is described more fully in the section entitled Governmental Regulation below. The mutual recognition process for subcutaneous Remodulin was completed in August 2005, with positive decisions received from most EU member countries. We withdrew our applications in Ireland, Spain and the United Kingdom following a request for additional documentation from these countries. We anticipate resubmitting these applications following approval of intravenous Remodulin in the EU. Licenses and pricing approvals have been received in most EU member countries. In addition, we have submitted a variation of the license for approval of intravenous Remodulin in the EU through the mutual recognition process, as we are required to follow the same approval process used for the approval of subcutaneous Remodulin. The license variation for intravenous Remodulin is currently under review by the host nation, France, which has notified us that it is not currently satisfied with our application. We are working to address their concerns and believe that we will eventually receive commercial approval for intravenous Remodulin in at least some EU member countries. In the meantime, we will continue to sell (but not market) Remodulin under the named-patient system in EU member countries where we are not approved. Under the named-patient system, we are permitted to import Remodulin into EU member countries for sale to hospitals for use in treating specifically identified patients.

Sales and Marketing

Our marketing strategy for Remodulin is to use our sales and marketing teams to educate the prescriber community to increase PAH awareness and awareness of our products. The sales and marketing team consisted of approximately 80 employees as of December 31, 2008, up from approximately 65 employees as of December 31, 2007. We anticipate continued growth in our sales force in the near-term as we position our business for further expansion. We divide our domestic sales force into two teams. One sales team is primarily responsible for medical practice accounts that are historical Remodulin prescribers. The other sales team is primarily responsible for medical practice accounts that have not historically prescribed Remodulin. The efforts of our sales and marketing teams are supplemented by our specialty pharmaceutical distributors. For additional information about our agreements with our distributors, see the next section entitled Domestic Distribution of Remodulin . Our distributors are experienced in all aspects of using and administering chronic therapies, as well as patient care, the sale and distribution of these medicines and reimbursement from insurance companies and other payers. Outside of the United States, we have entered into exclusive distribution agreements covering most of Europe, South America, Israel, and parts of Asia. Sales in Canada are currently conducted under the management of our wholly-owned subsidiary, Unither Biotech Inc., through a national specialty pharmaceutical wholesaler. We are working with our current distributors to expand Remodulin sales into other countries in which they have distribution rights.

Domestic Distribution of Remodulin

To market, promote and distribute subcutaneous and intravenous Remodulin through specialty pharmaceutical distributors in the United States, we entered into non-exclusive distribution agreements with CuraScript, Inc. (a wholly-owned subsidiary of Express Scripts, Inc., formerly Priority Healthcare Corporation) (CuraScript), Accredo Therapeutics, Inc. (a wholly-owned subsidiary of Medco Health Solutions, Inc.) (Accredo) and CVS Caremark Corporation (Caremark). Effective January 1, 2007, Accredo also became the exclusive U.S. distributor for Flolan. Our distributors are responsible for assisting patients with obtaining reimbursement for the cost of Remodulin therapy and providing other support services. Under our distribution agreements, we sell Remodulin to our distributors at a discount from an average wholesale price recommended by us. Our distribution agreements with Accredo and Caremark include automatic term renewals for additional one-year periods subject to notice of termination. Our distribution agreement with Curascript contains two-year term renewal periods. We update our distribution agreements from time to time to reflect changes in the regulatory environment. These changes have not had a significant impact on our operations or our relationships with our distributors, and tend to occur in the ordinary course of business. If our distribution agreements expire or terminate, we may, under certain circumstances, be required to repurchase any unsold Remodulin inventory held by our distributors. We have also established a patient assistance program in the United States, which provides qualified uninsured or underinsured patients with Remodulin at no charge. None of our current agreements grants our distributors the distribution rights for inhaled or oral treprostinil in the United States.

International Distribution of Remodulin

We currently sell Remodulin to six distributors who have certain exclusive distribution rights for subcutaneous and intravenous Remodulin in EU member countries, and other non-EU countries, such as South America, Israel and parts of Asia. In the European markets where we are not licensed, we sell (but do not market) Remodulin under the named-patient system in which patients typically are approved for therapy on a case by case review by a national medical review board. We are working on expanding our sales of subcutaneous and intravenous Remodulin into new territories outside of the United States through our existing distributors and by creating relationships with new distributors. In March 2007, we entered into a distribution agreement with Mochida Pharmaceutical Co., Ltd. (Mochida) to obtain approval and exclusively distribute subcutaneous and intravenous Remodulin in Japan. In addition, Grupo Ferrer Internacional, S.A. (Grupo Ferrer) has been actively working toward commencing commercial sales of Remodulin in Taiwan and South Korea. However, certain countries, like Japan, may require that new clinical trials, called bridging studies, be conducted in order to demonstrate the efficacy and safety of a drug in their patient population. Commercial sales in such countries could therefore be several years from realization.

Inhaled Treprostinil

We are working to gain approval of an inhaled formulation of treprostinil for the treatment of PAH. During 2004 and 2005, independent clinical investigators in Europe and the United States performed small uncontrolled trials of inhaled formulations of treprostinil in patients with PAH. In April 2004, the EMEA granted orphan designation for inhaled treprostinil for the treatment of both PAH and chronic thromboembolic pulmonary hypertension. We also plan to seek orphan drug designation for inhaled treprostinil in the United States. If successful, we will be granted a seven-year period of orphan drug exclusivity for inhaled treprostinil that will begin upon the approval of our NDA.


CEO BACKGROUND

Ray Kurzweil Age 61

Mr. Kurzweil is an inventor, entrepreneur and author, and has created several important technologies in the artificial intelligence field. He has received the National Medal of Technology, the MIT-Lemelson Prize, eighteen honorary doctorates and honors from three U.S. Presidents. Mr. Kurzweil was selected as a 2002 inductee into the National Inventors Hall of Fame. Since 1995, Mr. Kurzweil has served as the Chief Executive Officer of Kurzweil Technologies, Inc., a technology development firm. He has served as a United Therapeutics director since 2002.


Martine Rothblatt, Ph.D., J.D., M.B.A. Age 54

Chairman Dr. Rothblatt started United Therapeutics in 1996 and has served as Chairman and Chief Executive Officer since its inception. Prior to creating United Therapeutics, she launched several satellite communications companies. She also represented the radio astronomy interests of the National Academy of Sciences' Committee on Radio Frequencies before the FCC and led the International Bar Association's efforts to present the United Nations with a draft Human Genome Treaty. Her book, YOUR LIFE OR MINE: HOW GEOETHICS CAN RESOLVE THE CONFLICT BETWEEN PUBLIC AND PRIVATE INTERESTS IN XENOTRANSPLANTATION , was published by Ashgate in 2004. She is a co-inventor on three of our patents pertaining to treprostinil. She has served as a United Therapeutics director since 1996.

Louis Sullivan, M.D. Age 75 Member, Compensation Committee Member, Nominating and Governance Committee
Dr. Sullivan currently serves as a Director of Henry Schein, Inc., BioSante Pharmaceuticals, Inc., and Emergent BioSolutions, Inc., all publicly traded companies. Dr. Sullivan was the founding President of Morehouse School of Medicine, from 1981 to 1989 and 1993 to 2002, and he became President Emeritus of Morehouse School of Medicine in July 2002. Dr. Sullivan was also founder and Chairman of Medical Education for South African Blacks, Inc., a member of the National Executive Council for the Boy Scouts of America, and a member of the Board of Trustees of the Little League of America. Dr. Sullivan served as Secretary of the United States Department of Health and Human Services from 1989 to 1993. He has served as a United Therapeutics director since 2002.


Directors Continuing in Office

Christopher Causey, M.B.A. Age 46 Chairman, Compensation Committee Member, Audit Committee
Mr. Causey has served as the Principal of Causey Consortium, a professional services organization providing business strategy and marketing counsel to the healthcare industry, since 2002. Previously, Mr. Causey served as a senior marketing officer for a variety of healthcare and technology companies. From 2001 to 2002, Mr. Causey served as the Chief Marketing Officer for Definity Health Incorporated. Mr. Causey has served as a United Therapeutics director since 2003, and his current term expires in 2010.

Raymond Dwek, F.R.S. Age 67 Member, Nominating and Governance Committee
Professor Dwek is a Fellow of the Royal Society, London, and currently serves as Director of the Glycobiology Institute, Professor of Glycobiology at the University of Oxford and as the President of the Institute of Biology. From 2000 to 2006, Professor Dwek served as head of the Department of Biochemistry at the University of Oxford. Professor Dwek has been serving in various positions at the University of Oxford since 1966. In 1988, Professor Dwek was the scientific founder of Oxford GlycoSciences PLC, which was publicly traded on the London Stock Exchange and NASDAQ, and he served as a member of its Board of Directors until its sale in 2003. He was the 2008 Kluge Chair of Technology and Society at the U.S. Library of Congress. Professor Dwek is considered the founder of glycobiology. He has served as a United Therapeutics director since 2002, and his current term expires in 2011.


Richard Giltner Age 45
Mr. Giltner has over twenty years of experience in the financial sector. His areas of expertise include international financial markets, financial derivatives, alternative investments and asset management. Prior to beginning a one-year sabbatical on October 15, 2008, Mr. Giltner served as a managing director of Société Générale Asset Management and head of the European office for its fund of hedge funds group, a position he has held since 2006. From 2003 to 2006, Mr. Giltner was the global head of foreign exchange options for the investment banking arm of Société Générale. He has also held various other managerial positions with Société Générale since joining the company in 1991. Mr. Giltner was appointed to the Board of Directors on April 29, 2009, and his current term expires in 2010.

R. Paul Gray Age 45 Chairman, Audit Committee Member, Compensation Committee
Mr. Gray serves as the Managing Member of Core Concepts, LLC, a strategic and financial consulting firm, which he founded in 2002. Mr. Gray currently serves as Chairman of the Board of Red Branch Technologies, Inc. and Critical Solutions, Inc., and is a member of the Board of Directors of C'Watre International, Inc. Until recently, Mr. Gray had served on the board of directors of several companies including Elevated Security, Inc., a private energy solutions company, and of TenthGate, Inc., a public medical holding company. From May 2004 to May 2005, Mr. Gray served a one-year term as a director of Earth Search Sciences, Inc., a publicly traded company. From 2003 to November 2004, Mr. Gray served as a director of Vertica Software, Inc., a publicly traded company until the completion of a merger transaction in November 2004. From September 2001 to May 2004, Mr. Gray served as Director and Chief Financial Officer of Power3 Medical Products, Inc., a publicly traded company. From 1985 to 1999, Mr. Gray practiced as a Certified Public Accountant at Ernst & Young LLP, KPMG LLP and Beers & Cutler LLP. The Board of Directors has determined that he is an audit committee financial expert as defined under the rules and regulations of the Securities and Exchange Commission and meets the financial sophistication requirement of the listing standards of the NASDAQ. He has served as a United Therapeutics director since 2003 and his current term expires in 2010.

Roger Jeffs, Ph.D. Age 47
Dr. Jeffs joined United Therapeutics in September 1998 as Director of Research, Development and Medical. Dr. Jeffs was promoted to Vice President of Research, Development and Medical in July 2000, and to President and Chief Operating Officer in January 2001. From 1995 to 1998, Dr. Jeffs worked at Amgen, Inc. where he served as the worldwide clinical leader of the Infectious Disease Program. Dr. Jeffs currently leads the clinical development, commercial and business development efforts at United Therapeutics. He has served as a United Therapeutics director since 2002, and his current term expires in 2011.

Christopher Patusky, J.D., M.G.A. Age 45 Vice Chairman Lead Director
Chairman, Nominating and Governance Committee Member, Audit Committee
Since August 2007, Prof. Patusky has served as Director, Office of Real Estate, for the Maryland Department of Transportation, where he is responsible for overseeing the Department's real estate matters statewide, including its transit-oriented development program. From 2002 until May 2007, Prof. Patusky served as the Executive Director and a member of the faculty of the Fels Institute of Government at the University of Pennsylvania. He has served as a United Therapeutics director since 2002, and his current term expires in 2011.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

We are a biotechnology company focused on the development and commercialization of unique products to address the unmet medical needs of patients with chronic and life-threatening cardiovascular and infectious diseases and cancer. Since our inception in June 1996, we have devoted substantially all of our resources to research and development programs and acquisitions.

Our key therapeutic platforms include:

•
Prostacyclin analogues: stable synthetic forms of prostacyclin, an important molecule produced by the body that has powerful effects on blood vessel health and function;

•
Phosphodiesterase 5 (PDE5) inhibitors: molecules that act to inhibit the degradation of cyclic guanosine monophosphate (cGMP) in cells. cGMP is activated by nitric oxide (NO), a naturally occurring substance in the body that signals the relaxation of vascular smooth muscle;

•
Monoclonal antibodies: antibodies that activate patients' immune systems to treat cancer; and

•
Glycobiology antiviral agents: a novel class of small, sugar-like molecules that have shown pre-clinical indications of efficacy against a broad range of viruses, such as hepatitis C.

We focus most of our resources on these key therapeutic platforms. In addition, we devote resources to the commercialization and development of telemedicine products and services, principally for the detection of cardiac arrhythmias (abnormal heart rhythms).

We began generating pharmaceutical revenues in 2002 upon receiving approval from the United States Food and Drug Administration (FDA) for our lead product, Remodulin® (treprostinil sodium) Injection (Remodulin) to be administered via subcutaneous (under the skin) infusion for the treatment of pulmonary arterial hypertension (PAH). Since 2002, the FDA has expanded its approval of Remodulin for intravenous (in the vein) use and for the treatment of patients who require transition from Flolan®. In addition to the United States, Remodulin is approved in many other countries worldwide, primarily for subcutaneous use. In June 2008, we filed a new drug application (NDA) with the FDA for our inhaled formulation of treprostinil. In December 2008, we filed a Marketing Authorization Application (MAA) for inhaled treprostinil with the European Medicines Agency (EMEA) using the centralized filing process.

Revenues

We derive substantially all of our revenues from the sale of Remodulin.

Our sales and marketing team included approximately 80 employees as of December 31, 2008, up from approximately 65 employees as of December 31, 2007. We anticipate continued growth in our sales force in the near-term as we continue to position our business for expansion. We divide our sales force into two teams. One sales team is primarily responsible for medical practice accounts that are historical Remodulin prescribers. The other sales team focuses on medical practices that have not historically prescribed Remodulin. In addition, our specialty pharmaceutical distributors supplement the efforts of our sales force. The market in which we operate is highly competitive. We face stiff competition from other companies that market and sell competing therapies, and we expect competition to increase in the future.

Our domestic distributors, Accredo Therapeutics, Inc. (Accredo), CuraScript, Inc. (CuraScript), and CVS Caremark Corporation (Caremark), sell Remodulin to patients in the United States. We also engage various international distributors to sell Remodulin abroad. Because discontinuation of Remodulin therapy can be life-threatening, we require that our distributors maintain minimum contingent inventory levels. Due to this requirement, sales of Remodulin to our distributors in any given quarter may not be entirely indicative of patient demand. Our distributors typically place one bulk order per month in the first half of the month. The size of bulk distributor orders is based on estimates of future demand and considerations of contractual minimum inventory requirements. As such, our sales of Remodulin are affected by the timing and magnitude of these bulk orders by our distributors.

Subsequent to receiving FDA approval of Remodulin in 2002, we have funded our operations mainly from sales of Remodulin in the United States and abroad. In addition to revenues derived from sales of Remodulin, we have generated revenues from telemedicine products and services sold in the United States. Our telemedicine products and services are designed to detect cardiac arrhythmias, and ischemic heart disease, a condition that causes poor blood flow to the heart.

Expenses

Since our inception, we have devoted substantial resources toward our research and development activities. Accordingly, we incur considerable costs relating to our clinical trials and research, conducted both internally and by third parties, on a variety of projects to develop pharmaceutical therapies. We also seek to acquire promising technologies and/or compounds from third parties to be incorporated in our developmental projects and products through licensing arrangements or acquisitions. Principal components of our operating expenses consist of research and development, selling, general and administrative, and cost of both product and service sales.

Major Research and Development Projects

Our major research and development projects focus on the use of treprostinil and tadalafil to treat cardiovascular diseases, monoclonal antibodies to treat a variety of cancers and glycobiology antiviral agents to treat infectious diseases.

Cardiovascular Disease Projects

Inhaled treprostinil. We are developing an inhaled formulation of treprostinil sodium for the treatment of PAH. In June 2005, we commenced a 12-week randomized, double-blind, placebo-controlled Phase III trial of inhaled treprostinil in patients with PAH who were also being treated with Tracleer®, an oral endothelin receptor antagonist (ERA), or Revatio®, a PDE5 inhibitor. This trial, TRIUMPH-1 ( TR eprostinil I nhalation U sed in the M anagement of P ulmonary Arterial H ypertension), was conducted at approximately 36 centers in the United States and Europe. In November 2007, we announced the completion of our TRIUMPH-1 trial. Analysis of the TRIUMPH-1 results demonstrated a highly statistically significant improvement in median six-minute walk distance (6MWD) of approximately 20 meters in patients receiving inhaled treprostinil compared to patients receiving placebo.

Consequently, we submitted an NDA on June 27, 2008, to obtain FDA approval to market inhaled treprostinil in the United States. The Optineb® nebulizer (the ultra-sonic nebulizer that was used exclusively for administration of inhaled treprostinil in the TRIUMPH-1 trial) was submitted for approval as part of this filing. Optineb is manufactured exclusively by NEBU-TEC International Med Products Eike Kern GmbH (NEBU-TEC). The Optineb is CE-marked in Europe, which means that NEBU-TEC has asserted that the device conforms to European Union health and safety requirements. On December 15, 2008, we executed an Agreement of Sale and Transfer and related agreements (Agreement) with NEBU-TEC to acquire the Optineb business and all of the assets, properties and rights used in the Optineb business (Acquired Assets). We entered into the Agreement to reduce the risks associated with our dependency on NEBU-TEC and to obtain control over the production of the Optineb nebulizer. Pursuant to the Agreement, the aggregate purchase price consists of €5.0 million, and up to €10.0 million in contingent consideration (see Note 18 to the consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K). The Acquired Assets under the Agreement will not transfer to us until the closing, which is to occur following the FDA's approval of our NDA for inhaled treprostinil. Standard FDA review of an NDA generally takes 10 to 12 months from the date of submission. The Optineb nebulizer was also included as part of our December 2008 MAA submission.

We were recently notified that the FDA Office of Safety and Epidemiology has preliminarily approved the tradename Tyvaso for our inhaled treprostinil therapy. The FDA Division of Cardiorenal Drug Products will conduct the final review and approval of the tradename, which usually occurs simultaneously with NDA approval.

We are conducting a Phase IV open-label study in the United States to investigate what occurs when patients on Ventavis®, the only currently approved inhaled prostacyclin, are switched to inhaled treprostinil. Enrollment for this study is expected to range from 300 to 400 patients. We commenced enrollment for this study in December 2008.

Oral treprostinil. We are developing an oral formulation of treprostinil (treprostinil diethanolamine). In October 2006 we initiated two multi-national, placebo-controlled clinical trials of oral treprostinil in patients with PAH at approximately 60 centers to study both dosing and efficacy. The FREEDOM-C trial was a 16-week study of patients currently on approved background therapy using a PDE5 inhibitor, such as Revatio® or an ERA, such as Tracleer®, or a combination of both. We completed enrollment for the FREEDOM-C trial at 354 patients in May 2008 and subsequently announced the results of the FREEDOM-C trial in November 2008. Analysis of the results demonstrated that the trial did not achieve statistical significance for its primary endpoint (the change in 6MWD at week 16 compared to baseline). Initial investigation of the results suggested that the inability to dose titrate (increase the dose to tolerability) oral treprostinil above what appeared to be suboptimal dosing levels in this study was a limiting factor that suppressed the overall treatment effect. We believe that the results of the FREEDOM-C trial, particularly as they relate to treatment effect and dosing achieved, warrant the continued development of oral treprostinil. We are planning a second FREEDOM-C trial, FREEDOM-C 2 , to continue studying dosage and efficacy of oral treprostinil in PAH patients on approved background therapy. We estimate enrolling 300 patients in the FREEDOM-C 2 clinical trial beginning in late 2009.

The FREEDOM-M trial is a 12-week study of newly diagnosed patients not currently on any background therapy. Enrollment in FREEDOM-M was closed on October 31, 2008 with 171 patients enrolled in the trial. Based on what we learned from the FREEDOM-C trial relating to patient tolerability of our three different tablet strengths of oral treprostinil, we submitted a protocol amendment to the FDA on February 20, 2009 seeking to increase the number of patients enrolled in FREEDOM-M by approximately 140. These new patients will start the study on the 0.25 mg tablet, which we learned from the FREEDOM-C trial is the best-tolerated tablet strength. In addition, our amendment to the FREEDOM-M protocol seeks to limit the primary statistical analysis of the trial to those patients who started the trial using the 0.25 mg tablet.

We believe that this protocol amendment will allow us to more accurately assess the effectiveness of oral treprostinil. We hope that by starting the additional patients on the 0.25 mg tablets and titrating the doses, patients will be able to reach an effective maintenance dose with the lower dosage tablet. The study should have a reduced rate of premature discontinuation due to adverse events. If we are successful in enrolling patients for this extended portion of the study, we will then be able to statistically power our analysis using a reduced effect size (from a 50 to 45 meter change in 6MWD), a change in the study's statistical significance (from 0.05 to 0.01) and a change the 6MWD study endpoint to include only patients who had access to the 0.25 mg tablets at randomization (when study drug is first administered at the beginning of the trial). If these amendments to the study are successful, we believe that the results will reflect the expected dosing regimen for oral treprostinil. Due to the time required to receive FDA consent for the protocol amendment and to package and ship new clinical trial supplies to study sites, we expect to begin enrolling additional patients in the second quarter of 2009.

