Common use of Income Taxes Clause in Contracts

Income Taxes. The provision for income taxes consists of the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Current: Federal................................................... $11,611 $-- $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- $ 7,893 $-- $259 ======= === ==== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======= $ --======= The valuation allowance at December 31, 1998 and 1997 was attributed to deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of these items such that a full valuation allowance was recorded. The Company's income taxes payable for federal, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value.

Income Taxes. The provision for income taxes consists of the followingIncome tax expense is summarized as follows: DECEMBER YEARS ENDED JANUARY 31, 2000 1999 1998 1997 (IN THOUSANDS) Current: Federal................................................... .................................................. $11,611 2,601 $ 3,080 $-- $168 1,675 State.................................................... 154 (775) 197 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 .................................................. 1,521 (361) 2,421 Total.................................................. 4,276 1,944 4,293 Deferred: Federal................................................... .................................................. (4,143542) (1,914) 2,449 State.................................................... -- -- 881 (573) Foreign................................................... -- -- -- State..................................................... .................................................. 1,367 227 990 Total.................................................. 825 (1,335806) -- -- (5,478) -- -- 2,866 $5,101 $ 7,893 1,138 $-- $259 7,159 ====== ======= === ==== 44 The Company's (benefit) provision for Actual income taxes differed tax expense differs from the amount computed that obtained by applying the statutory U.S. federal Federal income tax rate of 34% (35% in fiscal 1998) to income (loss) before income taxes as follows: DECEMBER YEARS ENDED JANUARY 31, 2000 1999 1998 1997 (IN THOUSANDS) Provision at statutory Statutory Federal income tax rate........................... $11,051 ....................... 34% 34% 35% Computed expected tax expense (benefit)................. $(7,2943,820) $(11,827) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) 5,968 State income taxes, net of federal Federal income tax benefit................... 48 -- 1 ... 102 (806) 815 Incremental tax expense from foreign operations......... (507) 415 203 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) withholding taxes............................... 768 -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred Net change in valuation allowance....................... 11,407 13,401 (267) Meals and entertainment................................. 426 407 325 Research, AMT and foreign tax assets previously reserved...... credits................... (3,2495,155) (408) (1,135) Foreign dividends....................................... -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized 541 Reduction of research and development costs............. 283 71 234 Reserves not currently deductiblecredits and foreign tax credits previously recorded............... -- -- 600 Tax expense related to prior years...................... 4,863 2,814 1,657 1,599 -- -- Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- ................................................... 281 (7,43444) (4,742) Net deferred tax assets................................ $5,478====== 109 $ -- 5,101======= $ 1,138 ======== $ --======= The valuation allowance at December 31, 1998 and 1997 was attributed to 7,159======= Significant components of the deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of these items such that a full valuation allowance was recorded. The Company's income taxes payable assets and liabilities are as follows: -------- -------- Allowance for federal, state, doubtful accounts and foreign purposes have been reduced by the sales adjustments..... $ 1,013 $ 2,231 Accrued vacation.......................................... 1,064 661 Accrued commission........................................ 128 369 Alternative minimum tax................................... 296 91 Research and development credits.......................... 6,387 1,232 Foreign tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise credits....................................... 2,265 1,594 Depreciation and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value.amortization............................. 215 269 Net operating loss carryforwards.......................... 18,716 14,937

Income Taxes. The components of the provision for income taxes consists of the followingare as follows: YEARS ENDED DECEMBER 31, 2001 2000 1999 1998 1997 (IN THOUSANDS) Current: Federal................................................... $11,611 $-- $168 Foreign................................................... 351 -- 90 .................................................. $ 86.1 $ 93.9 $ 69.9 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... .................................................... 8.4 11.7 13.9 Federal and state deferred................................. (4,14310.7) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) 29.8 50.6 Change in valuation allowance.............................. -- -- (5,4788.7) Provision for income taxes................................. $ 83.8====== $135.4====== $125.7====== A reconciliation of the statutory federal income tax rate to the Company's effective tax rate is shown below: YEARS ENDED DECEMBER 31, 2001 2000 1999 Statutory federal income tax rate........................... 35.0% 35.0% 35.0% Non-deductible expenses..................................... 1.3 1.3 1.2 State income taxes, net of federal benefit.................. 2.6 3.0 3.5 Other, net.................................................. 1.1 (1.3) (1.2) Effective income tax rate................................... 40.0%==== 38.0%==== 38.5%==== Components of deferred income taxes in the accompanying Consolidated Balance Sheets are as follows: ------------------ 2001 2000 ------- ------- Deferred tax assets (liabilities): Current portion -- -- Book basis in property over tax basis.................. $ 7,893 $-- $259 .8 $ .8 Accruals not currently deductible...................... 5.8 (2.6) ------- ------- Total............................................. $ 6.6 $ (1.8) ======= === ===== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income Long-term portion -- Book basis in property over tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 basis.................. $(7,294140.1) $ 1,764 Differential $(benefit138.3) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves Accruals not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- 21.4 13.5 ------- ------- Total............................................. $(7,434118.7) $(4,742124.8) Net deferred tax assets................................ $5,478====== $ -- ======= $ --======= ======= In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company adjusts the valuation allowance at in the period management determines it is more likely than not that deferred tax assets will or will not be realized. The Company made income tax payments of approximately $109.3 million, $89.3 million and $100.3 million for the years ended December 31, 1998 2001, 2000 and 1997 was attributed to deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of these items such that a full valuation allowance was recorded. The Company's income taxes payable for federal1999, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par valuerespectively.

Income Taxes. The components of income (loss) from continuing operations before income taxes and the details of the provision for (benefit from) income taxes consists of the followingare as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) ------------------------ 1995 1994 1993 ------- -------- Income (loss) from continuing operations before income taxes: Domestic.......................................... $51,470 $42,995 $(19,233) Foreign........................................... 17,787 14,768 6,672 ------- -------- Total......................................... $69,257 $57,763 $(12,561) Provision for (benefit from) income taxes: Current: ------- ------- -------- Federal................................................... ......................................... $11,611 12,764 $-- $168 10,963 $ 10,182 Foreign................................................... 351 -- 90 ......................................... 7,378 5,860 2,001 State..................................................... 1,409 -- 1 13,371 -- 259 ........................................... 1,423 258 2,608 ------- -------- Total current................................. 21,565 17,081 14,791 Deferred: ------- ------- -------- Federal................................................... ......................................... 1,851 1,214 (4,14317,784) -- -- Foreign................................................... -- -- -- ......................................... 1,410 2,209 2,122 State..................................................... ........................................... 674 640 (1,3353,601) -- -- ------- -------- Total deferred................................ 3,935 4,063 (5,47819,263) -- -- ------- -------- Total provision (benefit)..................... $25,500 $21,144 $ 7,893 $-- $259 (4,472) ======= === ===== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======== $ --======= The valuation allowance at December 31, 1998 and 1997 was attributed to NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Significant components of the Company's deferred tax assets. Management believed that sufficient uncertainty existed regarding (asset) liability as of December 31 are as follows: (IN THOUSANDS) ------------------ 1995 1994 -------- -------- Current deferred tax asset: Reserves not currently deductible........................ $ (9,825) $(11,106) Other.................................................... (2,000) (1,531) -------- -------- Net current deferred tax asset......................... (11,825) (12,637) Long-term deferred tax (asset) liability: Differences in basis of property and accelerated -------- -------- Reserves not currently deductible........................ (13,798) (15,928) Other.................................................... 10,910 6,528 -------- -------- Net long-term deferred tax liability................... 31,927 26,088 -------- -------- The effective rate of the realizability of these items such that a full valuation allowance was recorded. The Company's provision for (benefit from) income taxes payable for federal, state, and foreign purposes have been reduced by reconciles to the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated statutory rate as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value.follows: 1995 1994 1993 ---- ----- Statutory rate............................................ 35.0% 35.0% (35.0)%

Income Taxes. The income tax provision for income taxes consists of the following: following (in thousands): YEARS ENDED DECEMBER 31, 1999 1998 1997 2003 2002 2001 Income (IN THOUSANDSloss) Currentbefore provision (credit) for income taxes: Domestic $49,488 $37,668 $36,289 Foreign............................................... (5,998) 8,855 10,712 Current provision (credit) for income taxes: $43,490======= $46,523======= $47,001======= Federal............................................... $ 1,396 $15,006 $12,621 State................................................. (119) (831) 3,298 Foreign............................................... 1,871 2,464 2,943 3,148 16,639 18,862 Deferred provision (credit) for income taxes: Federal................................................... ............................................... 15,337 2,086 (1,028) State................................................. 625 (554) 454 Foreign............................................... (3,801) (13) 298 12,161 1,519 (276) Provision for income taxes.............................. $11,611 15,309======= $-- 18,158======= $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- 18,586======= NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (5,478CONTINUED) The tax effects of timing differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities consist of the following (in thousands): AS OF DECEMBER 31, ------------------- 2003 -------- 2002 -------- Deferred tax assets: Allowance for credit losses............................... $ 4,870 $ 6,448 Less: Valuation allowance.............................. Total deferred tax assets.............................. Deferred tax liabilities: (1,294) ------- 14,236 ------- (437) ------- 15,968 ------- Other, net................................................ Total deferred tax liabilities......................... Net deferred tax liability.................................. -- -- $ 7,893 ------- 37,006 ------- $-- $259 22,770 ======= === ==== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... 1,254 ------- 26,026 ------- $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- 10,058 ======= $ --======= The valuation allowance at December A reconciliation of the U.S. Federal statutory rate to the Company's effective tax rate are as follows: YEARS ENDED DECEMBER 31, 1998 and 1997 -------------------- 2003 ---- 2002 ---- 2001 ---- U.S. federal statutory rate................................. 35.0% 35.0% 35.0% State income taxes........................................ 0.8 (2.3) 5.5 Foreign income taxes...................................... 0.4 (1.4) (1.1) Undistributed foreign earnings............................ (3.0) 6.8 -- Valuation allowance....................................... 2.0 0.9 -- Other..................................................... Provision for income taxes.................................. -- ---- 35.2% ==== -- ---- 39.0% ==== 0.1 ---- 39.5% ==== NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) In 2001, there was attributed to deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of these items such that a full valuation allowance was recorded. The Company's income taxes payable for federal, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital state income taxes due to the re-characterization of revenue resulting from the Internal Revenue Service examination. The 2001 state income tax expense is an estimated cumulative amount of taxes owed to various states for the years 1993 to 2001. The decrease in excess state income taxes in 2002 was primarily due to a change in the estimate of par valuethe cumulative amounts owed from 1993 to 2001. During 2002, management determined that the undistributed earnings of the Company's foreign subsidiaries should no longer be considered to be permanently reinvested. As a result of that determination, the Company recorded the amount of U.S. federal income taxes and withholding taxes that would be due upon repatriation of these earnings.

Income Taxes. The Components of the provision for income taxes consists of the followingare as follows: DECEMBER 31, 1999 1998 1997 1996 1995 -------- --------- U.S....................................... $ (IN THOUSANDS660,000) Current$183,000 $ 775,000 Foreign................................... 143,000 197,000 -- ferred: Federal................................................... U.S....................................... 3,404,000 (91,000) (603,000) ---------- -------- --------- $11,611 2,887,000 $-- $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- 289,000 $ 7,893 $-- $259 172,000 ========== === ====== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ========= Current: De Approximately $35,000 and $101,000 in 1996 and 1995, respectively, represent the tax benefit from the Company's stock option exercises which directly increased paid-in capital and did not reduce the provision for income taxes. A reconciliation of the expected U.S. tax benefit to the actual consolidated tax provision is as follows: 1997 ----------- 1996 --------- 1995 ----------- Expected tax benefit at U.S. statutory rate.................................... $(5,008,000) $(121,000) $(1,331,000) State taxes.............................. 58,000 50,000 15,000 Foreign taxes............................ 128,000 51,000 75,000 Unbenefitted U.S. losses, net............ 4,810,000 -- -- Increase in U.S. valuation allowance, net..................................... 3,404,000 -- -- Unbenefitted (utilization of) foreign losses, net............................. (530,000) 40,000 1,171,000 Non-deductible goodwill.................. 158,000 165,000 130,000 Other, net............................... (133,000) ----------- $ --======= The valuation allowance at 2,887,000 104,000 --------- $ 289,000 112,000 ----------- $ 172,000 =========== ========= =========== NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Components of the Company's deferred tax assets and liabilities as of December 31, 1998 1997 and 1996 are as follows: 1997 was attributed to 1996 ------------ ------------ Deferred tax assets: Non-deductible reserves.......................... $ 3,796,000 $ 1,742,000 Losses of foreign subsidiaries and joint ventures........................................ 7,271,000 10,473,000 U.S. net operating loss carryforwards............ 3,021,000 -- Tax credit carryforwards......................... 2,193,000 490,000 Amortization of intangibles...................... -- 256,000 Other, net....................................... 483,000 536,000 ------------ ------------ Total deferred tax assets. Management believed that sufficient uncertainty existed regarding ...................... 16,764,000 13,497,000 Valuation allowance for deferred tax assets........ (15,680,000) (10,093,000) ------------ ------------ 1,084,000 3,404,000 Deferred tax liabilities: Amortization of intangibles...................... 1,084,000 -- ------------ ------------ In 1996, the realizability of these items such that a full valuation allowance primarily represented losses from foreign operations due to the uncertainty of future taxable income in these jurisdictions. In the second quarter of 1997, in light of continued operating losses, the Company determined that future taxable income in the U.S. was recordeduncertain. As a result, all of the Company's U.S. deferred tax assets have been fully reserved in 1997. The Company's income taxes payable for federal, state, and foreign purposes subsidiaries have been reduced by net operating loss carryforwards which begin to expire in the tax benefits of disqualifying dispositions of stock optionsyear 1998. The Company receives an income U.S. subsidiaries have net operating loss carryforwards which expire in 2012. Tax credit carryforwards in the U.S. include research tax benefit for compensation expense for credits which are available through 2012 and alternative minimum tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par valuecredits that do not expire.

