10-K/A 1 lnc2008form10ka.txt LEUCADIA NATIONAL CORPORATION 2008 FORM 10-KA SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- FORM 10-K/A (Amendment No. 1) [x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2008 or [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to ___________ Commission file number: 1-5721 LEUCADIA NATIONAL CORPORATION (Exact Name of Registrant as Specified in its Charter) New York 13-2615557 -------------------------------------------------------------------------------- (State or Other Jurisdiction of Incorporation (I.R.S. Employer or Organization) Identification No.) 315 Park Avenue South New York, New York 10010 (212) 460-1900 (Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant's Principal Executive Offices) Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered Common Shares, par value $1 per share New York Stock Exchange 7-3/4% Senior Notes due August 15, 2013 New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None. (Title of Class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [x] No [ ] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [x] Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [x] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [ ] (Do not check if a smaller reporting company) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [x] Aggregate market value of the voting stock of the registrant held by non-affiliates of the registrant at June 30, 2008 (computed by reference to the last reported closing sale price of the Common Shares on the New York Stock Exchange on such date): $8,492,086,000. On February 20, 2009, the registrant had outstanding 238,498,598 Common Shares. DOCUMENTS INCORPORATED BY REFERENCE: -------------------------------------------------------------------------------- Certain portions of the registrant's definitive proxy statement pursuant to Regulation 14A of the Securities Exchange Act of 1934 in connection with the 2009 annual meeting of shareholders of the registrant are incorporated by reference into Part III of this Report. 1 EXPLANATORY NOTE This Report on Form 10-K/A amends and restates in its entirety Item 15 of the Annual Report on Form 10-K, of Leucadia National Corporation (the "Company") for the fiscal year ended December 31, 2008 to reflect that the financial statements referred to in Item 15(c)(1), (2) and (3) have been filed herewith pursuant to Item 3-09(b) of Regulation S-X. 2 PART IV Item 15. Exhibits and Financial Statement Schedule.

(a)(1)(2) Financial Statements and Schedule. Report of Independent Registered Public Accounting Firm..................................... F-1 Financial Statements: Consolidated Balance Sheets at December 31, 2008 and 2007.................................. F-2 Consolidated Statements of Operations for the years ended December 31, 2008, 2007 and 2006........................................................................... F-3 Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006........................................................................... F-4 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2008, 2007 and 2006........................................................ F-6 Notes to Consolidated Financial Statements................................................. F-7 Financial Statement Schedule: Schedule II - Valuation and Qualifying Accounts............................................ F-49

(3) Executive Compensation Plans and Arrangements. See Item 15(b) below for a complete list of Exhibits to this Report. 1999 Stock Option Plan, as amended April 5, 2006 (filed as Annex C to the Company's Proxy Statement dated April 17, 2006 (the "2006 Proxy Statement")). Form of Grant Letter for the 1999 Stock Option Plan (filed as Exhibit 10.4 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004 (the "2004 10-K")). Amended and Restated Shareholders Agreement dated as of June 30, 2003 among the Company, Ian M. Cumming and Joseph S. Steinberg (filed as Exhibit 10.5 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003 (the "2003 10-K")). Form of Amendment No. 1 to the Amended and Restated Shareholders Agreement dated as of June 30, 2003 (filed as Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2006 (the "2nd Quarter 2006 10-Q")). Leucadia National Corporation 2003 Senior Executive Annual Incentive Bonus Plan, as amended May 16, 2006 (filed as Annex A to the 2006 Proxy Statement). Leucadia National Corporation 2006 Senior Executive Warrant Plan (filed as Annex B to the 2006 Proxy Statement). Employment Agreement made as of June 30, 2005 by and between the Company and Ian M. Cumming (filed as Exhibit 99.1 to the Company's Current Report on Form 8-K dated July 13, 2005 (the "July 13, 2005 8-K")). Employment Agreement made as of June 30, 2005 by and between the Company and Joseph S. Steinberg (filed as Exhibit 99.2 to the July 13, 2005 8-K). (b) Exhibits. We will furnish any exhibit upon request made to our Corporate Secretary, 315 Park Avenue South, New York, NY 10010. We charge $.50 per page to cover expenses of copying and mailing. All documents referenced below were filed pursuant to the Securities Exchange Act of 1934 by the Company, file number 1-5721, unless otherwise indicated. 3 3.1 Restated Certificate of Incorporation (filed as Exhibit 5.1 to the Company's Current Report on Form 8-K dated July 14, 1993).* 3.2 Certificate of Amendment of the Certificate of Incorporation dated as of May 14, 2002 (filed as Exhibit 3.2 to the 2003 10-K).* 3.3 Certificate of Amendment of the Certificate of Incorporation dated as of December 23, 2002 (filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002 (the "2002 10-K")).* 3.4 Amended and Restated By-laws as amended through December 1, 2008 (filed as Exhibit 3.1 to the Company's Current Report on Form 8-K dated December 2, 2008).* 3.5 Certificate of Amendment of the Certificate of Incorporation dated as of May 13, 2004 (filed as Exhibit 3.5 to the Company's 2004 10-K).* 3.6 Certificate of Amendment of the Certificate of Incorporation dated as of May 17, 2005 (filed as Exhibit 3.6 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2005 (the "2005 10-K")).* 3.7 Certificate of Amendment of the Certificate of Incorporation dated as of May 23, 2007 (filed as Exhibit 4.7 to the Company's Registration Statement on Form S-8 (No. 333-143770)).* 4.1 The Company undertakes to furnish the Securities and Exchange Commission, upon written request, a copy of all instruments with respect to long-term debt not filed herewith. 10.1 1999 Stock Option Plan, as amended April 5, 2006 (filed as Annex A to the 2006 Proxy Statement).* 10.2 Form of Grant Letter for the 1999 Stock Option Plan (filed as Exhibit 10.4 to the Company's 2004 10-K).* 10.3 Amended and Restated Shareholders Agreement dated as of June 30, 2003 among the Company, Ian M. Cumming and Joseph S. Steinberg (filed as Exhibit 10.5 to the 2003 10-K).* 10.4 Services Agreement, dated as of January 1, 2004, between the Company and Ian M. Cumming (filed as Exhibit 10.37 to the 2005 10-K).* 10.5 Services Agreement, dated as of January 1, 2004, between the Company and Joseph S. Steinberg (filed as Exhibit 10.38 to the 2005 10-K).* 10.6 Leucadia National Corporation 2003 Senior Executive Annual Incentive Bonus Plan, as amended May 16, 2006 (filed as Annex A to the 2006 Proxy Statement).* 10.7 Employment Agreement made as of June 30, 2005 by and between the Company and Ian M. Cumming (filed as Exhibit 99.1 to the July 13, 2005 8-K).* 10.8 Employment Agreement made as of June 30, 2005 by and between the Company and Joseph S. Steinberg (filed as Exhibit 99.2 to the July 13, 2005 8-K).* 10.9 First Amended Joint Chapter 11 Plan of Reorganization of Williams Communications Group, Inc. ("WCG") and CG Austria, Inc. filed with the Bankruptcy Court as Exhibit 1 to the Settlement Agreement (filed as Exhibit 99.3 to the Current Report on Form 8-K of WCG dated July 31, 2002 (the "WCG July 31, 2002 8-K")).* 4 10.10 Tax Cooperation Agreement between WCG and The Williams Companies Inc. dated July 26, 2002, filed with the Bankruptcy Court as Exhibit 7 to the Settlement Agreement (filed as Exhibit 99.9 to the WCG July 31, 2002 8-K).* 10.11 Exhibit 1 to the Agreement and Plan of Reorganization between the Company and TLC Associates, dated February 23, 1989 (filed as Exhibit 3 to Amendment No. 12 to the Schedule 13D dated December 29, 2004 of Ian M. Cumming and Joseph S. Steinberg with respect to the Company).* 10.12 Information Concerning Executive Compensation (filed as Exhibit 10.1 to the Company's Current Report on Form 8-K dated January 24, 2008).* 10.13 Form of Unit Purchase Agreement, dated as of April 6, 2006, by and among GAR, LLC, the Company, AA Capital Equity Fund, L.P., AA Capital Biloxi Co-Investment Fund, L.P. and HRHC Holdings, LLC (filed as Exhibit 10.1 to the 2nd Quarter 2006 10-Q).* 10.14 Form of Loan Agreement, dated as of April 6, 2006, by and among Goober Drilling, LLC, the Subsidiaries of Goober Drilling, LLC from time to time signatory thereto and the Company (filed as Exhibit 10.2 to the 2nd Quarter 2006 10-Q).* 10.15 Form of First Amendment to Loan Agreement, dated as of June 15, 2006, between Goober Drilling, LLC, the Subsidiaries of Goober Drilling, LLC from time to time signatory thereto and the Company (filed as Exhibit 10.3 to the 2nd Quarter 2006 10-Q).* 10.16 Form of First Amended and Restated Limited Liability Company Agreement of Goober Drilling, LLC, dated as of June 15, 2006, by and among Goober Holdings, LLC, Baldwin Enterprises, Inc., the Persons that become Members from time to time, John Special, Chris McCutchen, Jim Eden, Mike Brown and Goober Drilling Corporation (filed as Exhibit 10.4 to the 2nd Quarter 2006 10-Q).* 10.17 Form of Purchase and Sale Agreement, dated as of May 3, 2006, by and among LUK-Symphony Management, LLC, Symphony Health Services, LLC and RehabCare Group, Inc. (filed as Exhibit 10.5 to the 2nd Quarter 2006 10-Q).* 10.18 Form of Amendment No. 1, dated as of May 16, 2006, to the Amended and Restated Shareholders Agreement dated as of June 30, 2003, by and among Ian M. Cumming, Joseph S. Steinberg and the Company (filed as Exhibit 10.6 to the 2nd Quarter 2006 10-Q).* 10.19 Form of Credit Agreement, dated as of June 28, 2006, by and among the Company, the various financial institutions and other Persons from time to time party thereto and JPMorgan Chase Bank, National Association (filed as Exhibit 10.7 to the 2nd Quarter 2006 10-Q).* 10.20 Form of Subscription Agreement, dated as of July 15, 2006, by and among FMG Chichester Pty Ltd, the Company, and Fortescue Metals Group Ltd (filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2006 (the "3rd Quarter 2006 10-Q")).* 10.21 Form of Amending Agreement, dated as of August 18, 2006, by and among FMG Chichester Pty Ltd, the Company and Fortescue Metals Group Ltd (filed as Exhibit 10.2 to the 3rd Quarter 2006 10-Q).* 10.22 Compensation Information Concerning Non-Employee Directors (filed under Item 1.01 of the Company's Current Report on Form 8-K dated May 22, 2006).* 10.23 Leucadia National Corporation 2006 Senior Executive Warrant Plan (filed as Annex B to the 2006 Proxy Statement).* 10.24 Asset Purchase and Contribution Agreement, dated as of January 23, 2007, by and among Baldwin Enterprises, Inc., STiPrepaid, LLC, Samer Tawfik, Telco Group, Inc., STi Phonecard Inc., Dialaround Enterprises Inc., STi Mobile Inc., Phonecard Enterprises Inc.,VOIP Enterprises Inc., STi PCS, LLC, Tawfik & Partners, SNC, STiPrepaid & Co., STi Prepaid Distributors & Co. and ST Finance, LLC (filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2007 (the "1st Quarter 2007 10-Q")).* 5 10.25 Registration Rights Agreement, dated as of March 8, 2007, among STi Prepaid, LLC and ST Finance, LLC (filed as Exhibit 10.2 to the 1st Quarter 2007 10-Q).* 10.26 Amended and Restated Limited Liability Company Agreement, dated as of March 8, 2007, by and among STi Prepaid, LLC, BEI Prepaid, LLC and ST Finance, LLC (filed as Exhibit 10.3 to the 1st Quarter 2007 10-Q).* 10.27 Master Agreement for the Formation of a Limited Liability Company dated as of February 28, 2007, among Jefferies Group, Inc., Jefferies & Company, Inc. and Leucadia National Corporation (filed as Exhibit 10.4 to the 1st Quarter 2007 10-Q).* 10.28 Amended and Restated Limited Liability Company Agreement of Jefferies High Yield Holdings, LLC, dated as of April 2, 2007, by and among Jefferies Group, Inc., Jefferies & Company, Inc., Leucadia National Corporation, Jefferies High Yield Partners, LLC, Jefferies Employees Opportunity Fund LLC and Jefferies High Yield Holdings, LLC (filed as Exhibit 10.5 to the 1st Quarter 2007 10-Q).* 10.29 Stock Purchase Agreement by and among BEI-RZT Corporation, Gaylord Hotels, Inc. and Gaylord Entertainment Company (Mainland Agreement), dated June 1, 2007 (filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2007).* 10.30 Investment Agreement dated as of April 20, 2008, by and between Leucadia National Corporation and Jefferies Group, Inc. (filed as Exhibit 10.1 to the Company's Current Report on Form 8-K filed on April 21, 2008).* 10.31 Letter Agreement dated April 20, 2008, between Leucadia National Corporation and Jefferies Group, Inc. (filed as Exhibit 10.2 to the Company's Current Report on Form 8-K filed on April 21, 2008).* 10.32 Share Forward Transaction Agreement, dated January 11, 2008 (filed as Exhibit 1 to the Company's Schedule 13D dated January 10, 2008 with respect to AmeriCredit Corp.).* 21 Subsidiaries of the registrant.* 23.1 Consent of PricewaterhouseCoopers LLP with respect to the incorporation by reference into the Company's Registration Statements on Form S-8 (No. 333-51494), Form S-8 (No. 333-143770), and Form S-3 (No. 333-145668).* 23.2 Consent of independent auditors from Ernst & Young LLP, with respect to the inclusion in this Annual Report on Form 10-K of the financial statements of Pershing Square IV, L.P. and Pershing Square IV A, L.P. and with respect to the incorporation by reference in the Company's Registration Statements on Form S-8 (No. 333-51494), Form S-8 (No. 333-143770), and Form S-3 (No. 333-145668). 23.3 Consent of independent auditors from PricewaterhouseCoopers LLP, with respect to the inclusion in this Annual Report on Form 10-K of the financial statements of Premier Entertainment Biloxi, LLC and with respect to the incorporation by reference in the Company's Registration Statements on Form S-8 (No. 333-51494), Form S-8 (No. 333-143770), and Form S-3 (No. 333-145668). 23.4 Consent of independent auditors from PricewaterhouseCoopers LLP, with respect to the inclusion in this Annual Report on Form 10-K of the financial statements of HFH ShortPLUS Fund, L.P. and HFH ShortPLUS Master Fund, Ltd. and with respect to the incorporation by reference in the Company's Registration Statements on Form S-8 (No. 333-51494), Form S-8 (No. 333-143770), and Form S-3 (No. 333-145668). 6 31.1 Certification of Chairman of the Board and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* 31.2 Certification of President pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* 31.3 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* 31.4 Certification of Chairman of the Board and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.5 Certification of President pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.6 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chairman of the Board and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* 32.2 Certification of President pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* 32.3 Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* 32.4 Certification of Chairman of the Board and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.** 32.5 Certification of President pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.** 32.6 Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.** (c) Financial statement schedules. (1) Pershing Square IV, L.P. financial statements as of and for the year ended December 31, 2008 (unaudited), and as of December 31, 2007 and for the period from June 1, 2007 (commencement of operations) to December 31, 2007 (audited) and Pershing Square IV A, L.P. financial statements as of and for the year endeded December 31, 2008 (unaudited), and as of December 31, 2007 and for the period from June 1, 2007 (commencement of operations) to December 31, 2007 (audited). (2) Premier Entertainment Biloxi, LLC financial statements as of and for the year ended December 31, 2006 (unaudited) and as of August 9, 2007 and for the period from January 1, 2007 through August 9, 2007 (audited). (3) HFH ShortPLUS Fund, L.P. financial statements as of and for the year ended December 31, 2008 (unaudited) and as of and for the year ended December 31, 2007 (audited), and HFH ShortPLUS Master Fund, Ltd.financial statements as of and for the year ended December 31, 2008 (unaudited) and as of and for the year ended December 31, 2007 (audited). ---------------------------- * Incorporated by reference. ** Furnished herewith pursuant to item 601(b) (32) of Regulation S-K. 7 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. LEUCADIA NATIONAL CORPORATION March 25, 2009 By: /s/ Barbara L. Lowenthal --------------------- Barbara L. Lowenthal Vice President and Comptroller 8 FINANCIAL STATEMENTS Pershing Square IV, L.P. Year Ended December 31, 2008 (Unaudited) Pershing Square IV, L.P. Financial Statements Year Ended December 31, 2008 (Unaudited) Contents Financial Statements Statement of Assets, Liabilities and Partners' Capital .............. 1 Statement of Operations.............................................. 2 Statement of Changes in Partners' Capital ........................... 3 Statement of Cash Flows ............................................. 4 Notes to Financial Statements ....................................... 5 Consolidated Financial Statements of Pershing Square IV A, L.P. Pershing Square IV, L.P. Statement of Assets, Liabilities and Partners' Capital December 31, 2008 (Unaudited) Assets Investment in Pershing Square IV A, L.P. $ 373,490,155 ------------------ Total assets $ 373,490,155 ================== Partners' capital Partners' capital $ 373,490,155 ------------------ Total partners' capital $ 373,490,155 ================== The accompanying notes and attached consolidated financial statements of Pershing Square IV A, L.P. are an integral part of the financial statements. 3 Pershing Square IV, L.P. Statement of Operations Year Ended December 31, 2008 (Unaudited)