Tadalafil. In November 2008, we entered into the following agreements with Eli Lilly and Company and one of its subsidiaries (collectively, Lilly): a license agreement, a manufacturing and supply agreement and a stock purchase agreement. We completed the initial transactions contemplated by these agreements in December 2008. Pursuant to the license agreement, we paid an upfront fee to Lilly of $25.0 million for the exclusive right to develop, market, promote and commercialize the orally administered tadalafil for the treatment of pulmonary hypertension in the United States and Puerto Rico. Tadalafil is the active ingredient in Cialis®, also developed and marketed by Lilly for the treatment of erectile dysfunction. Additionally, we agreed to pay Lilly royalties equal to 5% of net sales of tadalafil for pulmonary hypertension as a pass through of Lilly's third-party royalty obligations. We will purchase tadalafil from Lilly pursuant to the manufacturing and supply agreement. The terms of the manufacturing and supply agreement provide that Lilly will manufacture and distribute tadalafil through its wholesaler network as Lilly would for its other pharmaceutical products and included an upfront fee of $125.0 million. The total upfront fees paid to Lilly in December 2008 of $150.0 million under the license and manufacturing and supply agreements were charged to research and development expenses during the quarter ended December 31, 2008, because tadalafil had not yet received marketing approval from the FDA and therefore, commercial feasibility had not yet been established. Pursuant to the stock purchase agreement, we issued 3,150,837 shares of our common stock from treasury to Lilly in exchange for $150.0 million. See Note 15 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Beraprost-MR. We are developing a modified release formulation of beraprost (beraprost-MR) for PAH. Beraprost-MR is an oral prostacyclin analogue. In March 2007, our subsidiary Lung Rx., Inc. (Lung Rx) entered into an amended version of the June 2000 license agreement between Toray Industries, Inc. (Toray) and us to expand our rights related to the commercialization of beraprost-MR. We are currently enrolling a Phase II clinical study of beraprost-MR to explore multiple-dose tolerability in patients with PAH and planning a Phase III clinical trial to evaluate the efficacy of beraprost-MR for the treatment of PAH. In October 2007, Toray announced that beraprost-MR received regulatory approval in Japan for the treatment of PAH. In July 2008, beraprost-MR was granted Orphan Medicinal Product Designation by the EMEA.

We incurred expenses of approximately $210.5 million, $49.4 million and $33.0 million for the years ended December 31, 2008, 2007 and 2006, respectively, on our cardiovascular programs. We have spent approximately $453.9 million from inception to December 31, 2008, on our cardiovascular programs.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Overview

We are a biotechnology company focused on the development and commercialization of unique products to address the unmet medical needs of patients with chronic and life-threatening cardiovascular and infectious diseases and cancer. Since our inception in June 1996, we have devoted a significant amount of our resources to research and development programs and acquisitions.



Our key therapeutic platforms include:



• Prostacyclin analogues: stable synthetic forms of prostacyclin, an important molecule produced by the body that has powerful effects on blood vessel health and function;



• Phosphodiesterase 5 (PDE5) inhibitors: molecules that act to inhibit the degradation of cyclic guanosine monophosphate (cGMP) in cells. cGMP is activated by nitric oxide (NO), a naturally occurring substance in the body that mediates the relaxation of vascular smooth muscle;



• Monoclonal antibodies: antibodies that activate patients’ immune systems to treat cancer; and



• Glycobiology antiviral agents: a novel class of small, sugar-like molecules that have shown pre-clinical indications of efficacy against a broad range of viruses.



We focus most of our resources on these key therapeutic platforms. In addition, we devote resources to the commercialization and development of telemedicine products and services, principally for the detection of cardiac arrhythmias (abnormal heart rhythms).



We began generating pharmaceutical revenues in 2002 upon receiving approval from the FDA for our lead product, Remodulin ® (treprostinil sodium) Injection (Remodulin) to be administered via subcutaneous (under the skin) infusion for the treatment of pulmonary arterial hypertension (PAH). Since 2002, the FDA has expanded its approval of Remodulin for intravenous (in the vein) use and for the treatment of patients who require transition from Flolan ® . In addition to the United States, Remodulin is approved in many other countries worldwide, primarily for subcutaneous use. We are also developing both inhaled and oral forms of treprostinil for the treatment of PAH. To further these initiatives, we filed a New Drug Application (NDA) with the FDA for our inhaled formulation of treprostinil in June 2008 and a Marketing Authorization Application (MAA) with the European Medicines Agency (EMEA) for inhaled treprostinil in December 2008. Presently, FDA and EMEA reviews of inhaled treprostinil are underway. The EMEA granted Orphan Medicinal Product Designation for inhaled and oral treprostinil for PAH in April 2004 and August 2005, respectively. We are currently conducting several clinical trials related to oral treprostinil.



Revenues



We derive substantially all of our revenues from the sale of Remodulin.



Our sales and marketing team included approximately 80 employees as of March 31, 2009. We divide our sales force into two teams. One sales team is primarily responsible for medical practice accounts that are historical Remodulin prescribers. The other sales team focuses on medical practices that have not previously prescribed Remodulin. In addition, our distributors supplement the efforts of our sales force. The market in which we operate is highly competitive. The success of our sales force and ultimate sales levels achieved is affected by the activities of other companies that market and sell competing therapies. It is our expectation that the competition within our industry will continue to increase.



Our domestic distributors, Accredo Therapeutics, Inc. (Accredo), CuraScript, Inc. (CuraScript), and CVS Caremark Corporation (Caremark), sell Remodulin to patients in the United States. We also engage various international distributors to sell Remodulin abroad. Because discontinuation of Remodulin therapy can be life-threatening, we require that our distributors maintain minimum contingent inventory levels. Because of this requirement, sales of Remodulin to our distributors in any given quarter may not be entirely indicative of patient demand. Our distributors typically place one bulk order per month in the first half of the month. The size of bulk distributor orders is based on estimates of future demand and considerations of contractual minimum inventory requirements. As such, our sales of Remodulin are affected by the timing and magnitude of these bulk orders by our distributors.



In addition to revenues derived from sales of Remodulin, we generate revenues from the sale of telemedicine products and services in the United States. Our telemedicine products and services are designed to detect cardiac arrhythmias and ischemic heart disease, a condition that causes poor blood flow to the heart.



Expenses



Since our inception, we have devoted substantial resources toward our various research and development initiatives. Accordingly, we incur considerable costs relating to our clinical trials and research, conducted both internally and by third parties, on a variety of projects to develop pharmaceutical therapies. We also seek to acquire promising technologies and/or compounds from third parties to be incorporated in our developmental projects and products through licensing arrangements or acquisitions. Principal components of our operating expenses consist of research and development, selling, general and administrative, and cost of both product and service sales.



Major Research and Development Projects



Our major research and development projects focus on the use of prostacyclin analogues and PDE5 inhibitors to treat cardiovascular diseases, monoclonal antibodies to treat a variety of cancers and glycobiology antiviral agents to treat infectious diseases.



Cardiovascular Disease Projects



Inhaled treprostinil. We are developing an inhaled formulation of treprostinil sodium for the treatment of PAH. In November 2007, we completed a Phase III trial of inhaled treprostinil in patients with PAH who were also being treated with Tracleer ® , an oral endothelin receptor antagonist (ERA), or Revatio ® , a PDE5 inhibitor. This trial, TRIUMPH-1 ( TR eprostinil I nhalation U sed in the M anagement of P ulmonary Arterial H ypertension), demonstrated a highly statistically significant improvement in median six-minute walk distance.



Subsequently, we submitted an NDA in June 2008 to obtain FDA approval to market inhaled treprostinil in the U.S. The Optineb ® nebulizer, an ultra-sonic portable nebulizer that was used exclusively for administration of inhaled treprostinil during the TRIUMPH-1 trial, was submitted for approval as part of this filing. The Optineb is manufactured exclusively by NEBU-TEC International Med Products Eike Kern GmbH (NEBU-TEC). The Optineb is CE-marked in Europe, which means that NEBU-TEC has asserted that the device conforms to European Union health and safety requirements. In December 2008, we executed an Agreement of Sale and Transfer and related agreements with NEBU-TEC to acquire the Optineb business and all its related assets, properties and rights for an aggregate purchase price of €5.0 million, plus up to €10.0 million in future contingent consideration. We will not acquire these assets, properties and rights until the FDA approves of our NDA for inhaled treprostinil.



In December 2008, we also filed an MAA for inhaled treprostinil with the EMEA using the centralized filing process. The Optineb was also included as part of our MAA submission. The duration of a typical review of an NDA by the FDA and an MAA by the EMEA is approximately 10 to 12 months, but can take significantly longer.



In March 2009, the FDA notified us that it required human factors testing to validate the instructions for use (IFU) of the Optineb in order to complete its evaluation of our inhaled treprostinil NDA. On March 16, 2009, we issued a press release disclosing this requirement and the likelihood that it would delay the FDA’s review of our inhaled treprostinil NDA beyond the April 30, 2009, Prescription Drug User Fee Act (PDUFA) date. We conducted a human factors study that consisted of a relatively small number of volunteers and assessed whether the revised IFU properly guided patients to accomplish such tasks as proper device assembly and disassembly, drug administration and device cleaning. The study also evaluated the occurrence of common use errors that a new user may experience. We submitted the findings of this study to the FDA in April 2009, and on April 28, 2009, the FDA notified us that it will require additional time to complete its review of our inhaled treprostinil NDA and extended the PDUFA date to July 30, 2009. This three-month extension was triggered by our April 2009 human factors study submission, which was considered a major amendment to our NDA.

In December 2008 we began enrolling patients in an open-label study in the United States to investigate what occurs when patients on Ventavis ® , the only currently approved inhaled prostacyclin analogue, are switched to inhaled treprostinil.



Oral treprostinil. We are developing an oral formulation of treprostinil (treprostinil diethanolamine). During the fourth quarter of 2006, we initiated two clinical trials to evaluate the safety and efficacy of oral treprostinil in patients with PAH, FREEDOM-C and FREEDOM-M. The FREEDOM-C trial was a study of patients currently on approved background therapy using a PDE5 inhibitor, such as Revatio ® , or an ERA, such as Tracleer ® , or a combination of both. We completed enrollment for the FREEDOM-C trial in May 2008 and subsequently announced top-line results of the FREEDOM-C trial in November 2008. Preliminary analysis of the data revealed that the trial did not achieve statistical significance because the initial tablet strength was too high, resulting in the inability to dose titrate (increase the dose to tolerability), which, in turn, led to suboptimal dosing and a muting of the overall treatment effect. Accordingly, the ongoing FREEDOM-M trial, discussed below, was modified to address dose-tolerability issues by extending enrollment in that study and providing newly-enrolled patients with the tablet strength that was better tolerated among patients in the FREEDOM-C trial. We believe that the results of the FREEDOM-C trial, particularly as they relate to treatment effect and dosing, warrant the continued development of oral treprostinil. We are planning a second trial based on FREEDOM-C, FREEDOM-C 2 , to continue studying dosage and efficacy of oral treprostinil in PAH patients on approved background therapy. We estimate enrolling 300 patients in the FREEDOM-C 2 trial beginning in mid 2009.



The FREEDOM-M trial is a 12-week study of newly-diagnosed patients not currently on any background therapy. Based on what we learned from the FREEDOM-C trial relating to patient tolerability of our tablet strengths, we submitted a protocol amendment to the FDA in February 2009 seeking to add 140 patients to the ongoing FREEDOM-M trial and provide new patients with the 0.25 mg tablet when they start the trial, which we learned from the FREEDOM-C trial is the best-tolerated tablet strength. In addition, our amendment to the FREEDOM-M protocol seeks to limit the primary statistical analysis of the trial to those patients who started the trial using the 0.25 mg tablet. We believe that the protocol amendment will allow us to more accurately assess the effectiveness of oral treprostinil. We hope that by starting all newly added patients on the 0.25 mg tablets and titrating their doses in 0.25 mg increments, patients will better tolerate the therapy and reach an effective maintenance dose. We also anticipate that the protocol amendment will reduce the rate of premature discontinuation due to adverse events. In April 2009, we began enrolling patients under the amended protocol. The statistical assumptions of the amended study provide for 90% power to observe a 45-meter treatment benefit in the six-minute walk distance at the significance level of 0.01. If we are able to successfully implement these and other amendments to the study, we believe that the results will reflect the expected dosing regimen for oral treprostinil. As of March 31, 2009, there were approximately 172 patients enrolled in the FREEDOM-M trial.



Tadalafil. In November 2008, we entered into a license agreement, a manufacturing and supply agreement and a stock purchase agreement with Eli Lilly and Company (Lilly) to obtain exclusive rights to develop, market, promote and commercialize the orally administered drug, tadalafil for pulmonary hypertension. Tadalafil is also the active ingredient in Cialis ® , which was developed and is exclusively marketed by Lilly for the treatment of erectile dysfunction. Pursuant to the license agreement, we paid an upfront fee to Lilly of $25.0 million for the exclusive rights to commercialize tadalafil for pulmonary hypertension in the United States and Puerto Rico. Under the manufacturing and supply agreement, we will purchase tadalafil in finished form from Lilly, which will manufacture and distribute tadalafil for us through its wholesaler network. Lilly is also responsible for all aspects of FDA regulatory review of tadalafil for PAH. Terms of the manufacturing and supply agreement included an upfront fee of $125.0 million. Because FDA approval for tadalafil for PAH is pending, the upfront fees paid to Lilly totaling $150.0 million were charged as research and development expense during the quarter ended December 31, 2008, as commercial approval had not been granted. These agreements became effective in December 2008 upon the issuance of approximately 3.2 million shares of our common stock to Lilly in exchange for $150.0 million in accordance with the terms of the stock purchase agreement.



Beraprost-MR. We are developing a modified release formulation of beraprost (beraprost-MR), an oral prostacyclin analogue, for PAH. In March 2007, we entered into an amended version of our June 2000 license agreement with Toray Industries, Inc. (Toray) to expand our rights related to the commercialization of beraprost-MR. We are currently enrolling patients in a Phase II clinical trial of beraprost-MR to explore multiple-dose tolerability in patients with]]>Fri, 19 Jun 2009 10:55:20 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/2783/http://www.dailystocks.com/forum/showtopic.php?tid/2783/
BUSINESS OVERVIEW

General

UDR, Inc. is a self administered real estate investment trust, or REIT, that owns, acquires, renovates, develops, and manages apartment communities nationwide. At December 31, 2008, our wholly-owned apartment portfolio included 161 communities located in 23 markets, with a total of 44,388 completed apartment homes. In addition, we have an ownership interest in 4,158 apartment units through joint ventures.

We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, which we refer to in this Report as the “Code”. To continue to qualify as a REIT, we must continue to meet certain tests which, among other things, generally require that our assets consist primarily of real estate assets, our income be derived primarily from real estate assets, and that we distribute at least 90% of our REIT taxable income (other than our net capital gain) to our stockholders annually. As a qualified REIT, we generally will not be subject to U.S. federal income taxes at the corporate level on our net income to the extent we distribute such net income to our stockholders annually. In 2008, we declared total distributions on an adjusted basis of $2.11 per common share and a dividend of $0.89 per common share to our stockholders due to our disposition activities during 2008, which on a pre-adjusted dividend basis is $2.28 per common share, inclusive of a special dividend of $0.96 per common share to our stockholders.


Business Objectives

Our principal business objective is to maximize the economic returns of our apartment communities to provide our stockholders with the greatest possible total return and value. To achieve this objective, we intend to continue to pursue the following goals and strategies:


• own and operate apartments in markets that have the best growth prospects based on favorable job formation and low home affordability, thus enhancing stability and predictability of returns to our stockholders;

• manage real estate cycles by taking an opportunistic approach to buying, selling, and building apartment communities;

• empower site associates to manage our communities efficiently and effectively;

• measure and reward associates based on specific performance targets; and

• manage our capital structure to ensure predictability of earnings and dividends.

2008 Accomplishments


• We closed on a two-year unsecured term loan of $240 million of which $200 million was swapped into a fixed rate of 3.61% and $40 million has a rate of LIBOR plus 85 basis points. Proceeds from this loan were used to redeem maturing debt.

• We closed on a $400 million credit facility which matures November 2018. At December 31, 2008, we had $224.8 million outstanding on the facility — $70.0 million at a fixed interest rate of 5.85% and $154.8 million at a variable interest rate, fixed with two- and three-year LIBOR swaps at an average rate of 4.32%. The Company has five years to draw on the additional $175.2 million of capacity.

• We sold 8,661,201 shares of common stock adjusted for the special dividend (8,000,000 shares of common stock on an unadjusted basis) in a public offering, resulting in gross proceeds to us of $194.0 million, which were in part used to reduce corporate debt.

• We completed development on two wholly-owned communities consisting of 644 apartment homes with an aggregate carrying value of $44.4 million.

• We acquired 4,558 apartment homes in 13 communities for approximately $976.3 million, two parcels of land for $20.0 million, certain rights held by joint venture partner for $1.5 million and a retail property for $19.2 million.

• We sold 86 communities with a total of 25,684 apartment homes for gross consideration of $1.7 billion.

UDR’s Strategies and Vision

UDR previously announced its vision to be the innovative multifamily public real estate investment of choice. We identified the following strategies to guide decision-making and accelerated growth:

1. Strengthen our portfolio

2. Continually improve operations

3. Maintain access to low-cost capital

Strengthen our Portfolio

UDR is focused on increasing its presence in markets with favorable job formation, low housing affordability, and a favorable demand/supply ratio for multifamily housing. Portfolio decisions consider third-party research, taking into account job growth, multifamily permitting and housing affordability.

In 2008, UDR sold a portfolio of properties in 86 communities for total consideration of approximately $1.7 billion. This portfolio sale dramatically accelerated our transformation to focus on markets that have the best growth prospects based on favorable job formation and low single-family home affordability. At December 31, 2008, approximately 56.6% of the Company’s same store net operating income was provided by our communities located in California, Washington, Oregon and Metropolitan Washington, D.C.

Acquisitions

During 2008, in conjunction with our strategy to strengthen our portfolio, UDR acquired 13 communities with 4,558 apartment homes at a total cost of approximately $976.3 million, including the assumption of secured debt. In addition, we purchased two parcels of land for $20.0 million, acquired certain rights held by a joint venture partner for $1.5 million in a consolidated operating joint venture and acquired a retail property for $19.2 million. UDR targets apartment community acquisitions in markets where job growth expectations are above the national average, home affordability is low, and the demand/supply ratio for multi-family housing is favorable.

When evaluating potential acquisitions, we consider:


• population growth, cost of alternative housing, overall potential for economic growth and the tax and regulatory environment of the community in which the property is located;

• geographic location, including proximity to our existing communities which can deliver significant economies of scale;

• construction quality, condition and design of the community;

• current and projected cash flow of the property and the ability to increase cash flow;

• potential for capital appreciation of the property;

• ability to increase the value and profitability of the property through upgrades and repositioning;

• terms of resident leases, including the potential for rent increases;

• occupancy and demand by residents for properties of a similar type in the vicinity;

• prospects for liquidity through sale, financing, or refinancing of the property; and

• competition from existing multifamily communities and the potential for the construction of new multifamily properties in the area.

Continually Improve Operations

UDR is committed to improving operations through automation and enhancing the customer’s experience. Since adopting our new corporate strategies, UDR has out-sourced a call center and created MyUDR, our resident services portal on our website. UDR customers have access to conduct business with us 24 hours a day, 7 days a week to pay rent on line and to submit a service request. Through transforming operations and engaging technology our residents get the convenience they want and our operating teams become more efficient.

In 2008, UDR continually enhanced www.udr.com and individual community websites deploying an innovative 3D interactive photo viewer, customized version of the apartment selector program, and special views or photos that feature specific apartment homes that commands an excellent view from the apartment, floor plans and availability. In addition to UDR.com improvements, we also launched a Quick Response 2D bar code program that can be used on most mobile devices. An industry first iPhone apartment search website was launched, and we established a social media website presence in MySpace.com. These enhancements have increased overall web visitor traffic to over 1.4 million visitors and more than 1.0 million organic search engine visitors which contributed to a 15% year-over-year lead stream increase.

Previously, UDR launched a new Spanish-language site, marketing to Latinos, the nation’s fastest-growing ethnic group. The site offers over 4,000 Spanish translated web pages and includes apartments for rent search resources. The website can be found at http://es.udr.com and can also be found on any web-enabled mobile device.

Maintaining Access to Low-Cost Capital

We seek to maintain a capital structure that allows us to seek, and not just react to, opportunities available in the marketplace. We have structured our borrowings to layer our debt maturities and to be able to access both secured and unsecured debt.

Special Dividend

On November 5, 2008, our Board of Directors declared a dividend on a pre-adjusted basis of $1.29 per share (approximately $176.0 million or $1.19 per share on an adjusted basis) payable to holders of our common stock (“the Special Dividend”). The Special Dividend was paid on January 29, 2009 to stockholders of record on December 9, 2008. The dividend represented the Company’s fourth quarter recurring pre-adjusted distribution of $0.33 per share ($0.305 per share on an adjusted basis) and an additional special distribution in the pre-adjusted amount of $0.96 per share ($0.89 per share on an adjusted basis) due to taxable income arising from our dispositions occurring during the year. Subject to the Company’s right to pay the entire Special Dividend in cash, stockholders had the option to make an election to receive payment in cash or in shares, however, the aggregate amount of cash payable to stockholders, other than cash payable in lieu of fractional shares, would not be less than $44.0 million.