Income Taxes. The provision for income taxes consists of included the followingfollowing components: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Current: Current Federal................................................... $11,611 $-- $168 ............................................................ $ 8,605 $ 4,215 $ 2,255 Foreign................................................... 351 -- 90 ............................................................ 535 895 625 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- $ 7,893 $-- $259 ======= === ==== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... refunds.............................................. Deferred............................................................. 890 ---------- $ 10,030 ---------- (30780) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized ---------- 800 --------- $ 5,910 --------- 860 --------- 780 --------- $ 3,660 --------- 590 --------- $ 9,950 $ 6,770 $ 4,250 --------- --------- --------- --------- The deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= provisions result primarily from differences between book and tax income arising from depreciation and leveraged leases. Refundable income taxes included within Deferred tax assets, deposits and other, principally represent refunds of Federal income taxes resulting from additional tax benefits generated from export sales and foreign tax credits carried back to prior years. Deferred tax liabilities and assets (result primarily from the differences in the timing of the recognition for transactions between book and income tax purposes and consist of the following components: Deferred tax liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... Depreciation.................................................................. $ -- 9,740 $ 845 7,390 Other......................................................................... Total deferred tax liabilities................................................ Deferred tax assets--current: 950 ---------- $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 32,920 ---------- ---------- 950 --------- $ 33,400 --------- --------- Other.................................................. 332 419 96 ......................................................................... Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net --current............................................ Deferred tax assets--noncurrent: 680 ---------- $ 8,330 ---------- 480 --------- $ 6,370 --------- Alternative minimum tax credits............................................... Total deferred tax assets................................ $5,478====== $ -- ======= $ --======= The valuation allowance at December 31, 1998 and 1997 was attributed to --noncurrent......................................... Total deferred tax assets..................................................... -- ---------- 360 ---------- $ 8,690 ---------- ---------- 2,160 --------- 2,720 --------- $ 9,090 --------- --------- 24 AAR CORP. Management believed that sufficient uncertainty existed regarding the realizability of these items such that a full valuation allowance was recorded. The Company's income taxes payable for federalAND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (IN THOUSANDS, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value.EXCEPT PER SHARE AND PERCENTAGE DATA)

Income Taxes. The provision for Pretax income (income before income taxes consists and extraordinary item) and income tax expense consist of the following: DECEMBER 31, 1997 1998 1999 1998 1997 (IN THOUSANDS) CurrentPretax income: Federal................................................... United States........................................... $11,611 6,214 $-- 19,352 $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- $ 7,893 26,929 Outside the United States............................... 3,391 2,440 10,669 Total pretax income....................................... $-- $259 9,605 21,792 37,598 ====== ======= === ===== 44 The Company's Income tax expense (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows): Current: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... Federal............................................... $11,051 $(7,294) 2,926 $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- 3,533 $ 7,908 Foreign............................................... (176) Acquired in-process technology and non-deductible goodwill1,667 3,988 State................................................. 17 (164) 528 Total current........................................... 2,767 5,036 12,424 Deferred: Federal............................................... (842) 2,243 784 Foreign............................................... 809 (606) 55 State................................................. 685 724 199 Total deferred............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 652 2,361 1,038 $3,419 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ 7,397 $5,478====== $ -- 13,462 ====== ======= $ --======= The valuation allowance at December 31======= In June 1998, 1998 and 1997 a tax benefit of $1,263 was attributed to deferred tax assets. Management believed that sufficient uncertainty existed regarding recorded in conjunction with the realizability loss on early extinguishment of these items such that a full valuation allowance was recordeddebt. The following reconciles the Federal statutory income tax rate with the Company's income taxes payable for federal, state, and foreign purposes have been reduced by the effective tax benefits of disqualifying dispositions of stock options. The Company receives an rate: 1997 -------- 1998 -------- 1999 -------- Statutory Federal income tax benefit for compensation expense for rate........................... 35.0% 35.0% 35.0% DISC/FSC commission income.................................. (1.2) (1.6) (0.7) Effect of foreign items and rate differentials.............. 0.3 0.8 1.6 State income taxes, net..................................... 4.9 4.1 1.2 Reduction of prior year tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value.provision....................... (3.0) (2.8) (2.0) Other....................................................... (0.4) ---- 35.6% ==== (1.6) ---- 33.9% ==== 0.7 ---- 35.8% ==== F-20 RAYOVAC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Income Taxes. In the fourth quarter of 1993, the Company adopted SFAS No. 109, "Accounting for Income Taxes," retroactive to October 1, 1992. The provision Company recognized the cumulative effect of adoption, which resulted in an increase to net income for the year ended September 30, 1993, of approximately $17,100,000. Income before income taxes consists and the cumulative effect of the followingaccounting changes was as follows: DECEMBER 31YEARS ENDED SEPTEMBER 30, 1999 1998 1997 1995 1994 1993 ---- ---- ---- (DOLLARS IN THOUSANDS) Current: Federal................................................... Domestic $11,611 102,980 $ 30,388 $-- 32,780 Foreign 153,362 87,937 35,120 Total $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- $ 7,893 $-- $259 256,342 ======== === ==== 44 $118,325======== $67,900======== 45 A summary of taxes on income is as follows: YEARS ENDED SEPTEMBER 30, 1995 1994 1993 ---- ---- ---- (DOLLARS IN THOUSANDS) Current........................................... $ 64,204 $ (3,131) $16,798 Deferred.......................................... (25,794) 15,644 (5,305) Total..................................... $ 38,410======== $ 12,513======== $11,493======== oreign: Current........................................... $ 61,039 $ 21,010 $26,077 Total..................................... $ 62,670 $ 32,450 $19,206 U.S. federal and state: F The Company's (benefit) provision for income taxes at the Company's effective tax rate differed from the amount computed by applying provision for income taxes at the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31YEARS ENDED SEPTEMBER 30, 1999 1998 1997 1995 1994 1993 ---- ---- ---- (DOLLARS IN THOUSANDS) Provision Computed tax expense at the expected statutory rate........................... ............................................... $ 89,720 $11,051 41,414 $23,596 Foreign income: Impact of taxation at different rates, repatriation and other....................................... 5,407 (7,294257) $ 1,764 Differential (benefit) in rates on 2,412 Impact of foreign earnings... (20) 774 (111) losses for which a current tax benefit is not available........................ 529 701 2,158 State taxes, net of federal benefiteffect................... 48 -- 1 5,560 2,655 407 Foreign sales corporation benefit..................... corporation............................ (3071,500) (1,158) (1,000) Increase in U.S. tax rate............................ -- -- (176812) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 OthersOther, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= 1,364 1,608 3,938 Provision for income taxes......................... $101,080======== $44,963======= $30,699======= Significant components of deferred income taxes were as follows: Deferred tax assets (liabilities) comprise the followingassets: DECEMBER 31Property, 1999 1998 1997 (IN THOUSANDS) plant and equipment................................ $ 28,467 $ 23,257 Pension and other benefits................................... 44,640 43,572 Environmental issues......................................... 18,008 14,761 Restructuring charges........................................ 5,633 10,337 Investments.................................................. 10,850 -- State and local taxes........................................ 5,449 1,804 Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 other tax carryforwards............... 12,132 14,568 Other........................................................ 33,373 25,338 Subtotal.................................................. 332 419 96 158,552 133,637 Valuation allowances........................................... (9,318) (14,915) Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred ............................ $149,234 $118,722 Deferred tax assetsliabilities: -------- -------- Property, plant and equipment................................ $5,478====== $ -- ======= 71,629 $ --======= 72,379 Pension and other benefits................................... 10,235 10,967 Investments.................................................. 36,629 34,480 Other........................................................ 100,532 99,894 The valuation allowance for deferred tax assets decreased $5,597,000 in 1995 primarily because of improved business results which allowed realization of deferred tax assets for which a valuation allowance had been previously established. The major component of the valuation allowance at December 31September 30, 1998 and 1997 was attributed 1995 relates to the uncertainty of realizing certain foreign deferred tax assets. Management believed that sufficient uncertainty existed regarding Approximately $45,415,000 of net operating losses and other tax carryforwards remain at September 30, 1995, $24,005,000 of which expire in the realizability years 1996 through 2002, and $21,410,000 of which can be carried forward indefinitely. The benefits of these items such that carryforwards are dependent on taxable income during the carryforward period in those foreign jurisdictions wherein they arose, and accordingly, a full valuation allowance was recordedhas been provided where the Company has determined that it is more likely than not that the carryforwards will not be utilized. The Company's United States income tax returns for fiscal years 1990 and 1991 are currently under examination by the Internal Revenue Service. Assessments, if any, are not expected to have a material adverse effect on the financial statements. Provision has not been made for U.S. income taxes payable for federal, state, or foreign withholding taxes on approximately $130,000,000 of undistributed earnings of foreign subsidiaries as these earnings are considered indefinitely reinvested. These earnings could become subject to U.S. income taxes and foreign purposes have been reduced by withholding taxes (subject to a reduction for foreign tax credits) if they were remitted as dividends, if foreign earnings were loaned to the Company or a U.S. subsidiary, or if the Company should sell its stock in the subsidiaries. However, the Company believes that U.S. foreign tax benefits of disqualifying dispositions of stock options. The Company receives an credits would largely eliminate any U.S. income tax benefit and offset any foreign withholding tax that might otherwise be due. 47 Cash paid for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise income taxes during 1995, 1994 and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value1993 totalled $60,340,000, $23,855,000 and $25,934,000, respectively.

Income Taxes. The components of the provision for income taxes consists of the followingare as follows: YEARS ENDED DECEMBER 31, 2000 1999 1998 1997 (IN THOUSANDS) Current: Federal................................................... $ 93.9 $ 69.9 $11,611 $-- $168 Foreign................................................... 351 -- 90 59.8 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- 11.7 13.9 7.5 Federal and state deferred.................................. 29.8 50.6 23.2 Change in valuation allowance............................... -- (5,4788.7) -- -- $ 7,893 (4.0) Provision for income taxes.................................. $-- 135.4====== $259 ==125.7====== $86.5 ===== === ==== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying A reconciliation of the statutory U.S. federal income tax rate to income (loss) before income taxes as followsthe Company's effective tax rate is shown below: YEARS ENDED DECEMBER 31, 2000 1999 1998 1997 (IN THOUSANDS) Provision at statutory Statutory federal income tax rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) 35.0% 35.0% 35.0% Non-deductible expenses..................................... 1.3 1.2 1.3 State income taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... .................. 3.0 3.5 2.1 Other, net.................................................. (3071.3) -- (1761.2) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization (2.4) Effective income tax rate................................... 38.0%==== 38.5%==== 36.0%==== 55 Components of the net operating loss carryovers.......... (597) -- (1,661) Utilization of research creditsdeferred income tax liability in the accompanying Consolidated Balance Sheets are as follows: ------ ------ Book basis in property over tax basis....................... (548) -- -- Future benefits $137.5 $107.5 Accruals not currently recognized.............. 508 2,116 364 Realized deductible........................... (10.9) (13.1) ------ ------ In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves will not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======= $ --======= The valuation allowance at December 31, 1998 and 1997 was attributed to deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of these items such that a full valuation allowance was recorded. The Company's income taxes payable for federal, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock optionsbe realized. The Company receives an income adjusts the valuation allowance in the period management determines it is more likely than not that deferred tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par valueassets will or will not be realized.