Net realized and unrealized losses allocated from investment in Pershing Square IV A, L.P. Net realized loss from investments in securities $ (587,544,670) Net change in unrealized loss from investments in securities 66,417,787 Net realized loss on derivative contracts (257,867,878) Net change in unrealized loss on derivative contracts (971,357) ------------------- Net realized and unrealized loss allocated from investment in Pershing Square IV A, L.P. $ (779,966,118) Net investment loss allocated from investment in Pershing Square IV A, L.P. Investment income Dividends (net of withholding $303,349) 2,762,841 Interest 2,097,657 Total expenses (7,078,899) ------------------- Net investment loss allocated from investment in Pershing Square IV A, L.P. (2,218,401) Partnership investment income Reimbursement of expenses 64,831 ------------------- Net investment loss (2,153,570) -------------- Net loss $ (782,119,688) ==============

The accompanying notes and attached consolidated financial statements of Pershing Square IV A, L.P. are an integral part of the financial statements. 4 Pershing Square IV, L.P. Statement of Changes in Partners' Capital Year Ended December 31, 2008 (Unaudited) Partners' capital at beginning of year $ 1,127,609,843 Limited partners capital contributions 28,000,000 Net loss (782,119,688) -------------------- Partners' capital at end of year $ 373,490,155 ==================== The accompanying notes and attached consolidated financial statements of Pershing Square IV A, L.P. are an integral part of the financial statements. 5 Pershing Square IV, L.P. Statement of Cash Flows Year Ended December 31, 2008 (Unaudited)

Cash flows from operating activities Net loss $ (782,119,688) Adjustments to reconcile net loss to net cash used in operating activities: Decrease in investment in Pershing Square IV A, L.P. 754,184,519 Decrease in accrued expenses (44,961) Decrease in withholding tax payable (19,870) ------------------- Net cash used in operating activities (28,000,000) Cash flows from financing activities Capital contributions 28,000,000 ------------------- Net change in cash and cash equivalents -- Cash and cash equivalents at beginning of year -- ------------------- Cash and cash equivalents at end of year $ -- ===================

The accompanying notes and attached consolidated financial statements of Pershing Square IV A, L.P. are an integral part of the financial statements. 6 Pershing Square IV, L.P. Notes to Financial Statements December 31, 2008 (Unaudited) 1. Organization Pershing Square IV, L.P. (the "Partnership") was organized as a limited partnership under the laws of the state of Delaware on May 22, 2007 and commenced operations on June 1, 2007. The objective of the Partnership is to invest all of its assets in Pershing Square IV A, L.P. (the "Subsidiary Partnership"). The Subsidiary Partnership is an exempted limited partnership formed under the limited liability partnership laws of the Cayman Islands on May 31, 2007 and commenced operations on June 1, 2007. The investment objective of the Partnership and the Subsidiary Partnership (collectively, the "PSIV Partnerships") is to create significant capital appreciation by investing in stock, total return swaps and call options of Target Corporation. The Partnership is a "master" fund in a "master-feeder" structure whereby Pershing Square International IV, Ltd. (the "Fund") invests all of its assets in the Partnership. The Partnership is also a "feeder" fund in a "master-feeder" structure as the Partnership invests all of its assets in the Subsidiary Partnership. Pershing Square Holdings GP, LLC, a limited liability company organized under the laws of the state of Delaware and registered as a foreign company under the laws of the Cayman Islands, serves as the "General Partner" to the PSIV Partnerships. The General Partner is responsible for making all investment decisions on behalf of the PSIV Partnerships and is solely responsible for the development and implementation of the PSIV Partnerships' investment policy and strategy. William A. Ackman is the managing member of the General Partner and is primarily responsible for managing the PSIV Partnerships. The General Partner delegates administrative functions relating to the management of the PSIV Partnerships to Pershing Square Capital Management, L.P. ("PSCM"), a limited partnership organized under the laws of the state of Delaware. William A. Ackman is the managing member of PS Management GP, LLC, the general partner of PSCM. Pursuant to an Administration Agreement dated May 2007, Goldman Sachs (Cayman) Trust, Limited (the "Administrator") has been appointed administrator to the PSIV Partnerships. The Administrator provides certain administrative and accounting services and receives customary fees, plus out of pocket expenses, based on the nature and extent of services provided. See attached consolidated financial statements of Pershing Square IV A, L.P. 7 Pershing Square IV, L.P. Notes to Financial Statements (continued) 2. Significant Accounting Policies Basis of Presentation The financial statements of the Partnership have been prepared in accordance with accounting principles generally accepted in the United States. The following is a summary of the significant accounting and reporting policies used in preparing the financial statements. Valuation of Investment in the Subsidiary Partnership The Partnership's investment in the Subsidiary Partnership is valued at fair value, which represents the Partnership's proportionate interest in the partners' capital of the Subsidiary Partnership at December 31, 2008. The limited partners' interests of the Subsidiary Partnership are entirely owned by the Partnership and Pershing Square IV-I L.P. ("PSIV-I"), an affiliated entity managed by PSCM. The performance of the Partnership is directly affected by the performance of the Subsidiary Partnership. Attached to these financial statements are the audited consolidated financial statements of the Subsidiary Partnership, including the consolidated condensed schedule of investments and significant accounting and reporting policies, which are an integral part of these financial statements. Valuation of the investment held by the Partnership is discussed in the notes of the Subsidiary Partnership's financial statements. As of December 31, 2008, the Partnership has approximately 91.77% ownership interest in the Subsidiary Partnership. Fair Value of Financial Instruments The fair value of the Partnership's assets and liabilities, which qualify as financial instruments under Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments," approximates the carrying amounts presented in the statement of assets, liabilities and partners' capital. Investment Transactions and Related Investment Income The Partnership records its proportionate share of the Subsidiary Partnership's income, expenses and realized and unrealized gains and losses. The Partnership accounts for its own income and expenses on an accrual basis. Use of Estimates The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. See attached consolidated financial statements of Pershing Square IV A, L.P. 8 Pershing Square IV, L.P. Notes to Financial Statements (continued) 2. Significant Accounting Policies (continued) Taxation No Federal, state or local income taxes have been provided on income or loss of the Partnership since the partners are individually liable for the taxes on their share of the Partnership's income or loss. The only taxes payable by the Partnership on its income are withholding taxes applicable to certain investment income. As a result, no income tax liability or expense has been recorded in the accompanying financial statements. 3. Guarantees The Partnership enters into contracts that contain a variety of indemnifications. The Partnership's maximum exposure under these arrangements is unknown. However, the Partnership has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote. 4. Related Party Transactions The Partnership is not charged a management fee nor performance allocation at the Partnership level. Management fees and performance allocation are charged indirectly through the Partnership's investment in the Subsidiary Partnership. During the year ended December 31, 2008, Pershing Square, L.P. ("PSLP"), an affiliated investment fund managed by PSCM, had an investment in the Partnership. PSLP was not charged a management fee nor performance allocation by PSCM in relation to its investment in the Partnership and indirectly through its investment in the Subsidiary Partnership. At December 31, 2008, PSLP owned 2.14% of the total partners' capital of the Partnership. On June 30, 2008, the Fund and the Partnership were re-opened to allow an additional contribution in the Fund of $28,000,000 made by Pershing Square International Ltd., an affiliated fund managed by PSCM. 5. Allocation of Net Income/(Loss) In accordance with the Partnership Agreement (the "Agreement"), net income or loss is allocated as of the last business day of each Fiscal Period, as defined, to all partners in proportion to each partner's capital account at the time of such allocation. See attached consolidated financial statements of Pershing Square IV A, L.P. 9 Pershing Square IV, L.P. Notes to Financial Statements (continued) 6. Partner's Capital In accordance with the Agreement, a limited partner commits capital until December 31, 2009 (the "Lock-Up Date"). The General Partner, in its sole discretion, may advance or extend the Lock-Up Date for up to one year beyond December 31, 2009 if the General Partner believes it is in the best interest of the Partnership to do so. The General Partner has extended the Lock-Up Date for up to one year beyond December 31, 2009 of the Partnership and the Subsidiary Partnership. 7. Financial Highlights The following represents the ratios to average limited partners' capital and total return information for the year ended December 31, 2008: Ratios to average limited partners' capital: Expenses 0.73% ====== Net investment loss (0.22)% ====== Total return (67.91)% ====== The above ratios and total return are calculated for all limited partners taken as a whole. Individual partner's ratios and returns may vary from the above based on different management fee and performance allocation arrangements and timing of capital transactions. 8. Subsequent Events Beginning January 1, 2009, the General Partner elected to waive all future management fees and the performance allocation for all investors in the Partnership. During the period from January 1, 2009 to February 28, 2009, performance for the Partnership was (60%). On January 31, 2009, the Fund redeemed its entire investment in the Partnership and subsequently subscribed its entire investment into the Subsidiary Partnership. Pershing Square IV Trade-Co, L.P. ("PSIV TradeCo LP"), a Delaware Limited Partnership, was formed on January 13, 2009. PSIV TradeCo LP is a wholly owned subsidiary of the Partnership. PSIV TradeCo LP, may invest in stock, total return swaps and/or call options of Target Corporation. See attached consolidated financial statements of Pershing Square IV A, L.P. 10 Pershing Square IV, L.P. Notes to Financial Statements (continued) 8. Subsequent Events (continued) On February 8, 2009, the General Partner decided to waive the lock-up and permitted investors to redeem on February 28, 2009 from the Partnership. Any investor that elected not to redeem on February 28, 2009 will be committed until the Lock-Up Date. Redemptions on February 28, 2009 for the Partnership totaled approximately $51,490,000. In addition, the General Partner will also permit investors in the Partnership to apply a highwater mark adjustment to their existing, or new, investments in any affiliated entities managed by PSCM to compensate for losses incurred in the Partnership. On March 1, 2009, the PSIV Partnerships, the Fund, PSIV-I and Pershing Square International IV-I, Ltd., an affiliated entity managed by PSCM, (collectively the "PSIV entities"), opened for new and additional capital contributions. Total contributions received on March 1, 2009 by the PSIV entities were $68,997,000. Contributions from William A. Ackman, affiliated entities managed by PSCM, certain employees and advisory board members represented $67,672,000 of the total contributions received. Total contributions received on March 1, 2009 by the Partnership were $1,175,000. Contributions from certain employees and advisory board members represented $850,000 of the total contributions received by the Partnership. See attached consolidated financial statements of Pershing Square IV A, L.P. 11 CONSOLIDATED FINANCIAL STATEMENTS Pershing Square IV A, L.P. Year Ended December 31, 2008 (Unaudited) Pershing Square IV A, L.P. Consolidated Financial Statements Year Ended December 31, 2008 (Unaudited) Contents Consolidated Financial Statements Consolidated Statement of Assets, Liabilities and Partners' Capital .......... 1 Consolidated Condensed Schedule of Investments ............................... 2 Consolidated Statement of Operations.......................................... 3 Consolidated Statement of Changes in Partners' Capital ....................... 4 Consolidated Statement of Cash Flows ......................................... 5 Notes to Consolidated Financial Statements ................................... 6 Pershing Square IV A, L.P. Consolidated Statement of Assets, Liabilities and Partners' Capital (Stated in United States Dollars) December 31, 2008 (Unaudited)

Assets Cash and cash equivalents $ 7,500,000 Due from brokers 38,494,447 Investments in securities, at fair value (cost $1,050,018,441) 389,245,072 Net unrealized gain on swap contracts 5,068,275 Dividend receivable 4,778 Interest receivable 896 -------------- Total assets $ 440,313,468 ============== Liabilities and partners' capital Due to broker $ 32,389,275 Net unrealized loss on swap contracts 134,834 Accrued expenses and other liabilities 811,812 -------------- Total liabilities 33,335,921 Partners' capital 406,977,547 -------------- Total liabilities and partners' capital $ 440,313,468 ==============

The accompanying notes are an integral part of the consolidated financial statements. 3 Pershing Square IV A, L.P. Consolidated Condensed Schedule of Investments (Stated in United States Dollars) December 31, 2008 (Unaudited)

Percentage Shares/ of Partners' Contracts Description/Name Fair Value Capital ------------------------------------------------------------------------------------------------------------------- Investments in Securities Equity Securities United States: Retail 2,601,875 Target Corp. $ 89,842,744 22.07% ----------------------------- Total Equity Securities (cost $80,646,000) 89,842,744 22.07 Equity Option Contracts United States: Retail Target Corp., Calls, Strike Prices $40.00 - 58,925,962 $51.04, 04/02/09 - 03/19/10 299,402,328 73.57 ----------------------------- Total Equity Option Contracts (cost $969,372,441) 299,402,328 73.57 ----------------------------- Total Investments in Securities $ 389,245,072 95.64% (cost $1,050,018,441) ============================= Derivative Contracts Credit Default Swaps, buy protection United States: Banking $ (134,834) (0.03)% Total Return Swaps, long exposure United States: Banking 5,068,275 1.25 ----------------------------- Total Derivative Contracts $ 4,933,441 1.22% =============================

The accompanying notes are an integral part of the consolidated financial statements. 4 Pershing Square IV A, L.P. Consolidated Statement of Operations (Stated in United States Dollars) Year Ended December 31, 2008 (Unaudited)