The Special Dividend, totaling $177.1 million was paid on 137,266,557 pre-adjusted shares issued and outstanding on the record date. Approximately $133.1 million of the Special Dividend was paid through the issuance of 11,358,042 shares of common stock, which was determined based on the volume weighted average closing sales price of our common stock of $11.71 per share on the NYSE on January 21, 2009 and January 22, 2009. The effect of the issuance of additional shares of common stock pursuant to the Special Dividend was retroactively reflected in each of the historical periods presented within this Report as if those shares were issued and outstanding at the beginning of the earliest period presented. Accordingly, all activity including share issuances, repurchases and forfeitures have been adjusted to reflect the 8.27% increase in the number of shares, except where otherwise noted.

Financing Activities

As part of our plan to strengthen our capital structure, we utilized proceeds from dispositions, debt and equity offerings and refinancings to extend maturities, pay down existing debt, and acquire apartment communities. The following is a summary of our major financing activities in 2008:


• Closed on a $240 million, two-year unsecured term loan facility of which $200 million was swapped into a fixed rate of 3.61% and $40 million has a rate of LIBOR plus 85 basis points. Proceeds were used to redeem $200 million of our 4.5% medium term notes due in March 2008 with the remaining $40 million used for general corporate purposes.

• Closed on a $400 million credit facility which matures November 2018. At December 31, 2008, we had $224.8 million outstanding on the facility - $70.0 million at a fixed interest rate of 5.85% and $154.8 million at a variable interest rate, fixed with two- and three-year LIBOR swaps at an average rate of 4.32%. The Company has five years to draw on the additional $175.2 million of capacity.

• Sold 8,661,201 shares of our common stock adjusted for the Special Dividend (8,000,000 shares of common stock on an unadjusted basis) in a public offering, resulting in gross proceeds to us of $194.0 million.

• Obtained five construction loans for a total of $179.3 million of which the Company has drawn $53.9 million for our development projects. The construction loans all have a two- to three-year initial term with extension provisions ranging from one to two years and incur interest at variable rates which range from LIBOR plus 140 basis points to LIBOR plus 225 basis points.

• Repaid $216.4 million of secured debt and $793.0 million of unsecured debt (represents the notional amount of debt repaid and excludes the gain on extinguishment). The $793.0 million of unsecured debt consisted of $309.5 million for the revolving credit facility, $275.8 million for maturing debt instruments and $207.7 million for the repurchase of unsecured debt instruments.

• Repurchased unsecured debt with a notional amount of $207.7 million for $176.2 million resulting in a gain on extinguishment of $29.6 million, net of deferred finance charges. The debt retired by the Company matured in 2011, 2014, 2015 and 2016.

• Repurchased 969,300 shares of our Series G Cumulative Redeemable Preferred Stock for $20.3 million, less than their liquidation value of $24.2 million.

Markets and Competitive Conditions

Upon completion of our dispositions activity, approximately 56.6% of the Company’s same store net operating income was generated from apartment homes located in markets of California, Oregon, Washington and Metropolitan Washington D.C. We believe that this diversification increases investment opportunity and decreases the risk associated with cyclical local real estate markets and economies, thereby increasing the stability and predictability of our earnings.

Competition for new residents is generally intense across all of our markets. Some competing communities offer features that our communities do not have. Competing communities can use concessions or lower rents to obtain temporary competitive advantages. Also, some competing communities are larger or newer than our communities. The competitive position of each community is different depending upon many factors including sub-market supply and demand. In addition, other real estate investors compete with us to acquire existing properties and to develop new properties. These competitors include insurance companies, pension and investment funds, public and private real estate companies, investment companies and other public and private apartment REITs and our competitors may have greater resources, or lower capital costs, than we do.

We believe that, in general, we are well-positioned to compete effectively for residents and investments. We believe our competitive advantages include:


• a fully integrated organization with property management, development, redevelopment, acquisition, marketing, sales and financing expertise;

• scalable operating and support systems;

• purchasing power;

• geographic diversification with a presence in 23 markets across the country; and

• significant presence in many of our major markets that allows us to be a local operating expert.

Moving forward, we will continue to emphasize aggressive lease management, improved expense control, increased resident retention efforts and the alignment of employee incentive plans tied to our bottom line performance. We believe this plan of operation, coupled with the portfolio’s strengths in targeting renters across a geographically diverse platform, should position us for continued operational improvement in spite of the difficult economic environment.

Communities

At December 31, 2008, our apartment portfolio included 161 wholly-owned communities having a total of 44,388 completed apartment homes and an additional 2,242 under development. The overall quality of our portfolio has significantly improved with the disposition of non-core apartment homes and our upgrade and rehabilitation programs. The upgrading of the portfolio provides several key benefits related to portfolio profitability. It enables us to raise rents more significantly and to attract residents with higher levels of disposable income who are more likely to accept the transfer of expenses, such as water and sewer costs, from the landlord to the resident. In addition, it potentially reduces recurring capital expenditures per apartment home, and therefore should result in increased cash flow.

Same Community Comparison

We believe that one pertinent qualitative measurement of the performance of our portfolio is tracking the results of our same store community’s net operating income (“NOI”), which is total rental revenue, less rental expenses excluding property management and other operating expenses. Our same store population are operating communities which we own and have stabilized occupancy, revenues and expenses as of the beginning of the prior year. For the year ended December 31, 2008, our same store NOI increased by $10.8 million or 3.8% compared to the prior year. The increase in NOI for the 32,124 apartment homes which make up the same store population was driven by an increase in revenues and physical occupancy at our communities.

Revenue growth in 2009 may be impacted by general adverse conditions affecting the economy, reduced occupancy rates, increased rental concessions, increased bad debt and other factors which may adversely impact our ability to increase rents.

Tax Matters

We have elected to be taxed as a REIT under the Code. To continue to qualify as a REIT, we must continue to meet certain tests that, among other things, generally require that our assets consist primarily of real estate assets, our income be derived primarily from real estate assets, and that we distribute at least 90% of our REIT taxable income (other than net capital gains) to our stockholders annually. Provided we maintain our qualification as a REIT, we generally will not be subject to U.S. federal income taxes at the corporate level on our net income to the extent such net income is distributed to our stockholders annually. Even if we continue to qualify as a REIT, we will continue to be subject to certain federal, state and local taxes on our income and property.

We may utilize taxable REIT subsidiaries to engage in activities that REITs may be prohibited from performing, including the provision of management and other services to third parties and the conduct of certain nonqualifying real estate transactions. Taxable REIT subsidiaries generally are taxable as regular corporations and therefore are subject to federal, state and local income taxes.

Inflation

Substantially all of our leases are for a term of one year or less, which may enable us to realize increased rents upon renewal of existing leases or the beginning of new leases. Such short-term leases generally minimize the risk to us of the adverse effects of inflation, although as a general rule these leases permit residents to leave at the end of the lease term without penalty. Short-term leases and relatively consistent demand allow rents to provide an attractive hedge against inflation.

Environmental Matters

Various environmental laws govern certain aspects of the ongoing operation of our communities. Such environmental laws include those regulating the existence of asbestos-containing materials in buildings, management of surfaces with lead-based paint (and notices to residents about the lead-based paint), use of active underground petroleum storage tanks, and waste-management activities. The failure to comply with such requirements could subject us to a government enforcement action and/or claims for damages by a private party.

To date, compliance with federal, state and local environmental protection regulations has not had a material effect on our capital expenditures, earnings or competitive position. We have a property management plan for hazardous materials. As part of the plan, Phase I environmental site investigations and reports have been completed for each property we acquire. In addition, all proposed acquisitions are inspected prior to acquisition. The inspections are conducted by qualified environmental consultants, and we review the issued report prior to the purchase or development of any property. Nevertheless, it is possible that our environmental assessments will not reveal all environmental liabilities, or that some material environmental liabilities exist of which we are unaware. In some cases, we have abandoned otherwise economically attractive acquisitions because the costs of removal or control of hazardous materials have been prohibitive or we have been unwilling to accept the potential risks involved. We do not believe we will be required to engage in any large-scale abatement at any of our properties. We believe that through professional environmental inspections and testing for asbestos, lead paint and other hazardous materials, coupled with a relatively conservative posture toward accepting known environmental risk, we can minimize our exposure to potential liability associated with environmental hazards.

Federal legislation requires owners and landlords of residential housing constructed prior to 1978 to disclose to potential residents or purchasers of the communities any known lead paint hazards and imposes treble damages for failure to provide such notification. In addition, lead based paint in any of the communities may result in lead poisoning in children residing in that community if chips or particles of such lead based paint are ingested, and we may be held liable under state laws for any such injuries caused by ingestion of lead based paint by children living at the communities.

We are unaware of any environmental hazards at any of our properties that individually or in the aggregate may have a material adverse impact on our operations or financial position. We have not been notified by any governmental authority, and we are not otherwise aware, of any material non-compliance, liability, or claim relating to environmental liabilities in connection with any of our properties. We do not believe that the cost of continued compliance with applicable environmental laws and regulations will have a material adverse effect on us or our financial condition or results of operations. Future environmental laws, regulations, or ordinances, however, may require additional remediation of existing conditions that are not currently actionable. Also, if more stringent requirements are imposed on us in the future, the costs of compliance could have a material adverse effect on us and our financial condition.

Insurance

We carry comprehensive general liability coverage on our communities, with limits of liability customary within the industry to insure against liability claims and related defense costs. We are also insured, in all material respects, against the risk of direct physical damage in amounts necessary to reimburse us on a replacement cost basis for costs incurred to repair or rebuild each property, including loss of rental income during the reconstruction period.


CEO BACKGROUND

Katherine A. Cattanach, Ph.D. was a General Partner of INVESCO Private Capital, Inc. (formerly Sovereign Financial Services, Inc.), a company specializing in private equity investments, from 1987 to 2005. From 2005 to March 2006, she served as a director and member of the audit and compensation committees of Collect America, Ltd. She is currently a member and Vice Chair of the Denver Museum of Nature and Science Foundation Board and a member, former director and President of the Denver Society of Security Analysts. She is active in and serves as a member of numerous charitable organizations.

Eric J. Foss is Chairman, President and Chief Executive Officer of The Pepsi Bottling Group, Inc. From September 2005 to July 2006, Mr. Foss served as the Chief Operating Officer of The Pepsi Bottling Group, Inc. Previously, Mr. Foss served as the President of the North America division of Pepsi Bottling Group, Inc. from September 2001 to September 2005. Mr. Foss also served as Executive Vice President of the North America division of Pepsi Bottling Group, Inc., from August 2000 to September 2001, was Senior Vice President of Sales and Marketing for the North America division of Pepsi Bottling Group, Inc., from March 1999 to August 2000 and was General Manager of European Operations for PepsiCo from December 1996 to March 1999.

Robert P. Freeman has served as Senior Managing Director and Principal of Greyfields Investors LLC, a real estate private equity company, since 2007, and has also served as President of Landfall Capital LLC, a private real estate merchant bank, since 2001. Previously, Mr. Freeman was a Managing Director of Wells Hill Partners, Ltd., a real estate investment banking firm, from 1999-2001 and a Managing Director of Lazard Frères & Co. LLC, a private investment bank, and President of Lazard Frères Real Estate Investors, L.L.C., a real estate investment company, from 1992 to 1999. Each of the companies mentioned is based in New York, New York. He is active in and serves as a director of numerous private companies and charitable organizations.

Jon A. Grove was the Chairman, President and Chief Executive Officer of ASR Investments Corporation since its organization in 1987 until our acquisition of ASR in 1998. He currently serves as a director of American Southwest Holdings, Inc. in Phoenix, Arizona.

James D. Klingbeil is Vice Chairman of the Board of Directors and the Chairman and Chief Executive Officer of Klingbeil Multifamily Fund IV, Klingbeil Multifamily Fund V (f/k/a American Apartment Communities III), Klingbeil Multifamily Fund VI, Klingbeil Multifamily Fund VII and Klingbeil Multifamily Fund VIII. He was Chairman and Chief Executive Officer of American Apartment Communities II from 1995 until its merger with the company in December of 1998. He is also Chairman and Chief Executive Officer of Klingbeil Capital Management and The Klingbeil Company. He currently serves as a director of Broad Street Financial and numerous other private companies. He is also the past Chairman and a lifetime member of the Board of Trustees of the Urban Land Institute and Chairman of the ULI Foundation Board.

Robert C. Larson has been Chairman of the Board of Directors since March 2001. He is a Senior Advisor of Lazard Alternative Investments LLC and Chairman and Senior Advisor of Lazard Real Estate Partners LLC. He is also chairman of Larson Realty Group, a privately owned, Detroit-based company engaged in real estate investment, development, management and leasing. He was a Managing Director of Lazard Frères & Co. LLC from 1999 until May 2005. Prior to joining Lazard, Mr. Larson was Chairman of the Taubman Realty Group from 1990 until 1998, Chief Executive Officer from 1988 through 1990 and President and Chief Operating Officer from 1978 until 1988. Mr. Larson currently serves as a Director of Atria Senior Living Group, Inc.

Thomas R. Oliver was Chairman of InterContinental Hotels, Inc. from 2002 until his retirement on March 31, 2003. From 1997 to October 2002 he also served as Chief Executive Officer of InterContinental Hotels, Inc. From 1996 to 1997 he was Chief Executive Officer of AudioFax, Inc. and from 1993 to 1996 he was Chief Executive Officer of VoiceCom Systems, Inc. From 1991 to 1993 Mr. Oliver served as Chief Operating Officer and Executive Vice President of Worldwide Customer Operations for FedEx. At FedEx he led the development and launch of the FedEx letter packaging concept, and created and led the quality process that enabled FedEx to become the first American service company to win the United States Malcolm Baldrige National Quality Award. He currently serves as a director of Interface, Inc., the world’s largest manufacturer and marketer of carpet tiles.

Lynne B. Sagalyn, Ph.D. has been the Earle W. Kazis and Benjamin Schore Professor of Real Estate and Director of the Paul Milstein Center for Real Estate at Columbia Business School since July 2008, positions she also held from 1992 through 2003. From January 2004 to July 2008 she was a Professor of Real Estate Development and Planning at the University of Pennsylvania, with appointments in both the School of Design (City Planning) and the Wharton School (Real Estate). She is an associate professor of Planning and Real Estate Development at Massachusetts Institute of Technology. Currently, she is also on the faculty of the Weimer School for Advanced Studies in Real Estate and Land Economics. Dr. Sagalyn is a trustee and Chair of the Audit Committee of Capital Trust, Inc., a public real estate investment trust that specializes in real estate lending and a member of the Advisory Board of Goldman Family Enterprises. She also serves on the Board of Directors of the Regional Plan Association of New York, an independent not-for-profit regional planning organization. In addition, she has also served on the New York City Board of Education Chancellor’s Commission on the Capital Plan.

Mark J. Sandler was a Senior Managing Director of Bear, Stearns & Co., Inc., an investment banking firm, in charge of its real estate operations until his retirement in October 1988. From 1968 through 1980 he was a Partner with Donaldson Lufkin & Jenrette, an investment banking firm. Since that time, Mr. Sandler has managed his personal and family investments. He served as a Trustee of Amherst College and of Northfield Mt. Hermon School and was also a founder of New Jersey SEEDS, which provides private school education for gifted, motivated but financially disadvantaged children.

Thomas W. Toomey has been our Chief Executive Officer and President since February 2001. Prior to joining us, Mr. Toomey was with Apartment Investment and Management Company, or AIMCO, a publicly traded real estate investment trust, where he served as Chief Operating Officer for two years and Chief Financial Officer for four years. During his tenure at AIMCO, Mr. Toomey was instrumental in the growth of AIMCO from 34,000 apartment homes to 360,000 homes. He has also served as a Senior Vice President at Lincoln Property Company, a national real estate development, property management and real estate consulting company, from 1990 to 1995. He currently serves as a member of the board of the National Association of Real Estate Investment Trusts, the National MultiHousing Council, a member of the Real Estate Roundtable, an Urban Land Institute Governor and a trustee of the Oregon State University Foundation.

Thomas C. Wajnert currently serves as a Senior Advisor to Irving Place Capital Partners. Mr. Wajnert had been Managing Director of Fairview Advisors, LLC, a merchant bank, from January 2002 to July 2006. He was Chairman and Chief Executive Officer of SEISMIQ, Inc, a provider of advanced technology to the commercial finance and leasing industry, from its founding in April 2000 until December 2001. Mr. Wajnert also was the Chairman of EPIX Holdings, Inc., a professional employer organization, from March 1998 until November 2003, where he also served as Chief Executive Officer from March 1998 to April 1999. Previously, Mr. Wajnert was Chairman of the Board of Directors from January 1992 until December 1997, and Chief Executive Officer from November 1984 until December 1997, of AT&T Capital Corporation (NYSE), a commercial finance and leasing company. He was self-employed from December 1997 to March 1998. Mr. Wajnert serves on the boards of directors of Reynolds American, Inc. (NYSE) and NYFIX, Inc. (NASDAQ).


MANAGEMENT DISCUSSION FROM LATEST 10K

Business Overview

We are a real estate investment trust, or REIT, that owns, acquires, renovates, develops, and manages apartment communities nationwide. We were formed in 1972 as a Virginia corporation. In June 2003, we changed our state of incorporation from Virginia to Maryland. Our subsidiaries include two operating partnerships, Heritage Communities L.P., a Delaware limited partnership, and United Dominion Realty, L.P., a Delaware limited partnership. Unless the context otherwise requires, all references in this Report to “we,” “us,” “our,” “the Company,” or “UDR” refer collectively to UDR, Inc. and its subsidiaries.

At December 31, 2008, our wholly-owned real estate portfolio included 161 communities with 44,388 apartment homes and our total real estate portfolio, inclusive of our unconsolidated communities, included an additional 11 communities with 4,158 apartment homes.

Liquidity and Capital Resources

Liquidity is the ability to meet present and future financial obligations either through operating cash flows, the sale or maturity of existing assets, or by the acquisition of additional funds through capital management. Both the coordination of asset and liability maturities and effective capital management are important to the maintenance of liquidity. Our primary source of liquidity is our cash flow from operations as determined by rental rates, occupancy levels, and operating expenses related to our portfolio of apartment homes. We routinely use our unsecured bank credit facility to temporarily fund certain operating, investing, financing and other activities prior to arranging for longer-term financing. During the past several years, proceeds from the sale of real estate have been used for debt repayment, investing and financing activities.

We expect to meet our short-term liquidity requirements generally through net cash provided by operations and borrowings under credit arrangements. We expect to meet certain long-term liquidity requirements such as scheduled debt maturities, the repayment of financing on development properties, and potential property acquisitions, through long-term secured and unsecured borrowings, the disposition of properties, and the issuance of additional debt or equity securities. Dividends and budgeted expenditures for improvements and renovations of certain properties are expected to be funded from cash provided by our unsecured revolving credit facility, other debt and equity issuances and cash flows provided by property operations.

We have a shelf registration statement filed with the Securities and Exchange Commission which provides for the issuance of an indeterminate amount of common stock, preferred stock, debt securities, guarantees of debt securities, warrants, subscription rights, purchase contracts and units to facilitate future financing activities in the public capital markets. Access to capital markets is dependent on market conditions at the time of the financing activity.

Future Capital Needs

Future development expenditures are expected to be funded with proceeds from construction loans, the sale of property, our unsecured revolving credit facility, and to a lesser extent, with cash flows provided by operating activities. Acquisition activity in strategic markets is expected to be largely financed through the reinvestment of proceeds from the sale of properties, the issuance of equity and debt securities, the issuance of operating partnership units, the assumption or placement of secured and/or unsecured debt.

During 2009, we have approximately $146.1 million of secured debt and $250.1 million of unsecured debt maturing and we anticipate repaying that debt with proceeds from borrowings under our secured or unsecured credit facilities, proceeds from our note receivable, the issuance of new unsecured debt securities or equity or from disposition proceeds. We also anticipate using contractually provided extensions for secured debt.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. A critical accounting policy is one that is both important to our financial condition and results of operations as well as involves some degree of uncertainty. Estimates are prepared based on management’s assessment after considering all evidence available. Changes in estimates could affect our financial position or results of operations. Below is a discussion of the accounting policies that we consider critical to understanding our financial condition or results of operations where there is uncertainty or requires significant judgment.

Capital Expenditures

In conformity with GAAP, we capitalize those expenditures related to acquiring new assets, materially enhancing the value of an existing asset, or substantially extending the useful life of an existing asset. Expenditures necessary to maintain an existing property in ordinary operating condition are expensed as incurred.

During 2008, $131.0 million or $2,838 per home was spent on capital expenditures for all of our communities, excluding development, condominium conversions and commercial properties compared to $194.4 million or $2,829 per home spent in 2007. These capital improvements included turnover related expenditures for floor coverings and appliances, other recurring capital expenditures such as roofs, siding, parking lots, and asset preservation capital expenditures, which aggregated $29.1 million or $630 per home. In addition, revenue enhancing capital expenditures, kitchen and bath upgrades, upgrades to HVAC equipment, and other extensive exterior/interior upgrades totaled $50.1 million or $1,085 per home, and major renovations totaled $51.8 million or $1,123 per home for the year ended December 31, 2008.

Impairment of Long-Lived Assets

We record impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by the future operation and disposition of those assets are less than the net book value of those assets. Our cash flow estimates are based upon historical results adjusted to reflect our best estimate of future market and operating conditions and our estimated holding periods. The net book value of impaired assets is reduced to fair market value. Our estimates of fair market value represent our best estimate based upon industry trends and reference to market rates and transactions.

Real Estate Investment Properties

We purchase real estate investment properties from time to time and allocate the purchase price to various components, such as land, buildings, and intangibles related to in-place leases in accordance with FASB Statement No. 141, “Business Combinations.” The purchase price is allocated based on the relative fair value of each component. The fair value of buildings is determined as if the buildings were vacant upon acquisition and subsequently leased at market rental rates. As such, the determination of fair value considers the present value of all cash flows expected to be generated from the property including an initial lease-up period. We determine the fair value of in-place leases by assessing the net effective rent and remaining term of the lease relative to market terms for similar leases at acquisition. In addition, we consider the cost of acquiring similar leases, the foregone rents associated with the lease-up period, and the carrying costs associated with the lease-up period. The fair value of in-place leases is recorded and amortized as amortization expense over the remaining contractual lease period.