Income Taxes. The provision for income taxes consists of the following: DECEMBER 31YEARS ENDED APRIL 30, 1999 1998 1997 (IN THOUSANDS) Current1996 CURRENT: DEFERRED: Federal................................................... ............................................. (1,597) (2,394) (1,880) State............................................... (152) (400) (220) Total deferred...................................... (1,749) (2,794) (2,100) Deferred income taxes result from differences in the timing of certain expense items for tax and financial reporting purposes. 20 The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate as follows: YEARS ENDED APRIL 30, 1998 1997 1996 Tax computed at federal statutory rate................. $11,611 11,741 $1,415 $ 2,310 State income taxes, net of federal benefit............. 1,482 764 405 Non-deductible acquisition charges related to the IMC acquisition.......................................... -- $168 Foreign................................................... 351 2,904 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... Research and experimentation credit.................... (4,143555) -- -- Foreign................................................... -- -- -- State..................................................... (1,335410) (50) Investment tax credit.................................. -- -- (5,478150) Benefit of foreign sales corporation................... (489) (105) -- Tax exempt interest.................................... (281) (184) -- Change in valuation allowance.......................... -- (673) (2,510) Business meal exclusion................................ 100 45 -- Other.................................................. 584 37 (5) Provision for income taxes............................. $12,582 $3,793 $ 7,893 $-- $259 ======= === ==== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======= $ --======= The valuation allowance income tax benefits associated with dispositions from employee stock transactions reduced taxes currently payable by $4,291, $2,487 and $238, respectively, for fiscal 1998, 1997 and 1996. Income before income taxes is as follows: YEARS ENDED APRIL 30, 1998 1997 1996 Domestic $33,175 $3,983 $6,580 Foreign................................................. 372 60 20 Total $33,547 ======= $4,043====== $6,600====== Current net deferred tax assets are $5,280 and $3,100, as of April 30, 1998 and April 30, 1997, respectively. Non-current net deferred tax assets at December 31April 30, 1998 and 1997 was attributed to of $1,363 and $1,794, respectively, are included in other assets within the accompanying consolidated balance sheets. The components of the Company's net deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of these items such that a full valuation allowance was recorded. The Company's income taxes payable for federal, state, assets are as follows: ---------------- 1998 ------ 1997 ------ Reserves and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense accruals not currently deductible for tax purposes which is calculated as purposes............................................... $4,599 $2,662 Tax benefit of options issued in IMC acquisition.......... 1,074 1,304 Net operating loss carryforwards.......................... 236 116 As of April 30, 1998, the difference between the market value Company had federal net operating loss carryforwards of the stock issued at the time of exercise and the option price at the applicable income tax ratesapproximately $674 available to offset future taxable income. This benefit is recorded as an increase These carryforwards expire in capital in excess of par valuefiscal 2010.

Income Taxes. For financial reporting purposes, income (loss) before income taxes and extraordinary item, showing domestic and international sources, was as follows: YEARS ENDED DECEMBER 31, 2000 1999 1998 Domestic.................................................... $ 491 $ (42) $(897) International (170) (121) 197 Income (loss) before income taxes and extraordinary item.... $ 321 $(163) $(700) ===== ===== ===== The provision for income taxes consists before extraordinary item consisted of the following: 2000 1999 1998 $238 $(150) $ 356 YEARS ENDED DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Current: Federal................................................... $11,611 $-- $168 State..................................................... 74 (19) 88 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 41 83 73 353 (86) 517 Deferred: Federal................................................... 50 270 (4,143463) State..................................................... 6 40 (52) Foreign................................................... 9 8 65 65 318 (450) Provision for income taxes........................ $418==== $ 232===== $ 67===== 62 WASTE MANAGEMENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The federal statutory rate is reconciled to the effective rate as follows: YEARS ENDED DECEMBER 31, 2000 1999 1998 Income tax expense (benefit) at federal statutory rate..... 35.00% (35.00)% (35.00)% State and local income taxes, net of federal income tax benefit.................................................. 16.17 19.31 3.23 Nondeductible costs relating to acquired intangibles....... 48.40 22.01 16.85 Nondeductible merger costs................................. -- -- 8.22 Writedown of investments in subsidiaries................... 12.81 74.85 -- Minority interest.......................................... 2.54 5.20 0.82 Sale of foreign subsidiaries............................... 23.53 -- -- Deferred tax valuation and other tax reserves.............. 1.21 25.24 8.79 Federal tax on foreign income, net of U.S. benefit......... 3.13 30.30 4.35 Nonconventional fuel tax credit............................ (8.30) -- -- Foreign................................................... -- -- -- State..................................................... (1,3353.61) -- -- Other...................................................... (5,4784.27) -- -- 0.42 5.92 Provision for income taxes....................... 130.22% 142.33% 9.57% ====== ====== ====== The components of the net deferred tax assets (liabilities) at December 31 are as follows: 2000 1999 ------- ------- Deferred tax assets: Net operating loss, capital loss and tax credit carryforwards.......................................... $ 7,893 $-- $259 334 $ 244 Environmental and other reserves.......................... 1,032 1,021 Reserves not deductible until paid........................ 138 205 ------- ------- Subtotal.......................................... 1,504 1,470 Deferred tax liabilities: ------- ------- Property, equipment, intangible assets, and other......... (1,627) (1,574) Valuation allowance......................................... (444) (328) ------- ------- Net deferred tax liabilities...................... $ (567) $ (432) ======= === ==== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======= $ --======= At December 31, 2000 the Company's subsidiaries have approximately $64 of federal net operating loss ("NOL") carryforwards, $3,700 of state NOL carryforwards, and $116 of foreign NOL carryforwards. The NOL carryforwards have expiration dates through the year 2019. The Company's subsidiaries have $2 of alternative minimum tax credit carryforwards that may be used indefinitely; state tax credit carryforwards of $11; and foreign tax credit carryforwards of $33. Valuation allowances have been established for uncertainties in realizing the benefit of tax loss and credit carryforwards. While the Company expects to realize the deferred tax assets, net of the valuation allowances, changes in estimates of future taxable income or in tax laws may alter this expectation. The valuation allowance increased approximately $116 and $121 in 2000 and 1999, respectively, primarily due to the uncertainty of realizing foreign and state NOL carryforwards and the expiration of foreign tax credits. Prior to the Company's August 1999 decision to divest its WM International operations, the Company did not provide for United States income taxes on unremitted earnings of foreign subsidiaries as it was the intention of management to reinvest the unremitted earnings in its foreign operations. Since the adoption of the strategic plan in August 1999, the Company has provided for United States income taxes on unremitted foreign earnings on its international operations other than in Canada. The amount of United States income tax provided for the repatriation of the Company's international operations other than in Canada was approximately $13 for 1999. For 2000, with respect to its Canadian operations, the Company provided $9 for the 63 WASTE MANAGEMENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) repatriation of $58 of capital. Unremitted earnings in Canada were approximately $62 at December 31, 1998 and 1997 was attributed 2000, which the Company intends to deferred tax assetsreinvest. Management believed that sufficient uncertainty existed regarding It is not practicable to determine the realizability amount of these items such that a full valuation allowance was recorded. The Company's United States based income taxes that would be payable for federal, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value upon remittance of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par valueassets that represent those earnings.

Income Taxes. Income before income taxes is as follows: YEARS ENDED APRIL 30, 2000 1999 1998 Domestic............................................. $105,806 $45,617 $33,175 Foreign.............................................. 8,600 11,373 372 Total...................................... $114,406======== $56,990======= $33,547======= The provision for income taxes consists of the following: DECEMBER 31YEARS ENDED APRIL 30, 2000 1999 1998 1997 (IN THOUSANDS) CurrentCURRENT: DEFERRED: Federal................................................... ............................................ (8,631) (4,078) (1,597) State.............................................. (2,983) (1,006) (152) Total deferred..................................... (11,614) (5,084) (1,749) Provision for income taxes................. $ 40,614 $11,611 21,377 $-- $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- $ 7,893 $-- $259 12,582 ======== ======= ======= 44 The Company's (benefit) provision for income taxes differed differs from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31YEARS ENDED APRIL 30, 2000 1999 1998 1997 (IN THOUSANDS) Provision Tax computed at federal statutory rate........................... ................ $11,051 40,042 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) 19,947 $11,741 State income taxes, net of federal benefit................... 48 -- 1 Foreign ............ 5,720 2,850 1,482 Federal and state credits............................. (2,623) (1,802) (555) Benefit of foreign sales corporation benefit..................... (307) corporation.................. -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434142) (4,742489) Net deferred tax assets................................ Tax exempt interest................................... (3,301) (547) (281) Other................................................. 776 1,071 684 Provision for income taxes............................ $5,478====== $ -- 40,614 $21,377 $12,582 ======= $ --======= ======= ======= The valuation allowance at December 31income tax benefits associated with dispositions from employee stock transactions of $56,248, 1998 $17,776 and 1997 was attributed to $4,291, respectively, for fiscal 2000, 1999 and 1998, were recognized as additional paid in capital. 39 NETWORK APPLIANCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AND SHARE AMOUNTS IN THOUSANDS, EXCEPT PER-SHARE DATA) The components of net deferred tax assets are as follows: YEARS ENDED APRIL 30, ---------------------- 2000 --------- 1999 --------- Inventory reserves.......................................... $12,732 $ 5,120 Reserves and accruals not deductible for tax purposes....... 5,197 2,654 Research and development credits............................ 4,285 2,227 Tax benefit of options issued in IMC acquisition............ 532 913 Depreciation................................................ 544 585 Other....................................................... Deferred tax assets............................... 51 ------- $23,341 ======= 228 ------- $11,727 ======= Current net deferred tax assets are $22,215 and $10,134, as of April 30, 2000 and April 30, 1999, respectively. Management believed that sufficient uncertainty existed regarding Non-current net deferred tax assets at April 30, 2000 and 1999 of $1,126 and $1,593, respectively, are included in other assets within the realizability accompanying consolidated balance sheets. As of April 30, 2000, the federal and state net operating loss carryforwards for income tax purposes were approximately $209,702 and $136,814, respectively. The federal net operating loss carryforwards will begin to expire in 2020, and the state net operating loss carryforwards will begin to expire in 2006. As of April 30, 2000, we had federal and state research and development credit carryforwards of approximately $6,440 and $6,135, respectively, available to offset future taxable income. These federal credit carryforwards will begin to expire in 2013. Deferred tax assets of approximately $89,493 consisting of certain net operating loss and credit carryforwards resulting from the exercise of employee stock options have not been recognized in the financial statements. When utilized, the tax benefit of these items such that loss and credit carryforwards will be accounted for as a full valuation allowance was recorded. The Company's income taxes payable for federal, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase credit to additional paid in capital in excess of par valuecapital.

Income Taxes. The provision YEARS ENDED DECEMBER 31, ------------------------- 1994 1993 1992 ------- ------- (IN THOUSANDS) Earnings before income taxes consist of: Domestic........................................... $51,975 $41,305 $35,499 Foreign............................................ 1,263 7,142 1,338 ------- ------- Provision for income taxes consists of the followingof: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Current: Federal................................................... Federal-- $11,611 53,238 $-- 48,447 $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- $ 7,893 $-- $259 36,837 ======= === ===== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======= Current.......................................... $18,596 $17,428 $10,927 Deferred......................................... (4,475) (4,773) (2,245) ------- ------- 14,121 12,655 8,682 State and local-- ------- ------- ------- Current.......................................... 4,972 4,667 3,693 Deferred......................................... (639) (682) (559) ------- ------- 4,333 3,985 3,134 Foreign-- ------- ------- ------- Current.......................................... (856) 2,407 1,459 Deferred......................................... 1,100 (46) (361) ------- ------- 244 2,361 1,098 ------- ------- Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31 are as follows: Deferred tax liabilities: Leveraged leases.............................................. $ --======= The valuation 2,972 $ 3,847 Other......................................................... 3,773 2,805 Deferred tax liabilities.................................... 6,745 6,652 Deferred tax assets: ------- ------- Accrued and unfunded compensation and employee benefits....... 9,776 6,620 Accrued liabilities........................................... 7,487 6,206 Unrealized investment losses.................................. 1,929 -- Other......................................................... 1,875 1,166 Total deferred tax assets................................... 21,067 13,992 Valuation allowance for deferred tax assets................. -- -- Deferred tax assets......................................... 21,067 13,992 A reconciliation of the provision for income taxes with the U.S. federal income tax rate is as follows: YEARS ENDED DECEMBER 31, ----------------------------------------------- 1994 1993 1992 --------------- --------------- % OF % OF % OF PRETAX PRETAX PRETAX AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME ------ ------- ------ ------- ------ Federal statutory rate......... $18,640 35.0 $16,956 35.0 $12,525 34.0 State income taxes--net of federal....................... 2,693 5.1 2,090 4.3 2,035 5.5 Dividend exclusion............. (993) (1.9) (699) (1.5) (888) (2.4) Pre-acquisition earnings of pooled companies taxed to previous owners............... (750) (1.4) 1,158 2.4 (65) (0.1) Foreign taxes.................. 388 .7 1,262 2.6 740 2.0 General business credits....... (2,510) (4.7) (1,655) (3.4) (1,074) (2.9) Other--net..................... 1,230 2.3 (111) (0.2) (359) (1.0) ------- ---- ------- ---- ------- ---- $18,698 35.1 $19,001 39.2 $12,914 35.1 ======= ==== ======= ==== ======= ==== Due to changes in the U.S. federal income tax laws, effective in 1994, the Company began providing for U.S. income taxes on the undistributed earnings of its foreign subsidiaries. Prior to 1994, the Company did not provide for U.S. income taxes on the undistributed earnings ($19,200,000 at December 31, 1998 and 1997 was attributed to 1994) of certain foreign subsidiaries which are considered permanently invested outside of the U.S. The amount of unrecognized deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of liability on these items such that a full valuation allowance was recorded. The Company's income taxes payable for federal, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which undistributed earnings is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value$5,300,000.