Net realized and unrealized loss from investments Net realized loss from investments in securities $ (613,261,514) Net change in unrealized loss from investments in securities 61,609,793 Net realized loss on derivative contracts (280,816,758) Net change in unrealized loss on derivative contracts 5,451,528 ------------------ Net loss from investments $ (827,016,951) Investment income Dividends (net of withholding taxes of $303,349) 2,865,077 Interest 2,165,567 ------------------ Total investment income 5,030,644 Partnership expenses Management fee 2,299,475 Professional fees 4,899,706 Interest 267,389 Withholding tax 67,505 ------------------ Total expenses 7,534,075 ------------------ Net investment loss (2,503,431) --------------- Net loss $ (829,520,382) ===============

The accompanying notes are an integral part of the consolidated financial statements. 5 Pershing Square IV A, L.P. Consolidated Statement of Changes in Partners' Capital (Stated in United States Dollars) Year Ended December 31, 2008 (Unaudited)

Limited General Total Partners Partner ---------------------------------------------------------------------- Partners' capital at beginning of year $ 1,128,247,929 $ 1,127,674,674 $ 573,255 Capital contributions 108,250,000 108,250,000* -- Net loss (829,520,382) (829,131,651) (388,731) ------------------- ------------------- --------------- Partners' capital at end of year $ 406,977,547 $ 406,793,023 $ 184,524 =================== =================== ===============

* William A. Ackman contributed $5,000,000 as a limited partner. The accompanying notes are an integral part of the consolidated financial statements. 6 Pershing Square IV A, L.P. Consolidated Statement of Cash Flows (Stated in United States Dollars) Year Ended December 31, 2008 (Unaudited)

Cash flows from operating activities Net loss $ (829,520,382) Adjustments to reconcile net loss to net cash used in operating activities: Net realized loss from investments in securities 613,261,514 Net change in unrealized loss from investments in securities (61,609,793) Net change in unrealized loss on derivative contracts (5,451,528) Purchases of investments (528,548,589) Proceeds from investments sold 646,993,967 Increase in due to/from brokers (5,773,222) Increase in dividend receivable (4,778) Decrease in interest receivable 629,581 Increase in accrued expenses and other liabilities 568,132 ------------------- Net cash used in operating activities (169,455,098) Cash flows from financing activities Capital contributions 108,250,000 ------------------- Net change in cash and cash equivalents (61,205,098) Cash and cash equivalents at beginning of year 68,705,098 ------------------- Cash and cash equivalents at end of year $ 7,500,000 =================== Supplemental disclosure of cash flow information Cash paid during the year for interest $ 267,389 ===================

The accompanying notes are an integral part of the consolidated financial statements. 7 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements December 31, 2008 (Unaudited) 1. Organization Pershing Square IV A, L.P. (the "Subsidiary Partnership") is an exempted limited partnership formed under the limited liability partnership laws of the Cayman Islands on May 31, 2007 and commenced operations on June 1, 2007. The investment objective of the Subsidiary Partnership is to create significant capital appreciation by investing in stock, total return swaps and call options of Target Corporation. The Subsidiary Partnership acts as the master fund in a "master-feeder" structure whereby Pershing Square IV, L.P. ("PSIV LP") and Pershing Square IV-I, L.P. ("PSIV-I LP") invest all of their capital in the Subsidiary Partnership. PSIV LP and PSIV-I LP (collectively, the "Partnerships") were organized as limited partnerships under the laws of the state of Delaware on May 22, 2007 and June 27, 2008, respectively, and commenced operations on June 1, 2007 and June 30, 2008, respectively. The Partnerships are also "master" funds in a "master-feeder" structure whereby Pershing Square International IV, Ltd. ("PSIV Ltd") invests all of its assets in PSIV LP and Pershing Square International IV-I, Ltd ("PSIV-I Ltd") invests all of its assets in PSIV-I LP. PSIV Ltd and PSIV-I Ltd (collectively, the "Funds") are exempted companies formed under the limited liability laws of the Cayman Islands on May 15, 2007 and May 23, 2008, respectively, and are registered under the Cayman Islands Mutual Funds Law. Pershing Square IV B, L.P. (the "PSIV B") is a wholly owned subsidiary of the Subsidiary Partnership and was incorporated on July 17, 2007 under the laws of the state of Delaware. Since inception there has been no activity in PSIV B and PSIV B did not hold any assets on behalf of the Subsidiary Partnership at December 31, 2008. Pershing Square Holdings GP, LLC, a limited liability company organized under the laws of the state of Delaware and registered as a foreign company under the laws of the Cayman Islands, serves as the "General Partner" to the Subsidiary Partnership and the Partnerships (collectively, the "PSIV Partnerships"). The General Partner is responsible for making all investment decisions on behalf of the PSIV Partnerships and is solely responsible for the development and implementation of the PSIV Partnerships' investment policy and strategy. William A. Ackman is the managing member of the General Partner and is primarily responsible for managing the PSIV Partnerships. The General Partner delegates administrative functions relating to the management of the PSIV Partnerships to Pershing Square Capital Management, L.P. ("PSCM"), a limited partnership organized under the laws of the state of Delaware. William A. Ackman is the managing member of PS Management GP, LLC, the general partner of PSCM. 8 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 1. Organization (continued) Pursuant to an Administration Agreement dated May 2007, Goldman Sachs (Cayman) Trust, Limited (the "Administrator") has been appointed administrator to the PSIV Partnerships and Funds. The Administrator provides certain administrative and accounting services and receives customary fees, plus out of pocket expenses, based on the nature and extent of services provided. 2. Significant Accounting Policies Basis of Presentation The Subsidiary Partnership's consolidated financial statements and the following significant accounting policies have been prepared in accordance with accounting principles generally accepted in the United States of America and are stated in United States dollars. The following is a summary of the significant accounting and reporting policies used in preparing the consolidated financial statements. Basis of Consolidation The Subsidiary Partnership's policy is to consolidate all subsidiaries that are wholly owned. The consolidated financial statements include the results of the Subsidiary Partnership and its subsidiary, PSIV B. Intercompany transactions have been eliminated on consolidation. Investment Transactions and Related Investment Income The Subsidiary Partnership records its securities transactions and the related revenue and expenses on a trade date basis. Generally, realized gains and losses from security transactions are calculated on a highest cost relief method. Dividends are recorded on the ex-dividend date, net of any applicable foreign withholding taxes. Interest is recorded on the accrual basis. Valuation of Investments In general, the Subsidiary Partnership values investments at their last sales price on the date of determination. If no sales occurred on such date, such investments are valued at the mean of the last "bid" and "ask" price on the last business day such investments were traded. Investments for which no such market prices are available are valued at fair value by the General Partner based upon counterparty and independent third party prices. All unrealized gains and losses are reflected on the consolidated statement of operations. 9 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 2. Significant Accounting Policies (continued) Cash and Cash Equivalents The Subsidiary Partnership considers all highly liquid financial instruments with a maturity of three months or less to be cash equivalents. As of December 31, 2008, cash and cash equivalents consist of a money market fund invested in U.S. Treasury securities and are held with an affiliate of the Administrator. Fair Value of Financial Instruments The fair value of the Subsidiary Partnership's assets and liabilities which qualify as financial instruments under Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments," approximates the carrying amounts presented in the consolidated statement of assets, liabilities and partners' capital. Use of Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Income Taxes The Subsidiary Partnership is not subject to any income or capital gains taxes in the Cayman Islands since the partners are individually liable for the taxes on their share of the Subsidiary Partnership's income or loss. The only taxes payable by the Subsidiary Partnership on its income are withholding taxes applicable to dividend income. As a result, no income tax liability or expense has been recorded in the accompanying consolidated financial statements. 10 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 2. Significant Accounting Policies (continued) New Accounting Pronouncements On July 13, 2006, the Financial Accounting Standards Board ("FASB") released FASB Interpretation No. 48 "Accounting for Uncertainty in Income Taxes" (FIN 48). FIN 48 provides guidance for how uncertain tax positions should be recognized, measured, presented and disclosed in the consolidated financial statements. FIN 48 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Subsidiary Partnership's tax returns to determine whether the tax positions are "more-likely-than-not" of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold would be recorded as a tax benefit or expense in the current year. Adoption of FIN 48 was deferred to fiscal years beginning after December 15, 2008 and is to be applied to all open tax years as of the effective date. At this time, the Subsidiary Partnership is evaluating the implications of FIN 48 and its impact on the consolidated financial statements, if any, has not yet been determined. The Subsidiary Partnership elected to defer adoption of FIN 48, allowable under FASB Staff Position ("FSP") FIN 48-3, and will adopt for the fiscal year ending December 31, 2009, as required. In March 2008, the FASB released Statement No. 161, "Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133" ("FAS 161"). FAS 161 requires enhanced disclosure about an entity's derivative and hedging activities, thereby improving the transparency of financial reporting. FAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Subsidiary Partnership believes the implications of FAS 161 would have no impact to partners' capital. 3. Fair Value Measurement In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement on Financial Accounting Standards No. 157, "Fair Value Measurements" ("FAS 157"). This standard clarifies the definition of fair value for financial reporting, establishes a framework for measuring fair value and requires additional disclosures about the use of fair value measurements. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. FAS 157 requires a categorization of assets and liabilities stated at fair value based upon an assessment of the valuation inputs and techniques used by the Subsidiary Partnership. There are three levels of categorization under FAS 157 as follows: 11 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 3. Fair Value Measurement (continued) Level 1 - Inputs are unadjusted quoted prices in active markets at the measurement date. The assets and liabilities in this category will generally include equities listed in active markets, treasuries ("on the run") and listed options. Level 2 - Inputs (other than quoted prices included in Level 1) are obtained directly or indirectly from observable market data at the measurement date. The assets and liabilities in this category will generally include equity options, credit default swaps, total return swaps and certain derivatives. Level 3 - Inputs reflect the Partnership's best estimate of what market participants would use in pricing the assets and liabilities at the measurement date. The assets and liabilities in this category will generally include private investments and certain derivatives. The Partnership's assets and liabilities measured at fair value as of December 31, 2008 are categorized in the below table:

-------------------------------------------------------------------------------------------------------------- Fair Value Measurements at December 31, 2008 -------------------------------------------------------------------------------------------------------------- Description Level 1 Level 2 Level 3 Total -------------------------------------------------------------------------------------------------------------- Assets: Investments in securities $ 89,842,744 $ 299,402,328 +/- $ -- $ 389,245,072 Derivative contracts -- 5,068,275 ^ -- 5,068,275 ------------ ------------------- ------------- -------------------- Total Assets $ 89,842,744 $ 304,470,603 $ -- $ 394,313,347 ============ =================== ============= ==================== Liabilities: Derivative contracts $ -- $ (134,834)^ $ -- $ (134,834) ============ =================== ============= ==================== Total Liabilities $ -- $ (134,834) $ -- $ (134,834) ============ =================== ============= ====================