REIT Status

We are a Maryland corporation that has elected to be treated for federal income tax purposes as a REIT. A REIT is a legal entity that holds interests in real estate and is required by the Code to meet a number of organizational and operational requirements, including a requirement that a REIT must distribute at least 90% of our REIT taxable income (other than our net capital gain) to our stockholders. If we were to fail to qualify as a REIT in any taxable year, we will be subject to federal and state income taxes at the regular corporate rates and may not be able to qualify as a REIT for four years. Based on the net earnings reported for the year ended December 31, 2008 in our Consolidated Statements of Operations we would have incurred $284.8 million in federal and state GAAP income taxes if we had failed to qualify as a REIT.

Statements of Cash Flow

The following discussion explains the changes in net cash provided by operating activities and net cash provided by/(used in) investing and financing activities that are presented in our Consolidated Statements of Cash Flows.

Operating Activities

For the year ended December 31, 2008, our net cash flow provided by operating activities was $179.8 million compared to $269.3 million for 2007. During 2008, the decrease in cash flow from operating activities resulted primarily from a reduction in property operating income from our apartment community portfolio. The reduction was driven by the Company completing the sale of a significant component of our portfolio in the first quarter of 2008. A portion of the proceeds from the disposition were reinvested in subsequent quarters which diluted the net cash provided by operations for the period in which the Company held restricted 1031 cash funds in lieu of revenue generating operating communities.

For the year ended December 31, 2007, our net cash flow provided by operating activities was $269.3 million compared to $237.9 million for 2006. During 2007, the increase in cash flow from operating activities resulted primarily from the increase in property operating income from the Company’s portfolio performing well on a same community basis for revenues and NOI.

Investing Activities

For the year ended December 31, 2008, net cash provided by investing activities was $302.3 million compared to net cash used of $90.1 million for 2007. Changes in the level of investing activities from period to period reflects our strategy as it relates to acquisitions, capital expenditures, development and disposition activities, as well as the impact of the capital market environment on these activities, all of which are discussed in further detail throughout this Report.

For the year ended December 31, 2007, net cash used in investing activities was $90.1 million compared to $158.2 million for 2006. Changes in the level of investing activities from period to period reflects our strategy as it relates to our acquisition, capital expenditure, development, and disposition programs, as well as the impact of the capital market environment on these activities.

Acquisitions

For the year ended December 31, 2008, we acquired 13 apartment communities with 4,558 apartment homes, two parcels of land, and one retail property for aggregate consideration of $1.0 billion. Our long-term strategic plan is to achieve greater operating efficiencies by investing in fewer, more concentrated markets. As a result, we have been expanding our interests in communities located in California, Florida, Metropolitan Washington D.C. and the Washington markets over the past years. Prospectively, we plan to continue to channel new investments into those markets we believe will provide the best investment returns. Markets will be targeted based upon defined criteria including favorable job formation and low housing affordability.

Real Estate Under Development

At December 31, 2008, our development pipeline for wholly-owned communities totaled 2,407 homes with a budget of $375.9 million in which we have a carrying value of $186.8 million. We expect to have the first of the communities complete development during 2009. In addition, we own several parcels of land held for future development in which the Company is seeking entitlements and preparing for development, although we do not anticipate development to commence during 2009.

For the year ended December 31, 2008, we invested approximately $160.1 million in development projects, an increase of $58.6 million from our 2007 level of $101.5 million. As a result of our investment in developments, we completed development on two wholly-owned communities with 644 apartment homes that have a carrying value of $44.4 million and acquired three pre-sale communities with 820 apartment homes that have a carrying value of $126.4 million during the year ended December 31, 2008.

Consolidated Development Joint Venture

In 2006, we entered into a joint venture to develop an apartment community with 298 apartment homes in Marina del Rey, California. Our initial investment was $27.5 million. Our joint venture partner was the managing partner as well as the developer, general contractor and property manager. In December 2008, we acquired for $1.5 million our joint venture partner’s interest in their profit participation and terminated the property management agreement that had approximately two years remaining on the pre-existing contract. As a result of terminating our arrangement, the Company recorded a charge to earnings of $305,000 as the profit component related to the management agreement and capitalized the balance as part of the investment in real estate, which will be depreciated over the average remaining life of the tangible asset. As of December 31, 2008, this property is included as a component of our wholly-owned communities.

Unconsolidated Joint Ventures

UDR is a partner in a joint venture to develop a site in Bellevue, Washington. At closing, we owned 49% of the project that involves building a 430 home high rise apartment building with ground floor retail. The project is currently ongoing and will commence construction once market conditions improve and favorable financing has been obtained. Our investment at December 31, 2008 and 2007 was $10.2 million and $8.1 million, respectively.

UDR is a partner in a joint venture which will develop 274 apartment homes in the central business district of Bellevue, Washington. Construction began in the fourth quarter of 2006 and is scheduled for completion in the third quarter of 2009. At closing, we owned 49% of the project. Our investment at December 31, 2008 and 2007 was $9.9 million and $8.9 million, respectively.

In January 2007, we entered into a joint venture which owns and operates a recently completed 23-story, 166 apartment home high rise community in the central business district of Bellevue, Washington. At closing, UDR owned 49% of the project. Our investment at December 31, 2008 and 2007 was $10.4 million and $11.2 million, respectively.

In November 2007, UDR and an institutional unaffiliated partner formed a joint venture which owns and operates various apartment communities located in Texas. On the closing date, UDR sold nine operating properties, consisting of 3,690 units, and contributed one property under development to the joint venture. The property under development has 302 units and was completed in the third quarter of 2008 and commenced lease up at that time. UDR contributed cash and property equal to 20% of the fair value of the properties. The unaffiliated partner contributed cash equal to 80% of the fair value of the properties comprising the venture, which was then used to purchase the nine operating properties from UDR. Our investment at December 31, 2008 and 2007 was $16.5 million and $20.1 million, respectively. In addition, during 2008 we received payment in full of a note receivable of $18.8 million from the joint venture.

Disposition of Investments

During the year ended December 31, 2008, UDR sold 86 communities with a total of 25,684 apartment homes, for gross consideration of $1.7 billion, 53 condominiums from two communities with a total of 640 condominiums for gross consideration of $6.9 million, one parcel of land for gross proceeds of $1.6 million and one commercial property for gross proceeds of $6.5 million. We recognized after-tax gains for financial reporting purposes of $786.4 million on these sales. Proceeds from the sales were used primarily to acquire new communities and reduce debt. During 2008, we decided to discontinue sales of units with the two communities identified for condominium conversion until such time that the market conditions turn favorable and it is economically beneficial to sell those units versus operate the residual 525 units of those communities. As a result of our decision to revert the remaining units to operations the Company recorded a charge to earnings of $1.7 million, excluding the catch up for depreciation on the units when they were returned to operations.

As a result of our disposition activities in 2008, the Company declared a Special Dividend payable to holders of our common stock for $0.96 per share included with our recurring distribution for the Company’s fourth quarter of 2008 for a total of $1.29 per share ($1.19 per share in the aggregate adjusted for the Special Dividend) payable on January 29, 2009 to stockholders of record on December 9, 2008. Additional information regarding the Special Dividend is set forth in Item 1. Business in Part 1 of this Report.

In conjunction with the transaction in which we sold 86 communities for $1.7 billion, we received a note in the amount of $200.0 million. The note, which is secured by a pledge, security agreement and a guarantee from the buyer’s parent entity, bears interest at the rate of 7.5% per annum and matures on March 31, 2014, provided however that the master credit facility agreement pursuant to which the buyer financed the acquisition of the properties provides that the buyer will pay or prepay the note on or before the date that is fourteen (14) months after the Initial Closing Date (May 3, 2009) and further that it is an event of default under the master credit facility agreement if the note is not paid in full by June 1, 2009.

For the year ended December 31, 2007, UDR sold 21 communities with a total of 7,125 apartment homes for gross consideration of $729.2 million, one parcel of land for $4.5 million, and contributed one property under development, at cost, to a joint venture arrangement in Texas. In addition, we sold 61 condominiums from two communities with a total of 640 condominiums for gross consideration of $10.4 million. We recognized after-tax gains for financial reporting purposes of $239.1 million on these sales. Proceeds from the sales were used primarily to reduce debt.

Financing Activities

For the year ended December 31, 2008, our net cash used in financing activities was $472.5 million compared to $178.1 million for the comparable period of 2007.

The following significant financing activity occurred during the year ended December 31, 2008:


• Closed on a $240.0 million, two-year unsecured term loan facility of which $200 million was swapped into a fixed rate of 3.61% and $40.0 million has a rate of LIBOR plus 85 basis points. Proceeds were used to redeem $200.0 million of our 4.5% medium term notes due in March 2008 with the remaining $40.0 million used for general corporate purposes.

• Closed on a $400 million credit facility which matures November 2018. At December 31, 2008, we had $224.8 million outstanding on the facility - $70.0 million at a fixed interest rate of 5.85% and $154.8 million at a variable interest rate, fixed with two- and three-year LIBOR swaps at an average rate of 4.32%. The Company has five years to draw on the additional $175.2 million of capacity. This facility replaced a debt instrument with an outstanding balance of $138.9 million that matured on April 1, 2010 that had a stated rate of 6.09%. As a result of this refinancing the Company incurred a charge to earnings of $4.7 million related to the write off of deferred financing charges and prepayment penalties associated with the retired debt instrument. Some of the incremental proceeds from this note were used to purchase unsecured long term debt at a discount to par.

• Sold 8,661,201 shares of our common stock adjusted for the Special Dividend (8,000,000 shares of common stock on an unadjusted basis) in a public offering resulting in gross proceeds of $194.0 million.

• Obtained five construction loans for a total of $179.3 million of which the Company has drawn $53.9 million for our development projects. The construction loans all have a three-year initial terms with an extension provision(s) and incur interest at a variable rates which range from LIBOR plus 140 basis points to LIBOR plus 225 basis points.

• Repaid $216.4 million of secured debt and $793.0 million of unsecured debt (represents the notional amount of debt repaid and excludes the gain on extinguishment). The $793.0 million of unsecured debt consisted of $309.5 million for the revolving credit facility, $275.8 million for maturing debt and $207.7 million for the repurchase of unsecured debt.

• Repurchased unsecured debt with a notional amount of $207.7 million for $176.2 million resulting in a gain on extinguishment of $29.6 million, net of deferred finance charges. The unsecured debt repurchased by the Company matured in 2011, 2014, 2015 and 2016, respectively. As a result of these repurchases, the gain is presented as a reduction to interest expense on the Consolidated Statement of Operations.

• Repurchased 969,300 shares of our Series G Cumulative Redeemable Preferred Stock for $20.3 million, less than their liquidation value of $24.2 million.

For the year ended December 31, 2007, our net cash used in financing activities was $178.1 million compared to $93.0 million for the comparable period of 2006. The increase in financing activities was due to the Company repaying additional secured debt, the redemption of our Series B Cumulative Redeemable Preferred Stock, repurchase of common stock in the marketplace which was offset by the issuance of issuance of debt and equity securities and drawing down on our unsecured credit facility.

Credit Facilities

As of December 31, 2008, we have secured revolving credit facilities with Fannie Mae with an aggregate commitment of $1.0 billion with $831.2 million outstanding. The Fannie Mae credit facilities are for an initial term of 10 years, bear interest at floating and fixed rates, and certain variable rate facilities can be extended for an additional five years at our option. We have $666.6 million of the funded balance fixed at a weighted average interest rate of 5.5% and the remaining balance on these facilities is currently at a weighted average variable rate of 3.1%.

As of December 31, 2007, we had secured revolving credit facilities with Fannie Mae with an aggregate commitment of $748.9 million with $663.9 million outstanding. The Fannie Mae credit facilities are for an initial term of ten years, bear interest at floating and fixed rates, and certain variable rate facilities can be extended for an additional five years at our option. We had $583.1 million of the funded balance fixed at a weighted average interest rate of 5.9% and the remaining balance on these facilities was at a weighted average variable rate of 5.1%.

On July 27, 2007, we amended and restated our existing three-year $500 million unsecured revolving credit facility with a maturity date of May 31, 2008, (which could be extended for an additional year at our option) to increase the facility to $600 million and to extend its maturity to July 26, 2012. Under certain circumstances, we may increase the new $600 million credit facility to $750 million. Based on our current credit ratings, the $600 million credit facility carries an interest rate equal to LIBOR plus a spread of 47.5 basis points, which represents a 10 basis point reduction to the previous $500 million revolving credit facility. Under a competitive bid feature and for so long as we maintain an investment grade rating, we have the right under the new $600 million credit facility to bid out 50% of the commitment amount and we can bid out 100% of the commitment amount once per quarter. As of December 31, 2008 and 2007, there was $0 and $309.5 million, respectively, outstanding on the unsecured revolving credit facility.

The Fannie Mae credit facility and the bank revolving credit facility are subject to customary financial covenants and limitations.

Interest Rate Risk

We are exposed to interest rate risk associated with variable rate notes payable and maturing debt that has to be refinanced. We do not hold financial instruments for trading or other speculative purposes, but rather issue these financial instruments to finance our portfolio of real estate assets. Interest rate sensitivity is the relationship between changes in market interest rates and the fair value of market rate sensitive assets and liabilities. Our earnings are affected as changes in short-term interest rates impact our cost of variable rate debt and maturing fixed rate debt. We had $345.7 million in variable rate debt that is not subject to interest rate swap contracts as of December 31, 2008. If market interest rates for variable rate debt increased by 100 basis point, our interest expense would increase by $3.8 million based on the average balance outstanding during the year.

These amounts are determined by considering the impact of hypothetical interest rates on our borrowing cost. These analyses do not consider the effects of the adjusted level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management would likely take actions to further mitigate our exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no change in our financial structure.

Funds from Operations

Funds from operations, or FFO, is defined as net income (computed in accordance with GAAP), excluding gains (or losses) from sales of depreciable property, plus real estate depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. We compute FFO for all periods presented in accordance with the recommendations set forth by the National Association of Real Estate Investment Trust’s (“NAREIT”) April 1, 2002 White Paper. We consider FFO in evaluating property acquisitions and our operating performance, and believe that FFO should be considered along with, but not as an alternative to, net income and cash flow as a measure of our activities in accordance with generally accepted accounting principles. FFO does not represent cash generated from operating activities in accordance with generally accepted accounting principles and is not necessarily indicative of cash available to fund cash needs.

Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. Thus, NAREIT created FFO as a supplemental measure of REIT operating performance and defines FFO as net income (computed in accordance with accounting principles generally accepted in the United States), excluding gains (or losses) from sales of depreciable property, premiums or original issuance costs associated with preferred stock redemptions, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. The use of FFO, combined with the required presentations, has been fundamentally beneficial, improving the understanding of operating results of REITs among the investing public and making comparisons of REIT operating results more meaningful. We generally consider FFO to be a useful measure for reviewing our comparative operating and financial performance (although FFO should be reviewed in conjunction with net income which remains the primary measure of performance) because by excluding gains or losses related to sales of previously depreciated operating real estate assets and excluding real estate asset depreciation and amortization, FFO can help one compare the operating performance of a Company’s real estate between periods or as compared to different companies. We believe that FFO is the best measure of economic profitability for real estate investment trusts.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Business Overview
We are a real estate investment trust, or REIT, that owns, acquires, renovates, develops, and manages apartment communities nationwide. We were formed in 1972 as a Virginia corporation. In June 2003, we changed our state of incorporation from Virginia to Maryland. Our subsidiaries include two operating partnerships, Heritage Communities L.P., a Delaware limited partnership, and United Dominion Realty, L.P., a Delaware limited partnership. Unless the context otherwise requires, all references in this report to “we,” “us,” “our,” “the company,” or “UDR” refer collectively to UDR, Inc. and its subsidiaries.

Liquidity and Capital Resources
Liquidity is the ability to meet present and future financial obligations either through operating cash flows, the sale or maturity of existing assets, or by the acquisition of additional funds through capital management. Both the coordination of asset and liability maturities and effective capital management are important to the maintenance of liquidity. Our primary source of liquidity is our cash flow from operations as determined by rental rates, occupancy levels, and operating expenses related to our portfolio of apartment homes and borrowings under credit arrangements. We routinely use our unsecured bank credit facility to temporarily fund certain investing and financing activities prior to arranging for longer-term financing or the issuance of equity securities. During the past several years, proceeds from the sale of real estate have been used for both investing and financing activities as we reposition our portfolio.
We expect to meet our short-term liquidity requirements generally through net cash provided by operations and borrowings under credit arrangements. We expect to meet certain long-term liquidity requirements such as scheduled debt maturities, the repayment of financing on development activities, and potential property acquisitions, through long-term secured and unsecured borrowings, the disposition of properties, and the issuance of additional debt or equity securities. We believe that our net cash pro]]>Wed, 17 Jun 2009 03:42:46 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/2774/http://www.dailystocks.com/forum/showtopic.php?tid/2774/
BUSINESS OVERVIEW

The Company

Campbell Soup Company (“Campbell” or the “company”), together with its consolidated subsidiaries, is a global manufacturer and marketer of high-quality, branded convenience food products. Campbell was incorporated as a business corporation under the laws of New Jersey on November 23, 1922; however, through predecessor organizations, it traces its heritage in the food business back to 1869. The company’s principal executive offices are in Camden, New Jersey 08103-1799.

In fiscal 2008, the company continued its focus on achieving long-term sustainable sales and earnings growth by executing against the following seven key strategies:


• Expanding the company’s icon brands within simple meals, baked snacks and healthy beverages;

• Trading consumers up to higher levels of satisfaction centering on wellness, quality and convenience;

• Making the company’s products more broadly available in existing and new markets;

• Strengthening the company’s business through outside partnerships and acquisitions;

• Increasing margins by improving price realization and company-wide productivity;

• Improving overall organizational excellence, diversity, engagement and innovation; and

• Advancing a powerful commitment to sustainability and corporate social responsibility.

Consistent with these strategies, the company has undertaken several portfolio adjustments. The company divested its Godiva Chocolatier business on March 18, 2008 and certain Australian salty snack food brands and assets on May 12, 2008. On July 31, 2008, the company announced that it had entered into an agreement to divest its French sauce and mayonnaise business, which is marketed under the Lesieur brand. The sale of the French sauce and mayonnaise business was completed on September 29, 2008. These portfolio adjustments are designed to enhance the company’s focus on the core simple meals, baked snacks and healthy beverages businesses in markets with the greatest potential for growth. For additional information relating to the company’s seven key strategies, see “Management’s Discussion and Analysis of Results of Operations and Financial Condition.”

Prior to the second quarter of fiscal 2008, the company’s operations were organized and reported in the following segments: U.S. Soup, Sauces and Beverages; Baking and Snacking; International Soup, Sauces and Beverages; and Other. Other included the Godiva Chocolatier business and the company’s Away From Home operations. As of the second quarter of fiscal 2008, the results of the Godiva Chocolatier business were reported as discontinued operations for the periods presented due to the previously discussed divestiture. See Note 3 for additional information on the sale. Beginning with the second quarter of fiscal 2008, the Away From Home business was reported as North America Foodservice.

The segments are discussed in greater detail below.

U.S. Soup, Sauces and Beverages

The U.S. Soup, Sauces and Beverages segment includes the following retail businesses: Campbell’s condensed and ready-to-serve soups; Swanson broth and canned poultry; Prego pasta sauce; Pace Mexican sauce; Campbell’s Chunky chili; Campbell’s canned pasta, gravies, and beans; Campbell’s Supper Bakes meal kits; V8 juice and juice drinks; and Campbell’s tomato juice.

Baking and Snacking

The Baking and Snacking segment includes the following businesses: Pepperidge Farm cookies, crackers, bakery and frozen products in U.S. retail; Arnott’s biscuits in Australia and Asia Pacific; and Arnott’s salty snacks in Australia. As previously discussed, in May 2008, the company completed the divestiture of certain salty snack food brands and assets in Australia, which were historically included in this segment.

International Soup, Sauces and Beverages

The International Soup, Sauces and Beverages segment includes the soup, sauce and beverage businesses outside of the United States, including Europe, Mexico, Latin America, the Asia Pacific region and the retail business in Canada. The segment’s operations include Erasco and Heisse Tasse soups in Germany, Liebig and Royco soups in France, Devos Lemmens mayonnaise and cold sauces and Campbell’s and Royco soups in Belgium, and Blå Band soups and sauces in Sweden. In Asia Pacific, operations include Campbell’s soup and stock, Swanson broths and V8 beverages. In Canada, operations include Habitant and Campbell’s soups, Prego pasta sauce, V8 beverages and certain Pepperidge Farm products. The French sauce and mayonnaise business, which was marketed under the Lesieur brand and divested on September 29, 2008, was historically included in this segment.

North America Foodservice

The North America Foodservice segment includes the company’s Away From Home operations, which represent the distribution of products such as soup, specialty entrees, beverage products, other prepared foods and Pepperidge Farm products through various food service channels in the United States and Canada.