Income Taxes. The provision for income taxes consists of the following: DECEMBER 31following (in thousands): June 30, 1999 1998 1997 (IN THOUSANDS) Current------------- Current provision: Federal................................................... ........................................................ $ 350 State.......................................................... 200 Foreign........................................................ 1,100 ------ The difference between the provision for income taxes and the amount computed by applying the Federal statutory income tax rate (35 percent) to income before taxes is explained below (in thousands): For the Period From May 8, 1996 Years Ended June 30, (Date of Inception) --------------------- through 1999 ---------- 1998 ---------- June 30, 1997 ------------------- Tax at federal statutory rate (benefit)......................... $ 11 $ (4,878) $11,611 $-- $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,1432,773) State income tax................... 200 -- -- Foreign................................................... Federal alternative minimum taxes.. 350 -- -- -- State..................................................... (1,335) Foreign taxes...................... 1,100 -- -- Unutilized (5,478utilized) net operating losses............................ (11) 4,878 2,773 Total............................ --------- $ 1,650 ========= ---------- $ -- ========== ------- $ -- ======= Significant components of the Company's deferred tax assets are as follows (in thousands): Years Ended June 30, ---------------------- 1999 1998 ---------- ---------- Deferred tax assets: Net operating loss carryforwards................ $ 1,647 $ 7,448 Tax credit carryforwards........................ 2,238 1,139 Bad debt reserve................................ 801 177 Other reserves and accruals..................... 3,866 807 ---------- ---------- Total deferred tax assets......................... 8,552 9,571 Valuation allowance............................... (8,552) (9,571) ---------- ---------- Net deferred tax assets........................... $ -- $ 7,893 $-- $259 ========== === ==== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======= $ --======= The FASB Statement No. 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based upon the weight of available evidence, which includes the Company's historical operating performance and the reported cumulative net losses in all prior years, the Company has provided a full valuation allowance at December 31, 1998 and 1997 was attributed to against its net deferred tax assets. Management believed that sufficient uncertainty existed regarding The Company will continue to evaluate the realizability of these items such that the deferred tax assets on a full quarterly basis. The net valuation allowance was recordeddecreased by $ 1,019,000 during the year ended June 30, 1999 and increased by $6,242,000 during the year ended June 30, 1998. The Company's income taxes payable EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) As of June 30, 1999, the Company had net operating loss carryforwards for federalfederal and state tax purposes of approximately $4,100,000 and $3,900,000, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock optionsrespectively. The Company receives an income also had federal and state research and development tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value credit carryforwards of approximately $1,202,000 and $918,000, respectively. The federal and state net operating loss carryforwards will expire at various dates beginning in 2004 through 2019, if not utilized. Utilization of the stock issued at net operating losses and tax credits may be subject to a substantial annual limitation due to the time ownership change limitations provided by the Internal Revenue Code of exercise 1986 and similar state provisions. The annual limitation may result in the option price at the applicable income expiration of net operating losses and tax rates. This benefit is recorded as an increase in capital in excess of par valuecredits before utilization.

Income Taxes. The provision Income tax data from continuing operations is as follows: For the years ended December 31, ------------------------ 2002 ------ 2001 ------ 2000 ------ Pretax income U.S. .............................. $309.2 $190.0 $171.2 Foreign............................ Provision (benefit) for income taxes consists of the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Current: Federal................................................... tax 199.6 ------ $11,611 $-- $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- $ 7,893 $-- $259 =508.8 ====== 143.4 ------ $333.4 ====== 248.7 ------ $419.9 ====== Current U.S. federal....................... $(48.0) $ (9.8) $ 58.1 State and local.................... 0.9 5.2 8.3 Foreign............................ Deferred 44.7 ------ (2.4) ------ 32.7 ------ 28.1 ------ 93.2 ------ 159.6 ------ U.S. federal....................... 104.0 71.1 (3.1) Foreign............................ Total income tax expense............ 27.3 ------ 131.3 ------ $128.9 ====== 17.5 ------ 88.6 ------ $116.7 ====== (1.1) ------ (4.2) ------ $155.4 ====== A reconciliation of the tax provision at the U.S. statutory rate to the effective income tax expense rate as reported is as follows: For the years ended December 31, --------------------- 2002 ----- 2001 ----- 2000 ----- Tax provision at U.S. statutory rate..... 35.0% 35.0% 35.0% Effect of repatriation of foreign earnings................................ (1.6) (4.6) (0.3) State income taxes, net of federal benefit................................. 0.1 1.0 1.3 Goodwill................................. - 2.7 1.9 Research & development credit............ - (0.9) (1.5) Tax benefit of foreign sales corporation............................. (0.9) (1.7) (0.6) Capital loss carryback................... (6.0) - - Other.................................... (1.7) 1.4 (0.3) ---- ---- ---- Effective income tax expense rate........ 25.3% 35.0% 37.0% ==== ==== 44 The Company's (benefit) provision for ==== Deferred income taxes differed from are established for temporary differences between the amount computed by applying the statutory U.S. federal income of assets and liabilities recognized for financial reporting purposes and for tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= reporting purposes. Deferred tax assets (liabilities) comprise ), for which no valuation allowances have been provided, include the following: DECEMBER 31, 1999 1998 1997 Employee benefits............................ $379.2 $ 26.0 Accelerated depreciation..................... (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,43442.1) (4,74231.2) Net deferred tax assets................................ Nondeductible accruals....................... 146.9 250.3 Long-term contracts.......................... 1.1 6.8 Uniform capitalization....................... 9.8 9.3 Loss carryforward............................ - 13.6 Other........................................ 38.0 ------ $5,478====== $ -- =532.9 ====== $ --======= 22.8 ------ $297.6 ====== No provision was made for U.S. taxes payable on accumulated undistributed foreign earnings of certain subsidiaries amounting to approximately $48.6, since these amounts are permanently reinvested. As of December 31, 2002, the Company had approximately $23 of foreign tax credit carryforwards. The valuation allowance credit carryforwards will expire as follows: $0.5 on December 31, 2003, $0.2 on December 31, 2004, $10.2 on December 31, 2005 and $12.1 on December 31, 2006. Shareholders' equity at December 31, 1998 2002 and 1997 was attributed 2001 reflects tax benefits related to deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability stock options exercised in 2002 and 2001 of these items such that a full valuation allowance was recordedapproximately $40.2 and $30.8, respectively. The Company's IRS is currently examining the federal consolidated tax returns of the Company for the years ended December 31, 1996 and December 31, 1997. The IRS has completed its examination of all years through 1995. As of December 31, 2002, the Company believes the accrual for income taxes payable for federal, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock optionsis sufficient to cover potential liabilities arising from these examinations. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value.NOTE 8

Income Taxes. The provision for income taxes consists of the following: MAY 31, DECEMBER 31, 1999 1998 -------------------------- Current 1995 1995 1996 1997 Federal............. $ 7,602,000 $9,546,000 $ 20,655,000 $ 35,128,000 State............... 1,438,000 1,462,000 3,562,000 6,430,000 Foreign............. 1,070,000 Deferred State............... (IN THOUSANDS211,000) Current: Federal................................................... (134,000) (106,000) (453,000) ----------- ---------- ------------ ------------ $ 7,827,000 $11,611 $-- $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- 9,931,000 $ 7,893 $-- $259 22,960,000 $ 40,212,000 =========== ========== ============ 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income ============ Temporary differences which give rise to deferred tax rate to income (loss) before income taxes assets and liabilities are as follows: DECEMBER 31, 1999 1998 ---------------------- 1996 1997 Receivables, primarily allowance for doubtful accounts.......................................... $4,860,000 $8,635,000 Intangibles, primarily patient lists............... 5,241,000 6,055,000 Accrued vacation................................... 831,000 2,114,000 Deferred compensation.............................. 107,000 67,000 Foreign NOL carryforward........................... 944,000 Foreign tax credit carryforward.................... 200,000 Other.............................................. 14,000 417,000 ---------- ---------- Gross deferred tax assets.......................... 11,053,000 18,065,000 Depreciation and amortization...................... (IN THOUSANDS1,976,000) Provision at statutory (2,454,000) Intangible assets.................................. (3,442,000) (6,712,000) Change in tax accounting method.................... (313,000) (17,000) ---------- ---------- Gross deferred tax liabilities................... (5,731,000) (9,183,000) Valuation allowance.............................. (1,144,000) ---------- ---------- Net deferred tax assets.......................... $5,322,000 $7,738,000 ========== ========== The valuation allowance relates to deferred tax assets established under SFAS No. 109 for foreign net operating loss carryforwards of $2.86 million and foreign tax credit carryforwards of $200,000. These unutilized loss and credit carryforwards which expire in 2002, will be carried forward to future years for possible utilization. No benefit of these carryforwards has been recognized on the financial statements. The reconciliation between the Company's effective tax rate and the U.S. federal income tax rate on income is as follows: YEAR ENDED SEVEN MONTHS ENDED YEARS ENDED DECEMBER 31, MAY 31, DECEMBER 31, -------------- 1995 1995 1996 1997 Federal income tax rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) ............. 34.0% 35.0% 35.0% 35.0% State taxes, net of federal benefit................... 48 -- 1 . 4.0 3.8 4.1 4.1 Foreign sales income taxes................ Nondeductible amortization of intangible assets.................. 0.9 1.5 1.1 0.4 0.8 Federal and state income tax benefit from S corporation benefit..................... status of HCC... (3074.0) -- (1761.1) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (5970.3) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- ................. 1.2 Other............................... (7,4340.5) 1.1 0.1 0.7 ---- ---- ------ ------ Effective tax rate.................. 34.4 40.3 40.0 42.2 Minority interests in partnerships.. Effective tax rate before minority (4,7422.2) Net deferred tax assets................................ $5,478====== $ -- ---- (2.7) ---- (2.3) ------ (1.9) ------ interests.......................... 32.2% ==== 37.6% ==== 37.7% ====== $ --======= The valuation allowance at December 31, 1998 and 1997 was attributed to deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of these items such that a full valuation allowance was recorded. The Company's income taxes payable for federal, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value.40.3% ====== F-16

Income Taxes. The components of income from continuing operations before income taxes and the details of the provision for income taxes consists of the followingare as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) ----------------------- 1996 1995 1994 ------- ------- Income from continuing operations before income taxes: Domestic............................................. $72,005 $51,470 $42,995 Foreign.............................................. 6,655 17,787 14,768 ------- ------- Provision for income taxes: Current: Federal................................................... ............................................ $11,611 19,837 $-- 12,764 $168 10,963 Foreign................................................... 351 -- 90 ............................................ 2,640 7,378 5,860 State..................................................... 1,409 -- 1 13,371 -- 259 .............................................. 2,580 1,423 258 ------- ------- Total current.................................... 25,057 21,565 17,081 Deferred: ------- ------- ------- Federal................................................... ............................................ 227 1,851 1,214 Foreign............................................ 1,495 1,410 2,209 State.............................................. 691 674 640 ------- ------- Total deferred................................... 2,413 3,935 4,063 ------- ------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Significant components of the Company's deferred tax (4,143asset) -- -- Foreign................................................... -- -- -- State..................................................... liability as of December 31 are as follows: (1,335IN THOUSANDS) -- -- ------------------ 1996 1995 -------- -------- Current deferred tax asset: Reserves not currently deductible........................ $ (5,4789,171) -- -- $ 7,893 $-- $259 (9,825) Other.................................................... (1,915) (2,000) -------- -------- Net current deferred tax asset......................... (11,086) (11,825) ======== === ==== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======= $ --======= The valuation allowance at December 31, 1998 and 1997 was attributed to Long-term deferred tax assets. Management believed that sufficient uncertainty existed regarding (asset) liability: Differences in basis of property and accelerated depreciation............................................ 23,508 21,547 Purchased tax benefits................................... 10,110 13,268 Reserves not currently deductible........................ (11,528) (13,798) Other.................................................... 13,009 10,910 -------- -------- Net long-term deferred tax liability................... 35,099 31,927 -------- -------- The effective rate of the realizability of these items such that a full valuation allowance was recorded. The Company's provision for income taxes payable for federalreconciles to the statutory rate as follows: 1996 1995 1994 ---- ---- Statutory rate................................................ 35.0% 35.0% 35.0% State income taxes, state, and foreign purposes have been reduced by the tax benefits net of disqualifying dispositions of stock options. The Company receives an federal income tax benefit for compensation expense for benefit......... 2.7 2.0 0.9 Foreign Sales Corporation and other tax purposes which is calculated as the difference between the market value credits............... (2.7) (2.7) (3.2) Effect of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value.foreign operations.................................. 0.9 3.9 4.7 Other......................................................... (1.0) (1.4) (0.8) ---- ----