+/- Level 2 investments in securities include OTC call options which are fair valued by the General Partner using prices obtained from four different counterparties. ^ Level 2 derivative contracts include credit default swaps and total return swaps, which are valued by an independent third party. 12 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 4. Due to/from Brokers Due from brokers include cash balances held at the Subsidiary Partnership's clearing broker and cash collateral pledged to counterparties. Due to brokers include cash collateral received from counterparties. The Subsidiary Partnership has agreements with its counterparties whereby the Partnership receives and is required to pledge collateral. As of December 31, 2008, the Subsidiary Partnership had pledged $5,680,000 of cash collateral in connection with its derivative trading activities. Due to broker consists of cash received from one broker to collateralize the Subsidiary Partnership's OTC call options purchased from that broker. 5. Derivative Contracts and Financial Instruments with Off-Balance Sheet Risk or Concentrations of Credit Risk In the normal course of business, the Subsidiary Partnership enters into derivative contracts for investment purposes. Typically, derivative contracts serve as components of the Subsidiary Partnership's investment strategy and are utilized primarily to structure the portfolio to economically match the investment objectives of the Subsidiary Partnership. These instruments are subject to various risks similar to non-derivative instruments, including market, credit, liquidity, and operational risks. The Subsidiary Partnership manages these risks on an aggregate basis along with the risks associated with its investing activities as part of its overall risk management policies. The Subsidiary Partnership's derivative trading activities are primarily the purchase and sale of OTC options, credit default swaps and total return swaps. All derivatives are reported at fair value (as described in Note 2) in the consolidated statement of assets, liabilities and partners' capital and changes in fair value are reflected in the consolidated statement of operations. Total return swaps represent agreements between two parties to make payments based upon the performance of certain underlying assets. The Subsidiary Partnership is obligated to pay, or entitled to receive as the case may be, the net difference in the value determined at the onset of the swap versus the value determined at the termination or reset date of the swap. Therefore, the amounts required for the future satisfaction of the swaps may be greater or less than the amounts recorded on the consolidated statement of assets, liabilities and partners' capital. The ultimate gain or loss depends upon the prices at which the underlying financial instruments of the swaps are valued on the settlement date. At December 31, 2008, the Subsidiary Partnership holds total return swaps with affiliated entities (see Note 6). 13 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 5. Derivative Contracts and Financial Instruments with Off-Balance Sheet Risk or Concentrations of Credit Risk (continued) A credit default swap contract represents an agreement in which one party, the protection buyer, pays a fixed fee, the premium, in return for a payment by the other party, the protection seller, contingent upon a specified credit event relating to an underlying reference asset. While there is no credit event, the protection buyer pays the protection seller the periodic premium. If a specified credit event occurs, there is an exchange of cash flows and/or securities designed so that the net payment to the protection buyer reflects the loss incurred by creditors of the reference asset in the event of its default. The nature of the credit event is established by the buyer and the seller at the inception of the transaction and such events include bankruptcy, insolvency, rating agency downgrade and failure to meet payment obligations when due. The Subsidiary Partnership clears all of its securities transactions through major U.S.-registered broker dealers, primarily through Goldman Sachs & Co., pursuant to customer agreements. At December 31, 2008, substantially all investments, derivative contracts and amounts due from brokers are positions with and amounts due from six brokers. The Subsidiary Partnership had substantially all its counterparty concentration with these brokers and their affiliates. Receivables and payables on derivative contracts are reported net by counterparty on the consolidated statement of assets, liabilities and partners' capital, provided the legal right of offset exists. At December 31, 2008, the following derivative contracts were included in the Subsidiary Partnership's consolidated statement of assets, liabilities and partners' capital: Assets Liabilities -------------- ---------------- OTC options $ 299,402,328 $ -- Swaps 6,727,838 1,794,397 -------------- -------------- Total $ 306,130,166 $ 1,794,397 ============== ============== 14 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 5. Derivative Contracts and Financial Instruments with Off-Balance Sheet Risk or Concentrations of Credit Risk (continued) The swaps and OTC options balances above represent the Subsidiary Partnership's assets and liabilities from OTC derivative contracts by brokers and are not representative of the outstanding credit risk to the Subsidiary Partnership due to the existence of netting agreements. After taking into effect the offsetting permitted under Financial Accounting Standards Board Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts, the Subsidiary Partnership views its credit exposure to be $277,626,494 at December 31, 2008, representing the fair value of derivative contracts in net asset position net of derivative contracts in net liability position and any collateral received or pledged to counterparties. The Subsidiary Partnership receives and pledges collateral from/to certain of its counterparties in accordance with bilateral collateral agreements. The Subsidiary Partnership's credit exposure is offset by cash collateral of $32,389,275 that the Subsidiary Partnership received from one counterparty at December 31, 2008. The Subsidiary Partnership pledged cash collateral of $5,680,000 to one counterparty to cover margin requirements for certain derivative positions at December 31, 2008. The Subsidiary Partnership has exposure to credit default swap contracts to hedge against the Subsidiary Partnership's credit exposure on derivative contracts. At December 31, 2008, the Subsidiary Partnership has exposure to credit default swap contracts on these counterparties with notional values of 425,000,000 on Deutsche Bank AG, 386,471,000 on Credit Suisse Group AG, 88,927,000 on Citigroup Inc. and 62,480,000 on BNP Paribas. 6. Related Party Transactions In accordance with the Partnership Agreement (the "Agreement"), PSCM provides management and administrative services to the Subsidiary Partnership. As compensation for such services, PSCM receives a quarterly management fee in advance equal to 0.0625% (0.25% on an annual basis) of the balance in the limited partners' capital account as of the last business day of the previous calendar quarter, taking into account contributions made on the first day of such calendar quarter. The management fee for the year ended December 31, 2008 was $2,299,475. The General Partner may, in its sole discretion, elect to waive the management fee with respect to any limited partner. Subsequent to year end the General Partner decided to waive all future fees for all investors (see Note 11). 15 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 6. Related Party Transactions (continued) As of December 31, 2008, the Subsidiary Partnership had unrealized gain on swap contracts with an affiliated entity managed by PSCM of $5,068,275. This amount relates to total return swap contracts with the affiliated entity whereby the Subsidiary Partnership has economic exposure to various credit default swaps held by the affiliated entity. The credit default swap contracts were purchased for the purpose of hedging the Subsidiary Partnership's credit exposure to certain option contract counterparties. The Subsidiary Partnership has the same terms and economic attributes as if it were the direct buyer of these credit default swap contracts and therefore all income and loss associated with these swap contracts are reflected in the Subsidiary Partnership's consolidated statement of operations. During the year ended December 31, 2008, Pershing Square, L.P. ("PSLP") and Pershing Square International Ltd. ("PSINTL"), affiliated investment funds managed by PSCM, had an investment in the Partnerships and the Funds, respectively. PSLP and PSINTL were not charged a management fee nor a performance allocation. On June 30, 2008, PSIV Ltd and PSIV LP were re-opened to allow an additional contribution of $28,000,000 made by PSINTL. PSIV-I Ltd and PSIV-I LP also commenced operations on June 30, 2008 and accepted contributions of $32,521,000 and $39,479,000, respectively, which were made by PSINTL and PSLP, respectively. William A. Ackman made a contribution of $5,000,000 on July 9, 2008 in PSIV-I Ltd. when PSIV-I Ltd. was re-opened. 7. Guarantees The Subsidiary Partnership enters into contracts that contain a variety of indemnifications. The Subsidiary Partnership's maximum exposure under these arrangements is unknown. However, the Subsidiary Partnership has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote. 8. Allocation of Net Income/(Loss) In accordance with the Agreement, net income or loss is allocated as of the last business day of each Fiscal Period, as defined, to all partners in proportion to each partner's capital account at the time of such allocation. 16 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 8. Allocation of Net Income/(Loss) (continued) At the end of each fiscal year or upon a limited partner's full withdrawal, for each limited partner's capital account which has been allocated net income, there shall be allocated to the capital accounts of the General Partner, 20% of the excess of the net income allocated to such limited partner's capital account above the loss carryforward (the "Performance Allocation"), if any, and the management fee with respect to the limited partner's capital account. The General Partner in its sole discretion has reduced the Performance Allocation to 10% for those limited partners that made initial contributions of at least $100 million. For the year ended December 31, 2008, there was no Performance Allocation. The General Partner may, in its sole discretion, elect to waive or reduce the Performance Allocation with respect to any limited partner. Subsequent to year end the General Partner decided to waive all future Performance Allocation for all investors (see Note 11). 9. Partners' Capital In accordance with the Agreement, a limited partner commits capital until December 31, 2009 (the "Lock-Up Date"). The General Partner, in its sole discretion, may advance or extend the Lock-Up Date for up to one year beyond December 31, 2009 if the General Partner believes it is in the best interest of the Subsidiary Partnership to do so. The General Partner has extended the Lock-Up Date for up to one year beyond December 31, 2009 of the Subsidiary Partnership. 10. Financial Highlights The following represents the ratios to average limited partners' capital and total return information for the year ended December 31, 2008. Ratios to average limited partners' capital: Expenses 0.75% =========== Net investment loss (0.25)% =========== Total return (67.91)% =========== The above ratios and total return are calculated for all limited partners taken as a whole. Individual partner's ratios and returns may vary from the above based on different management fee and Performance Allocation arrangements and the timing of capital transactions. 17 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 11. Subsequent Events Effective January 1, 2009, the General Partner elected to waive all future management fees and the performance allocation for all investors in the Partnerships and the Funds. During the period from January 1, 2009 to February 28, 2009, consolidated performance for the Subsidiary Partnership was (60%). On January 31, 2009, PSIV Ltd and PSIV-I Ltd withdrew their entire investment in PSIV LP and PSIV-I LP, respectively, and subsequently subscribed their entire investment into the Subsidiary Partnership. Pershing Square IV Trade-Co, L.P. ("PSIV TradeCo LP"), a Delaware Limited Partnership, was formed on January 13, 2009. PSIV TradeCo LP is a wholly owned subsidiary of Pershing Square IV, L.P. Pershing Square IV-I Trade-Co, L.P. ("PSIV-I TradeCo LP"), a Delaware Limited Partnership, was formed on January 13, 2009. PSIV-I TradeCo LP is a wholly owned subsidiary of Pershing Square IV-I, L.P. Pershing Square International IV Trade-Co, Ltd. ("PSIV TradeCo Ltd"), was incorporated as an exempted company on January 8, 2009 under the laws of the Cayman Islands. PSIV TradeCo Ltd is a wholly owned subsidiary of Pershing Square International IV, Ltd. Pershing Square International IV-I Trade-Co, Ltd. ("PSIV-I TradeCo Ltd"), was incorporated as an exempted company on January 8, 2009 under the laws of the Cayman Islands. PSIV-I TradeCo Ltd is a wholly owned subsidiary of Pershing Square International IV-I, Ltd. These newly formed entities, (collectively, the "TradeCos"), may invest in stock, total return swaps and/or call options of Target Corporation. On February 8, 2009, the General Partner decided to waive the lock-up and permitted investors to withdraw on February 28, 2009 from the Partnerships and the Funds. Any investor that elected not to withdraw on February 28, 2009 will be committed until the Lock-Up Date. Redemptions on February 28, 2009 totaled approximately $88,550,000. In addition, the General Partner will also permit investors in the Partnerships or the Funds to apply a highwater mark adjustment to their existing, or new, investments with any affiliated entities managed by PSCM to compensate for losses incurred in the Partnerships or in the Funds. On March 1, 2009, the Partnerships and the Funds opened for new and additional capital contributions. Total contributions received on March 1, 2009 by the Partnerships and the Funds collectively were $68,997,000. Contributions from William A. Ackman, affiliates of the General Partner, affiliated entities managed by PSCM, certain employees and advisory board members represented $67,672,000 of the total contributions received. 18 FINANCIAL STATEMENTS Pershing Square IV, L.P. Period from June 1, 2007 (commencement of operations) to December 31, 2007 with Report of Independent Registered Public Accounting Firm Pershing Square IV, L.P. Financial Statements Period from June 1, 2007 (commencement of operations) to December 31, 2007 CONTENTS Audited Financial Statement Schedules Index Report of Independent Registered Public Accounting Firm ................. 1 Statement of Assets, Liabilities and Partners' Capital .................. 2 Statement of Operations.................................................. 3 Statement of Changes in Partners' Capital ............................... 4 Statement of Cash Flows ................................................. 5 Notes to Financial Statements ........................................... 6 Financial Statements of Pershing Square IV A, L.P. Report of Independent Registered Public Accounting Firm The General Partner Pershing Square IV, L.P. We have audited the accompanying statement of asset, liabilities and partners' capital of Pershing Square IV, L.P. (the "Partnership") as of December 31, 2007, and the related statements of operations, changes in partners' capital and cash flows for the period from June 1, 2007 (commencement of operations) to December 31, 2007. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Partnership's internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Partnership's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Pershing Square IV, L.P. at December 31, 2007, and the results of its operations, the changes in its partners' capital and its cash flows for the period from June 1, 2007 (commencement of operations) to December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. /s/ ERNST & YOUNG March 19, 2008 1 Pershing Square IV, L.P. Statement of Assets, Liabilities and Partners' Capital (Stated in United States Dollars) December 31, 2007 ASSETS Investment in Pershing Square IV A, L.P. $1,127,674,674 -------------- Total assets $1,127,674,674 ============== LIABILITIES AND PARTNERS' CAPITAL Accrued expenses $ 44,961 Withholding tax payable 19,870 -------------- Total liabilities 64,831 Partners' capital 1,127,609,843 -------------- Total liabilities and partners' capital $1,127,674,674 ============== The accompanying notes and attached consolidated financial statements of Pershing Square IV A, L.P. are an integral part of the financial statements. 2 Pershing Square IV, L.P. Statement of Operations (Stated in United States Dollars) Period from June 1, 2007 (commencement of operations) to December 31, 2007 NET REALIZED AND UNREALIZED LOSSES ALLOCATED FROM INVESTMENT IN PERSHING SQUARE IV A, L.P. Net realized loss from investments in $ (40,790,512) securities Net change in unrealized loss from investments in securities (722,016,297) Net realized loss on derivative contracts (93,937,016) Net change in unrealized loss on derivative (517,824) contracts -- Net loss allocated from investment in Pershing Square IV A, L.P. $(857,261,649) NET INVESTMENT INCOME ALLOCATED FROM INVESTMENT IN PERSHING SQUARE IV A, L.P. INVESTMENT INCOME Interest 18,557,238 Dividends 383,405 Total expenses (4,104,320) ------------- Net investment income allocated from investment in Pershing Square IV A, L.P. 14,836,323 PARTNERSHIP EXPENSES Professional fees (44,961) Withholding tax (19,870) ------------- Total expenses (64,831) ------------- ------------- Net investment income 14,771,492 ------------- Net loss $(842,490,157) ============= The accompanying notes and attached consolidated financial statements of Pershing Square IV A, L.P. are an integral part of the financial statements. 3 Pershing Square IV, L.P. Statement of Changes in Partners' Capital (Stated in United States Dollars) Period from June 1, 2007 (commencement of operations) to December 31, 2007 Limited partners capital contributions $ 1,970,100,000 Net loss (842,490,157) --------------- Partners' capital at end of period $ 1,127,609,843 =============== The accompanying notes and attached consolidated financial statements of Pershing Square IV A, L.P. are an integral part of the financial statements. 4 Pershing Square IV, L.P. Statement of Cash Flows (Stated in United States Dollars) Period from June 1, 2007 (commencement of operations) to December 31, 2007 CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (842,490,157) Adjustments to reconcile net loss to net cash used in operating activities: Increase in investment in Pershing Square IV A, L.P. (1,127,674,674) Increase in accrued expenses 44,961 Increase in withholding tax payable 19,870 --------------- Net cash used in operating activities (1,970,100,000) CASH FLOWS FROM FINANCING ACTIVITIES Capital contributions 1,970,100,000 --------------- Net change in cash and cash equivalents -- Cash and cash equivalents at beginning of period -- --------------- Cash and cash equivalents at end of period $ -- =============== The accompanying notes and attached consolidated financial statements of Pershing Square IV A, L.P. are an integral part of the financial statements. 