Ingredients

The ingredients required for the manufacture of the company’s food products are purchased from various suppliers. While all such ingredients are available from numerous independent suppliers, raw materials are subject to fluctuations in price attributable to a number of factors, including changes in crop size, cattle cycles, product scarcity, demand for raw materials, energy costs, government-sponsored agricultural programs, import and export requirements and weather conditions during the growing and harvesting seasons. To help reduce some of this volatility, the company uses various commodity risk management tools for a number of its ingredients and commodities, such as soybean oil, wheat, soybean meal, corn, cocoa and natural gas. Ingredient inventories are at a peak during the late fall and decline during the winter and spring. Since many ingredients of suitable quality are available in sufficient quantities only at certain seasons, the company makes commitments for the purchase of such ingredients during their respective seasons. At this time, the company does not anticipate any material restrictions on availability or shortages of ingredients that would have a significant impact on the company’s businesses. For additional information on the impact of inflation on the company, see “Management’s Discussion and Analysis of Results of Operations and Financial Condition.”

Customers

In most of the company’s markets, sales activities are conducted by the company’s own sales force and through broker and distributor arrangements. In the United States, Canada and Latin America, the company’s products are generally resold to consumers in retail food chains, mass discounters, mass merchandisers, club stores, convenience stores, drug stores and other retail, commercial and non-commercial establishments. In Europe, the company’s products are generally resold to consumers in retail food chains, mass discounters, mass merchandisers, club stores, convenience stores and other retail, commercial and non-commercial establishments. In Mexico, the company’s products are generally resold to consumers in retail food chains, mass merchandisers, club stores, convenience stores, drug stores and other retail establishments. In the Asia Pacific region, the company’s products are generally resold to consumers through retail food chains, convenience stores and other retail, commercial and non-commercial establishments. The company makes shipments promptly after receipt and acceptance of orders.

The company’s largest customer, Wal-Mart Stores, Inc. and its affiliates, accounted for approximately 16% of the company’s consolidated net sales during fiscal 2008 and 15% during fiscal 2007. All of the company’s segments sold products to Wal-Mart Stores, Inc. or its affiliates. No other customer accounted for 10% or more of the company’s consolidated net sales.

Trademarks And Technology

As of September 15, 2008, the company owned over 4,400 trademark registrations and applications in over 150 countries and believes that its trademarks are of material importance to its business. Although the laws vary by jurisdiction, trademarks generally are valid as long as they are in use and/or their registrations are properly maintained and have not been found to have become generic. Trademark registrations generally can be renewed indefinitely as long as the trademarks are in use. The company believes that its principal brands, including Campbell’s, Erasco, Liebig, Pepperidge Farm, V8, Pace, Prego, Swanson, and Arnott’s, are protected by trademark law in the company’s relevant major markets. In addition, some of the company’s products are sold under brands that have been licensed from third parties.

Although the company owns a number of valuable patents, it does not regard any segment of its business as being dependent upon any single patent or group of related patents. In addition, the company owns copyrights, both registered and unregistered, and proprietary trade secrets, technology, know-how processes, and other intellectual property rights that are not registered.

Competition

The company experiences worldwide competition in all of its principal products. This competition arises from numerous competitors of varying sizes, including producers of generic and private label products, as well as from manufacturers of other branded food products, which compete for trade merchandising support and consumer dollars. As such, the number of competitors cannot be reliably estimated. The principal areas of competition are brand recognition, quality, price, advertising, promotion, convenience and service.

Working Capital

For information relating to the company’s cash and working capital items, see “Management’s Discussion and Analysis of Results of Operations and Financial Condition.”

Capital Expenditures

During fiscal 2008, the company’s aggregate capital expenditures were $298 million. The company expects to spend approximately $400 million for capital projects in fiscal 2009. The anticipated major fiscal 2009 capital projects include the previously announced expansion and enhancement of the company’s corporate headquarters in Camden, New Jersey, which is expected to continue into fiscal years following 2009, and expansion of the company’s beverage production capacity.

Research And Development

During the last three fiscal years, the company’s expenditures on research activities relating to new products and the improvement and maintenance of existing products for continuing operations were $115 million in 2008, $111 million in 2007 and $103 million in 2006. The increase from 2007 to 2008 was primarily due to the impact of currency. The increase from 2006 to 2007 was primarily due to expenses related to new product development, higher incentive compensation costs and the impact of currency. The company conducts this research primarily at its headquarters in Camden, New Jersey, although important research is undertaken at various other locations inside and outside the United States.

Environmental Matters

The company has requirements for the operation and design of its facilities that meet or exceed applicable environmental rules and regulations. Of the company’s $298 million in capital expenditures made during fiscal 2008, approximately $6 million was for compliance with environmental laws and regulations in the United States. The company further estimates that approximately $7 million of the capital expenditures anticipated during fiscal 2009 will be for compliance with United States environmental laws and regulations. The company believes that continued compliance with existing environmental laws and regulations will not have a material effect on capital expenditures, earnings or the competitive position of the company.

Seasonality

Demand for the company’s products is somewhat seasonal, with the fall and winter months usually accounting for the highest sales volume due primarily to demand for the company’s soup and sauce products. Demand for the company’s beverage, baking and snacking products, however, is generally evenly distributed throughout the year.

Regulation

The manufacture and marketing of food products is highly regulated. In the United States, the company is subject to regulation by various government agencies, including the Food and Drug Administration, the U.S. Department of Agriculture and the Federal Trade Commission, as well as various state and local agencies. The company is also regulated by similar agencies outside the United States and by voluntary organizations such as the National Advertising Division and the Children’s Food and Beverage Advertising Initiative of the Council of Better Business Bureaus.

Employees

On August 3, 2008, there were approximately 19,400 employees of the company.

Financial Information

For information with respect to revenue, operating profitability and identifiable assets attributable to the company’s business segments and geographic areas, see Note 6 to the Consolidated Financial Statements.

Company Website

The company’s primary corporate website can be found at www.campbellsoupcompany.com . The company makes available free of charge at this website (under the “Investor Center — Financial Reports — SEC Filings” caption) all of its reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, including its annual report on Form 10-K, its quarterly reports on Form 10-Q and its current reports on Form 8-K. These reports are made available on the website as soon as reasonably practicable after their filing with, or furnishing to, the Securities and Exchange Commission.

Item 1A. Risk Factors

In addition to the factors discussed elsewhere in this Report, the following risks and uncertainties could materially adversely affect the company’s business, financial condition and results of operations. Additional risks and uncertainties not presently known to the company or that the company currently deems immaterial also may impair the company’s business operations and financial condition.

The company operates in a highly competitive industry

The company operates in the highly competitive food industry and experiences worldwide competition in all of its principal products. A number of the company’s primary competitors have substantial financial, marketing and other resources. A strong competitive response from one or more of these competitors to the company’s marketplace efforts, or a consumer shift towards private label offerings, could result in the company reducing pricing, increasing marketing or other expenditures, or losing market share. These changes may have a material adverse effect on the business and financial results of the company.

The company’s results may be adversely impacted by increases in the price of raw and packaging materials

The raw and packaging materials used in the company’s business include tomato paste, grains, beef, poultry, vegetables, steel, glass, paper and resin. Many of these materials are subject to price fluctuations from a number of factors, including product scarcity, demand for raw materials, commodity market speculation, energy costs, currency fluctuations, weather conditions, import and export requirements and changes in government-sponsored agricultural programs. To the extent any of these factors result in an increase in raw and packaging material prices,


CEO BACKGROUND

Retired President and Chief Executive Officer of Barnes Group, Inc. (1998-2006). Previously Senior Managing Director of Clayton Dubilier & Rice. Former Chairman and Chief Executive Officer of General Signal Corporation.

Director of Altra Holdings, Inc. 66 1990.

Retired Chairman (1996-2006) and Chief Executive Officer (1995-2006) of Liz Claiborne Inc. 66 2003 .

President and Chief Executive Officer of Campbell Soup Company since January 2001. Previously President of Nabisco Foods Company. 57 2001.

Private investor and Chairman and Managing Director of DMB Associates in Phoenix, Arizona.

Director of Insight Enterprises, Inc. 62 1989.

Non-executive Chairman of Campbell Soup Company since November 2004. Retired Chairman and Chief Executive Officer of American Express Company (1993-2001). 69 1996.

Former non-executive Chairman of Olin Corporation (2003-2005). Retired President and Chief Executive Officer of United Stationers Inc. (1997-2003).

Director of Olin Corporation. 61 2002.

Private investor and President of Iron Spring Farm, Inc. 58 1990.

President and Chief Operating Officer (since March 2007) of The Dun and Bradstreet Corporation and Former Chief Financial Officer (2001-2007) and President-U.S. (2006-2007) of D&B. Previously Vice President — Finance, ASEAN Region, The Procter & Gamble Company. 53 2005.

Founder and Chairman, Brandywine Trust Company since 1989. 60 2002 .

Non-executive Chairman of Warnaco Group, Inc. since March 2004. Retired Chairman and Chief Executive Officer of Avon Products, Inc. (1998-1999). Former Chairman and Chief Executive Officer of Duracell International, Inc. (1994-1996).

Director of Warnaco Group, Inc. 63 1999.

Retired Chairman and Chief Executive Officer of Equitant, Inc. (2003-2005). Previously Chairman and Chief Executive Officer of Avis Group (1999-2001).

Director of Agilent Technologies, Inc. 63 2005.

Private investor and President of Augustin Stables, Inc. 70 1988.

Senior Advisor of STERIS Corporation. Former President and Chief Executive Officer of STERIS from 2000 to October 1, 2007. Previously Senior Vice President, Finance and Operations, of STERIS. Former Senior Vice President and Chief Financial Officer of the B.F. Goodrich Company. 59 2003.

Private investor and President and Chief Executive Officer of Live Oak Properties. 65 1990.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

Description of the Company

Campbell Soup Company is a global manufacturer and marketer of high-quality, branded convenience food products. Prior to the second quarter of fiscal 2008, the company’s operations were organized and reported in the following segments: U.S. Soup, Sauces and Beverages; Baking and Snacking; International Soup, Sauces and Beverages; and Other. Other included the Godiva Chocolatier worldwide business and the company’s Away From Home operations. As of the second quarter of fiscal 2008, the results of the Godiva Chocolatier business were reported as discontinued operations for the periods presented due to the divestiture of the business. Beginning with the second quarter of fiscal 2008, the Away From Home business was reported as North America Foodservice. See Note 6 to the Consolidated Financial Statements for additional information on segments.

The company’s well-known brands are sold in approximately 120 countries. Its principal geographies are North America, France, Germany, Belgium, and Australia.

Key Strategies

To achieve its financial goal of long-term sustainable sales and earnings growth, the company is focused on executing seven strategies:

1. expand its icon brands within simple meals, baked snacks and healthy beverages;

2. trade consumers up to higher levels of satisfaction centering on wellness, quality and convenience;

3. make its products more broadly available in existing and new markets;

4. strengthen its business through outside partnerships and acquisitions;

5. increase margins by improving price realization and company-wide productivity;

6. improve overall organizational excellence, diversity, engagement, and innovation; and

7. advance a powerful commitment to sustainability and corporate social responsibility.

Expand the company’s icon brands within simple meals, baked snacks and healthy beverages. The company’s overarching business strategy is focused on driving profitable growth in three large, global categories — simple meals, baked snacks, and healthy beverages — that are well aligned with consumer trends, and are growing in most of the markets in which the company does business. Principal brands in these core categories include Campbell’s, Swanson, Pace, Liebig, Erasco, Pepperidge Farm, Goldfish, Arnott’s, and V8. The company has strong market positions in the segments within these categories in the geographies in which it competes, and its businesses in these categories respond well to product innovation and consumer support.

Recent portfolio changes have been intended to enhance the company’s focus in these three core categories, in markets with the greatest potential for growth. In fiscal 2008, the company announced the divestiture of the Godiva Chocolatier business, which was completed in the third quarter of the fiscal year, and the divestiture of certain salty snack food brands and assets in Australia, which was completed in the fourth fiscal quarter. The company also announced the divestiture of its sauce and mayonnaise business in France marketed under the Lesieur brand, which was completed on September 29, 2008.

Trade consumers up to higher levels of satisfaction centering on wellness, quality and convenience. Within its core categories, the company is focused on meeting the demand for products that respond to growing consumer interest in health and nutrition, quality and convenience. In the past two years, the company introduced new and reformulated condensed and ready-to-serve soups with reduced sodium in the U.S., Canada, Australia and Europe. In fiscal 2008, it introduced Campbell’s Select Harvest soups, a new line of ready-to-serve soups with lower sodium, and a line of 100% vegetable soups in aseptic packaging marketed under the V8 brand. Responding to consumer interest in weight management, in fiscal 2008 the company also introduced Campbell’s Select Harvest Light soups and other lower calorie offerings. In the category of baked snacks, the company expanded the health credentials of its product lines through the introduction of Pepperidge Farm whole-grain breads, rolls and bagels and whole-grain Arnott’s Vita-Weat biscuits. It also expanded its healthy beverage portfolio with new varieties of V8 V-Fusion vegetable and fruit juice, a fast-growing extension of the V8 vegetable juice franchise. In the convenience arena, the company continues to focus on single-serve microwavable soups in North America, Europe and Australia, portable packages of cookie and cracker products, and merchandising innovations, such as gravity-feed shelving, that enhance the convenience of the shopping experience for the consumer.

Make the company’s products more broadly available in existing and new markets. The company is pursuing strategies designed to expand the availability of its products in existing markets and to capitalize on opportunities in emerging channels and markets around the globe. In North America, for example, it is developing distribution in convenience and other channels through its agreement with The Coca-Cola Company and Coca-Cola Enterprises Inc. for the distribution of refrigerated single-serve beverages. To realize the potential of emerging markets, the company is implementing its previously announced plans to establish soup businesses in Russia and the People’s Republic of China.

Strengthen the company’s business through outside partnerships and acquisitions. In fiscal 2008, the company announced a new commitment to enhance sales and earnings growth through value-creating external development. In July 2008, it acquired the existing Wolfgang Puck U.S. soup business and entered into a license agreement for the Wolfgang Puck brand on soup, stock and broth products in North America retail locations. Wolfgang Puck is one of the leading organic soup brands in the U.S.

Increase margins by improving price realization and company-wide productivity. The company remains focused on increasing margins though a combination of pricing and productivity improvements that are intended to cover cost increases and build margins over time. In April 2008, it announced a series of initiatives designed to improve operational efficiency and long-term profitability, including (i) plans for the closure of its plant in Listowel, Ontario, Canada; (ii) the sale of certain salty snack food brands and assets in Australia; (iii) plans for the discontinuation of private label biscuit and industrial chocolate production at the company’s Miranda, Australia facility, and the closure of the facility; and (iv) streamlining of the company’s management structure.

Improve overall organizational excellence, diversity, engagement and innovation. The company remains committed to building a diverse and engaged workforce that is focused on excellence and innovation. Its efforts span three primary areas: (1) capabilities, including improving skills, innovation capabilities, and manager and team effectiveness; (2) culture, including values, workplace flexibility and employee wellness, and (3) human resources infrastructure, including processes and technology. Ensuring an effective, motivated, inclusive and diverse workplace will be the foundation of all organizational initiatives. The company will continue to use annual employee surveys to assess its progress in building employee satisfaction and engagement.

Advance a powerful commitment to sustainability and corporate social responsibility. In August 2008, the company affirmed its commitment to corporate social responsibility and environmental sustainability and issued its first corporate social responsibility report, “Nourishing People’s Lives,” which describes the company’s strategies, policies, programs and initiatives. The report focuses on four areas of primary importance to the company’s stakeholders: Campbell’s consumers; the planet; Campbell’s employees; and Campbell’s communities.

Basis of Presentation

On March 18, 2008, the company completed the sale of its Godiva Chocolatier business for $850 million, pursuant to a Sale and Purchase Agreement dated December 20, 2007. The purchase price was subject to certain post-closing adjustments, which resulted in an additional $20 million of proceeds. The company has reflected the results of this business as discontinued operations in the consolidated statements of earnings for all years presented. The company used approximately $600 million of the net proceeds to purchase company stock. See Note 3 to the Consolidated Financial Statements for additional information.

In the third quarter of 2008, the company entered into an agreement to sell certain Australian salty snack food brands and assets. The transaction, which was completed on May 12, 2008, included salty snack brands such as Cheezels, Thins, Tasty Jacks, French Fries, and Kettle Chips, certain other assets and the assumption of liabilities. Proceeds of the sale were nominal. The business had annual net sales of approximately $150 million. This transaction is included in the restructuring initiatives described in Note 7.

In July 2008, the company entered into an agreement to sell its sauce and mayonnaise business comprised of products sold under the Lesieur brand in France. The business had annual net sales of approximately $70 million. The assets and liabilities of this business were reflected as assets and liabilities held for sale in the consolidated balance sheet as of August 3, 2008. The sale was completed on September 29, 2008. See Note 3 to the Consolidated Financial Statements for additional information.

In June 2008, the company acquired the Wolfgang Puck soup business from Country Gourmet Foods for approximately $10 million of which approximately $1 million will be paid in the next two years. The company also entered into a master licensing agreement with Wolfgang Puck Worldwide, Inc. for the use of the Wolfgang Puck brand on soup, stock, and broth products in North America retail locations. This business is included in the U.S. Soup, Sauces and Beverages segment. The business had annual sales of approximately $20 million. See Note 8 to the Consolidated Financial Statements for additional information.

On August 15, 2006, the company completed the sale of its businesses in the United Kingdom and Ireland for £460 million, or approximately $870 million, pursuant to a Sale and Purchase Agreement dated July 12, 2006. The United Kingdom and Ireland businesses included Homepride sauces, OXO stock cubes, Batchelors soups and McDonnells and Erin soups. The purchase price was subject to certain post-closing adjustments, which resulted in an additional $19 million of proceeds. The company has reflected the results of these businesses as discontinued operations in the consolidated statements of earnings for all years presented. The company used approximately $620 million of the net proceeds to purchase company stock. See Note 3 to the Consolidated Financial Statements for additional information.

In June 2007, the company completed the sale of its ownership interest in Papua New Guinea operations for approximately $23 million. This business had annual sales of approximately $20 million.

Results of Operations

2008

Net earnings were $1,165 million in 2008 ($3.06 per share) and $854 million ($2.16 per share) in 2007. (All earnings per share amounts included in Management’s Discussion and Analysis are presented on a diluted basis.)

The following items impacted the comparability of net earnings and net earnings per share:

Continuing Operations


• In fiscal 2008, the company recorded a pre-tax restructuring charge of $175 million ($102 million after tax or $.27 per share) in earnings from continuing operations associated with initiatives to improve operational efficiency and long-term profitability, including selling certain salty snack food brands and assets in Australia, closing certain production facilities in Australia and Canada, and streamlining the company’s management structure. In addition, in connection with these initiatives, the company recorded $7 million ($5 million after tax or $.01 per share) of accelerated depreciation in Cost of products sold. The aggregate impact was $182 million ($107 million after tax or $.28 per share). See Note 7 to the Consolidated Financial Statements and “Restructuring Charges” for additional information;


• In the second quarter of fiscal 2008, the company recorded a non-cash tax benefit of $13 million ($.03 per share) from the favorable resolution of a state tax contingency in the United States;


• In the third quarter of fiscal 2007, the company recorded a pre-tax non-cash benefit of $20 million ($13 million after tax or $.03 per share) in earnings from continuing operations from the reversal of legal reserves due to favorable results in litigation;


• In the third quarter of fiscal 2007, the company recorded a tax benefit of $22 million resulting from the settlement of bilateral advance pricing agreements (“APA”) among the company, the United States, and Canada related to royalties. In addition, the company reduced net interest expense by $4 million ($3 million after tax). The aggregate impact on earnings from continuing operations was $25 million or $.06 per share; and


• In the second quarter of 2007, the company recorded a pre-tax gain of $23 million ($14 million after tax or $.04 per share) from the sale of an idle manufacturing facility.

Discontinued Operations


• In 2008, the company recognized a pre-tax gain of $698 million ($462 million after tax or $1.21 per share) in earnings from discontinued operations from the sale of the Godiva Chocolatier business;

• In 2007, the company recognized a pre-tax gain of $39 million ($24 million after tax or $.06 per share) from the sale of the businesses in the United Kingdom and Ireland. In addition, a tax benefit of $7 million ($0.02 per share) was recognized from the favorable resolution of tax audits in the United Kingdom.

Earnings from continuing operations were $671 million in 2008 ($1.76 per share) and $792 million ($2.00 per share) in 2007.

After factoring in the items impacting comparability, earnings from continuing operations increased primarily due to higher sales, productivity improvements, the impact of currency and the benefit of the 53 rd week, partially offset by a reduction of gross margin as a percentage of sales and a higher effective tax rate. The additional week contributed approximately $.02 per share to earnings from continuing operations in 2008. Earnings per share from continuing operations also benefited from a reduction in weighted average diluted shares outstanding.

Earnings from discontinued operations were $494 million in 2008 ($1.30 per share) and $62 million ($.16 per share) in 2007. After factoring items impacting comparability, earnings at Godiva increased slightly.

2007

Earnings from continuing operations were $792 million ($2.00 per share) in 2007 and $720 million ($1.74 per share) in 2006.

In addition to the 2007 items that impacted the comparability of Earnings from continuing operations and Earnings per share from continuing operations, the following items also impacted comparability:


• In the first quarter of 2006, a $13 million pre-tax gain was recognized due to a change in the method of accounting for certain U.S. inventories from the LIFO method to the average cost method. The impact on Earnings from continuing operations was $8 million ($.02 per share). Prior periods were not restated since the impact of the change on previously issued financial statements was not considered material. (See Note 1 to the Consolidated Financial Statements);

• In the first quarter of 2006, the company recorded a non-cash tax benefit of $47 million resulting from the favorable resolution of a U.S. tax contingency related to transactions in government securities in a prior period. In addition, the company reduced interest expense and accrued interest payable by $21 million and adjusted deferred tax expense by $8 million ($13 million after tax). The aggregate non-cash impact of the settlement on Earnings from continuing operations was $60 million, or $.14 per share. (See Note 10 to the Consolidated Financial Statements);

• In 2006, incremental tax expense of $13 million ($.03 per share) was recognized associated with incremental dividends of $294 million as the company finalized its plan to repatriate earnings from non-U.S. subsidiaries under the provisions of the American Jobs Creation Act (the AJCA); and

• In the fourth quarter of 2006, the company recorded a deferred tax benefit of $14 million ($.03 per share) from the anticipated use of higher levels of foreign tax credits, which could be utilized as a result of the sale of the company’s United Kingdom and Ireland businesses in August 2006.