Income Taxes. The provision for For financial reporting purposes, loss from continuing operations before income taxes consists of the following: taxes, showing domestic and international sources, is as follows (in thousands): YEARS ENDED DECEMBER 31, 1999 1998 1997 Domestic.......................................... $ (IN THOUSANDS41,588) $(896,875) $(865,783) International..................................... (121,144) 196,996 203,286 Loss from continuing operations................. $(162,732)========= $(699,879)========= $(662,497)========= The provision for income taxes on continuing operations consists of the following (in thousands): YEARS ENDED DECEMBER 31, 1999 1998 1997 Current: Federal................................................... ......................................... $11,611 $-- $168 (149,519) $ 356,056 $ 569,935 State........................................... (19,265) 88,484 83,592 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 ......................................... 83,284 72,541 85,357 (85,500) 517,081 738,884 Deferred: Federal................................................... ......................................... 270,499 (4,143463,635) -- -- (369,408) State........................................... 39,621 (51,889) (27,271) Foreign................................................... -- -- -- State..................................................... ......................................... 7,699 65,366 21,136 317,819 (1,335450,158) -- (375,543) Provision for income taxes.............. $ 232,319========= $ 66,923========= $ 363,341========= 91 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (5,478CONTINUED) The federal statutory rate is reconciled to the effective rate as follows: YEARS ENDED DECEMBER 31, 1999 1998 1997 Income tax benefit at federal statutory rate............ (35.00)% (35.00)% (35.00)% State and local income taxes, net of federal income tax benefit............................................... 19.31 3.23 5.51 Nondeductible costs relating to acquired intangibles.... 22.01 16.85 30.88 Nondeductible merger costs.............................. -- 8.22 1.40 Writedown of investments in subsidiary.................. 74.85 -- $ 7,893 $6.46 Minority interest....................................... 5.20 0.82 2.40 Deferred tax valuation and other tax reserves........... 25.24 8.79 40.11 Federal tax on foreign income........................... 30.30 4.35 0.30 Nonconventional fuel tax credit......................... -- $259 (3.61) (2.80) Other................................................... 0.85 5.91 5.59 Provision for income taxes 142.76% 9.56% 54.85% ======= ====== ====== 44 The Company's components of the net deferred tax assets (benefit) provision liabilities), excluding $80 million of net deferred tax liability related to operations held for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income sale, are as follows (loss) before income taxes as follows: in thousands): DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the followingassets: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss, capital loss carryovers.......................... $ -- $ 845 $ 303 Research and development tax credit carryovers............. -- 3,285 2,452 Capitalized research Deferred tax liabilities: Property, equipment, intangible assets, and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 other........ (1,573,893) (1,072,138) Valuation allowance.................................... -- ........................................ (7,434327,929) (4,742331,592) Net deferred tax assets................................ $5,478====== liabilities..................... $ -- (431,469) $ (232,491) =========== $ --======= =========== At December 31, 1999 the Company's subsidiaries have approximately $142.4 million of federal net operating loss ("NOL") carryforwards, $1.8 billion of state NOL carryforwards, and $522.5 million of foreign NOL carryforwards. Foreign NOL carryforwards of approximately $287.3 million may be carried forward indefinitely; the remaining NOL carryforwards have expiration dates through 2019. The Company's subsidiaries have approximately $1.0 million of alternative minimum tax credit carryforwards that may be used indefinitely; state tax credit carryforwards of $13.6 million; federal investment tax credit carryforwards of approximately $0.1 million; and foreign tax credit carryforwards of $50.7 million. Certain foreign NOL carryforwards are included in operations held for sale. Valuation allowances have been established for uncertainties in realizing the benefit of tax loss and credit carryforwards. While the Company expects to realize the deferred tax assets, net of the valuation allowances, changes in estimates of future taxable income or in tax laws may alter this expectation. The valuation allowance increased approximately $121.2 million and $98.8 million in 1999 and 1998, respectively, primarily due to the uncertainty of realizing foreign tax credits and NOL carryforwards. However, valuation allowances of $124 million for certain foreign deferred tax assets are included in operations held for sale. Prior to the Board of Directors' adoption of the strategic plan in August 1999, which included the divestiture of the Company's WM International operations, the Company did not provide for United States income taxes on unremitted earnings of foreign subsidiaries as it was the intention of management to reinvest the unremitted earnings in its foreign operations. Since the adoption of the strategic plan in August 1999, the 92 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Company has provided for United States income taxes on unremitted foreign earnings on its international operations other than in Canada. The amount of United States income tax provided for the repatriation of its international operations other than in Canada in 1999 is approximately $13.0 million. With respect to its Canadian operations, the Company intends to reinvest its earnings. Unremitted earnings in Canada are approximately $28.0 million at December 31, 1998 and 1997 was attributed 1999. It is not practicable to deferred tax assets. Management believed that sufficient uncertainty existed regarding determine the realizability amount of these items such that a full valuation allowance was recorded. The Company's United States income taxes that would be payable for federal, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value upon remittance of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par valueassets that represent those earnings.

Income Taxes. The A summary of the provision for income taxes consists is as follows: YEAR ENDED DECEMBER 31, ------------------------------ 1999 -------- 2000 -------- 2001 -------- Federal: Current........................................ $35,658 $27,854 $24,144 State: Deferred....................................... Provision for income taxes....................... 2,174 ------- $56,719 ======= 955 ------- $38,952 ======= 715 ------- $33,325 ======= The effective income tax rate differs from the amount computed on income before income taxes by applying the U.S. federal income tax rate because of the followingeffect of the following items: YEAR ENDED DECEMBER 31, 1999 1998 1997 2000 2001 Tax at U.S. federal income tax rate................... 35% 35% 35% Nondeductible expenses................................ 3 2 2 State income taxes, net of federal benefit............ 7 4 3 Valuation allowance................................... (IN THOUSANDS) Current: Federal................................................... $11,611 $-- $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,1431) -- -- Foreign................................................... -- -- -- State..................................................... 44% 41% 40% == == == The components of deferred tax assets and liabilities are as follows: ------------------- 2000 2001 -------- -------- Deferred assets (1,335liabilities): State net operating loss carryforwards.................... $ 1,281 $ 2,345 Intangible amortization................................... (35,089) -- -- (5,47843,067) -- -- $ 7,893 Deferred compensation..................................... 1,934 1,716 Accruals.................................................. 1,248 2,721 -------- -------- (30,626) (36,285) -------- -------- Valuation allowance......................................... (1,281) (1,796) -------- -------- Net deferred income taxes................................... $-- (31,907) $259 (38,081) ======== === ==== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======= $ --======= AFFILIATED MANAGERS GROUP, INC. 7. INCOME TAXES (CONTINUED) At December 31, 2001, the Company had state net operating loss carryforwards of $49,962, which expire over a period of 15 years beginning in the year 2002. The realization of these carryforwards is dependent on generating sufficient taxable income prior to their expiration. The valuation allowance at December 31, 1998 2000 and 1997 was attributed 2001 is related to deferred tax assets. Management believed that sufficient the uncertainty existed regarding of the realizability realization of these items such that a full valuation allowance was recorded. The Company's income taxes payable for federal, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par valueloss carryforwards.

Income Taxes. The Company accounts for income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes. Under the liability method specified by SFAS No. 109, a deferred tax asset or liability is measured based on the difference between the financial statement and tax bases of assets and liabilities, as measured by the enacted tax rates. Income (loss) before provision for (benefit from) income taxes consists of the following: DECEMBER 31following (in thousands): YEARS ENDED JUNE 30, 1997 1998 1999 Domestic $21,312 $22,068 $(43,365) Foreign 3,058 6,617 1,519 Total $24,370 ======= $28,685======= $(41,846)======== The provisions for (benefit from) income taxes shown in the accompanying consolidated statements of operations are composed of the following (in thousands): YEARS ENDED JUNE 30, 1997 1998 1997 1999 Federal -- Current............................................ $ 7,176 $ 8,185 $ (IN THOUSANDS3,655) Deferred........................................... 1,092 1,893 (13,111) State -- Current: Federal................................................... ............................................ 1,011 746 104 Deferred........................................... 198 857 (1,013) Foreign -- Current............................................ 692 2,368 1,564 $11,611 10,169 $-- 14,049 $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,14316,111) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- $ 7,893 $-- $259 ======= === ===== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======== F-21 66 The provision for income taxes differs from the federal statutory rate due to the following: YEARS ENDED JUNE 30, 1997(1) PROVISION 1998(1) PROVISION 1999BENEFIT Federal tax at statutory rate........................... 34.5% 34.5% 35.0% State income tax, net of federal tax benefit............ 5.6 4.2 2.1 Foreign tax............................................. (0.9) (1.0) (2.7) Tax credits generated................................... (4.1) (4.7) 5.3 Permanent differences, net.............................. 1.3 0.6 (0.7) Valuation allowance and other........................... (0.5) -- (0.5) Provision for/Benefit from income taxes................. 35.9% 33.6% 38.5% ==== ==== ==== --------------- (1) Calculated based on pretax income, before nondeductible charges for in-process research and development and costs related to acquisitions, of $26,704,000 and $41,780,000 for 1997 and 1998, respectively. The components of the net deferred tax asset (liability) recognized in the accompanying consolidated balance sheets are as follows (in thousands): ------------------ 1998 1999 -------- ------ Deferred tax assets......................................... $ --======= 6,560 $2,978 Deferred tax liabilities.................................... (13,175) 4,531 -------- ------ $ (6,615) $7,509 ======== ====== The approximate tax effect of each type of temporary difference and carry forward is as follows (in thousands): 1998 ------- 1999 ------- Revenue related............................................. $(4,492) $ 2,174 US Income tax credits....................................... -- 1,896 US operating losses carryforward............................ -- 1,595 Restructuring items......................................... -- 4,166 Nondeductible reserves and accruals......................... 422 408 Intangible assets........................................... (2,720) (1,561) Other temporary differences................................. 175 ------- (6,615) 174 ------- 8,852 Valuation allowance......................................... -- ------- $(6,615) ======= (1,343) ------- $ 7,509 ======= The tax credits and net operating loss carryforwards expire at various dates from 1999 through 2019. Due to the uncertainty surrounding the realization and timing of these tax attributes, the Company has recorded a valuation allowance at December 31of approximately $1,343,000 as of June 30, 1998 and 1997 was attributed to deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of these items such that a full valuation allowance was recorded1999. The Company's income taxes payable for federalTax Reform Act of 1986 contains provisions that may limit the net operating loss and tax credit carryforwards available to be used in a any given year in the event of significant changes in ownership, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock optionsas defined. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value.67

Income Taxes. The provision for components of income before income taxes consists of the followingwere: YEAR ENDED DECEMBER 31, 1999 ----------------------------------------- 1998 1997 (IN THOUSANDS) Current: Federal................................................... 1996 ----------- ----------- ----------- Domestic............................ $11,611 28,082,000 $-- 44,769,000 $168 23,298,000 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- $ 7,893 ............................. 52,781,000 45,751,000 49,533,000 ----------- ----------- ----------- $-- 80,863,000 $259 90,520,000 $72,831,000 =========== === ==== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======= =========== III-22 79 HERBALIFE INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Income taxes are as follows: YEAR ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ----------- ----------- CURRENT: Foreign................................ $ --======= 33,048,000 $25,397,000 $26,349,000 Federal................................ 6,133,000 9,858,000 8,774,000 State.................................. 2,754,000 2,579,000 2,600,000 DEFERRED: Foreign................................ (395,000) 1,156,000 (3,367,000) Federal................................ (9,814,000) (3,749,000) (5,589,000) State.................................. (594,000) (391,000) (727,000) ------------ ----------- ----------- $ 31,132,000 $34,850,000 $28,040,000 ============ =========== =========== The tax effects of temporary differences which gave rise to deferred income tax assets and liabilities are as follows: YEAR ENDED DECEMBER 31, ------------------------- 1998 1997 ----------- ----------- DEFERRED INCOME TAX ASSETS: Intercompany profit in inventory.................... $ 1,131,000 $ 1,693,000 Accruals not currently deductible................... 15,479,000 11,798,000 Foreign tax credits and tax loss carryforwards of certain foreign subsidiaries...................... 5,539,000 3,966,000 Less valuation allowance at allowance............................ (3,458,000) (1,601,000) Depreciation/amortization........................... 201,000 -- Deferred compensation plan.......................... 6,786,000 2,960,000 Accrued state income taxes.......................... 630,000 640,000 Accrued vacation.................................... 1,670,000 -- Other............................................... 2,670,000 1,283,000 ----------- ----------- 30,648,000 20,739,000 ----------- ----------- DEFERRED INCOME TAX LIABILITIES: Depreciation/amortization........................... -- 975,000 Payments to former partners......................... 896,000 931,000 Inventory deductibles............................... 136,000 748,000 Unrealized foreign exchange......................... 1,050,000 Other............................................... -- 322,000 ----------- ----------- 2,082,000 2,976,000 ----------- ----------- NET................................................. $28,566,000 $17,763,000 =========== =========== At December 31, 1998 1998, the Company's deferred income tax asset for U.S. foreign tax credits ($1,039,000) and 1997 tax loss carryforwards of certain foreign subsidiaries totaling $5,539,000 was attributed to deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of these items such that reduced by a full valuation allowance was recordedof $3,458,000. The Company's income taxes payable for federal, state, tax loss carryforwards expire in varying amounts between 1999 and foreign purposes have been reduced by 2008. Realization of the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which carryforwards is calculated as dependent on generating sufficient taxable income prior to expiration of the difference between carryforwards. Although realization is not assured, management believes it is more likely than not that the market net carrying value of the stock issued at the time of exercise and the option price at the applicable income tax ratescarryforwards will be realized. This benefit The amount of the income tax carryforwards that is recorded considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The tax expense differs from the "expected" income tax expense by applying the United States statutory rate of 35% as an increase in capital in excess of par value.follows:

Income Taxes. The provision for income taxes consists of the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Current: Federal................................................... $11,611 $$ -- $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- $246 Foreign................................................... -- -- -- 90 41 State..................................................... (1,335) -- -- (5,478) -- -- 1 24 ---- ---- ---- $ 7,893 $-- $259 $311 ======= === ==== 44 ==== 43 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax provision reconciles to the provision at the federal statutory rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 1996 (IN THOUSANDS) Provision at statutory rate........................... $11,051 ................................. $(7,294) $ 1,764 $2,118 Differential (benefit) in rates on foreign earnings... (20) ................... 774 (111) -- State taxes, net of federal benefit................... 48 ......................... -- 1 16 Foreign sales corporation benefit..................... (307) ........................... -- (176) -- Acquired in-process technology and non-deductible goodwill............................................ 106 .................................................. 4,863 -- -- Utilization of net operating loss carryovers.......... (597) ................ -- (1,661) Utilization of research credits....................... (5482,490) -- -- Future benefits not currently recognized.............. 508 .................... 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- 429 Alternative minimum tax............................... -- ..................................... -- 51 Others, net........................................... 901 162 Other....................................................... (459) 27 $ 7,893======= 76 $ --======= $ 259======= $ 311====== Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 1996 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- ............................... $ 845 $ 303 $ 1,964 Research and development credit carryovers............. -- 3,285 2,452 .................. Capitalized research and development costs............. 283 .................. 3,285 71 2,452 234 2,112 254 Reserves not currently deductible...................... 4,863 ........................... 2,814 1,657 1,187 Other.................................................. 332 ....................................................... 419 96 12 Total deferred tax assets.................... 5,478 ......................... 7,434 4,742 5,529 Valuation allowance.................................... -- ......................................... (7,434) (4,742) (5,529) Net deferred tax assets................................ $5,478====== ......................................... $ -- ======= --======= $ --======= $ --======= The deferred tax assets valuation allowance at December 31, 1998 1998, 1997 and 1997 was 1996 is attributed to federal and state deferred tax assets. Management believed believes that sufficient uncertainty existed exists regarding the realizability of these items such that a full valuation allowance was has been recorded. At December 31, 1998, the Company had approximately $1,968,000 of net operating loss carryovers for federal tax reporting purposes available to offset future taxable income; such carryovers will expire in the years ending 2009 through 2019. The Company's income taxes payable for federalfederal net operating loss carryovers do not include approximately $4,887,000 resulting from disqualifying dispositions or exercises of non-incentive stock options, state, and foreign purposes have been reduced by the tax benefits benefit of disqualifying dispositions of stock options. The Company receives an income tax benefit which, when realized, will be accounted for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in addition to capital in excess of par value, rather than as a reduction of the provision for income taxes. At December 31, 1998, the Company also had approximately $2,175,000, and $1,110,000, of research and development credit carryovers for federal and state tax reporting purposes, respectively. The federal research and development credit carryovers will expire in the years ending 2004 through 2019. The state research and development carryovers will be carried forward indefinitely, until utilized. The amounts of and the benefit from net operating losses and tax credits that can be carried forward may be limited in the event of a cumulative stock ownership change of greater than 50% over a three year period. 44 NOTE 11: RESEARCH AND DEVELOPMENT GRANTS BIRD. In accordance with separate agreements signed with the Israel-U.S. Binational Industrial Research and Development Foundation ("BIRD") in December 1994 and December 1997, the Company obtained grants for research and development projects amounting to 50% of the actual expenditures incurred on each of the two projects subject to a maximum of $560,000 and $845,000, respectively. The Company earned the maximum of $560,000 under the first grant, which was offset against research and development expenses from 1995 through 1997. Under the second grant, the Company earned approximately $81,000 in 1998, which was also offset against research and development expenses for the same period. The Company is not obligated to repay the grants regardless of the outcome of its development efforts; however, it is obligated to pay the BIRD royalties at the rate of 2.5% - 5% of sales of any products or development resulting from such research, but not in excess of 150% of each grant. During 1998, approximately $175,000 of royalty expense was incurred. Chief Scientist. An agreement was signed in May 1998 with the Israeli Chief Scientist Office ("Chief Scientist") in which the Company obtained a grant for a research and development project amounting to 50% of the actual expenditures incurred, subject to a maximum of 1,113,000 Israeli Shekels which translated at the December 31, 1998 exchange rate approximates $265,000. The Company earned $265,000 during 1998, which was offset against research and development expense for the same period. The Company is not obligated to repay the grants regardless of the outcome of its development efforts; however, it is obligated to pay the Chief Scientist royalties at the rate of 3% - 5% of sales of any products or development resulting from such research, but not in excess of 100% of the grant. During 1998, royalty expenses incurred were not significant. NOTE 12: GEOGRAPHIC INFORMATION AND SIGNIFICANT CUSTOMERS The Company operates in one industry segment and markets its products worldwide through its own direct sales force and through systems integrators and distributors. The Company has a manufacturing facility located in the U.S., international sales and support centers in Europe and Asia, and its New Media Communication Ltd. subsidiary and a research and development facility in Israel. YEAR ENDED DECEMBER 31, 1998 1997 1996 (IN THOUSANDS) Geographic information consists of the following: Net Sales: United States....................................... $47,422 $30,651 $26,122 Canada.............................................. 7,208 12,806 9,119 China............................................... 11,647 8,254 1,139 United Kingdom...................................... 3,511 5,530 9,323 Other foreign countries............................. 14,069 17,201 15,191 Total............................................ Long-lived assets: $83,857======= $74,442 ======= $60,894======= United States....................................... $10,384 $ 8,617 $ 8,076 Israel.............................................. 1,501 1,373 675 Other foreign countries............................. 57 87 -- Total............................................ $11,942======= $10,077 ======= $ 8,751======= The Company sells to a significant number of its end users through distributors. In 1998 sales to one domestic customer and one foreign distributor represented 17% and 11% of total net sales, respectively. In 1997, sales to one distributor represented 17% of total net sales. In 1996, sales to three distributors represented 15%, 15% and 13% of total net sales, respectively.

Income Taxes. The provision for income taxes for fiscal 2000, 1999 and 1998 consists of the following: DECEMBER 31(Amounts in thousands) June 25, 2000 June 27, 1999 June 28, 1998 1997 (IN THOUSANDS) Current---------------------- ------------- ------------- ------------- Currently payable: Federal................................................... ............................ $ 6,629 $11,611 $-- $168 20,124 $ 43,245 State.............................. 1,682 2,951 5,704 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 ............................ (225) 653 1,474 ------- -------- Total current...................... 8,086 23,728 50,423 Deferred: ------- ------- -------- Federal................................................... ............................ 9,772 10,219 23,799 State.............................. (4,143261) (5,718) (11,715) Foreign............................ 78 140 275 ------- -------- Total deferred..................... 9,589 4,641 12,359 Income taxes before cumulative effect of accounting change (1999 ------- ------- -------- Income taxes were 31.7%, 32.5% and 32.8% of pretax earnings in fiscal 2000, 1999 and 1998, respectively. A reconciliation of the provision for income taxes (before cumulative effect of accounting changes, in 1999 and 1998) with the amounts obtained by applying the federal statutory tax rate is as follows: June 25, 2000 ------------- June 27, 1999 ------------- June 28, 1998 ------------- Federal statutory tax rate.......... 35.0% 35.0% 35.0% State income taxes net of federal tax benefit........................ 3.7 3.1 2.9 State tax credits net of federal tax benefit............................ (2.1) (5.1) (4.9) Foreign taxes less than domestic rate............................... -- (1.8) (1.9) Foreign tax benefit of losses less than domestic rate................. 2.5 -- -- Foreign Sales Corporation tax benefit............................ (1.1) (0.7) (0.4) Research and experimentation credit............................. (0.1) (0.1) -- Resolution of tax issues............ (7.4) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- $ 7,893 $-- $259 ===Nondeductible expenses and other.... Effective tax rate.................. 1.2 ---- 31.7% ==== === 2.1 ---- 32.5% ==== 44 2.1 ---- 32.8% ==== The deferred income taxes reflect the net tax effects of temporary differ- ences between the bases of assets and liabilities for financial reporting pur- poses and their bases for income tax purposes. Significant components of the Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income deferred tax rate to income (loss) before income taxes liabilities and assets as of June 25, 2000, and June 27, 1999, were as follows: DECEMBER 31(Amounts in thousands) June 25, 2000 June 27, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... ---------------------- ------------- ------------- Deferred tax liabilities: Property, plant and equipment...................... $ 97,051 $11,051 $(7,294) $ 1,764 Differential (benefit) 78,241 Investments in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefitequity affiliates................... 48 19,974 20,883 Other.............................................. 394 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized -------- ------- Total deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= liabilities...................... 117,419 99,124 Deferred tax assets (liabilities) comprise the followingassets: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research -------- ------- Accrued liabilities and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 valuation reserves......... 9,795 1,568 State tax credits.................................. 16,511 17,043 Other items........................................ 5,067 2,144 -------- ------- Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======= $ --======= The valuation allowance at December 31, 1998 and 1997 was attributed to deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of these items such that a full valuation allowance was recorded. The Company's income taxes payable for federal, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value............................ 31,373 20,755 -------- -------

Income Taxes. The provision for income taxes consists of the following: DECEMBER 31YEARS ENDED APRIL 30, 1999 1998 1997 (IN THOUSANDS) Current1996 EFERRED: Federal................................................... ............................................. (1,597) (2,394) (1,880) State............................................... (152) (400) (220) Total deferred...................................... (1,749) (2,794) (2,100) Provision for income taxes.................. $11,611 12,582======= $ 3,793======= $ --======= CURRENT: D Deferred income taxes result from differences in the timing of certain expense items for tax and financial reporting purposes. 30 The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate as follows: YEARS ENDED APRIL 30, 1998 1997 1996 Tax computed at federal statutory rate................. $11,741 $1,415 $ 2,310 State income taxes, net of federal benefit............. 1,482 764 405 Non-deductible acquisition charges related to the IMC acquisition.......................................... -- $168 Foreign................................................... 351 2,904 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... Research and experimentation credit.................... (4,143555) -- -- Foreign................................................... -- -- -- State..................................................... (1,335410) (50) Investment tax credit.................................. -- -- (5,478150) Benefit of foreign sales corporation................... (489) (105) -- Tax exempt interest.................................... (281) (184) -- Change in valuation allowance.......................... -- (673) (2,510) Business meal exclusion................................ 100 45 -- Other.................................................. 584 37 (5) Provision for income taxes............................. $12,582 $3,793 $ 7,893 $-- $259 ======= === ==== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======= $ --======= The valuation allowance income tax benefits associated with dispositions from employee stock transactions reduced taxes currently payable by $4,291, $2,487 and $238, respectively, for fiscal 1998, 1997 and 1996. Income before income taxes is as follows: YEARS ENDED APRIL 30, 1998 1997 1996 Domestic $33,175 $3,983 $6,580 Foreign................................................. 372 60 20 Total $33,547 ======= $4,043====== $6,600====== Current net deferred tax assets are $5,280 and $3,100, as of April 30, 1998 and April 30, 1997, respectively. Non-current net deferred tax assets at December 31April 30, 1998 and 1997 was attributed to of $1,363 and $1,794, respectively, are included in other assets within the accompanying consolidated balance sheets. The components of the Company's net deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of these items such that a full valuation allowance was recorded. The Company's income taxes payable for federal, state, assets are as follows: ---------------- 1998 1997 Reserves and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense accruals not currently deductible for tax purposes which is calculated as the difference between the market value purposes............................................... $4,599 $2,662 Tax benefit of the stock options issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value.IMC acquisition.......... 1,074 1,304 Net operating loss carryforwards.......................... 236 116