5 Pershing Square IV, L.P. Notes to Financial Statements December 31, 2007 1. ORGANIZATION Pershing Square IV, L.P. (the "Partnership") is organized as a limited partnership under the laws of the state of Delaware on May 22, 2007 and commenced operations on June 1, 2007. The objective of the Partnership is to invest all of its assets in Pershing Square IV A, L.P. (the "Subsidiary Partnership"). The Subsidiary Partnership is an exempted limited partnership formed under the limited liability partnership laws of the Cayman Islands on May 31, 2007 and commenced operations on June 1, 2007. The investment objective of the Partnership and the Subsidiary Partnership (collectively, the "PSIV Partnerships") is to create significant capital appreciation by investing in stock, total return swaps and call options of Target Corporation. The Partnership is a "master" fund in a "master-feeder" structure whereby Pershing Square International IV, Ltd. (the "Fund") invests all of its assets in the Partnership. The Partnership is also a "feeder" fund in a "master-feeder" structure as the Partnership invests all of its assets in the Subsidiary Partnership. Pershing Square Holdings GP, LLC, a limited liability company organized under the laws of the state of Delaware and registered as a foreign company under the laws of the Cayman Islands, will serve as the "General Partner" to the PSIV Partnerships. The General Partner is responsible for making all investment decisions on behalf of the PSIV Partnerships and is solely responsible for the development and implementation of the PSIV Partnerships' investment policy and strategy. William A. Ackman is the managing member of the General Partner and is primarily responsible for managing the PSIV Partnerships. The General Partner delegates administrative functions relating to the management of the PSIV Partnerships to Pershing Square Capital Management, L.P. ("PSCM"), a limited partnership organized under the laws of the state of Delaware. William A. Ackman is the managing member of the general partner of PSCM. Pursuant to an Administration Agreement entered into in May 2007, Goldman Sachs (Cayman) Trust, Limited (the "Administrator") has been appointed administrator to the PSIV Partnerships. The Administrator is compensated for its services in accordance with the fees stated in this Administration Agreement. 6 Pershing Square IV, L.P. Notes to Financial Statements (continued) 2. SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The financial statements of the Partnership have been prepared in accordance with accounting principles generally accepted in the United States of America and are stated in United States dollars. The following is a summary of the significant accounting and reporting policies used in preparing the financial statements. CASH AND CASH EQUIVALENTS The Partnership considers all highly liquid financial instruments with a maturity of three months or less to be cash equivalents. VALUATION OF INVESTMENT IN THE SUBSIDIARY PARTNERSHIP The Partnership's investment in the Subsidiary Partnership is valued at fair value, which represents the Partnership's proportionate interest in the partners' capital of the Subsidiary Partnership at December 31, 2007, determined from audited financial statements prepared in accordance with accounting principles generally accepted in the United States. The performance of the Partnership is directly affected by the performance of the Subsidiary Partnership. Attached are the audited financial statements of the Subsidiary Partnership, including the consolidated condensed schedule of investments and significant accounting and reporting policies, which are an integral part of these financial statements. Valuation of the investment held by the Partnership is discussed in the notes of the Subsidiary Partnership's financial statements. As of December 31, 2007, the Partnership has approximately 99.95% ownership interest in the Subsidiary Partnership. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of the Partnership's assets and liabilities, which qualify as financial instruments under Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments," approximates the carrying amounts presented in the statement of assets, liabilities and partners' capital. INVESTMENT TRANSACTIONS AND RELATED INVESTMENT INCOME The Partnership records its investment transactions and the related revenue and expenses on a trade-date basis. All unrealized gains and losses from the Partnership's investment in the Subsidiary Partnership are reflected in the statement of operations. 7 Pershing Square IV, L.P. Notes to Financial Statements (continued) 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) USE OF ESTIMATES The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. TAXATION No Federal, state or local income taxes have been provided on income or loss of the Partnership since the partners are individually liable for the taxes on their share of the Partnership's income or loss. The only taxes payable by the Partnership on its income are withholding taxes applicable to certain investment income. As a result, no income tax liability or expense has been recorded in the accompanying financial statements. NEW ACCOUNTING PRONOUNCEMENTS On July 13, 2006, the Financial Accounting Standards Board ("FASB") released FASB Interpretation No. 48 "Accounting for Uncertainty in Income Taxes" (FIN 48). FIN 48 provides guidance for how uncertain tax positions should be recognized, measured, presented and disclosed in the financial statements. FIN 48 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Partnership's tax returns to determine whether the tax positions are "more-likely-than-not" of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold would be recorded as a tax benefit or expense in the current year. Adoption of FIN 48 was deferred to fiscal years beginning after December 15, 2007 and is to be applied to all open tax years as of the effective date. At this time, the Partnership is evaluating the implications of FIN 48 and its impact on the financial statements has not yet been determined. In September 2006, the FASB issued Statement on Financial Accounting Standards No. 157, "Fair Value Measurements" ("FAS 157"). This standard clarifies the definition of fair value for financial reporting, establishes a framework for measuring fair value and requires additional disclosures about the use of fair value measurements. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Partnership does not believe that adoption of FAS 157 will impact the amounts reported in the financial statements. However, once adopted, additional disclosures will be required about the inputs used to develop the measurements of fair value and the effect of these fair value measurements on earnings reported in the statement of operations. 8 Pershing Square IV, L.P. Notes to Financial Statements (continued) 3. GUARANTEES The Partnership enters into contracts that contain a variety of indemnifications. The Partnership's maximum exposure under these arrangements is unknown. However, the Partnership has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote. 4. RELATED PARTY TRANSACTIONS The Partnership is not charged a management fee nor performance allocation at the Partnership level. Management fees and performance allocation are charged indirectly through the Partnership's investment in the Subsidiary Partnership. During the period from June 1, 2007 (commencement of operations) to December 31, 2007, Pershing Square, L.P. ("PSLP"), an affiliated investment fund managed by PSCM, had an investment in the Partnership. PSLP was not charged a management fee nor performance allocation by PSCM in relation to its investment in the Partnership and indirectly through its investment in the Subsidiary Partnership. At December 31, 2007, PSLP owned 2.20% of the total partners' capital of the Partnership. 5. ALLOCATION OF NET INCOME/(LOSS) In accordance with the Partnership Agreement (the "Agreement"), net income or loss is allocated as of the last business day of each Fiscal period, as defined, to all partners in proportion to each partner's capital account at the time of such allocation. 6. PARTNER'S CAPITAL In accordance with the Agreement, a Limited Partner commits capital until December 31, 2009 (the "Lock-Up Date"). The General Partner, in its sole discretion, may advance or extend the Lock-Up Date for up to one year beyond December 31, 2009 if the General Partner believes it is in the best interest of the Partnership to do so and has also extended the Lock-Up Date for up to one year beyond December 31, 2009 of the Subsidiary Partnership and the Fund. 9 Pershing Square IV, L.P. Notes to Financial Statements (continued) 7. FINANCIAL HIGHLIGHTS The following represents the ratios to average limited partners' capital and total return information for the financial highlights for the period from June 1, 2007 (commencement of operations) to December 31, 2007: Ratios to average limited partners' capital: Expenses 0.24% =============== Net investment income 0.83% =============== Total return (42.77)% =============== The above ratios and total return are calculated for all limited partners taken as a whole and have not been annualized. Individual partner's ratios or returns may vary from the above based on different management fee and performance allocation arrangements. 10 CONSOLIDATED FINANCIAL STATEMENTS Pershing Square IV A, L.P. Period from June 1, 2007 (commencement of operations) to December 31, 2007 with Report of Independent Registered Public Accounting Firm Pershing Square IV A, L.P. Consolidated Financial Statements Period from June 1, 2007 (commencement of operations) to December 31, 2007 CONTENTS Audited Consolidated Financial Statement Schedules Index Report of Independent Registered Public Accounting Firm ................. 1 Consolidated Statement of Assets, Liabilities and Partners' Capital ..... 2 Consolidated Condensed Schedule of Investments .......................... 3 Consolidated Statement of Operations..................................... 4 Consolidated Statement of Changes in Partners' Capital .................. 5 Consolidated Statement of Cash Flows .................................... 6 Notes to Consolidated Financial Statements .............................. 7 Report of Independent Registered Public Accounting Firm The General Partner Pershing Square IV A, L.P. We have audited the accompanying consolidated statement of assets, liabilities and partners' capital of Pershing Square IV A, L.P. (the "Subsidiary Partnership"), including the consolidated condensed schedule of investments, as of December 31, 2007, and the related consolidated statements of operations, changes in partners' capital and cash flows for the period from June 1, 2007 (commencement of operations) to December 31, 2007. These financial statements are the responsibility of the Subsidiary Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. We were not engaged to perform an audit of the Subsidiary Partnership's internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Subsidiary Partnership's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pershing Square IV A, L.P. at December 31, 2007, and the results of its operations, the changes in its partners' capital and its cash flows for the period from June 1, 2007 (commencement of operations) to December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. /s/ ERNST & YOUNG March 19, 2008 1 Pershing Square IV A, L.P. Statement of Consolidated Assets, Liabilities and Partners' Capital (Stated in United States Dollars) December 31, 2007 ASSETS Cash and cash equivalents $ 68,705,098 Due from brokers 109,158,091 Investments in securities, at fair value (cost 1,059,342,171 $1,781,725,333) Interest receivable 630,477 -------------- Total assets $1,237,835,837 ============== LIABILITIES AND PARTNERS' CAPITAL Collateral received $ 108,826,141 Net unrealized loss on swap contracts 518,087 Accrued expenses and other liabilities 243,680 -------------- Total liabilities 109,587,908 Partners' capital 1,128,247,929 -------------- Total liabilities and partners' capital $1,237,835,837 ============== The accompanying notes are an integral part of the consolidated financial statements. 2 Pershing Square IV A, L.P. Consolidated Condensed Schedule of Investments (Stated in United States Dollars) December 31, 2007 PERCENTAGE OF SHARES / PARTNERS' CONTRACTS DESCRIPTION/NAME FAIR VALUE CAPITAL -------------------------------------------------------------------------------- INVESTMENTS IN SECURITIES EQUITY SECURITIES United States: Retail 5,884,200 Target Corp. $ 294,210,000 26.08% ------------------------ Total Equity Securities (cost 294,210,000 26.08 $347,082,231) EQUITY OPTION CONTRACTS United States: Retail Target Corp., Calls, Strike Prices $41.62 - $53.12, 75,717,131 10/02/08 - 01/15/10 765,132,171 67.82 ------------------------ TOTAL EQUITY OPTION CONTRACTS (cost $1,434,643,102) 765,132,171 67.82 ------------------------ TOTAL INVESTMENTS IN SECURITIES (cost $1,059,342,171 93.90% $1,781,725,333) ======================== DERIVATIVE CONTRACTS TOTAL RETURN SWAPS United States: Banking $ (518,087) (0.05)% ------------------------ TOTAL DERIVATIVE CONTRACTS $ (518,087) (0.05)% ======================== The accompanying notes are an integral part of the consolidated financial statements. 3 Pershing Square IV A, L.P. Consolidated Statement of Operations (Stated in United States Dollars) Period from June 1, 2007 (commencement of operations) to December 31, 2007 NET REALIZED AND UNREALIZED LOSS FROM INVESTMENTS Net realized loss from investments in $ (40,811,094) securities Net change in unrealized loss from investments in securities (722,383,162) Net realized loss on derivative contracts (93,984,727) Net change in unrealized loss on derivative (518,087) contracts ------------- Net loss from investments $(857,697,070) INVESTMENT INCOME Interest 18,566,663 Dividends 383,600 ------------- Total investment income 18,950,263 PARTNERSHIP EXPENSES Management fee 2,651,777 Professional fees 1,173,267 Other 280,051 Interest 169 ------------- Total expenses 4,105,264 ------------- Net investment income 14,844,999 ------------- Net loss $(842,852,071) ============= The accompanying notes are an integral part of the consolidated financial statements. 4 Pershing Square IV A, L.P. Consolidated Statement of Changes in Partners' Capital (Stated in United States Dollars) Period from June 1, 2007 (commencement of operations) to December 31, 2007 LIMITED GENERAL TOTAL PARTNERS PARTNER ---------------------------------------------- Capital contributions $1,971,100,000 $1,970,100,000 $1,000,000 Net Loss (842,852,071) (842,425,326) (426,745) ---------------------------------------------- Partners' capital at end of $1,128,247,929 $1,127,674,674 $ 573,255 period ============================================== The accompanying notes are an integral part of the consolidated financial statements. 5 Pershing Square IV A, L.P. Consolidated Statement of Cash Flows (Stated in United States Dollars) Period from June 1, 2007 (commencement of operations) to December 31, 2007 CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (842,852,071) Adjustments to reconcile net loss to net cash used in operating activities: Net realized loss from investments in securities 40,811,094 Net change in unrealized loss from investments in 722,383,162 securities Net change in unrealized loss on swap contracts 518,087 Purchases of investments (2,834,455,274) Proceeds from investments sold 1,011,918,847 Increase in due from brokers (109,158,091) Increase in interest receivable (630,477) Increase in collateral received 108,826,141 Increase in accrued expenses and other liabilities 243,680 --------------- Net cash used in operating activities (1,902,394,902) CASH FLOWS FROM FINANCING ACTIVITIES Capital contributions 1,971,100,000 --------------- Net change in cash and cash equivalents 68,705,098 Cash and cash equivalents at beginning of period -- --------------- Cash and cash equivalents at end of period $ 68,705,098 =============== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the period for interest $ 169 =============== The accompanying notes are an integral part of the consolidated financial statements. 6 10 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements December 31, 2007 1. ORGANIZATION Pershing Square IV A, L.P. (the "Subsidiary Partnership") is an exempted limited partnership formed under the limited liability partnership laws of the Cayman Islands on May 31, 2007 and commenced operations on June 1, 2007. The investment objective the Subsidiary Partnership is to create significant capital appreciation by investing in stock, total return swaps and call options of Target Corporation. The Subsidiary Partnership acts as the master fund in a "master-feeder" structure whereby Pershing Square IV, L.P. invests all of its capital in the Subsidiary Partnership. Pershing Square IV, L.P. (the "Partnership") is organized as a limited partnership under the laws of the state of Delaware on May 22, 2007 and commenced operations on June 1, 2007. The Partnership is also a "master" fund in a "master-feeder" structure whereby Pershing Square International IV, Ltd. invests all of its assets in the Partnership. Pershing Square International IV, Ltd. (the "Fund") is an exempted company formed under the limited liability laws of the Cayman Islands on May 15, 2007 and is registered under the Cayman Islands Mutual Funds Law. Pershing Square IV B, L.P. (the "PSIV B") is a wholly owned subsidiary of the Subsidiary Partnership and was incorporated on July 17, 2007 under the laws of the state of Delaware. At December 31, 2007, PSIV B did not hold any assets on behalf of the Subsidiary Partnership. Pershing Square Holdings GP, LLC, a limited liability company organized under the laws of the state of Delaware and registered as a foreign company under the laws of the Cayman Islands, will serve as the "General Partner" to the Subsidiary Partnership and the Partnership (collectively, the "PSIV Partnerships"). The General Partner is responsible for making all investment decisions on behalf of the PSIV Partnerships and is solely responsible for the development and implementation of the PSIV Partnerships' investment policy and strategy. William A. Ackman is the managing member of the General Partner and is primarily responsible for managing the PSIV Partnerships. The General Partner delegates administrative functions relating to the management of the PSIV Partnerships to Pershing Square Capital Management, L.P. ("PSCM"), a limited partnership organized under the laws of the state of Delaware. William A. Ackman is the managing member of the general partner of PSCM. Pursuant to an Administration Agreement entered into in May 2007, Goldman Sachs (Cayman) Trust, Limited (the "Administrator") has been appointed administrator to the PSIV Partnerships. The Administrator is compensated for its services in accordance with the fees stated in this Administration Agreement. 7 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 2. SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The Subsidiary Partnership's consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and are stated in United States dollars. The following is a summary of the significant accounting and reporting policies used in preparing the consolidated financial statements. BASIS OF CONSOLIDATION The consolidated financial statements include the results of the Subsidiary Partnership and its subsidiary, PSIV B. Intercompany transactions have been eliminated on consolidation. INVESTMENT TRANSACTIONS AND RELATED INVESTMENT INCOME The Subsidiary Partnership records its securities transactions and the related revenue and expenses on a trade date basis. Dividends are recorded on the ex-dividend date, net of any applicable foreign withholding taxes. Interest is recorded on the accrual basis. VALUATION OF INVESTMENTS In general, the Subsidiary Partnership values investments at their last sales price on the date of determination. If no sales occurred on such date, such investments are valued at the mean of the last "bid" and "ask" price on the last business day such investments were traded. Investments for which no such market prices are available are valued at fair value by the General Partner based upon counterparty and independent third party prices. At December 31, 2007, such investments consisted of over-the-counter ("OTC") options with a value of $765,132,171, and total return swap contracts with a value of ($518,087). All unrealized gains and losses are reflected on the consolidated statement of operations. CASH AND CASH EQUIVALENTS The Subsidiary Partnership considers all highly liquid financial instruments with a maturity of three months or less to be cash equivalents. As of December 31, 2007, all cash and cash equivalents are held with an affiliate of the Administrator. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of the Subsidiary Partnership's assets and liabilities which qualify as financial instruments under Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments," approximates the carrying amounts presented in the consolidated statement of assets, liabilities and partners' capital. 8 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) USE OF ESTIMATES The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. INCOME TAXES The Subsidiary Partnership is not subject to any income or capital gains taxes in the Cayman Islands since the partners are individually liable for the taxes on their share of the Subsidiary Partnership's income or loss. The only taxes payable by the Subsidiary Partnership on its income are withholding taxes applicable to dividend income. As a result, no income tax liability or expense has been recorded in the accompanying consolidated financial statements. NEW ACCOUNTING PRONOUNCEMENTS On July 13, 2006, the Financial Accounting Standards Board ("FASB") released FASB Interpretation No. 48 "Accounting for Uncertainty in Income Taxes" (FIN 48). FIN 48 provides guidance for how uncertain tax positions should be recognized, measured, presented and disclosed in the consolidated financial statements. FIN 48 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Subsidiary Partnership's tax returns to determine whether the tax positions are "more-likely-than-not" of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold would be recorded as a tax benefit or expense in the current year. Adoption of FIN 48 was deferred to fiscal years beginning after December 15, 2007 and is to be applied to all open tax years as of the effective date. At this time, the Subsidiary Partnership is evaluating the implications of FIN 48 and its impact on the consolidated financial statements has not yet been determined. In September 2006, the FASB issued Statement on Financial Accounting Standards No. 157, "Fair Value Measurements" ("FAS 157"). This standard clarifies the definition of fair value for financial reporting, establishes a framework for measuring fair value and requires additional disclosures about the use of fair value measurements. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Subsidiary Partnership does not believe that adoption of FAS 157 will impact the amounts reported in the consolidated financial statements. However, once adopted, additional disclosures will be required about the inputs used to develop the measurements of fair value and the effect of these fair value measurements on earnings reported in the consolidated statement of operations. 9 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 3. DUE FROM BROKERS Due from brokers include cash balances held at the Subsidiary Partnership's clearing broker and cash collateral received. 4. DERIVATIVE CONTRACTS AND FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK OR CONCENTRATIONS OF CREDIT RISK In the normal course of business, the Subsidiary Partnership enters into derivative contracts for investment purposes. Typically, derivative contracts serve as components of the Subsidiary Partnership's investment strategies and are utilized primarily to structure the portfolio to economically match the investment objectives of the Subsidiary Partnership. These instruments are subject to various risks similar to non-derivative instruments, including market, credit, liquidity, and operational risks. The Subsidiary Partnership manages these risks on an aggregate basis along with the risks associated with its investing activities as part of its overall risk management policies. The Subsidiary Partnership's derivative trading activities are primarily the purchase and sale of OTC options, credit default swaps and total return swaps. All derivatives are reported at fair value (as described in Note 2) in the consolidated statement of assets, liabilities and partners' capital and changes in fair value are reflected in the consolidated statement of operations. Total return swaps represent agreements between two parties to make payments based upon the performance of certain underlying assets. The Subsidiary Partnership is obligated to pay, or entitled to receive as the case may be, the net difference in the value determined at the onset of the swap versus the value determined at the termination or reset date of the swap. Therefore, the amounts required for the future satisfaction of the swaps may be greater or less than the amounts recorded on the consolidated statement of assets, liabilities and partners' capital. The ultimate gain or loss depends upon the prices at which the underlying financial instruments of the swaps are valued on the settlement date. At December 31, 2007, the Subsidiary Partnership holds total return swaps with affiliated entities (see Note 5). The Subsidiary Partnership clears all of its securities transactions through major U.S.-registered broker dealers pursuant to customer agreements. At December 31, 2007, substantially all investments, derivative contracts and amounts due from broker are positions with and amounts due from these brokers. The Subsidiary Partnership had substantially all its counterparty concentration with these brokers. 10 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 4. DERIVATIVE CONTRACTS AND FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK OR CONCENTRATIONS OF CREDIT RISK (CONTINUED) Collateral received consists of cash received from one broker to collateralize the Subsidiary Partnership's OTC call options purchased from that broker. At December 31, 2007, collateral received by the Subsidiary Partnership represents 103.58% of the fair value of OTC call options purchased from that broker. The Subsidiary Partnership is restricted in its use of the collateral and may use up to 50% of the value of the collateral received. No collateral has been sold or repledged as of December 31, 2007. 5. RELATED PARTY TRANSACTIONS In accordance with the Partnership Agreement (the "Agreement"), PSCM provides management and administrative services to the Subsidiary Partnership. As compensation for such services, PSCM receives a quarterly management fee in advance equal to 0.0625% (0.25% on an annual basis) of the balance in the limited partners' capital account as of the last business day of the previous calendar quarter, taking into account contributions made on the first day of such calendar quarter. The management fee for the period from June 1, 2007 (commencement of operations) to December 31, 2007 was $2,651,777. The General Partner may, in its sole discretion, elect to waive the management fee with respect to any limited partner. As of December 31, 2007, the Subsidiary Partnership had unrealized loss on swap contracts with affiliated entities managed by PSCM of $518,087. This amount relates to total return swap contracts with the affiliated entities whereby the Subsidiary Partnership has economic exposure to various credit default swaps held by the affiliated entities. The credit default swap contracts were purchased for the purpose of hedging the Subsidiary Partnership's credit exposure to certain option contract counterparties. The Subsidiary Partnership has the same terms and economic attributes as if it were the direct buyer of these credit default swap contracts and therefore all income and loss associated with these swap contracts are reflected in the Subsidiary Partnership's consolidated statement of operations. During the period from June 1, 2007 (commencement of operations) to December 31, 2007, Pershing Square, L.P. ("PSLP") and Pershing Square International Ltd. ("PSINTL"), affiliated investment funds managed by PSCM, had an investment in the Partnership and the Fund, respectively. PSLP and PSINTL were not charged a management fee nor a performance allocation. 11 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 6. GUARANTEES The Subsidiary Partnership enters into contracts that contain a variety of indemnifications. The Subsidiary Partnership's maximum exposure under these arrangements is unknown. However, the Subsidiary Partnership has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote. 7. ALLOCATION OF NET INCOME/(LOSS) In accordance with the Agreement, net income or loss is allocated as of the last business day of each Fiscal Period, as defined, to all partners in proportion to each partner's capital account at the time of such allocation. At the end of each fiscal year or upon a limited partners' full redemption, for each limited partner's capital account which has been allocated net income, there shall be allocated to the capital accounts of the General Partner, 20% of the excess of the net income allocated to such limited partner's capital account above the loss carryforward, if any, and the management fee with respect to the limited partner's capital account. The General Partner in its sole discretion has reduced the performance allocation to 10% for those limited partners that made initial contributions of at least $100 million. For the period from June 1, 2007 (commencement of operations) to December 31, 2007, there was no performance allocation. The General Partner may, in its sole discretion, elect to waive or reduce the performance allocation with respect to any limited partner. 8. PARTNERS' CAPITAL In accordance with the Agreement, a limited partner commits capital until December 31, 2009 (the "Lock-Up Date"). The General Partner, in its sole discretion, may advance or extend the Lock-Up Date for up to one year beyond December 31, 2009 if the General Partner believes it is in the best interest of the Subsidiary Partnership to do so. 12 Pershing Square IV A, L.P. Notes to Consolidated Financial Statements (continued) 9. FINANCIAL HIGHLIGHTS The following represents the ratios to average limited partners' capital and total return information for the financial highlights for the period from June 1, 2007 (commencement of operations) to December 31, 2007. Ratios to average limited partners' capital: Expenses 0.24% ============ Net investment income 0.83% ============ Total return (42.77)% ============ The above ratios and total return are calculated for all limited partners taken as a whole and have not been annualized. Individual partner's ratios or returns may vary from the above based on different management fee and performance allocation arrangements. 13 CONSOLIDATED FINANCIAL STATEMENTS Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Period From January 1, 2007 Through August 9, 2007 (end of pre-emergence period) Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Consolidated Financial Statements Period From January 1, 2007 Through August 9, 2007 (end of pre-emergence period) CONTENTS Audited Consolidated Financial Statements Report of Independent Registered Public Accounting Firm...................1 Consolidated Statement of Financial Position..............................2 Consolidated Statement of Operations and Member's Equity..................4 Consolidated Statement of Cash Flows......................................5 Notes to Consolidated Financial Statements................................6 Report of Independent Registered Public Accounting Firm To the Board of Directors and Member: In our opinion, the accompanying consolidated statement of financial position and the related consolidated statements of operations and member's equity and of cash flows present fairly, in all material respects, the financial position of Premier Entertainment Biloxi LLC and Subsidiary at August 9, 2007 and the results of their operations and their cash flows for the period from January 1, 2007 to August 9, 2007 (end of pre-emergence period), in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with generally accepted auditing standards as established by the Auditing Standards Board (United States) and in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. As discussed under the heading "Liquidity and Management's Plans" in Note 1 to the consolidated financial statements, after considering the Company's operating results for 2008 and the potential impacts of the Company's failure to meet debt service obligations in 2009, which could include defaults under the related credit agreements and immediate acceleration of related amounts due, the Company is undertaking actions to improve operating results, obtain capital contributions and modify credit agreements in order to avoid defaults under such credit agreements. As discussed in Note 1 to the consolidated financial statements, the Company filed petitions on September 19, 2006 with the United States Bankruptcy Court for the Southern District of Mississippi, Southern Division, for reorganization under the provisions of Chapter 11 of the Bankruptcy Code. The Company's Joint Plan of Reorganization was substantially consummated on August 10, 2007 and the Company emerged from bankruptcy. In connection with its emergence from bankruptcy, the Company did not qualify for fresh start accounting. /s/ PricewaterhouseCoopers March 25, 2008, except with respect to our opinion on the consolidated financial statements insofar as it relates to the disclosures under the heading "Liquidity and Management Plans" in Note 1, as to which the date is March 13, 2009 Las Vegas, Nevada 1 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Consolidated Statement of Financial Position AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD) ASSETS Current assets: Cash and cash equivalents $ 17,158,856 Insurance receivable 11,089,220 Accounts receivable, net of doubtful accounts of $47,107 732,069 Inventories 1,158,523 Prepaid insurance 6,184,072 Prepaid expenses - other 1,813,143 Other current assets 30,234 ----------------- Total current assets 38,166,117 Property and equipment, net 214,058,811 Other noncurrent assets: Restricted cash 40,662,134 Other assets, net 854,718 ----------------- Total assets $ 293,741,780 ================= 2 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Consolidated Statement of Financial Position (continued) AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD) LIABILITIES AND MEMBER'S EQUITY Liabilities not subject to compromise: Current liabilities: Accounts payable $ 21,920,063 Accrued interest - related party 305,139 Amounts due to related parties 11,242,201 Accrued payroll and employee benefits 1,919,525 Gaming liabilities 1,211,896 Other accrued liabilities 5,640,958 Notes payable 9,084,267 --------------------- Total current liabilities 51,324,049 Long-term debt 16,730,358 Liabilities subject to compromise (Note 1) 208,624,318 --------------------- Total liabilities 276,678,725 Member's contributed capital 52,775,215 Accumulated deficit (35,712,160) --------------------- Total member's equity 17,063,055 --------------------- Total liabilities and member's equity $ 293,741,780 ===================== See accompanying notes. 3 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Consolidated Statement of Operations and Member's Equity PERIOD FROM JANUARY 1, 2007 THROUGH AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD) REVENUES Casino $ 12,317,597 Hotel 1,458,954 Food and beverage 3,070,697 Other 1,034,897 ---------------------- Gross revenues 17,882,145 Less promotional allowances 2,053,719 ---------------------- Net revenues 15,828,426 OPERATING EXPENSES Casino 7,314,675 Hotel 587,673 Food and beverage 1,505,075 General and administrative 1,681,892 Insurance recoveries (11,391,658) Management fees to related party 241,231 Pre-opening expenses 11,962,866 Utilities 310,226 Depreciation and amortization 1,664,898 Other operating 2,016,767 ---------------------- Total operating expenses 15,893,645 ---------------------- Loss from operations (65,219) OTHER (INCOME) EXPENSE Interest expense, net of capitalized interest 11,068,508 Interest income (71,632) ---------------------- Total other (income) expense 10,996,876 Loss before reorganization items (11,062,095) ---------------------- Reorganization costs, net 211,826 ---------------------- Net loss (11,273,921) Member's equity at beginning of the period 28,336,976 ---------------------- Member's equity at end of the period $ 17,063,055 ====================== See accompanying notes. 4 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Consolidated Statement of Cash Flows PERIOD FROM JANUARY 1, 2007 THROUGH AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD) OPERATING ACTIVITIES Net loss $ (11,273,921) Depreciation and amortization 1,664,898 Amortization of deferred financing costs, discount and repayment premium 57,839 Insurance recoveries receivable (11,089,220) Changes in operating assets and liabilities: Accounts receivable (180,361) Inventories (1,158,523) Prepaid assets (4,605,260) Other assets (59,458) Accounts payable and accrued expenses 11,332,205 Accrued interest 4,603,386 ------------------------- Net cash used in operating activities (10,708,415) INVESTING ACTIVITIES Purchases of property and equipment (66,571,126) Change in restricted cash 93,580,325 ------------------------- Net cash provided by investing activities 27,009,199 Net change in cash and cash equivalents 16,300,784 Cash and cash equivalents at beginning of period 858,072 ------------------------- Cash and cash equivalents at end of period $ 17,158,856 ========================= Cash paid during the period for: Interest, net of capitalized interest $ 5,921,064 ========================= Supplemental schedule of noncash investing and financing activities: Change in construction costs funded through accounts payable, amounts due to related parties and liabilities subject to compromise $ 15,043,007 ========================= Unpaid interest reclassified to principal $ 3,218,465 ========================= Reorganization items - See Note 1 See accompanying notes. 5 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD) 1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY Premier Entertainment Biloxi LLC, a Delaware limited liability company formed on October 16, 2003, (Premier Entertainment or the Company) owns and operates the Hard Rock Hotel & Casino Biloxi (Hard Rock Biloxi). The liability of GAR LLC (GAR), the Company's sole member, and officers of the Company is limited to the maximum amount permitted under the laws of the state of Delaware. Premier Finance Biloxi Corp. (Premier Finance) was incorporated in October 2003 as a Delaware corporation and is a wholly owned subsidiary of Premier Entertainment. Under Mississippi law, certain expenditures are exempt from sales tax if purchased with proceeds from industrial development revenue bonds issued by the Mississippi Finance Corporation. Premier Finance was formed to fund the capital expenditures that qualify for the tax-exempt status. Hard Rock Biloxi is a single casino gaming facility located on an 8.5 acre site on the Mississippi Gulf Coast and has approximately 1,375 slot machines, 50 table games, six live poker tables, five restaurants (including a Hard Rock Cafe and Ruth's Chris Steakhouse), a full service spa, a 5,200 square foot pool area, 3,000 square feet of retail space, an eleven-story hotel with 318 rooms and suites and a Hard Rock Live! entertainment venue with a capacity of 1,500 persons. Hard Rock Biloxi commenced operations on June 30, 2007. Casino operations are subject to extensive regulation in the State of Mississippi by the Mississippi Gaming Commission and Mississippi State Tax Commission. The Company, its ownership and management are subjected to findings of suitability reviews by the Mississippi Gaming Commission. In addition, the laws, rules and regulations of state and local governments in Mississippi require the Company to hold various licenses, registrations and permits and to obtain various approvals for a variety of matters. In order to continue operating, the Company must remain in compliance with all laws, rules and regulations and pay gaming taxes on its gross gaming revenues. Failure to maintain such approvals or obtain renewals when due, or failure to comply with new laws or regulations or changes to existing laws and regulations would have an adverse effect on the Company's business. Management believes it is currently in compliance with all governmental rules and regulations. 