In 2008, U.S. Soup, Sauces and Beverages sales increased 5%. As reported, U.S. soup sales increased 2% as condensed soup sales increased 1%, ready-to-serve soup sales increased 1%, and broth sales increased 12%. Excluding the benefit of the 53 rd week, U.S. soup sales increased 1% as condensed soup sales were flat, ready-to-serve soup sales increased 1%, and broth sales increased 11%. Within condensed soup, gains in cooking varieties were offset by declines in eating varieties. In ready-to-serve, sales gains in Campbell’s Chunky and Campbell’s Select canned soups were partially offset by a decline in the convenience platform, which includes soups in microwavable bowls and cups. Condensed and ready-to-serve soups benefited from the lower sodium varieties. Swanson broth sales increased due to continued growth of aseptically-packaged varieties. Excluding the impact of the 53 rd week, beverage sales increased double digits, primarily due to consumer demand for healthy beverages. V8 vegetable juice, V8 V-Fusion vegetable and fruit juice, and V8 Splash juice drinks contributed to the sales growth. Sales of Campbell’s tomato juice declined. Beverage sales benefited from expanded distribution of single-serve beverages due to the distribution agreement for refrigerated single-serve beverages with The Coca-Cola Company and Coca-Cola Enterprises Inc. Sales of Prego pasta sauces and Pace Mexican sauces increased.

In 2007, U.S. Soup, Sauces and Beverages sales increased 7%. U.S. soup sales increased 5% as condensed soup sales increased 3%, ready-to-serve soup sales increased 5% and broth sales increased 12%. The introduction in 2007 of new lower sodium varieties of condensed and ready-to-serve soups contributed to the sales growth. Within condensed soup, both eating and cooking varieties delivered solid sales gains. Sales growth in ready-to-serve soup was driven by gains in Campbell’s Chunky and Campbell’s Select soups which benefited from higher levels of advertising. In the convenience platform, which includes soups in microwavable bowls and cups, sales grew double digits. Swanson broth sales grew due to increased advertising and continued growth of aseptically-packaged products. Beverage sales grew significantly as V8 vegetable juice and V8 V-Fusion vegetable and fruit juice, introduced in the second quarter of 2006, responded favorably to new advertising campaigns and increased levels of advertising . V8 Splash juice drinks also experienced sales growth. Sales of Prego pasta sauces and Pace Mexican sauces increased.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

OVERVIEW
Basis of Presentation
On March 18, 2008, the company completed the sale of its Godiva Chocolatier business for $850 million, pursuant to a Sale and Purchase Agreement dated December 20, 2007. The purchase price was subject to certain post-closing adjustments, which resulted in an additional $20 million of proceeds. The company has reflected the results of this business as discontinued operations in the consolidated statements of earnings. The company used approximately $600 million of the net proceeds to purchase company stock. See Note (b) to the Consolidated Financial Statements for additional information.
In the third quarter of 2008, the company entered into an agreement to sell certain Australian salty snack food brands and assets. The transaction, which was completed on May 12, 2008, included salty snack brands such as Cheezels , Thins , Tasty Jacks , French Fries , and Kettle Chips , certain other assets and the assumption of liabilities. Proceeds of the sale were nominal. The business had annual net sales of approximately $150 million. This transaction is included in the restructuring initiatives described in Note (m).
In July 2008, the company entered into an agreement to sell its sauce and mayonnaise business comprised of products sold under the Lesieur brand in France. The sale was completed on September 29, 2008 and resulted in $36 million of proceeds. The purchase price was subject to working capital and other post-closing adjustments, which resulted in an additional $6 million of proceeds. The business had annual net sales of approximately $70 million. See Note (b) to the Consolidated Financial Statements for additional information.
Results of Operations
Net sales decreased 10% to $1.686 billion in the third quarter ended May 3, 2009 from $1.880 billion last year. The impact of currency translation and divestitures accounted for 9 percentage points of the decline. Net earnings were $174 million for the third quarter ended May 3, 2009, versus $532 million in the comparable quarter a year ago. The year-ago quarter included a $467 million ($1.23 per share) gain from the sale of the Godiva Chocolatier business. Net earnings per share were $.49 compared to $1.40 a year ago. (All earnings per share amounts included in Management’s Discussion and Analysis are presented on a diluted basis.)

The following items impacted the comparability of net earnings and net earnings per share:
Continuing Operations
• In the third quarter of fiscal 2009, the company recorded pre-tax restructuring related costs of $6 million ($4 million after tax or $.01 per share) in Cost of products sold associated with the previously announced initiatives to improve operational efficiency and long-term profitability. In the nine-months ended May 3, 2009, the company recorded pre-tax restructuring related costs of $21 million ($14 million after tax or $.04 per share) in Cost of products sold. In the third quarter of fiscal 2008, the company recorded a pre-tax restructuring charge of $172 million ($100 million after tax or $.26 per share) associated with the previously announced initiatives. See Note (m) to the Consolidated Financial Statements and “Restructuring Charges” for additional information;
• In the third quarter of fiscal 2009, the company recognized an $11 million ($7 million after tax or $.02 per share) favorable net adjustment on commodity hedge positions. The aggregate year-to-date impact from open commodity hedges was $14 million ($9 million after tax or $.02 per share) of unrealized losses;

• In the second quarter of fiscal 2008, the company recognized a non-cash tax benefit of $13 million ($.03 per share) from the favorable resolution of a state tax contingency in the United States;
Discontinued Operations
• In the second quarter of fiscal 2009, the company recorded a $4 million tax benefit ($.01 per share) related to the sale of the Godiva Chocolatier business; and

• In the third quarter of fiscal 2008, the company recognized a pre-tax gain of $707 million ($467 million after tax or $1.23 per share) from the sale of the Godiva Chocolatier business. The total after tax gain recognized in fiscal 2008 on the sale was $462 million or $1.20 per share as certain costs were recognized in the second quarter.

Earnings from discontinued operations in the prior-year quarter were $478 million, or $1.25 per share, and included the $467 million gain from the sale of the Godiva Chocolatier business. The operations of Godiva contributed to earnings of $.03 per share in 2008.

For the nine-months ended May 3, 2009, earnings from continuing operations were $663 million compared to $582 million a year ago. Earnings per share from continuing operations were $1.84 compared to $1.51 a year ago. After factoring in the items impacting comparability, earnings from continuing operations increased compared to the prior year primarily due to lower interest expense and reduced administrative costs, which were partly offset by the negative impact of currency translation. After factoring in the items impacting comparability, earnings per share from continuing operations increased in the current period due in part to the benefit from a reduction in the weighted average diluted shares outstanding. The reduction was primarily due to share repurchases utilizing the net proceeds from the divestiture of the Godiva Chocolatier business and the company’s strategic share repurchase programs. Earnings per share from continuing operations were negatively impacted by $.08 from currency translation in fiscal 2009.
For the nine-months ended May 3, 2009, earnings from discontinued operations of $4 million represented an adjustment to the tax liability associated with the sale of the Godiva Chocolatier business. Earnings from discontinued operations were $494 million in 2008 and included the $462 million gain from the sale of the Godiva Chocolatier business. Earnings per share from discontinued operations were $.01 in 2009 and $1.28 in 2008. The operations of Godiva contributed to earnings of $.08 per share in 2008.
After factoring in the items impacting comparability, net earnings declined due to the impact of the Godiva divestiture, partially offset by higher earnings from continuing operations. Net earnings per share increased reflecting a reduction in the weighted average diluted shares outstanding, which was primarily due to share repurchases utilizing the net proceeds from the divestiture of the Godiva Chocolatier business and the company’s strategic share repurchase programs.
Developments in Key Strategic Initiatives
The company continues to implement previously announced plans and programs intended to advance its seven key strategies to achieve long-term sustainable sales and earnings growth. These plans and programs, which include a number of initiatives designed to meet the growing consumer interest in health and nutrition, are more fully described in the company’s 2008 Annual Report on Form 10-K, as updated in the company’s Form 10-Q for the fiscal period ended February 1, 2009. Consistent with the strategy of strengthening the company’s business through outside partnerships and acquisitions, on May 4, 2009, the company completed the acquisition of artisan bread maker Ecce Panis, Inc. The company plans to run the Ecce Panis business as part of its Pepperidge Farm bakery operations. On May 26, 2009, the company announced it had entered into an agreement with Coca-Cola Hellenic Bottling Company S.A. for the distribution of Campbell’s Domashnaya Klassika ( Campbell’s Home Classics ) concentrated broth and other soup products in Russia. This arrangement is expected to significantly expand distribution of the company’s products in Russia.

In Baking and Snacking, Pepperidge Farm achieved sales growth with double-digit gains in Goldfish snack crackers and in Milano cookies. The introduction of Granola cookies contributed to the increase. On an as reported basis, Arnott’s sales declined due to the divestiture of certain salty snack food brands in May 2008, the reduction of the private label biscuit and industrial chocolate businesses associated with the closing of a production facility in Australia and the unfavorable impact of currency. Excluding these items, Arnott’s sales increased due to solid growth in both savory and sweet biscuit products with especially strong growth in Indonesia.
In International Soup, Sauces and Beverages, sales decreased in Europe primarily due to the unfavorable impact of currency, the divestiture of the company’s French sauce and mayonnaise business in September 2008, and lower sales in Germany and France. In Canada, sales declined due to the unfavorable impact of currency and lower soup sales. In Asia Pacific, sales increased primarily due to gains in the Australian soup business and Malaysia, partially offset by the unfavorable impact of currency.
In North America Foodservice, excluding the impact of currency, sales declined primarily due to weakness in the food service sector.
Gross Profit
Gross profit, defined as Net sales less Cost of products sold, decreased from $726 million in 2008 to $685 million in 2009. As a percent of sales, gross profit increased from 38.6% in 2008 to 40.6% in 2009. The percentage point increase was due to higher selling prices (approximately 3.8 percentage points), productivity improvements (approximately 2.0 percentage points), mix (approximately 0.7 percentage point), and a favorable net adjustment on commodity hedge positions (approximately 0.7 percentage point), partially offset by costs related to the initiatives to improve operational efficiency and long-term profitability (approximately 0.4 percentage point), increased promotional spending (approximately 0.6 percentage point), and the impact of cost inflation and other factors (approximately 4.2 percentage points).
Marketing and Selling Expenses
Marketing and selling expenses as a percent of sales were 14.6% in 2009 and 15.1% in 2008. Marketing and selling expenses decreased 13% in 2009 from 2008. The decrease was primarily due to the impact of currency (approximately 5 percentage points), lower advertising expenses (approximately 3 percentage points) and lower selling expenses (approximately 2 percentage points). The lower advertising expense was primarily in U.S. Soup, Sauces and Beverages, following a significant first half increase to support the launch of new soup products.
Administrative Expenses
Administrative expenses as a percent of sales were 7.7% in 2009 and 8.4% in 2008. Administrative expenses decreased by 18% in 2009 from 2008, primarily due to the impact of currency (approximately 5 percentage points), lower long-term compensation costs (approximately 8 percentage points), and the impact of cost reduction efforts and other factors (approximately 5 percentage points).

Nonoperating Items
Net interest expense decreased to $26 million from $37 million in the prior year, primarily due to significantly lower short-term interest rates.
The effective tax rate for the quarter was 33.1% in 2009. The effective rate benefit for the year-ago quarter was 20%. The prior-year quarter included a $72 million tax benefit on the $172 million pre-tax restructuring charge. After factoring in the restructuring related benefit, the effective rate increased primarily due to the benefit of tax planning strategies which reduced the rate in fiscal 2008.

Gross Profit
Gross profit, defined as Net sales less Cost of products sold, decreased from $2.507 billion in 2008 to $2.393 billion in 2009. As a percent of sales, gross profit decreased from 39.9% in 2008 to 39.5% in 2009. The percentage point decrease was due to unrealized losses on commodity hedges (approximately 0.2 percentage point), costs related to the initiatives to improve operational efficiency and long-term profitability (approximately 0.4 percentage point), increased promotional spending (approximately 1.2 percentage points) and the impact of cost inflation and other factors (approximately 5.3 percentage points), partially offset by higher selling prices (approximately 4.7 percentage points), productivity improvements (approximately 1.6 percentage points) and mix (approximately 0.4 percentage point).
Marketing and Selling Expenses
Marketing and selling expenses as a percent of sales were 14.3% in 2009 and in 2008. Marketing and selling expenses decreased 3% in 2009 from 2008. The decrease was primarily due to the impact of currency (approximately 3 percentage points) as increased advertising costs (approximately 2 percentage points) were offset by lower selling expenses (approximately 2 percentage points).
Administrative Expenses
Administrative expenses as a percent of sales were 6.7% in 2009 and 7% in 2008. Administrative expenses decreased by 8% in 2009 from 2008, primarily due to the impact of currency (approximately 3 percentage points), lower long-term compensation costs (approximately 3 percentage points), and the impact of cost reduction efforts and other factors (approximately 4 percentage points), partially offset by incremental costs to launch products in Russia and China (approximately 2 percentage points).

Nonoperating Items
Net interest expense decreased to $83 million from $121 million in the prior year, primarily due to lower interest rates.
The effective tax rate for the nine months was 30.7% in 2009. The effective tax rate for the nine months was 26.2% in 2008. The prior-year rate included a $13 million benefit from the favorable resolution of a state tax matter and a $72 million tax benefit on the $172 million pre-tax restructuring charge.
Restructuring Charges
On April 28, 2008, the company announced a series of initiatives to improve operational efficiency and long-term profitability, including selling certain salty snack food brands and assets in Australia, closing certain production facilities in Australia and Canada, and streamlining the company’s management structure. As a result of these initiatives, in 2008, the company recorded a restructuring charge of $175 million ($102 million after tax or $.27 per share). The charge consisted of a net loss of $120 million ($64 million after tax) on the sale of certain Australian salty snack food brands and assets, $45 million ($31 million after tax) of employee severance and benefit costs, including the estimated impact of curtailment and other pension charges, and $10 million ($7 million after tax) of property, plant and equipment impairment charges. In addition, approximately $7 million ($5 million after tax or $.01 per share) of costs related to these initiatives were recorded in Cost of products sold, primarily representing accelerated depreciation on property, plant and equipment. The aggregate after-tax impact of restructuring charges and related costs in 2008 was $107 million, or $.28 per share. In the nine-month period ended May 3, 2009, the company recorded approximately $21 million ($14 million after tax or $.04 per share) of costs related to these initiatives in Cost of products sold. Approximately $17 million of the costs represented accelerated depreciation on property, plant and equipment and approximately $4 million related to other exit costs. The company expects to incur additional pre-tax costs of approximately $15 million, consisting of the following: approximately $13 million in employee severance and benefit costs, including the estimated impact of curtailment and other pension charges and approximately $2 million in other exit costs. Of the aggregate $218 million of pre-tax costs for the total program, the company expects approximately $50 million will be cash expenditures, the majority of which will be spent in 2009. The cash outflows related to these programs are not expected to have a material adverse impact on the company’s liquidity. Annual pre-tax benefits are expected to be approximately $15-$20 million beginning in 2009.
In the third quarter of 2008, as part of the previously discussed initiatives, the company entered into an agreement to sell certain Australian salty snack food brands and assets. The transaction was completed on May 12, 2008. Proceeds of the sale were nominal. In connection with this transaction, the company recognized a net loss of $120 million ($64 million after tax) in 2008. The terms of the agreement required the company to provide a loan facility to the buyer of AUD $10 million, or approximately USD $7 million. The buyer borrowed AUD $5 million in November 2008 and the remaining AUD $5 million in March 2009 under the facility. Borrowings under the facility are to be repaid five years after the closing date. See also Note (b) to the Consolidated Financial Statements for additional information.
In April 2008, as part of the previously discussed initiatives, the company announced plans to close the Listowel, Ontario, Canada food plant. The Listowel facility produced primarily frozen products, including soup, entrees, and Pepperidge Farm products, as well as ramen noodles. The facility employed approximately 500 people. The company closed the facility in April 2009. Production was transitioned to its network of North American contract manufacturers and to its Downingtown, Pennsylvania plant. The company recorded $20 million ($14 million after tax) of employee severance and benefit costs, including the estimated impact of curtailment and other pension charges, and $7 million ($5 million after tax) in accelerated depreciation of property, plant and equipment in 2008. In the nine-month period ended May 3, 2009, the company recorded $16 million ($11 million after tax) in accelerated depreciation of property, plant and equipment and $2 million ($1 million after tax) of other exit costs. The company expects to incur approximately $13 million in additional employee severance and benefit costs and approximately $2 million in other exit costs.
In April 2008, as part of the previously discussed initiatives, the company also announced plans to discontinue the private label biscuit and industrial chocolate production at its Miranda, Australia facility. The company closed the Miranda facility, which employed approximately 150 people, in the second quarter of 2009. In connection with this action, the company recorded $10 million ($7 million after tax) of property, plant and equipment impairment charges and $8 million ($6 million after tax) in employee severance and benefit costs in 2008. In the nine-month period ended May 3, 2009, the company recorded $1 million in accelerated depreciation of property, plant and equipment and $2 million ($1 million after tax) of other exit costs.
As part of the previously discussed initiatives, the company is streamlining its management structure and eliminating certain overhead costs. These actions began in the fourth quarter of 2008 and will be substantially completed in 2009. In connection with this action, the company recorded $17 million ($11 million after tax) in employee severance and benefit costs in 2008.
In aggregate, the company incurred pre-tax costs of approximately $203 million in 2008 and in 2009 by segment as follows: Baking and Snacking — $147 million, International Soup, Sauces and Beverages — $9 million and North America Foodservice — $47 million. Additional pre-tax costs of $15 million are expected to be incurred in the North America Foodservice segment.

Significant Accounting Estimates
The consolidated financial statements of the company are prepared in conformity with accounting principles generally accepted in the United States. The preparation of these financial statements requires the use of estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the periods presented. Actual results could differ from those estimates and assumptions. The significant accounting policies of the company are described in Note 1 to the Consolidated Financial Statements and the significant accounting estimates are described in Management’s Discussion and Analysis included in the 2008 Annual Report on Form 10-K. The impact of new accounting standards is discussed in the following section. There have been no other changes in the company’s accounting policies in the current period that had a material impact on the company’s consolidated financial condition or results of operation.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157 “Fair Value Measurements,” which provides guidance for using fair value to measure assets and liabilities. SFAS No. 157 establishes a definition of fair value, provides a framework for measuring fair value and expands the disclosure requirements about fair value measurements. This standard does not require any new fair value measurements but rather applies to all other accounting pronouncements that require or permit fair value measurements. In February 2008, FASB Staff Position (FSP) No. FAS 157-2 was issued, which delayed by a year the effective date for certain nonfinancial assets and liabilities. The company adopted SFAS No. 157 for financial assets and liabilities in the first quarter of fiscal 2009. The adoption did not have a material impact on the consolidated financial statements. See Note (l) for additional information. The company is currently evaluating the impact of SFAS No. 157 as it relates to nonfinancial assets and liabilities.
In February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial Assets and Liabilities — Including an amendment of FASB Statement No. 115.” SFAS No. 159 allows companies to choose, at specific election dates, to measure eligible financial assets and liabilities at fair value that are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. The company adopted SFAS No. 159 at the beginning of fiscal 2009. The company elected not to adopt the fair value option under SFAS No. 159 for eligible financial assets and liabilities.

In December 2007, the FASB issued SFAS No. 141 (revised 2007) “Business Combinations,” which establishes the principles and requirements for how an acquirer recognizes the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date. This Statement applies to business combinations for which the acquisition date is after the beginning of the first annual reporting period beginning after December 15, 2008. Earlier adoption is not permitted. The company is currently evaluating the impact of SFAS No. 141 as revised.
In December 2007, the FASB issued SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements — an Amendment of ARB No. 51.” SFAS No. 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be recorded as equity in the consolidated financial statements. This Statement also requires that consolidated net income shall be adjusted to include the net income attributed to the noncontrolling interest. Disclosure on the face of the income statement of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest is required. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. Earlier adoption is not permitted. The company is currently evaluating the impact of SFAS No. 160.
In March 2008, the FASB issued SFAS No. 161 “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133,” which enhances the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) the location and amounts of derivative instruments in an entity’s financial statements, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The guidance in SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. This Statement encouraged, but did n]]>Tue, 16 Jun 2009 03:38:18 GMThttp://www.dailystocks.com/forum/showtopic.php?tid/2770/http://www.dailystocks.com/forum/showtopic.php?tid/2770/
BUSINESS OVERVIEW

Overview

Our company is a for-profit post-secondary education services corporation. Our mission is to make high quality, post-secondary education achievable and convenient for working adults in today’s economy. We work to fulfill this mission by offering a variety of academic programs through our wholly-owned subsidiary Strayer University, Inc., both in traditional classroom courses and online via the Internet. Strayer University prides itself on making post-secondary education accessible to working adults who were previously unable to take advantage of higher education opportunities.

Founded in 1892, Strayer University is an institution of higher learning that offers undergraduate and graduate degree programs in business administration, accounting, information technology, education, and public administration at 65 physical campuses in Alabama, Delaware, Florida, Georgia, Kentucky, Maryland, New Jersey, North Carolina, Pennsylvania, South Carolina, Tennessee, Utah, Virginia, West Virginia, and Washington, D.C. As of December 31, 2008, we had more than 44,000 students enrolled in our programs. Strayer University is accredited by the Middle States Commission on Higher Education (“Middle States”), one of the six regional collegiate accrediting agencies recognized by the U.S. Secretary of Education. As part of its program offering, the University also offers classes online via the Internet, providing its working adult students a flexible and convenient alternative. Strayer University, with its online offerings, attracts students from around the country and throughout the world.