Income Taxes. The provision for income taxes consists includes federal, state and foreign taxes currently payable and those deferred because of temporary differences between the financial statement and the tax bases of assets and liabilities. The components of the followingprovision for income taxes follow: FOR THE YEAR ENDED DECEMBER 31, 1997 1998 1999 1998 1997 (IN THOUSANDS) Current: Federal................................................... ............................................ $ 16,126 $11,611 $-- $168 18,316 $ 9,928 State.............................................. 2,639 4,426 1,746 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 ............................................ 28 724 5,508 18,793 23,466 17,182 Deferred: Federal................................................... ............................................ (4,1434,991) 282 532 Total provision................................. $ 7,078======== $24,716======= $26,600======= The reconciliation between the taxes payable based upon the U.S. federal statutory income tax rate and the recorded provision follows: FOR THE YEAR ENDED DECEMBER 31, 1997 1998 1999 Federal statutory rate.............................. $ 21,352 $35,257 $ 36,162 State taxes, net of federal benefit................. 1,285 2,877 2,028 S Corp. status of AEI through April 28, 1998........ (3,613) (4,500) -- Deferred taxes established at termination of S Corp. status of AEI..................................... -- Foreign................................................... (1,954) -- Income of foreign subsidiaries subject to tax holiday........................................... (5,106) (9,129) (14,860) Foreign exchange (losses)/gains recognized for income taxes...................................... (21,147) 12,602 8,023 Change in valuation allowance....................... 22,000 (8,079) (11,084) Difference in rates on foreign subsidiaries......... (7,693) (3,377) (630) Goodwill and other permanent differences............ -- 1,019 6,961 Total.......................................... $ 7,078======== $24,716======= $ 26,600======== The Company has structured its global operations to take advantage of lower tax rates in certain countries and tax incentives extended to encourage investment. AAAP has a tax holiday in the Philippines which expires at the end of 2002. Foreign exchange (losses)/gains recognized for income taxes relate to unrecognized net foreign exchange (losses)/gains on U.S. dollar denominated monetary assets and liabilities. These (losses)/gains, which are not recognized for financial reporting purposes as the U.S. dollar is the functional currency (see Note 1), result in deferred tax assets that will be realized, for Philippine tax reporting purposes, upon settlement of the related asset or liability. The net deferred tax asset related to these losses increased in 1997 as a result of the dramatic devaluation of the Philippine peso relative to the U.S. dollar. These assets decreased in 1998 and 1999 as they were realized for Philippine tax reporting purposes. The Company's ability to utilize these assets depends on the timing of the settlement of the related assets or liabilities and the amount of taxable income recognized within the Philippine statutory carryforward limit of 66 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) three years. During 1999, AAP reversed a valuation allowance established in prior years for a portion of the related deferred tax assets. During 1999, AAP realized all foreign net operating loss carryforwards established in 1998. In addition, minimum corporate income tax credits of $1,182 reversed to offset current foreign tax obligations. The following is a summary of the significant components of the Company's deferred tax assets and liabilities: FOR THE YEAR ENDED DECEMBER 31, 1997 1998 1999 Deferred tax assets (liabilities): Retirement benefits............................... $ 816 $ 1,038 $ 463 Other accrued liabilities......................... 100 4,571 2,579 Receivables....................................... 227 1,717 523 Inventories....................................... 6,509 2,583 3,892 Property, plant and equipment..................... -- (2,139) (2,539) Unrealized foreign exchange losses................ 37,447 15,805 480 Loss on sale of investment in ASI................. -- 1,620 1,620 Net foreign operating loss carryforward........... -- 3,646 -- Minimum corporate income tax...................... -- 1,182 -- Equity in earnings of investees................... -- -- -- State..................................................... 1,148 Other............................................. (1,3352) -- -- (5,478) -- -- 191 191 Net deferred tax asset............................ 36,013 26,684 6,182 Net deferred tax asset............................ $ 7,893 $-- $259 14,013 $ 12,763 $ 3,345 ======== === ====== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======= $ --======= Non-U.S. income before taxes and minority interest of the Company was approximately $33,000, $54,000 and $74,000 in 1997, 1998 and 1999, respectively. The valuation allowance at company does not pay or record U.S. income taxes on the undistributed earnings of its foreign subsidiaries as long as those earnings are permanently reinvested in the companies that produced them. These cumulative undistributed earnings are included in consolidated retained earnings on the balance sheet and amounted to approximately $112,000 as of December 31, 1999. An estimated $27,000 in U.S. income and foreign withholding taxes would be due if these earnings were remitted as dividends. At December 31, 1998 and 1997 was attributed to 1999 current deferred tax assets. Management believed that sufficient uncertainty existed regarding assets of $9,838 and $5,793, respectively, are included in other current assets and noncurrent deferred tax assets of $2,925 and $2,324, respectively, are included in other assets in the realizability of these items such that a full valuation allowance was recordedconsolidated balance sheet. The Company's income taxes payable for federalnet deferred tax assets include amounts which, statein the opinion of management, and foreign purposes are more likely than not to be realizable through future taxable income. In addition, at December 31, 1999, noncurrent deferred tax liabilities of $4,772 are included in other noncurrent liabilities in the consolidated balance sheet. The Company's tax returns have been reduced by examined through 1995 in the Philippines and through 1994 in the U.S. The tax benefits returns for open years are subject to changes upon final examination. Changes in the mix of disqualifying dispositions income from the Company's foreign subsidiaries, expiration of stock optionstax holidays and changes in tax laws or regulations could result in increased effective tax rates for the Company. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value.67 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Income Taxes. The provision for income taxes consists of the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Current: Federal................................................... $11,611 $-- $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- $ 7,893 $-- $259 ======= === ==== 44 43 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax provision reconciles to the provision at the federal statutory rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 1996 (IN THOUSANDS) Provision at statutory rate........................... $11,051 ................................. $(7,294) $ 1,764 $2,118 Differential (benefit) in rates on foreign earnings... (20) ................... 774 (111) -- State taxes, net of federal benefit................... 48 ......................... -- 1 16 Foreign sales corporation benefit..................... (307) ........................... -- (176) -- Acquired in-process technology and non-deductible goodwill............................................ 106 .................................................. 4,863 -- -- Utilization of net operating loss carryovers.......... (597) ................ -- (1,661) Utilization of research credits....................... (5482,490) -- -- Future benefits not currently recognized.............. 508 .................... 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- 429 Alternative minimum tax............................... -- ..................................... -- 51 Others, net........................................... 901 162 Other....................................................... (459) 27 $ 7,893======= 76 $ --======= $ 259======= $ 311====== Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 1996 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- ............................... $ 845 $ 303 $ 1,964 Research and development credit carryovers............. -- 3,285 2,452 .................. Capitalized research and development costs............. 283 .................. 3,285 71 2,452 234 2,112 254 Reserves not currently deductible...................... 4,863 ........................... 2,814 1,657 1,187 Other.................................................. 332 ....................................................... 419 96 12 Total deferred tax assets.................... 5,478 ......................... 7,434 4,742 5,529 Valuation allowance.................................... -- ......................................... (7,434) (4,742) (5,529) Net deferred tax assets................................ $5,478====== ......................................... $ -- ======= --======= $ --======= $ --======= The deferred tax assets valuation allowance at December 31, 1998 1998, 1997 and 1997 was 1996 is attributed to federal and state deferred tax assets. Management believed believes that sufficient uncertainty existed exists regarding the realizability of these items such that a full valuation allowance was has been recorded. At December 31, 1998, the Company had approximately $1,968,000 of net operating loss carryovers for federal tax reporting purposes available to offset future taxable income; such carryovers will expire in the years ending 2009 through 2019. The Company's income taxes payable for federalfederal net operating loss carryovers do not include approximately $4,887,000 resulting from disqualifying dispositions or exercises of non-incentive stock options, state, and foreign purposes have been reduced by the tax benefits benefit of disqualifying dispositions of stock options. The Company receives an income tax benefit which, when realized, will be accounted for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in addition to capital in excess of par value., rather than as a reduction of the provision for income taxes. At December 31, 1998, the Company also had approximately $2,175,000, and $1,110,000, of research and development credit carryovers for federal and state tax reporting purposes, respectively. The federal research and development credit carryovers will expire in the years ending 2004 through 2019. The state research and development carryovers will be carried forward indefinitely, until utilized. The amounts of and the benefit from net operating losses and tax credits that can be carried forward may be limited in the event of a cumulative stock ownership change of greater than 50% over a three year period. 44 NOTE 11: RESEARCH AND DEVELOPMENT GRANTS BIRD. In accordance with separate agreements signed with the Israel-U.S. Binational Industrial Research and Development Foundation ("BIRD") in December 1994 and December 1997, the Company obtained grants for research and development projects amounting to 50% of the actual expenditures incurred on each of the two projects subject to a maximum of $560,000 and $845,000, respectively. The Company earned the maximum of $560,000 under the first grant, which was offset against research and development expenses from 1995 through 1997. Under the second grant, the Company earned approximately $81,000 in 1998, which was also offset against research and development expenses for the same period. The Company is not obligated to repay the grants regardless of the outcome of its development efforts; however, it is obligated to pay the BIRD royalties at the rate of 2.5% - 5% of sales of any products or development resulting from such research, but not in excess of 150% of each grant. During 1998, approximately $175,000 of royalty expense was incurred. Chief Scientist. An agreement was signed in May 1998 with the Israeli Chief Scientist Office ("Chief Scientist") in which the Company obtained a grant for a research and development project amounting to 50% of the actual expenditures incurred, subject to a maximum of 1,113,000 Israeli Shekels which translated at the December 31, 1998 exchange rate approximates $265,000. The Company earned $265,000 during 1998, which was offset against research and development expense for the same period. The Company is not obligated to repay the grants regardless of the outcome of its development efforts; however, it is obligated to pay the Chief Scientist royalties at the rate of 3% - 5% of sales of any products or development resulting from such research, but not in excess of 100% of the grant. During 1998, royalty expenses incurred were not significant. NOTE 12: GEOGRAPHIC INFORMATION AND SIGNIFICANT CUSTOMERS The Company operates in one industry segment and markets its products worldwide through its own direct sales force and through systems integrators and distributors. The Company has a manufacturing facility located in the U.S., international sales and support centers in Europe and Asia, and its New Media Communication Ltd. subsidiary and a research and development facility in Israel. YEAR ENDED DECEMBER 31, 1998 1997 1996 (IN THOUSANDS) Geographic information consists of the following: Net Sales: United States....................................... $47,422 $30,651 $26,122 Canada.............................................. 7,208 12,806 9,119 China............................................... 11,647 8,254 1,139 United Kingdom...................................... 3,511 5,530 9,323 Other foreign countries............................. 14,069 17,201 15,191 Total............................................ Long-lived assets: $83,857======= $74,442 ======= $60,894======= United States....................................... $10,384 $ 8,617 $ 8,076 Israel.............................................. 1,501 1,373 675 Other foreign countries............................. 57 87 -- The Company sells to a significant number of its end users through distributors. In 1998 sales to one domestic customer and one foreign distributor represented 17% and 11% of total net sales, respectively. In 1997, sales to one distributor represented 17% of total net sales. In 1996, sales to three distributors represented 15%, 15% and 13% of total net sales, respectively. 45 NOTE 13: COMMITMENTS AND CONTINGENCIES Commitments. The Company leases its facilities under noncancelable operating leases which expire at various dates through 2006. Total rent expense related to these operating leases were $1,602,000 $1,413,000, and $828,000, for 1998, 1997 and 1996, respectively. Future minimum lease payments under noncancelable operating leases at December 31, 1998, were as follows: (in thousands)

Income Taxes. The provision for income taxes consists components of the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Current: Federal................................................... $11,611 $-- $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- $ 7,893 $-- $259 ======= === ==== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes, an extraordinary item, and the cumulative effect of an accounting change, and the details of the provision for (benefit from) income taxes are as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... ------------------------- 1994 1993 1992 -------- ------- Income (loss) before income taxes: Domestic........................................... $11,051 47,039 $(7,29417,869) $57,619 Foreign............................................ 14,768 6,672 9,100 -------- ------- Total.......................................... $61,807 $(11,197) $66,719 Provision for (benefit from) income taxes: Current: ------- -------- ------- Federal.......................................... $10,963 $ 1,764 Differential 10,182 $17,221 Foreign.......................................... 5,860 2,001 1,025 State............................................ 258 2,608 2,189 -------- ------- Total current.................................. 17,081 14,791 20,435 Deferred: ------- -------- ------- Federal.......................................... 2,630 (benefit17,307) in rates on foreign earnings... (20864) 774 Foreign.......................................... 2,209 2,122 3,653 State............................................ 896 (1113,471) State taxes, net (862) -------- ------- Total deferred................................. 5,735 (18,656) 1,927 -------- ------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Significant components of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized the Company's deferred tax assets previously reserved...... (3,249asset) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the followingliability as of December 31 are as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 ------------------ 1994 1993 -------- -------- Current deferred tax assets: Reserves not currently deductible...................... 4,863 2,814 1,657 ........................ $(11,106) $(13,235) Other.................................................. 332 419 96 Total .................................................... (1,531) (111) -------- -------- Net current deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- asset......................... (7,43412,637) (4,74213,346) Net Long-term deferred tax (assets................................ $5,478====== $ -- ======= $ --======= The valuation allowance at December 31, 1998 ) liabilities: Differences in basis of property and 1997 was attributed to accelerated -------- -------- Reserves not currently deductible........................ (15,928) (17,015) Other.................................................... 6,545 4,253 -------- -------- Net long-term deferred tax assets. Management believed that sufficient uncertainty existed regarding liability................... 28,482 27,948 -------- -------- The effective rate of the realizability of these items such that a full valuation allowance was recorded. The Company's provision for (benefit from) income taxes payable for federal, state, and foreign purposes have been reduced by reconciles to the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated statutory rate as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value.follows: 1994 1993 1992 ----- ---- Statutory rate............................................. 35.0% (35.0)% 34.0%

Income Taxes. The provision for income taxes consists of the following: DECEMBER 31, following components (in thousands): 2000 1999 1998 1997 -------- ------- Current...................................... $ (IN THOUSANDS137) Current: Federal................................................... $11,611 $$ -- $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 $ (64) Deferred: Federal................................................... (4,143) -- -- Foreign................................................... ..................................... -- -- -- State..................................................... -------- ------- $ (1,335137) -- -- (5,478) -- $ -- $ 7,893 $-- $259 ======= === ==== 44 (64) -------- ------- The current income tax expense for the year ended December 31, 2000 is related to the Company's (benefit) international operations in Europe. The provision for income taxes differed differs from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, follows (in thousands): 2000 -------- 1999 -------- 1998 1997 ------- Income tax (IN THOUSANDSprovision) Provision / benefit at federal statutory rate........................... $11,051 $rate of 35%....................... $ 99,728 $ 28,070 $ 9,966 Nondeductible goodwill....................... (7,29446,706) (8,237) (186) Nondeductible acquisition costs.............. (5,079) (1,099) (488) Nondeductible charges for purchased research and development............................. (28,035) (3,220) -- Change in valuation allowance resulting from items other than those attributable to paid-in capital and acquisition adjust- ments....................................... (16,949) (14,305) (7,284) Other........................................ (3,096) -------- (1,209) -------- (2,072) ------- Net tax (provision) / benefit................ $ (137) $ 1,764 Differential 0 $ (benefit64) in rates on foreign earnings... (20) 774 (111) State taxes, net -------- -------- ------- The tax effects of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology temporary differences and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized carryforwards that give rise to the Company's deferred tax assets previously reserved...... and liabilities are as follows (3,249) in thousands): 2000 1999 1998 -------- -------- Deferred Tax Assets: Current Deferred revenue........................ $ 5,366 $ 367 $ 473 Compensation expense--stock options..... -- -- Alternative minimum tax............................... -- -- 51 Others2,002 59 Other, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) .............................. 4,175 5,156 2,535 Total current............................. --------- 9,541 -------- 7,525 -------- 3,067 Non-current Net operating loss carryovers.......................... $ carryforward......... 375,240 51,327 4,262 Tax credit carryforward................. 8,645 1,643 513 Deductible acquisition costs, net....... 5,140 -- $ 845 $ 303 Research and development credit carryovers-- Unrealized investment losses............ 5,501 -- -- Depreciation & amortization............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 10,595 2,292 233 Other.................................................. 332 419 96 , net.............................. Total non-current......................... Total gross deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... ............. 7,747 --------- 412,868 --------- 422,409 --------- 17,964 -------- 73,226 -------- 80,751 -------- 8,214 -------- 13,222 -------- 16,289 -------- Deferred Tax Liabilities: Non-current Other unrealized income................. 6,924 -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======= $ --======= The valuation allowance at December 31, 1998 and 1997 was attributed to deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of these items such that a full valuation allowance was recorded. The Company's income taxes payable for federal, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value.--