6 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY (CONTINUED) LIQUIDITY AND MANAGEMENT'S PLANS The Company has incurred losses and negative cash flows from operations since inception and although management has reduced operating expenses and expects to be able to meet operating obligations, it does not anticipate that cash flows from operations during 2009 will be sufficient to meet its interest obligations under the $180 million senior secured credit facility with BHR Holdings, Inc., (as further described below) without capital contributions from GAR or modifications to the BHR credit facility. Failure to meet the interest obligation under the BHR credit facility when due would constitute a default under the BHR credit facility which would also create a default under the 15% junior subordinated note with LUK-Ranch Entertainment, LLC ("LRE") described in Note 7. Such defaults allow the respective lenders to declare the notes immediately due and payable. Furthermore, a default under the BHR credit facility provides Hard Rock Hotel Licensing, Inc. the right to terminate the Hard Rock license agreement (Note 9) under certain conditions. BHR and LRE are related parties that are controlled by Leucadia National Corporation, who through its subsidiaries is also the controlling member of GAR. Management intends to improve operating results by continued growth in revenues as marketing and customer loyalty programs mature and by continued emphasis on expense control and reductions. In addition, management intends to seek capital contributions from GAR and or modifications to the BHR credit facility, in order to meet its interest obligations under the BHR credit facility. There is no assurance that management's plans will generate sufficient cash flows from operations to meet the related party interest obligations or that modifications to the BHR credit facility will be obtained. As such, there is substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. BANKRUPTCY FILING On September 19, 2006 (the Petition Date), the Company filed voluntary petitions for reorganization under Chapter 11 of Title 11 of the United States Code, before the United States Bankruptcy Court (the Court) for the Southern District of Mississippi, Southern Division (Case No. 06-50975 (ERG). The Company sought the Court's assistance in gaining access to Hurricane Katrina - related insurance proceeds over which U.S. Bank National Association, in its capacity as trustee and disbursement agent (the Trustee) for the Company's 10 3/4% First Mortgage Notes (the Notes) and a group of majority holders of the Notes had denied access. Under Chapter 11, certain claims against the Company in existence prior to the filing of the petitions were stayed while the Company continued business operations as a debtor-in-possession. As a debtor-in-possession, the Company followed the guidance of Statement of Position 90-7, Financial Reporting by Entities in Reorganization Under the Bankruptcy Code. Accordingly, certain of the stayed claims which were impaired under the plan are reflected in the August 9, 2007 consolidated statement of financial position as "liabilities subject to compromise." Certain revenues and expenses resulting from the reorganization are reported as reorganization items in the August 9, 2007 statement of operations and member's equity. On December 11, 2006, the Company filed with the Court a plan of reorganization (the Plan) and subsequently filed an amended Plan with the Court on February 22, 2007. On July 30, 2007, the Court entered an order confirming the Plan, subject to a modification which the Company filed on August 1, 2007. On August 10, 2007, Premier Entertainment and Premier Finance emerged from bankruptcy when the Plan was substantially consummated (the Effective Date). As such, Premier Entertainment and Premier Finance are no longer classified as debtors-in-possession. The Court continues to retain jurisdiction of certain matters including the ultimate resolution of the disputed escrow amount as described below and resolution of certain other disputed claims. 7 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY (CONTINUED) Under the Plan, as approved by the Court, noteholders received principal of $160 million and accrued unpaid interest of $9.1 million in cash on the Effective Date. In addition, the Company placed $14.7 million in escrow with U.S. Bank. $13.7 million of this amount represents a prepayment premium or penalty, to which the noteholders may be entitled. The Company disputes that any prepayment premium or penalty is due the noteholders and as such the disputed amount has been placed in escrow pending resolution by the Court. In addition, the Company placed $1 million in escrow for fees and expenses which may be incurred by the Trustee in conjunction with the dispute resolution. Entitlement to the escrows is expected to be determined by the Court during 2008. The Company believes it is probable that the Court will approve payment of Trustee legal fees and expenses and has fully reserved for that contingency. However, the Company does not believe it is probable or remote that the Court will find in favor of the noteholders with respect to the additional damages escrow, and any potential loss can not be reasonably estimated. Accordingly, the Company has not accrued a loss for the additional damages contingency. On the Effective Date, Peoples Bank, holder of the senior secured reducing line of credit facility received $1.3 million of principal plus interest at a reduced rate of 7% from the Petition Date through the Effective Date. The reduction in interest rate resulted in a $29,672 difference in interest costs. Holders of other secured claims received 100% of their allowed claim, including contractual interest on the Effective Date. Holders of general unsecured claims received 50% of their allowed claim plus post petition interest at the federal judgment rate of 5.02% on the Effective Date and received the balance, with interest, on October 10, 2007. The reduction in contractual interest rates and interest paid under the plan on certain general unsecured claims resulted in $1.2 million difference in interest costs. The Plan was funded by a $180 million senior secured credit facility dated August 10, 2007 provided by BHR Holdings, Inc. (BHR), a related party, and a $20 million loan and security agreement dated August 10, 2007 provided by International Game Technology (IGT). The BHR credit facility will mature February 2012, bears interest at 10 3/4%, is prepayable at any time without penalty, and contains other covenants, terms and conditions similar to those contained in the indenture that governed the Notes 8 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY (CONTINUED) (see Note 7). On the Effective Date, $160 million was advanced to the Company under this facility. As of October 11, 2007, the full $180 million had been advanced. The IGT loan was initially funded on the Effective Date and $19.8 million had been advanced as of August 17, 2007. The IGT loan is secured by certain IGT slot machines, slot system, and non-IGT ancillary equipment and is payable in thirty-five consecutive monthly installments based on a sixty-month amortization with a balloon payment on the thirty-sixth month of the outstanding remaining principal balance. Interest accrues at the "high Wall Street Journal prime lending rate," (8.25% at August 9, 2007) and the first payment of principal and interest was due September 20, 2007. The loan also includes a 2% loan fee of $139,332 for the portion of the loan representing the non-IGT ancillary equipment On August 2, 2007, certain of the noteholders filed a notice of appeal of the confirmation order and a motion for stay of the confirmation order pending resolution of the appeal. On August 10, 2007, the motion for stay of the confirmation was denied by both the Court and the United States District Court for the Southern District of Mississippi. The Company has filed a motion to dismiss the appeal on the basis of equitable mootness due to the fact that the Plan has been substantially carried out. On March 19, 2008 the United States District Court for the Southern District of Mississippi granted the Company's motion to dismiss the appeal. Liabilities Subject to Compromise The following table summarizes the components of liabilities subject to compromise included on the consolidated statement of financial position as of August 9, 2007: Senior note in default, including accrued interest $ 169,105,847 Equipment financing in default, including accrued interest 15,967,710 Accounts payable and other accrued liabilities (a) 23,550,761 ----------------------- Total liabilities subject to compromise $ 208,624,318 ======================= (a) Accounts payable and other accrued liabilities include $15.7 million payable to related parties (see Note 8). 9 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY (CONTINUED) Liabilities subject to compromise refers to pre-petition obligations that may have been impacted by the Chapter 11 reorganization process. At August 9, 2007, liabilities subject to compromise represents the balances of pre-petition liabilities as resolved by the Plan. REORGANIZATION ITEMS, NET The following table summarizes the components included in reorganization items, net on the consolidated statement of operations and member's equity for the period from January 1, 2007 through August 9, 2007: Professional fees $ 3,738,148 Net gain on claim settlements (1,069,981) Interest income (2,456,341) ---------------------- Total reorganization items, net $ 211,826 ====================== 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION AND USE OF ESTIMATES The Company's accounting policies and its standards of financial disclosure are in conformity with United States generally accepted accounting principles. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Significant estimates include the estimated useful lives for depreciable assets, the estimated allowance for doubtful accounts receivable, estimated cash flows in assessing the recoverability of long-lived assets, and estimated liabilities for the slot bonus point program and self insurance claims. Actual results could differ significantly from those estimates. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Premier Entertainment and its wholly owned subsidiary, Premier Finance Biloxi Corp. All significant inter-company accounts and transactions have been eliminated. 10 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) CASH AND CASH EQUIVALENTS Cash includes cash required for gaming operations. For purposes of reporting the statements of cash flows, the Company considers all cash accounts and all short-term investments with maturity dates of ninety days or less when purchased to be cash equivalents. ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS Accounts receivable are principally comprised of casino and hotel receivables, which do not bear interest and are recorded at cost. The Company extends credit to approved casino customers following background checks and investigations of creditworthiness. The Company reserves an estimated amount of receivables that may not be collected. The methodology for estimating the allowance includes specific reserves and applying various percentages to aged receivables. Historical collection rates are considered, as are customer relationships, in determining specific allowances. As with many estimates, management must make judgments about potential actions by third parties in establishing and evaluating the allowance for bad debts. INVENTORIES Inventories, consisting principally of food, beverages and operating supplies, are stated at the lower of cost (first-in, first-out) or market. PROPERTY AND EQUIPMENT Property and equipment are stated at cost less accumulated depreciation and amortization. The Company capitalizes the cost of purchases of property and equipment and capitalizes the cost of improvements to property and equipment that increase the value or extend the useful life of the asset. Maintenance and repairs are charged to expense as incurred. Depreciation is computed using the straight-line method over the following estimated useful lives of the assets: Land improvements 20 years Building 40 years Furniture, fixtures, and equipment 3-10 years 11 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived Assets", long-lived assets to be held and used by the Company are reviewed to determine whether any events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. Factors that might indicate a potential impairment may include, but are not limited to, significant decreases in the market value of the long-lived asset, a significant change in the long-lived asset's physical condition, a change in industry conditions or a reduction in cash flows associated with the use of the long-lived asset. If these or other factors indicate the carrying amount of the asset may not be recoverable, the Company determines whether an impairment has occurred through the use of an undiscounted cash flow analysis of the asset at the lowest level for which identifiable cash flows exist. If an impairment has occurred, the Company recognizes a loss for the difference between the carrying amount and the fair value of the asset. The fair value of the asset is measured using market prices or, in the absence of market prices, is based on an estimate of discounted cash flows. At August 9, 2007 and for the period January 1, 2007 through August 9, 2007, there has been no impairment of long-lived assets. CAPITALIZATION OF INTEREST In accordance with SFAS No. 34, Capitalization of Interest Cost (SFAS No. 34), the Company capitalizes the interest cost associated with construction projects as part of the cost of the project. Interest is typically capitalized on amounts expended on the project using the weighted-average cost of outstanding borrowings. Capitalization of interest starts when construction activities, as defined in SFAS No. 34, begin and ceases when construction is substantially complete. Such capitalized interest becomes part of the cost of the related asset and is depreciated over the estimated useful life. INTANGIBLE ASSETS The Company has a license agreement with Hard Rock Hotel Licensing, Inc., which provides for an initial term of twenty years and the option to renew for two successive ten-year terms. Under the license agreement, the Company has the exclusive right to use the "Hard Rock" brand name in connection with its hotel and casino resort. As consideration for the licensed rights as provided in the license agreement, the Company paid a one-time territory fee of $500,000. This cost was capitalized and is recorded as other assets on the consolidated statement of financial position and is being amortized over a 20-year period that began in September 2005. 12 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) REVENUE AND PROMOTIONAL ALLOWANCES Casino revenue is the aggregate net difference between gaming wins and losses, with liabilities recognized for funds deposited by customers before gaming play occurs, for chips outstanding and "ticket-in, ticket-out" coupons in the customers' possession, and for accruals related to the anticipated payout of progressive jackpots. Progressive slot machines, which contain base jackpots that increase at a progressive rate based on the number of credits played, are charged to revenue as the amount of the progressive jackpots increase. Sales incentives to customers such as points earned in point-loyalty programs related to gaming play are recorded as a reduction of gross casino revenues. Hotel revenue recognition criteria are met at the time of occupancy. Food and beverage revenue recognition criteria are met at the time of service. Advance deposits for hotel rooms are recorded as liabilities until revenue recognition criteria are met. The retail value of accommodations, food and beverage, and other services furnished to hotel/casino guests without charge is included in gross revenue and then deducted as promotional allowances. The estimated retail value of such promotional allowances is included in operating revenues as follows: Food & beverage $ 1,546,760 Rooms 243,640 Other 263,319 ----------------------- Total $ 2,053,719 ======================= The estimated departmental cost of providing such promotional allowances is included in casino operating expenses as follows: Food & beverage $ 1,014,003 Rooms 118,385 Other 378,759 ----------------------- Total $ 1,511,147 ======================= 13 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) FREQUENT PLAYERS PROGRAM The Company has established a promotional club to encourage repeat business from frequent and active slot machine customers. Members earn points based on gaming activity and such points can be redeemed for free slot play. The Company accrues for club points as a reduction to gaming revenue based upon the estimates for expected redemptions. ADVERTISING COSTS Costs for advertising are expensed as incurred. Advertising costs included in casino expense was $350,956 for the period from January 1, 2007 through August 9, 2007. SELF-INSURANCE The Company is self-insured for employee medical insurance coverage up to an individual stop loss of $50,000. Self-insurance liabilities are estimated based on the Company's claims experience and are included in other accrued liabilities on the consolidated statement of financial position. Such amount at August 9, 2007 was $345,817. At August 9, 2007, the total amount of claims exceeding the stop loss was immaterial. PRE-OPENING COSTS Pre-opening costs are expensed as incurred, consistent with Statement of Position 98-5, Reporting on the Costs of Start-up Activities (SOP 98-5). Expenses incurred include payroll and payroll related expenses, marketing expenses, rental expenses, outside services, legal and professional fees, management fees to related party and other expenses related to the start-up phase of operations. INCOME TAXES As a limited liability company, the Company has elected to be treated as a partnership for income tax purposes; accordingly, any tax related to the Company's income is the obligation of its member and no federal or state income tax provision has been recorded in the Company's consolidated financial statements. 14 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 3. HURRICANE INSURANCE RECOVERIES On August 29, 2005, just two days before the Hard Rock Biloxi was originally scheduled to open to the public, Hurricane Katrina hit the Mississippi Gulf Coast and severely damaged the hotel and related structures and completely destroyed the casino. On August 15, 2005, the Company purchased a comprehensive blanket insurance policy providing up to $181.1 million in coverage for damage to real and personal property, including business interruption coverage. The insurance was comprised of a $25.0 million primary layer underwritten by Industrial Risk Insurers, a $25.0 million first excess layer underwritten by several insurance carriers, and a second excess layer comprising $131.1 million underwritten by several insurance carriers. The syndicated coverage was spread over twelve different insurance carriers. The Company had a 3.0% deductible on its coverage, but purchased three additional insurance policies to reduce the Company's exposure related to that deductible. As of August 9, 2007, the Company had reached final settlements with all but one of its carriers under its blanket insurance policies and had collected total insurance recoveries of $161.2 million. In January 2008, the Company settled the remaining insurance claim. As of and for the period ended August 9, 2007, the Company has recognized insurance recoveries of $11.4 million with an insurance receivable of $11.1 million. Such receivable was collected in full on February 21, 2008. All other insurance recoveries were recognized in years ended prior to 2007. 