Over the last several years, we have experienced significant growth, primarily by expanding geographically by opening new campuses. Since our initial public offering in 1996, we have grown from eight campuses in one state and Washington, D.C., to 65 campuses in 14 states and Washington, D.C. Our mission is to serve working adults’ demand for post-secondary education. We accomplish this by opening new campuses in the promising areas in those states in which we currently operate physical campuses, as well as by expanding into contiguous states that exhibit strong demand for adult education in business and information technology programs. We have opened 51 of our campuses since the beginning of 2001 and currently plan to open 11 new campuses in 2009, including five already opened. We have also developed a robust online education program. Since receiving regulatory approval to offer our degree programs online in 1997, our online programs have experienced rapid growth, with over 32,000 students enrolled in at least one class online during the 2008 fall term. To better serve students who do not reside or work near one of our physical campus locations, we plan to open a second Global Online Operations Center in 2009.

In May 2001, we hired a new senior management team, made significant investments in information technology infrastructure to support planned growth in our online programs, and embarked on a long term program to open new campuses in areas where there is a strong demand for adult education. As a result of these efforts, between 2000 and 2008 our revenues grew 23% on a compound annual basis, as our revenues increased from $78 million in 2000 to $396 million in 2008. During the same period, diluted earnings per share grew at a compound annual rate of 19% including the impact of stock-based compensation which we began recording in 2006, as we continued to invest heavily in our various initiatives to serve working adult students. For more information relating to our revenues, profits and total assets, please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Industry Background and Outlook

The market for post-secondary education is large, growing and highly fragmented. The U.S. Bureau of Labor Statistics has reported that approximately 61 million working adults in the United States do not have more than a high school education and approximately 32 million people have some college experience but no degree. We believe that the demand for post-secondary education will continue to increase during the next several years as a result of demographic, economic and social trends, including:


• an increase in demand by employers for professional and skilled workers;

• a projected 18% growth in the annual number of high school graduates from 2.8 million in 2000 to 3.3 million in 2010;

• the significant and measurable income premium attributable to post-secondary education; and

• budgetary constraints at traditional colleges and universities.

The adult education market is a significant and growing component of the post-secondary education market. We believe that the market for post-secondary adult education should continue to increase as working adults seek additional education to update and improve their skills. In addition, we believe that many working adults will seek regionally accredited degree programs that provide flexibility to accommodate the fixed schedules and time commitments associated with their professional, family and personal obligations.

In addition to Strayer, there are currently several hundred not-for-profit universities, several public companies and numerous smaller private companies operating in the post-secondary education market in which we operate.

Company Strengths

We have a 117-year operating history and a track record of providing practical and convenient education programs for working adults. We believe the following strengths position us to capitalize on the growing demand for post-secondary education among working adults:


• Consistent operating history. We have been in continuous operation since 1892 and have demonstrated an ability to operate consistently and grow profitably. Our enrollment and revenue have grown each year since our initial public offering in 1996.

• Practical and diversified curricula. We offer core curricula in stable, high-demand areas of adult education. In order to keep pace with a changing knowledge-based economy, we constantly strive to meet the evolving needs of our working adult students and their employers by regularly refining and updating our existing educational programs. Additionally, we replicate programs that are successful in a given campus at additional locations throughout our network of campuses. Strayer University currently offers 91 different degree, diploma and certificate programs, including emphases and concentrations, to its students.

• Focus on working adults pursuing degree programs. We focus on serving working adults who are pursuing college degrees in order to advance their career and employment opportunities. We believe this is an attractive market within the post-secondary education sector due to the growing number of adult students enrolling in post-secondary education programs and the highly motivated nature of adult students. We consider adult students to be our primary customers, with the various business and government organizations that provide tuition assistance to their employees as our secondary customers. In addition, we believe that the structure of our curriculum, featuring associate, bachelor’s and graduate-level degree programs, encourages students to continue their education and results in extended periods of student enrollment which positively impacts the visibility and predictability of our future revenues. Approximately 92% of our students were enrolled in degree programs for the 2008 fall term.

• Flexible program offerings. We maintain flexible quarterly programs that allow working adult students to attend classes and complete coursework on a convenient evening and weekend schedule throughout the calendar year. Additionally, we developed online programs to enable students to pursue a degree partially or entirely via the Internet, thereby increasing the convenience, accessibility and flexibility of our educational programs. Approximately 72% of our students enrolled for the 2008 fall term were taking at least one course online. We believe that these flexible offerings distinguish us from many traditional universities that currently do not effectively address the special requirements of working adults.


• Attractive and convenient campus locations. Our campuses are located in growing metropolitan areas, mostly in the Mid-Atlantic and Southern regions where there are large populations of working adults with demographic characteristics similar to those of our typical students. Strayer University’s campuses are attractive and modern, offering conducive learning environments in convenient locations.

• Established brand name and alumni support. With a 117-year operating history, Strayer University is an established brand name in post-secondary adult education, and our students and graduates work throughout corporate America. Our alumni network fosters additional recruitment opportunities for students.

• Strong owner-oriented management team. In connection with our recapitalization in 2001, we developed a new growth strategy and hired a new senior management team to implement this strategy. As described below, under the leadership of Robert S. Silberman, our Chairman and Chief Executive Officer, we embarked on various initiatives to serve the working adult market by expanding our campuses and developing an online learning platform. In addition, all of our senior officers have made investments in Strayer through outright share purchases, in addition to any compensatory stock awards.

Company Strategy

Our goal is to be a leading, nationwide provider of high quality post-secondary education programs for working adults primarily in the areas of business administration, accounting and information technology. We have identified the following factors as key to executing our growth strategy:


• Maintain stable enrollment in our mature markets. We have 37 mature campuses (those in operation for more than three years) out of a total number of 65 campuses (including two new campuses opened for the 2009 winter term in Augusta, Georgia and Huntsville, Alabama and three new campuses opened for the 2009 spring term in Allentown, Pennsylvania; Charleston, West Virginia; and Salt Lake City, Utah). Our goal is to maintain stable campus enrollments in our mature markets, while increasing revenues by continuing market-based tuition increases.

• Open new campuses. Our goal is to open new campuses every year by meeting unmet demand in states in which we currently operate physical campuses, and by expanding into contiguous states that exhibit strong demand for adult education in business and information technology programs. Since our initial public offering in 1996, we have grown from eight campuses to 65 campuses while expanding into 14 states and Washington, D.C.

Curriculum

Strayer University offers business, information technology and professional-oriented curricula to equip students with specialized and practical knowledge and skills for careers in business, industry and government. Our Academic School Deans and Program Curriculum Committees regularly review and revise the University’s course offerings to improve the educational programs and respond to competitive changes in job markets. We regularly evaluate new programs and degrees to ensure that we stay current with the needs of our students and their employers.

Online Programs

In August 1997, we began offering our programs online via the Internet. The University offers courses and degree programs online using both synchronous (“real time”) and asynchronous (“on demand”) approaches to online learning. The asynchronous format was first introduced by the University in the summer 2001 quarter and has grown rapidly due to increasing demand. Students may take all of their courses online or may take online courses as a supplement to traditional, site-based courses. A student taking classes online has the same admission and financial aid requirements, policies and procedures and receives the same student services as other Strayer University students. Tuition for online courses is the same as for campus courses. During the fall 2008 quarter, Strayer University had over 32,000 students participating in its online programs, approximately 27,300 of whom took classes solely online.

Faculty

The University appoints faculty who hold appropriate academic credentials, are dedicated, active professionals in their field and are enthusiastic and committed to teaching working adults. In accordance with our educational mission, the University faculty focuses its efforts on teaching. The normal course load for a full-time faculty member is four courses per quarter for each of three quarters, or 12 courses per academic year. In addition, the University requires full-time faculty members to provide eight hours per week of student academic counseling and other student support services. Further, full-time faculty members participate actively in the life of the University through service on curricular and assessment committees.

We provide financial support for faculty members seeking to update their skills and knowledge. The University maintains a tuition plan that typically reimburses full-time faculty enrolled in advanced degree programs for 75% of the tuition for one new course per term when taken at institutions other than Strayer. Deans pursuing doctorate degrees may be eligible for up to 100% tuition reimbursement. Full-time faculty (and all other employees) receive a 90% discount for all Strayer courses. The University also conducts annual in-house faculty workshops in each discipline. We believe that our dedicated and capable faculty is one of the keys to our success.

Organization of Strayer University

The University’s annual financial budget and overall academic and business decisions are directed by its Board of Trustees. The Board of Trustees consists of Dr. Charlotte F. Beason, Chairwoman of the Board of Trustees, and 10 other members. The University By-Laws prescribe that a majority of voting members be unaffiliated with either University management or Strayer Education, Inc. to assure independent oversight of all academic programs and services. With the exception of the University President and the Company’s President, all of our trustees are independent, non-management members.

CEO BACKGROUND

Mr. Robert S. Silberman
has been Chairman of the Board since February 2003 and Chief Executive Officer since March 2001. From 1995 to 2000, Mr. Silberman served in a variety of senior management positions at CalEnergy Company, Inc., including as President and Chief Operating Officer. From 1993 to 1995, Mr. Silberman was Assistant to the Chairman and Chief Executive Officer of International Paper Company. From 1989 to 1993, Mr. Silberman served in several senior positions in the U.S. Department of Defense, including as Assistant Secretary of the Army. Mr. Silberman has been a Director of Strayer since March 2001. He serves on the Board of Directors of Covanta Holding Company and on the Management Advisory Board of New Mountain Capital, LLC. He also serves on the Board of Visitors of The Johns Hopkins University School of Advanced International Studies. Mr. Silberman is a member of the Council on Foreign Relations. Mr. Silberman holds a bachelor’s degree in history from Dartmouth College and a master’s degree in international policy from The Johns Hopkins University.

Dr. Charlotte F. Beason
is a former consultant in education and health care administration. From 1988 to 1996, she was Director of Health Professions Education Service and the Health Professional Scholarship Program at the Department of Veterans Affairs. From 2000 to 2003, Dr. Beason was Chair and Vice Chair of the Commission on Collegiate Nursing Education (an autonomous agency accrediting baccalaureate and graduate programs in nursing); she currently serves as an evaluator for the Commission on Collegiate Nursing Education. Dr. Beason has served on the Board since 1996 and is a member of the Nominating/Governance Committee of the Board. She is also Chairwoman of the Strayer University Board of Trustees. Dr. Beason holds a bachelor’s degree in nursing from Berea College, a master’s degree in psychiatric nursing from Boston University and a doctorate in clinical psychology and public practice from Harvard University.

Mr. William E. Brock
is the Founder and Chairman of the Brock Offices, a firm specializing in international trade, investment and human resources. From 1985 to 1987, Mr. Brock served in the President’s Cabinet as the U.S. Secretary of Labor, and from 1981 to 1985, as the U.S. Trade Representative. Elected Chairman of the Republican National Committee from 1977 to 1981, Mr. Brock previously served as a Member of Congress and, subsequently, as U.S. Senator for the State of Tennessee. Mr. Brock serves as a Counselor and Trustee of the Center for Strategic and International Studies, and as a member of the Board of Directors of On Assignment, Inc., Health Extras, Inc., and ResCare, Inc. Mr. Brock has been a member of the Board since 2001 and is Chair of the Nominating/Governance Committee of the Board. He holds a bachelor’s degree in commerce from Washington and Lee University. Mr. Brock has also received a number of honorary degrees.

Mr. David A. Coulter
is currently Managing Director and Senior Advisor at Warburg Pincus, LLC. He was Vice Chairman of J.P. Morgan Chase & Co. from December 2000 to December 2005. Mr. Coulter was Vice Chairman of The Chase Manhattan Corporation from July 2000 to December 2000. Prior to joining Chase, Mr. Coulter led the West Coast operations of the Beacon Group, a private investment and strategic advisory firm, and prior to that, Mr. Coulter served as the Chairman and Chief Executive Officer of the BankAmerica Corporation. Mr. Coulter is a member of the Board of Directors of The Irvine Company, Metavante Technologies, Inc., Aeolus Re, and MBIA, Inc. Mr. Coulter is currently serving as the Presiding Independent Director of the Strayer Education, Inc. Board of Directors, on which he has served since 2002. Mr. Coulter holds a bachelor’s degree in mathematics and economics and a master’s degree in industrial administration, both from Carnegie Mellon University.

Mr. Robert R. Grusky
is the Founder and Managing Member of Hope Capital Management, LLC, an investment manager, since 2000. He co-founded New Mountain Capital, LLC, a private equity firm, in 2000 and was a Principal and Member from 2000 to 2005, and has been a Senior Advisor since then. From 1998 to 2000, Mr. Grusky served as President of RSL Investments Corporation. From 1985 to 1997, with the exception of 1990 to 1991 when he was on a leave of absence to serve as a White House Fellow and Assistant for Special Projects to the Secretary of Defense, Mr. Grusky served in a variety of capacities at Goldman, Sachs & Co., first in its Mergers & Acquisitions Department and then in its Principal Investment Area. He is also on the Board of Directors of AutoNation, Inc., and AutoZone, Inc., as well as a member of the Board of Trustees of Hackley School. Mr. Grusky has served on the Board since 2001, and is a member of the Audit Committee of the Board. He became the Chair of this Committee effective February 10, 2009. He holds a bachelor’s degree in history from Union College and an MBA from Harvard University.

Mr. Robert L. Johnson
is the Founder and Chairman of RLJ Companies, which owns or holds interests in the banking/financial services, real estate, hospitality, professional sports, film production, gaming and automotive industries. Mr. Johnson is the founder of Black Entertainment Television (BET), a subsidiary of Viacom and the leading African-American operated media and entertainment company in the United States, and served as its Chief Executive Officer until January 2006. In 2002, Mr. Johnson became the first African-American majority owner of a major sports franchise, the Charlotte Bobcats of the NBA. From 1976 to 1979, he served as Vice President of Governmental Relations for the National Cable & Telecommunications Association (NCTA). Mr. Johnson also served as Press Secretary for the Honorable Walter E. Fauntroy, Congressional Delegate from the District of Columbia. He also serves on the following boards: KB Home, Lowe’s Companies, Inc., NBA Board of Governors, Deutsche Bank Advisory Committee, The Business Council, The Johns Hopkins University, and the Smithsonian Institution’s National Museum of African American History and Culture. Mr. Johnson has served on the Board since 2003, and is a member of the Compensation Committee of the Board. He holds a bachelor’s degree in social studies from the University of Illinois and a master’s degree in international affairs from the Woodrow Wilson School of Public and International Affairs at Princeton University.

Mr. Todd A. Milano
has been President and Chief Executive Officer of Central Pennsylvania College since 1989. Mr. Milano has served on the Board since 1996, is a member of the Compensation Committee of the Board and is also a member of the Strayer University Board of Trustees. Mr. Milano holds a bachelor’s degree in industrial management from Purdue University.

Mr. G. Thomas Waite, III
has been Treasurer and Chief Financial Officer of the Humane Society of the United States since 1993. In 1992, Mr. Waite was the Director of Commercial Management of The National Housing Partnership. Mr. Waite has served on the Board since 1996, is a member of the Audit Committee of the Board and is a former member of the Strayer University Board of Trustees. Mr. Waite holds a bachelor’s degree in commerce from the University of Virginia and is a Certified Public Accountant.

Mr. J. David Wargo
has been President of Wargo and Company, Inc., an investment management company, since 1993. Mr. Wargo is a co-founder and has been a Member of New Mountain Capital, LLC since January 2000. From 1989 to 1992, Mr. Wargo was a Managing Director and Senior Analyst of The Putnam Companies, a Boston-based investment management company. From 1985 to 1989, Mr. Wargo was a partner and held other positions at Marble Arch Partners. Mr. Wargo is a Director of Liberty Global, Inc. and Discovery Communications, Inc. Mr. Wargo has served on the Board since 2001, was Chair of the Compensation Committee of the Board in 2008, and became a member of the Audit Committee of the Board on February 10, 2009. Mr. Wargo holds a bachelor’s degree in physics and a master’s degree in nuclear engineering, both from the Massachusetts Institute of Technology. He also holds a master’s degree in management science from the Sloan School of Management, Massachusetts Institute of Technology.

MANAGEMENT DISCUSSION FROM LATEST 10K

Background and Overview

We are an education services holding company that owns Strayer University, Inc. The University is an institution of higher education which offers undergraduate and graduate degree programs at 65 campuses (including two new campuses opened for the 2009 winter term enrollment and three new campuses opened for the 2009 spring term enrollment) in Alabama, Delaware, Florida, Georgia, Kentucky, Maryland, New Jersey, North Carolina, Pennsylvania, South Carolina, Tennessee, Utah, Virginia, West Virginia, Washington, D.C., and worldwide via the Internet. The Company is planning to open a total of 11 new campuses in 2009, including the five that have already been opened. The Company is also planning to open a second Global Online Operations Center in Salt Lake City, Utah in 2009.

Strayer University derives approximately 97% of its revenue from tuition collected from its students. The academic year of the University is divided into four quarters, which approximately coincide with the four quarters of the calendar year. Students make payment arrangements for the tuition for each course prior to the beginning of the quarter. When students register for courses, tuition is recorded as unearned tuition, and is recognized in the quarter of instruction. If a student withdraws from a course prior to completion, the University refunds a portion of the tuition depending on when the withdrawal occurs. Tuition revenue is shown net of any refunds, withdrawals, corporate discounts, employee tuition discounts and scholarships. The University also derives revenue from other sources such as textbook-related income, application fees, commencement fees, placement test fees, withdrawal fees, loan administration fees, and other income, which are all recognized when earned.

At the time of registration, unearned tuition (a liability) is recorded for academic services to be provided and a tuition receivable is recorded for the portion of the tuition not paid upfront in cash. Because the University’s academic quarters coincide with the calendar quarters, tuition receivable at the end of any calendar quarter largely represents student tuition due for the following academic quarter. Based upon past experience and judgment, the University establishes an allowance for doubtful accounts with respect to accounts receivable not included in unearned tuition. Any uncollected account more than six months past due for students who have left the University is charged against the allowance. Our bad debt expense as a percentage of revenues for the years ended December 31, 2006, 2007, and 2008 was 2.9%, 3.3%, and 3.2%, respectively.

Strayer University’s expenses consist of instruction and educational support expenses, selling and promotion expenses, and general and administration expenses. Instruction and educational support expenses generally contain items of expense directly attributable to the educational activity of the University. This expense category includes salaries and benefits of faculty and academic administrators and, beginning in 2006, stock-based compensation expense. Instruction and educational support expenses also include costs of educational supplies and facilities, including rent for campus facilities, certain costs of establishing and maintaining computer laboratories and all other physical plant and occupancy costs, with the exception of costs attributable to the corporate offices.

Selling and promotion expenses include salaries, benefits and, beginning in 2006, stock-based compensation expense of personnel engaged in recruitment, admissions, retention, promotion and development, as well as costs of advertising and production of marketing materials.

General and administration expenses include salaries, benefits and, beginning in 2006, stock-based compensation expense of management and employees engaged in student services, accounting, human resources, compliance and other corporate functions, along with the occupancy costs attributable to such functions. Bad debt expense is also included as a general and administration expense.

Investment and other income consists primarily of earnings and realized gains or losses on investments.

Critical Accounting Policies and Estimates

“Management’s Discussion and Analysis of Financial Condition and Results of Operations” discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosures of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates and judgments related to its allowance for uncollectible accounts, income tax provisions, valuation of deferred tax assets, forfeiture rates for stock-based compensation plans and accrued expenses. Management bases its estimates and judgments on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments regarding the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Management believes that the following critical accounting policies are its more significant judgments and estimates used in the preparation of its consolidated financial statements. Tuition revenue is deferred at the time of registration and is recognized as income, net of any refunds or withdrawals, in the respective quarter of instruction. Advance registrations for the next quarter are recorded as unearned tuition. We record estimates for our allowance for uncollectible accounts for tuition receivable from students. If the financial condition of our students were to deteriorate, resulting in impairment of their ability to make required payments for tuition payable to us, additional allowances may be required. We record estimates for our accrued expenses and income tax liabilities. We periodically review our assumed forfeiture rates for stock-based awards and adjust them as necessary. Should actual results differ from our estimates, revisions to our accrued expenses, stock-based compensation expense, and income tax liabilities may be required.

New Campuses

The Company’s goal is to serve the demand for post secondary adult education nationwide by opening new campuses every year. A new campus typically requires up to $1 million in upfront capital costs for leasehold improvements, furniture and fixtures, and computer equipment. In the first year of operation, assuming a midyear opening, the Company expects to incur operating losses of approximately $1 million including depreciation related to the upfront capital costs. A new campus is typically expected to begin generating operating income on a quarterly basis in four to six quarters of operation, which is generally upon reaching an enrollment level of about 300 students. The Company’s new campus notional model assumes an increase of average enrollment by 100-150 students per year until reaching a level of about 1,000 students. Given the potential internal rate of return achieved with each new campus (an estimated 70%), opening new campuses is an important part of the Company’s strategy. The Company believes it has sufficient capital resources from cash, cash equivalents, marketable securities and cash generated from operating activities to continue to open new campuses for at least the next 12 months.

The Company plans to open 11 new campuses in 2009 including five already opened. The Company opened nine new campuses in 2008 and eight in 2007. See “New Campuses Opened” table in Item 1 for information regarding the locations of these new campuses.

Second Global Online Operations Center

The Company also plans to open its second Global Online Operations Center in 2009 to accommodate the demand among students who neither live nor work near a physical campus location. This new operations center will be located in Salt Lake City, Utah.