Income Taxes. The provision for income taxes consists Significant components of the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Current: Federal................................................... $11,611 $-- $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143) -- -- Foreign................................................... -- -- -- State..................................................... (1,335) -- -- (5,478) -- -- $ 7,893 $-- $259 ======= === ==== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets and (liabilities) comprise the followingare as follows at December 31: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) -------- 2000 -------- Net operating loss carryovers.......................... carryforward........................ $ 8,962 $ 10,354 Effect of state income taxes........................... (1,022) -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Accrued expenses....................................... 333 89 Tax credits............................................ 1,730 2,457 Bad debt reserve....................................... 64 45 Depreciation........................................... (114) (141) Amortization........................................... (1,782) (1,393) Inventory write-downs.................................. 266 137 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 development................... 2,313 1,963 Deferred revenue....................................... 777 175 Deferred compensation amortization..................... 327 417 Other.................................................. 332 419 96 Total deferred Deferred tax assets.................... 5,478 7,434 4,742 .................................... 3 -------- 11,857 1 -------- 14,104 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== (11,857) -------- $ -- ======== (14,104) -------- $ --======= -- ======== The valuation allowance at December 31increased by $3,486, 1998 $1,762 and 1997 was attributed to deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of these items such that a full valuation allowance was recorded$2,247 in 1998, 1999 and 2000, respectively. The Company's effective tax rate differs from the statutory rate of 35% due to federal and state losses which were recorded without tax benefit. At December 31, 2000, the Company has net operating loss carryforwards for federal and state income taxes payable tax purposes of approximately $29,709 and $4,340, respectively, which begin to expire in 2009 and 2001, respectively. In addition, the Company has research and development and other tax credits for federal, statefederal and state income tax purposes of approximately $1,284, and foreign purposes have been reduced by $1,173, respectively, which begin to expire in 2011. Because of the "change of ownership" provision of the Tax Reform Act of 1986, utilization of the Company's net operating loss and research credit carryforwards may be subject to an annual limitation against taxable income in future periods. As a result of the annual limitation, a portion of these carryforwards may expire before ultimately becoming available to reduce future income tax benefits of disqualifying dispositions of stock optionsliabilities. The Company receives an income tax benefit results of operations for compensation expense for tax purposes which is calculated as the difference between years ended December 31, 1998, 1999 and 2000 includes the market value net losses of the stock issued at the time Company's wholly-owned German and majority-owned Japanese subsidiary of exercise $1,029, $177 and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value$176, respectively.

Income Taxes. For financial reporting purposes, income (loss) from continuing operations before income taxes, showing domestic and international sources, is as follows (in thousands): 1998 --------- 1997 --------- 1996 -------- Domestic................................... $(896,875) $(865,783) $757,537 International.............................. Income (loss) from continuing 196,996 --------- 203,286 --------- 16,695 -------- operations..................... $(699,879) ========= $(662,497) ========= $774,232 ======== The provision for income taxes on continuing operations consists of the followingfollowing (in thousands): --------- -------- Current: Federal.................................. $ 356,056 $ 569,935 $216,814 State.................................... 88,484 83,592 57,860 Foreign.................................. 72,541 85,357 22,875 --------- -------- 517,081 738,884 297,549 Deferred: --------- --------- -------- Federal.................................. (463,635) (369,408) 86,654 State.................................... (51,889) (27,271) 26,936 Foreign.................................. 65,366 21,136 75,561 --------- -------- (450,158) (375,543) 189,151 --------- -------- 88 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The federal statutory rate is reconciled to the effective rate as follows: YEARS ENDED DECEMBER 31, 1999 ------------------------- 1998 ------ 1997 ------ 1996 ----- Income taxes (benefit) at federal statutory rate............................................ (35.00)% (35.00)% 35.00% State and local income taxes, net of federal income tax benefit.............................. 3.23 5.51 7.11 Nondeductible costs relating to acquired intangibles..................................... 16.85 30.88 7.55 Nondeductible merger costs........................ 8.22 1.40 1.33 Writedown of investments in subsidiary............ -- 6.46 7.66 Minority interest................................. 0.82 2.40 1.87 Gain on sale of foreign subsidiary................ -- -- 2.26 Deferred tax valuation and other tax reserves..... 8.79 40.11 0.90 Federal tax on foreign income..................... 4.35 0.30 1.20 Nonconventional fuel tax credit................... (3.61) (2.80) (1.99) Other............................................. Provision for income taxes...................... 5.91 ------ 9.56% ====== 5.59 ------ 54.85% ====== (0.07) ----- 62.82% ===== The components of the net deferred tax assets (liabilities) are as follows (in thousands): DECEMBER 31, ------------------------- 1998 1997 ----------- ----------- Deferred tax assets: Net operating loss, capital loss and tax credit carryforwards................................. $ 322,129 $ 287,384 Environmental and other reserves................. 670,502 754,195 Reserves not deductible until paid............... 178,608 291,168 ----------- ----------- Subtotal................................. 1,171,239 1,332,747 Deferred tax liabilities: Property, equipment, intangible assets, and Valuation allowance................................ (IN THOUSANDS331,592) Current: Federal................................................... $11,611 $-- $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,143232,800) -- -- Foreign................................................... -- -- -- State..................................................... ----------- ----------- Net deferred tax liabilities............. $ (1,335232,491) -- -- $ (5,478467,632) -- -- $ 7,893 $-- $259 =========== === ==== 44 The Company's (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 $(7,294) $ 1,764 Differential (benefit) in rates on foreign earnings... (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,434) (4,742) Net deferred tax assets................................ $5,478====== $ -- ======= $ --======= At December 31, 1998, the Company's subsidiaries have approximately $200,599,000 of federal net operating loss ("NOL") carryforwards, $1,007,749,000 of state NOL carryforwards, and $598,930,000 of foreign NOL carryforwards. Foreign NOL carryforwards of approximately $535,530,000 may be carried forward indefinitely; the remaining NOL carryforwards have expiration dates through 2013. The Company's subsidiaries have $16,062,000 of alternative minimum tax credit carryforwards that may be used indefinitely; state tax credit carryforwards of $5,039,000; federal investment tax credit carryforwards of $381,000; and foreign tax credit carryforwards of $32,614,000. Valuation allowances have been established for uncertainties in realizing the benefit of tax loss and credit carryforwards. While the Company expects to realize the deferred tax assets, net of the valuation allowances, changes in estimates of future taxable income or in tax laws may alter this expectation. During 1997, the valuation allowance increased approximately $101,056,000, composed of increases to allowances due to the uncertainty of realizing alternative minimum tax credits, tax benefits from certain asset impairment writedowns (primarily land), foreign tax credits, and NOL carryforwards partially offset by reductions in allowances attributable primarily to foreign net operating loss carryforwards. In 1998, the 89 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) valuation allowance increased approximately $98,792,000 primarily due to the uncertainty of realizing foreign NOL carryforwards. The Company does not provide for U.S. income taxes on unremitted earnings of foreign subsidiaries as it is the present intention of management to reinvest the unremitted earnings in its foreign operations. Unremitted earnings of foreign subsidiaries are approximately $498,000,000 at December 31, 1998 and 1997 was attributed 1998. It is not practicable to deferred tax assets. Management believed that sufficient uncertainty existed regarding determine the realizability amount of these items such that a full valuation allowance was recorded. The Company's U.S. income taxes that would be payable for federal, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value upon remittance of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par valueassets that represent those earnings.

Income Taxes. The Company accounts for income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes. Under the liability method specified by SFAS No. 109, a deferred tax asset or liability is measured based on the difference between the financial statement and tax bases of assets and liabilities, as measured by the enacted tax rates. Income (loss) before provision for income taxes consists of the following (in thousands): YEARS ENDED JUNE 30, ----------------------------- 1996 ------- 1997 ------- 1998 ------- Domestic...................................... $(8,435) $21,312 $22,068 Foreign....................................... Total............................... 194 ------- $(8,241) ======= 3,058 ------- $24,370 ======= 6,617 ------- $28,685 ======= F-22 64 ASPEN TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The provisions for income taxes shown in the accompanying consolidated statements of operations are composed of the following (in thousands): ---------------------------- 1996 ------ 1997 ------- 1998 ------- Federal -- Current...................................... $4,933 $ 7,174 $ 8,185 State -- Current...................................... 966 1,011 746 Foreign -- Current...................................... 505 692 2,368 ------ ------- ------- $6,146 ====== $10,169 ======= $14,049 ======= The provision for income taxes differs from the federal statutory rate due to the following: DECEMBER 31YEARS ENDED JUNE 30, 1999 1998 1997 ----------------------------- 1996(1) 1997(1) 1998(1) ------- ------- Federal tax at statutory rate.................... 34.5% 34.5% 34.5% State income tax, net of federal tax benefit..... 5.5 5.6 4.2 Foreign tax...................................... 1.2 (IN THOUSANDS0.9) Current: Federal................................................... $11,611 $-- $168 Foreign................................................... 351 -- 90 State..................................................... 1,409 -- 1 13,371 -- 259 Deferred: Federal................................................... (4,1431.0) Tax credits generated............................ (5.0) (4.1) (4.7) Permanent differences, net....................... 2.2 1.3 0.6 Valuation allowance and other.................... (0.4) (0.5) -- -- Foreign................................................... -- -- -- State..................................................... ---- ---- Provision for income taxes....................... 38.0% 35.9% 33.6% ==== ==== ==== - --------------- (1,3351) -- -- Calculated based on pretax income, before nondeductible charges for in-process research and development and costs related to acquisitions, of $14,850,000, $26,704,000 and $41,780,000 for 1996, 1997 and 1998, respectively. The components of the net deferred tax liability recognized in the accompanying consolidated balance sheets are as follows (5,478in thousands): -------- -------- Deferred tax assets.................................... $ 6,344 $ 6,560 Deferred tax liabilities............................... (14,908) -- -- (13,175) -------- -------- $ 7,893 $-- $259 (8,564) $ (6,615) ======== === ====== 44 65 ASPEN TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company's approximate tax effect of each type of temporary difference and carryforward is as follows (benefit) provision for income taxes differed from the amount computed by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as follows: DECEMBER 31in thousands): JUNE 30, 1999 ------------------ 1997 1998 1997 (IN THOUSANDS) Provision at statutory rate........................... $11,051 ------- ------- Revenue related.......................................... $(7,2948,430) $ 1,764 Differential $(benefit4,492) in rates on foreign earnings... Foreign operating losses................................. 1,063 -- Nondeductible reserves and accruals...................... 1,118 422 Intangible assets........................................ (20) 774 (111) State taxes, net of federal benefit................... 48 -- 1 Foreign sales corporation benefit..................... (307) -- (176) Acquired in-process technology and non-deductible goodwill............................................ 106 4,863 -- Utilization of net operating loss carryovers.......... (597) -- (1,661) Utilization of research credits....................... (548) -- -- Future benefits not currently recognized.............. 508 2,116 364 Realized deferred tax assets previously reserved...... (3,249) -- -- Alternative minimum tax............................... -- -- 51 Others, net........................................... 901 (459) 27 $ 7,893======= $ --======= $ 259======= Deferred tax assets (liabilities) comprise the following: DECEMBER 31, 1999 1998 1997 (IN THOUSANDS) Net operating loss carryovers.......................... $ -- $ 845 $ 303 Research and development credit carryovers............. -- 3,285 2,452 Capitalized research and development costs............. 283 71 234 Reserves not currently deductible...................... 4,863 2,814 1,657 Other.................................................. 332 419 96 Total deferred tax assets.................... 5,478 7,434 4,742 Valuation allowance.................................... -- (7,4342,241) (4,7422,720) Net deferred tax assets................................ Other temporary differences.............................. (74) 175 ------- ------- $5,478====== $ -- (8,564) $(6,615) ======= $ --======= The valuation allowance at December 31, 1998 and 1997 was attributed to deferred tax assets. Management believed that sufficient uncertainty existed regarding the realizability of these items such that a full valuation allowance was recorded. The Company's income taxes payable for federal, state, and foreign purposes have been reduced by the tax benefits of disqualifying dispositions of stock options. The Company receives an income tax benefit for compensation expense for tax purposes which is calculated as the difference between the market value of the stock issued at the time of exercise and the option price at the applicable income tax rates. This benefit is recorded as an increase in capital in excess of par value.=======