Results of Operations

In 2008, the Company generated $396.3 million in revenue, a 25% increase compared to 2007, primarily as a result of average enrollment growth of 20% and a 5% tuition increase which commenced in January 2008. Income from operations was $126.9 million in 2008, an increase of 30% compared to 2007. Net income in 2008 was $80.8 million, an increase of 24% compared to 2007. Earnings per diluted share was $5.67 in 2008 compared to $4.47 in 2007, an increase of 27%.

Year Ended December 31, 2008 Compared To Year Ended December 31, 2007

Enrollment. Average enrollment increased 20% to 38,449 students for the year ended December 31, 2008 from 32,087 students for the same period in 2007. This growth is principally due to new campus openings, stable growth in our mature markets and the rapid growth in markets outside of commuting distance to a Strayer University physical campus through the University’s online programs.

Revenues. Revenues increased 25% to $396.3 million in 2008 from $318.0 million in 2007 principally due to a 20% increase in the average enrollment and a 5% tuition increase which commenced in January 2008.

Instruction and educational support expenses. Instruction and educational support expenses increased $21.9 million, or 20%, to $130.8 million in 2008 from $108.9 million in 2007. This increase was principally due to direct costs necessary to support the increase in student enrollments including faculty compensation, related academic staff salaries, and campus facility costs which increased $7.1 million, $4.9 million, and $5.0 million, respectively. These costs as a percentage of revenues decreased to 33.0% in 2008 from 34.2% in 2007 largely attributable to faculty costs and facility costs growing at a lower rate than tuition revenue.

Selling and promotion expenses. Selling and promotion expenses increased $15.4 million, or 25%, to $76.2 million in 2008 from $60.8 million in 2007. This increase was principally due to the increased cost of advertising in new markets and the addition of admissions personnel, particularly at new campuses and for online programs, which increased $5.5 million and $6.6 million, respectively. These expenses as a percentage of revenues increased slightly to 19.2% in 2008 from 19.1% in 2007.

General and administration expenses. General and administration expenses increased $11.6 million, or 23%, to $62.4 million in 2008 from $50.8 million in 2007. The increase is largely attributable to increased employee compensation and related expenses at both corporate and campus locations, higher bad debt expense, and information technology-related expenses, which increased by $4.6 million, $2.2 million, and $1.1 million, respectively. General and administration expenses as a percentage of revenues decreased slightly to 15.8% in 2008 from 16.0% in 2007.

Income from operations. Income from operations increased $29.3 million, or 30%, to $126.9 million in 2008 from $97.6 million in 2007 due to the aforementioned factors.

Investment and other income. Investment and other income decreased $2.0 million, or 30%, to $4.5 million in 2008 from $6.5 million in 2007. This decrease was principally due to lower investment yields and a lower average cash balance, partly offset by a gain on sale of marketable securities of $0.8 million recognized in 2008.

Provision for income taxes. Income tax expense increased $11.5 million, or 29%, to $50.6 million in 2008 from $39.1 million in 2007 primarily due to the increase in income before taxes attributable to the factors discussed above. Another contributing factor was the Company’s higher effective tax rate of 38.5% in 2008 as compared to 37.6% in 2007 primarily driven by lower income from tax exempt securities in 2008.

Net income. Net income increased $15.9 million, or 24%, to $80.8 million in 2008 from $64.9 million in 2007 because of the factors discussed above.

Year Ended December 31, 2007 Compared To Year Ended December 31, 2006

Enrollment. Average enrollment increased 16% from 27,554 students for the year ended December 31, 2006 to 32,087 students for the same period in 2007. This growth is principally due to new campus openings, stable growth in our mature markets and the rapid growth in markets outside of commuting distance to a Strayer University physical campus through the University’s online programs.

Revenues. Revenues increased 21% from $263.6 million in 2006 to $318.0 million in 2007 principally due to a 16% increase in the average enrollment and a 5% tuition increase which commenced in January 2007.

Instruction and educational support expenses. Instruction and educational support expenses increased $17.8 million, or 19%, from $91.1 million in 2006 to $108.9 million in 2007. This increase was principally due to direct costs necessary to support the increase in student enrollments including faculty compensation, related academic staff salaries, and campus facility costs which increased $6.0 million, $4.7 million, and $3.7 million, respectively. These costs as a percentage of revenues decreased to 34.2% in 2007 from 34.6% in 2006.

Selling and promotion expenses. Selling and promotion expenses increased $8.5 million, or 16%, from $52.3 million in 2006 to $60.8 million in 2007. This increase was principally due to the increased cost of advertising in new markets and the addition of admissions personnel, particularly at new campuses and for online programs, which increased $5.3 million and $2.0 million, respectively. These expenses as a percentage of revenues decreased from 19.8% in 2006 to 19.1% in 2007 largely attributable to both marketing costs and staffing costs growing slower than tuition revenue, as the Company maintained the same number of new campuses openings (eight in both years).

General and administration expenses. General and administration expenses increased $10.1 million, or 25%, from $40.7 million in 2006 to $50.8 million in 2007. The increase is largely attributable to increased employee compensation and related expenses at both corporate and campus locations, higher bad debt expense, and higher stock-based compensation expense, which increased by $3.5 million, $2.9 million, and $2.0 million, respectively. General and administration expenses as a percentage of revenues increased to 16.0% in 2007 from 15.4% in 2006 primarily due to the aforementioned factors.

Income from operations. Income from operations increased $18.1 million, or 23%, from $79.5 million in 2006 to $97.6 million in 2007 due to the aforementioned factors.

Investment and other income. Investment and other income increased $2.0 million, or 43%, from $4.5 million in 2006 to $6.5 million in 2007. This increase was principally due to higher yields from the Company’s investments in a short-term tax-exempt bond fund and tax-exempt money market funds, and a higher average cash balance.

Provision for income taxes. Income tax expense increased $7.3 million, or 23%, from $31.8 million in 2006 to $39.1 million in 2007 primarily due to the increase in income before taxes attributable to the factors discussed above. This was partly offset by a lower effective tax rate of 37.6% in 2007, compared to 37.8% in 2006, resulting primarily from higher income from tax-exempt securities.

Liquidity and Capital Resources

At December 31, 2008, the Company had cash, cash equivalents and marketable securities of $107.3 million compared to $171.3 million at December 31, 2007. Most of the Company’s excess cash is invested in tax-exempt money market funds and a diversified, short-term, investment grade, tax-exempt bond fund to minimize the Company’s principal risk and to benefit from the tax efficiency of the funds’ underlying securities. As of December 31, 2008, the Company had $51.0 million invested in the short-term, tax-exempt bond fund. At December 31, 2008, the 577 issues in this fund had an average credit rating of AA, an average maturity of 1.3 years, an average duration of 1.1 years, and an average yield to maturity of 2.4%. The Company had no debt as of December 31, 2008 or December 31, 2007.

For the year ended December 31, 2008, the Company generated $88.6 million net cash from operating activities compared to $80.8 million for the same period in 2007. Capital expenditures were $20.7 million for the year ended December 31, 2008 compared to $14.9 million for the same period in 2007. Capital expenditures for the year ending December 31, 2009 are expected to be in the range of 7 - 8% of 2009 revenues inclusive of the expected openings of 11 new campuses and a second Global Online Operations Center. For the year ended December 31, 2008, the Company paid $23.1 million in regular cash dividends and $28.9 million in special cash dividends to our common stockholders. The Company invested $109.1 million repurchasing common shares in the open market and received $10.6 million upon the exercise of stock options.

Commencing in the fourth quarter of 2008, the Company increased its annual cash dividend to $2.00 per share from $1.50 per share, or to $0.50 per share quarterly from $0.375 per share.

In 2008, bad debt expense as a percentage of revenue was 3.2% compared to 3.3% for the same period in 2007. Days sales outstanding, adjusted to exclude tuition receivable related to future quarters, was 14 days at the end of the fourth quarter 2008 compared to 12 days in 2007.

Currently, the Company invests its cash in bank overnight deposits, money market funds and a short-term tax-exempt bond fund. In addition, the Company has available two $10.0 million credit facilities from two banks. There have been no borrowings by the Company under these credit facilities. The Company believes that existing cash, cash equivalents, and marketable securities, cash generated from operating activities, and if necessary, cash borrowed under the credit facilities, will be sufficient to meet the Company’s requirements for at least the next 12 months.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Certain of the statements included in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as well as elsewhere in this report on Form 10-Q are forward-looking statements made pursuant to the Private Securities Litigation Reform Act of 1995 (“Reform Act”). These statements are based on the Company’s current expectations and are subject to a number of assumptions, risks and uncertainties. In accordance with the safe harbor provisions of the Reform Act, the Company has identified important factors that could cause the actual results to differ materially from those expressed in or implied by such statements. The assumptions, uncertainties and risks include the pace of growth of student enrollment, our continued compliance with Title IV of the Higher Education Act, and the regulations thereunder, as well as regional accreditation standards and state regulatory requirements, competitive factors, risks associated with the opening of new campuses, risks associated with the offering of new educational programs and adapting to other changes, risks associated with the acquisition of existing educational institutions, risks relating to the timing of regulatory approvals, our ability to continue to implement our growth strategy, risks associated with the ability of our students to finance their education in a timely manner, and general economic and market conditions. Further information about these and other relevant risks and uncertainties may be found in the Company’s annual report on Form 10-K and its other filings with the Securities and Exchange Commission. The Company undertakes no obligation to update or revise forward looking statements, except as may be required by law.
Additional Information
We maintain a website at http://www.strayereducation.com . The information on our website is not incorporated by reference in this Quarterly Report on Form 10-Q and our web address is included as an inactive textual reference only. We make available, free of charge through our website, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
Results of Operations
In the first quarter of 2009, the Company generated $124.5 million in revenue, an increase of 28% compared to the same period in 2008, as a result of average enrollment growth of 22% and a 5% tuition increase at the beginning of 2009. Income from operations was $47.6 million for the first quarter of 2009, an increase of 34% compared to the same period in 2008. Net income was $29.1 million in the first quarter of 2009, an increase of 24% compared to the same period in 2008. Diluted earnings per share was $2.07 in the first quarter of 2009 compared to $1.64 in the same period in 2008, an increase of 26%.

Three Months Ended March 31, 2009 Compared to Three Months Ended March 31, 2008
Enrollment. Enrollment at Strayer University for the 2009 winter term, which began January 12, 2009 and ended March 30, 2009, increased 22% to 45,697 students compared to 37,323 students for the same term in 2008. Across the Strayer University campus network, new student enrollments increased 20% and continuing student enrollments increased 23%. Global online enrollments increased 47%, while students taking 100% of their classes online (including campus based students) increased 25%. The total number of students taking any courses online (including students at brick and mortar campuses taking at least one online course) in the 2009 winter term increased 24% to 32,771.
Revenues . Revenues increased 28% to $124.5 million in the first quarter of 2009 from $97.1 million in the first quarter of 2008, principally due to a 22% increase in enrollment and a 5% tuition increase at the beginning of 2009.
Instruction and educational support expenses. Instruction and educational support expenses increased $7.5 million, or 23%, to $39.1 million in the first quarter of 2009 from $31.6 million in the first quarter of 2008. This increase was principally due to direct costs necessary to support the increase in student enrollments, including faculty compensation, related academic staff salaries and campus facility costs, which increased $2.3 million, $1.6 million, and $1.9 million, respectively. Instruction and educational support expenses as a percentage of revenues decreased to 31.4% in the first quarter of 2009 from 32.6% in the first quarter of 2008, largely attributable to faculty costs growing at a lower rate than tuition revenue.
Selling and promotion expenses. Selling and promotion expenses increased $4.8 million, or 32%, to $19.9 million in the first quarter of 2009 from $15.1 million in the first quarter of 2008. This increase was principally due to the direct costs required to build the Strayer University brand and attract prospective students, and the addition of admissions personnel, particularly at new campuses. Selling and promotion expenses as a percentage of revenues increased to 16.0% in the first quarter of 2009 from 15.5% in the first quarter of 2008, which was largely attributable to the opening of three new campuses for spring term 2009 compared to two new campuses for the spring term in the prior year.
General and administration expenses. General and administration expenses increased $3.1 million, or 21%, to $17.9 million in the first quarter of 2009 from $14.8 million in the first quarter of 2008. This increase was principally due to increased employee salaries and higher bad debt expense, which increased $2.2 million and $1.5 million, respectively, partly offset by lower stock-based compensation which decreased $0.8 million. General and administration expenses as a percentage of revenues decreased to 14.4% in the first quarter of 2009 from 15.2% in the first quarter of 2008 primarily due to the decrease in stock-based compensation expense.
Income from operations. Income from operations increased $12.0 million, or 34%, to $47.6 million in the first quarter of 2009 from $35.6 million in the first quarter of 2008, due to the aforementioned factors.

Investment and other income. Investment and other income decreased $1.5 million, or 76%, to $0.5 million in the first quarter of 2009 from $2.0 million in the first quarter of 2008. The decrease was principally due to lower investment yields and a lower average cash balance, as well as a gain on sale of marketable securities of $0.8 million recognized in 2008.
Provision for income taxes. Income tax expense increased $4.9 million, or 35%, to $19.0 million in the first quarter of 2009 from $14.1 million in the first quarter of 2008, primarily due to the increase in income before taxes attributable to the factors discussed above. The Company’s effective tax rate was 39.6% for the first quarter of 2009 compared to 37.4% for the first quarter of 2008. The increase in the Company’s effective tax rate is largely attributable to lower income from tax-exempt securities in 2009.
Net income. Net income increased $5.6 million, or 24%, to $29.1 million in the first quarter of 2009 from $23.5 million in the first quarter of 2008, because of the factors discussed above.
Liquidity and Capital Resources
At March 31, 2009, the Company had cash, cash equivalents and marketable securities of $84.0 million compared to $107.3 million at December 31, 2008 and $118.9 million at March 31, 2008. At March 31, 2009, most of the Company’s excess cash was invested in tax-exempt money market funds and a diversified, short-term, investment grade, tax-exempt bond fund to minimize the Company’s principal risk and to benefit from the tax efficiency of the funds’ underlying securities. As of March 31, 2009, the Company had a total of $51.5 million invested in the short-term, tax-exempt bond fund. At March 31, 2009, the 677 issues in this fund had an average credit rating of AA, an average maturity of 1.2 years, an average duration of 1.1 years, as well as an average yield to maturity of 1.9%. The Company had no debt as of December 31, 2008 or March 31, 2009.
For the three months ended March 31, 2009, the Company reported $47.1 million net cash from operating activities compared to $34.2 million for the same period in 2008. Capital expenditures were $6.6 million for the quarter ended March 31, 2009 compared to $5.1 million for the same period in 2008. During the quarter ended March 31, 2009, the Company paid a regular, quarterly common stock dividend of $7.1 million ($0.50 per share). The Company also received $1.7 million upon the exercise of 20,000 stock options. During the three months ended March 31, 2009, the Company invested $60.1 million to repurchase 348,085 shares of common stock at an average price of $172.57 per share as part of a previously announced common stock repurchase authorization. The Company’s remaining authorization for common stock repurchases was approximately $10.1 million at March 31, 2009.
In the first quarter of 2009, bad debt expense as a percentage of revenues was 3.2% compared to 2.5% for the same period in 2008. Days sales outstanding, adjusted to exclude tuition receivable related to future quarters, was 15 days at the end of the first quarter of 2009 compared to 12 days at the end of the first quarter of 2008.
Currently, the Company invests its cash in bank overnight deposits, money market funds and a short-term, tax-exempt bond fund. In addition, the Company has available two $10.0 million credit facilities from two banks. There have been no borrowings by the Company under these credit facilities. The Company believes that existing cash and cash equivalents, cash generated from operating activities, and if necessary, cash borrowed under the credit facilities, will be sufficient to meet the Company’s requirements for at least the next 12 months.

New Campuses / Second Global Online Operations Center
Strayer University successfully opened two new campuses for the summer academic term. Both campuses are in the state of Ohio — one in Cincinnati and the other in Columbus. With these two new campuses, the Company has opened seven of 11 new campuses planned for 2009. The University also successfully opened its second Global Online Operations Center in Salt Lake City, Utah for the summer academic term.

CONF CALL

Sonya Udler

Good morning. With us today to discuss the results are Robert Silberman, Chairman and Chief Executive Officer for Strayer Education and Mark Brown, Executive Vice President and Chief Financial Officer.

For those of you that wish to listen to the conference via the Internet, please go to www.strayereducation.com where the call will be archived for 90 days. If you are unable to listen to the call in real time, a replay will be available beginning today at 1:00 pm Eastern Time through Tuesday, May 5. The replay is available at 888-203-1112, pass code 1744172.

Following Strayer’s remarks, we will open the call for questions-and-answers. Please note that today’s press release contains statements that are forward-looking and are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act. The statements are based on the company’s current expectations and are subject to a number of uncertainties and risks that the company has identified in the press release and that could cause the company’s actual results to differ materially.

Further information about these and other relevant uncertainties may be found in the company’s annual report on Form 10-K, and its other filings with the Securities and Exchange Commission.

Now, I’d like to turn the call over to Rob. Rob, please go

Rob Silberman

Thank you, Sonya. Good morning, ladies and gentlemen. As it is our custom, I’d like to begin this morning with a brief overview of both our company and our business model for any listeners who are new to Strayer. I’ll then ask Mark to report on the detailed financial results for the first quarter, after which I’ll comment on our enrollment results for the spring academic term, provide an update on our growth strategies and finally end up with the company’s earnings outlook for Q2 2009.

Strayer Education Inc. is an education service company whose primary asset is Strayer University, 46,000 student, 65 campus, post secondary education institution which offers Undergraduate and Graduate degrees, Business Administration, Accounting, Computer Science, Public Administration and Education.

Strayer’s students are working adults who are returning to school to further their careers. Our revenue comes from tuition payments and associated fees. Approximately 70% of that revenue comes to us from federally insured Title IV loans issued to our students.

Our expenses at Strayer Education include the cost of our professors, our admissions and administrative staff, marketing expenses and facilities and supplies costs. We serve students in 16 states through physical campuses, as well as in all 50 states and over 30 foreign countries through our on-line courses.

Strayer University is accredited by the Middle States Association of Colleges and Schools.

Mark, you want to run them through the financials?

Mark Brown

Revenues for the three months ended March 31, 2009 increased 28% to $124.5 million, compared to $97.1 million for the same period in 2008 due to increased enrollment and a 5% tuition increase which commenced in January of ‘09. Income from operations was $47.6 million compared to $35.6 million for the same period in ‘08, an increase of 34%. Operating income margin was 38.2% compared to 36.6% for the same period in ‘08.

Net income was $29.1 million compared to $23.5 million for the same period in ‘08, an increase of 24%. Diluted earnings per share were $2.07 compared to $1.64 for the same period in 2008, an increase of 26%. Diluted weighted average shares outstanding decreased to approximately 14 million from 14,340,000 for the same period in ‘08.

At March 31, ‘09 the company had cash, cash equivalents and marketable securities of $84 million and no debt. The company generated $47.1 million from operating activities in the first quarter of ‘09 compared to $34.2 million during the same period in ‘08. Capital expenditures were $6.6 million for the three months ended March 31, ‘09 compared to $5.1 million for the same period in ‘08.

During the three months ended March 31, ‘09 the company invested $60.1 million to repurchase approximately 348,000 shares of its common stock, at an average price of $172.57 per share as parts of a previously announced common stock repurchase authorization. The company’s remaining authorization for common stock repurchases was $10.1 million at March 31, ‘09.

During the there months ended March 31, ‘09, the company paid a regular quarterly common stock dividend of $7.1 million or $0.50 per share. For the first quarter of ‘09, bad debt expense as a percentage of revenues was 3.2% compared to 2.5% for the same period in ‘08. Day sales outstanding adjusted to exclude tuition receivables related to future quarters was 15 days at the end of the first quarter of ‘09 compared to 12 days at the end of the first quarter of ‘08. Rob.

Rob Silberman

Thanks Mark, just a few amplifying comments on the financials from my perspective. For the first quarter as Mark mentioned, we earned $0.10 more than the midpoint of our forecast which is admittedly a little bigger variance than normal. Almost all of that positive variance was caused by higher than expected revenue. Our revenue growth of 28% was a full 200 basis points higher than Mark and I had forecast from the 22% enrollment growth that we had for the winter term.

That extra revenue was largely the result of a lower number of students dropping during the quarter than we normally experience. It led to a fairly significant 160 basis point operating margin expansion and roughly $0.08 of the $0.10 of the EPS out performance. On expenses, we were pretty much right on our forecast for the quarter with the exception of stock based compensation which ended up lower than last year.

That lower stock based compensation, combined with a slightly lower share count led to the remaining $0.02 of our EPS out performance. Bad debt, invested income and tax rates were all right on target. Distributive cash flow in the quarter was particularly strong, up a little over 40%. Some of that was associated with the timing impact of the tax benefits from stock based compensation activities in the fourth quarter of 2008 as we mentioned on the last call, but even without that the free cash flow growth would have been well in excess of net income in the quarter, so the cash was quite strong.

Turning to the spring term enrollment results; total University enrollment increased 22% on a year-over-year basis. New students increased 26% and continuing student enrollment increased a little over 21%. With regard to student mix, business administration, accounting and economic degree seekers continue to make up about 70% of our student body for the spring term, with computer science degree candidates at below 20%, just below 20% of the total student population.

Our graduate population is remaining around 30% of our student mix for the spring term. We did start instruction on our new criminal justice bachelor’s degree at several of our campuses for this spring term and in our on-line three year offerings and so we are excited about that and keeping careful track of that. Turning to an update on the growth strategy; many of you will remember that our strategy is based on five objectives.

First, mai