4. RESTRICTED CASH Restricted cash consists of cash and highly liquid instruments with original maturities of 90 days or less, which carrying amounts approximate fair value. The net proceeds from the issuance of the Notes, a portion of the equity investment and the proceeds from the junior subordinated note were deposited into a construction disbursement account and a tidelands lease reserve account pursuant to the disbursement agreement of the Notes. These proceeds were utilized to construct the property which was substantially completed in August 2005 and subsequently damaged by Hurricane Katrina. The insurance proceeds related to Hurricane Katrina received prior to August 9, 2007 totaling $161.2 million have been deposited into the restricted accounts held by the Trustee. These accounts were pledged to the Trustee as security for the Company's obligations under the Notes, and could only be released to the Company in accordance with the disbursement agreement or approval from the Court (see Note 1). The Company also has a $1.0 million certificate of deposit which is pledged as security for the Company's obligations under the Hard 15 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 4. RESTRICTED CASH (CONTINUED) Rock license agreement. In the accompanying consolidated statement of financial position, restricted cash is classified as noncurrent as it is primarily designated for the reconstruction of property and purchases of equipment. Restricted cash at August 9, 2007 includes the following: Construction disbursement $ 23,157,552 Tidelands lease reserve 880,872 Insurance proceeds in escrow (a) 15,623,710 ----------------------- Cash restricted by the Notes 39,662,134 Certificate of deposit restricted by the Hard Rock license agreement 1,000,000 ----------------------- Total restricted cash $ 40,662,134 ======================= (a) Includes $1.3 million escrowed on behalf of Peoples Bank and $14.3 million escrowed on behalf of IGT pending determination of their rights, if any to the insurance proceeds. 5. PROPERTY AND EQUIPMENT Property and equipment held at August 9, 2007 consisted of the following: Land $ 31,416,920 Building 131,072,698 Equipment 54,316,354 ----------------------- 216,805,972 Less accumulated depreciation 2,747,161 ----------------------- Property and equipment, net $ 214,058,811 ======================= Depreciation expense totaled $1.6 million for the period from January 1, 2007 through August 9, 2007. Interest capitalized for the period from January 1, 2007 through August 9, 2007 was $2.7 million. 16 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 6. OTHER NONCURRENT ASSETS Other assets, net consisted of the following at August 9, 2007: Hard Rock license fee, net of accumulated amortization of $48,589 $ 451,411 Deferred financing costs, net of accumulated amortization of $182,813 242,187 Deposit 161,120 ----------------------- Other assets, net $ 854,718 ======================= Amortization expense for the Hard Rock license fee and the leasehold contract was $15,137 for the period from January 1, 2007 through August 9, 2007. For the Hard Rock license fee, the estimated amortization expense per year for the next five years is $25,000. 7. LONG-TERM DEBT AND LOAN AND SECURITY AGREEMENT Long-term debt as of August 9, 2007 is as follows: 10 3/4% First Mortgage Notes due 2012 in default $ 160,000,000 15% Junior Subordinated Note due 2012 16,730,358 Variable rate IGT note payable in default 12,870,932 Variable rate Senior Secured Reducing Line of Credit Facility in default 1,250,000 Fixed rate BHR note payable in default 9,084,267 ------------------------ 199,935,557 Less debt and loan agreements classified as liabilities subject to compromise 174,120,932 Less notes payable current 9,084,267 ------------------------ Long-term debt $ 16,730,358 ======================== 10 3/4% FIRST MORTGAGE NOTES DUE 2012 On January 23, 2004, the Company issued $160 million of 10 3/4% First Mortgage Notes due February 1, 2012 in a private placement offering which were subsequently exchanged in an exchange offer registered on Form S-4. The Notes were senior to all existing and future senior unsecured indebtedness, but were subordinated to $14.1 million of senior secured indebtedness incurred to finance 17 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 7. LONG-TERM DEBT AND LOAN AND SECURITY AGREEMENT (CONTINUED) the acquisition and installation of furniture, fixtures, and equipment. The Notes were secured by a pledge of the Company's membership interests and substantially all of the existing and future assets, except for assets securing certain other indebtedness. In addition, the Trustee was named as a loss payee on behalf of the noteholders under the Company's insurance policies. Interest on the Notes was payable semiannually on each February 1 and August 1 through maturity. Under the governing indenture, the Notes may have been redeemed, in whole or in part, at any time on or after February 1, 2008 at the redemption prices (expressed as percentages of principal amount) set forth below, plus accrued and unpaid interest, to the applicable redemption date, if redeemed during the 12-month period beginning on February 1 of the years indicated below: ------------------------------------------------- YEAR PERCENTAGE ------------------------------------------------- 2008 105.38% 2009 102.69% 2010 and thereafter 100.00% In addition, up to 35% of the Notes may have been redeemed at a premium on or prior to February 1, 2007 with the net cash proceeds of an initial public offering. As a result of the bankruptcy, the Notes are classified as liabilities subject to compromise in the accompanying consolidated statement of financial position. The Notes were paid in full on August 10, 2007 in accordance with the Company's confirmed plan of reorganization (see Note 1). 15% JUNIOR SUBORDINATED NOTE DUE 2012 On January 13, 2004 the Company borrowed $10.0 million in the form of a junior subordinated note due August 1, 2012 from Rank America, Inc., an affiliate of The Rank Group Plc, and owner of Hard Rock Hotel Licensing, Inc. On April 25, 2006 the junior subordinated note was acquired by LUK-Ranch Entertainment, LLC (LRE), a related party. Interest on the junior subordinated note accrues at a rate of 15% per annum. Accrued interest at each semi annual interest payment date of February 1 and August 1 is added to the principal balance to the extent not paid. The Company will be required to pay a repayment premium of 3% of the principal amount of the junior subordinated note when it is repaid. Such premium is being accrued over the term of the junior subordinated note. 18 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 7. LONG-TERM DEBT AND LOAN AND SECURITY AGREEMENT (CONTINUED) IGT NOTE PAYABLE On January 5, 2005, the Company entered into a Commercial Sales and Security Agreement with IGT (the IGT Agreement) for the financing of certain gaming devices and systems. Pursuant to the IGT Agreement, the Company purchased approximately 1,100 slot devices from IGT, as well as software licenses and related equipment for the gaming system. Under the IGT Agreement, interest accrued at the "high Wall Street Journal prime lending rate" (8.25% at August 9, 2007) and payments were based on a 60-month amortization payable in thirty-six monthly installments of principal and accrued interest with the balance due on the thirty-seventh month (November 2008). IGT was named as a loss payee under the Company's insurance policies. As a result of the bankruptcy, the amount due under the IGT Agreement is classified as liabilities subject to compromise in the accompanying consolidated statement of financial position. In accordance with the Company's confirmed plan of reorganization, $7.6 million of principal, accrued pre-petition interest at the contract rate, and post-petition accrued interest at the reduced rate of 5.02% was paid on August 10, 2007. The remaining balance of principal and accrued interest was paid October 10, 2007 (see Note 1). SENIOR SECURED REDUCING LINE OF CREDIT FACILITY On August 26, 2005, the Company received a $1.3 million loan from The Peoples Bank pursuant to a $10.0 million Senior Secured Reducing Line of Credit Facility (the Credit Facility). The Credit Facility was secured by a security interest in certain collateral purchased by the Company and the lender was named as a loss payee under the Company's blanket insurance policies. The Credit Facility had a term of 66 months that included an initial funding period that ended on December 31, 2005. Interest on the Credit Facility accrued at the rate of LIBOR plus 4.25% (9.7475% at August 9, 2007). On December 31, 2005, the outstanding balance of the Credit Facility was converted into a fully amortizing, five-year term loan due December 31, 2010, requiring quarterly payments of principal and interest. As a result of the bankruptcy, the amounts due under the credit facility are classified as liabilities subject to compromise in the accompanying consolidated statement of financial position. In accordance with the Company's confirmed plan of reorganization, the credit facility was paid in full, with post petition accrued interest at the reduced rate of 7% per annum on August 10, 2007. 19 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 7. LONG-TERM DEBT AND LOAN AND SECURITY AGREEMENT (CONTINUED) BHR HOLDINGS, INC. FIXED RATE NOTE PAYABLE On May 23, 2006, the Company received an $8.0 million loan from BHR, a related party. An additional $0.1 million was received in September 2006. The note bears interest at 12% per annum and the principal balance and all accrued and unpaid interest is due on the earlier of May 23, 2007 or the date on which sufficient insurance proceeds received from certain insurance carriers become available to repay the note. Under the Fixed Rate Note, any interest not paid on the maturity date shall be compounded by increasing the principal amount by the amount of interest accrued through the maturity date. On May 23, 2007, $984,267 of accrued and unpaid interest was added to the principal balance of the BHR Fixed Rate Note. On February 26, 2008, the Company repaid the principal balance and accrued interest due under the BHR Fixed Rate Note in full. OTHER On July 1, 2005, the Company obtained an Irrevocable Letter of Credit from The Peoples Bank in favor of Hard Rock Hotel Licensing, Inc. in the amount of $1.0 million to comply with the terms and conditions of the Licensing Agreement with Hard Rock Hotel Licensing, Inc. The Letter of Credit is secured by a certificate of deposit in the amount of $1.0 million. The Letter of Credit reduces by $100,000 on the first of each month beginning January 1, 2008 until it reaches zero on October 1, 2008. 8. RELATED PARTY TRANSACTIONS Roy Anderson, III a member of GAR, is the President, Chief Executive Officer and majority stockholder of Roy Anderson Corp. (RAC), the Company's general contractor. In the aftermath of Hurricane Katrina, RAC performed remedial work in the amount of $7.5 million, of which $2.9 million was outstanding and reflected in liabilities subject to compromise in the August 9, 2007 consolidated statement of financial position. In accordance with the Company's confirmed plan of reorganization, this amount was paid in full with post petition interest as per the Plan on September 30, 2007 (see Note 1). On June 16, 2006, the Company entered into a $78.3 million guaranteed maximum price construction agreement (Construction Agreement) with RAC to provide for rebuilding the casino portion of the Hard Rock Biloxi and renovating and repairing the existing hotel tower, low-rise building, parking garage and pool 20 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 8. RELATED PARTY TRANSACTIONS (CONTINUED) and deck area that were severely damaged by Hurricane Katrina. Deductive change orders were issued on October 25, 2006, May 25, 2007, and October 10, 2007, reducing the amount of the guaranteed maximum price to $73.0 million. During the period from January 1, 2007 through August 9, 2007, $42.0 million was paid to RAC under the Construction Agreement and $4.6 million is outstanding and reflected in amounts due to related parties in the August 9, 2007 consolidated statement of financial position. Subsequent to August 9, 2007, the $4.6 million was paid to RAC. On June 16, 2006, the Company entered into a receivables purchase agreement with BHR and RAC. Pursuant to the terms of the receivables purchase agreement, BHR agreed to purchase up to $40.0 million of receivables due to RAC by the Company under the Construction Agreement if such receivables are past due for more than ten days. As of August 9, 2007, $11.3 million of the amount due to RAC was paid under this purchase agreement. The Company has reflected these amounts owing to BHR as liabilities subject to compromise in the August 9, 2007 consolidated statement of financial position. In accordance with the Company's confirmed plan of reorganization, this amount was paid in full with post petition interest as per the Plan on October 10, 2007 (see Note 1). During the bankruptcy proceedings, LRE purchased certain third party claims against the Company in the amount of $1.0 million. The Company has reflected these amounts owing to LRE as liabilities subject to compromise in the August 9, 2007 consolidated statement of financial position. In accordance with the Company's confirmed plan of reorganization, this amount was paid in full with post petition interest as per the Plan on October 10, 2007 (see Note 1). In 2006, in conjunction with a change of control of the Company's members, BHR commenced a tender offer (the Offer) for all of the Company's outstanding 10 3/4% First Mortgage Notes at a price equal to 101% of the par value of the Notes in satisfaction of the Company's obligation under the Indenture to make such an offer upon the occurrence of a change of control as defined in the Indenture. The offer expired with none of the Notes being tendered. In connection with the Offer, GAR agreed to cause Premier to pay BHR a fee of $2.0 million, which will be paid only to the extent distributions from the Company are available for such purpose. At August 9, 2007 the fee remains unpaid and is included in amounts due to related parties on the consolidated statement of financial position. 21 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 8. RELATED PARTY TRANSACTIONS (CONTINUED) In addition, the members of the Board of Managers of Premier are entitled to be paid an annual management fee in an aggregate amount of $2.0 million, which will be paid by Premier to the extent distributions from the Company are available for such purpose. The Company began accruing for this fee on April 26, 2006 and has accrued $2.6 million for this management fee in amounts due to related parties on the August 9, 2007 consolidated statement of financial position. As of August 9, 2007 LRE has paid $2.1 million of expenses on behalf of the Company. Such amount is included in amounts due to related parties on the August 9, 2007 consolidated statement of financial position. 9. COMMITMENTS OPERATING LEASES The Company is committed under various operating lease agreements which were assumed in the bankruptcy proceedings primarily related to property, submerged tidelands and equipment. Generally, these leases include renewal provisions and rental payments, which may be adjusted for taxes, insurance and maintenance related to the property. Future minimum rental commitments under noncancelable operating leases are as follows: 2007 $ 563,532 2008 1,358,660 2009 1,293,910 2010 1,293,940 2011 1,291,818 2012 1,294,135 Thereafter 27,762,291 ----------------------- $ 34,858,286 ======================= Total rent expense for these long-term lease obligations was $329,303 for the period from January 1, 2007 through August 9, 2007. 22 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 9. COMMITMENTS (CONTINUED) In October 2003, the Company entered into an agreement with the State of Mississippi for the lease and use of approximately 5 acres of submerged tidelands. The term of the lease is for a period of 30 years. For the initial period commencing on October 27, 2003 until the opening date as defined in the agreement, the Company was required to pay annual rent of $21,900. From the opening date through the remainder of the lease term, the lease rate was to be determined as fair value on that date. In conjunction with the opening of the casino, the revised lease rate is $985,000 annually. This rate will be adjusted every five years based on the greater of the Consumer Price Index change for the period or by appraisal of the fair market rent. In November 2003, the Company entered into an agreement with the City of Biloxi, Mississippi to lease property and the related airspace for a period of 40 years. For the initial three years of the lease beginning in October 2004, the Company must pay monthly rent of $12,500. The rent will increase by the Consumer Price Index beginning on the fifth anniversary date of execution of the lease and continuing on each fifth anniversary date. Under the Hard Rock licensing agreement, the Company is obligated to pay an annual lease fee of $150,000 for memorabilia displayed at the Hard Rock Biloxi. The annual lease fee is fixed for the first two years and then adjusts thereafter by the greater of 3% or an adjustment based on the inflation index, but in no event shall such adjustment exceed 5% annually. OTHER COMMITMENTS Under the Hard Rock licensing agreement, the Company is obligated to pay an annual fee of $1.1 million which increases to $1.5 million over five years and increases annually thereafter based on the consumer price index, plus fees based on future non-gaming revenues. The Company will pay a "Continuing Fee" equal to three percent (3%) of the Licensing Fee Revenues and a marketing fee equal to one percent (1%) of the Licensing Fee Revenues during the term of the agreement. In no event shall these fees be construed so as to allow licensor to share in any revenue generated by the Company's gaming operations. Fee expense under the license agreement was $231,489 for the period from commencement of operations on June 30, 2007 through August 9, 2007 and is included in other operating expenses on the consolidated statement of operations and member's equity. In April 2006, the Company agreed to accrue $150,000 per month in lieu of any other fees due under the terms of the license agreement until such time that the operations commence. Pursuant to this agreement, $900,000 was expensed during the period from January 1, 2007 through June 30, 2007 and is included in preopening expenses on the consolidated statement of operations and member's equity. At August 9, 2007, $3.5 million has been accrued and recorded in other accrued liabilities in the accompanying consolidated statement of financial position. 23 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 9. COMMITMENTS (CONTINUED) Such amounts were paid in full on November 30, 2007. In December 2004, the Company entered into a lease which gives RCSH Operations, LLC (RCSH) the right to operate a Ruth's Chris Steak House restaurant within the Hard Rock Biloxi. The initial term is for ten years beginning July 1, 2007 and RCSH has the right to extend the lease for four additional terms of five years each. RCSH is obligated to pay minimum annual rent of $179,000 to the Company in years one through five and $201,825 annually in years six through ten. In addition to the minimum rent, RCSH is obligated to pay rent in the amount by which 6% of RCSH's annual gross sales exceeds the minimum annual rent. Future minimum rent payable to the Company under the lease with RCSH is as follows: 2007 $ 70,253 2008 179,000 2009 179,000 2010 179,000 2011 179,000 2012 190,413 Thereafter 908,213 ----------------------- $ 1,884,879 ======================= 10. RECENTLY ISSUED ACCOUNTING STANDARDS SFAS NO. 159 In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities--Including an Amendment of FASB Statement No. 115," which permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 will become effective for the Company on January 1, 2008 (the first fiscal year beginning after November 15, 2007). The Company is currently evaluating the impact of adopting SFAS No. 159 but does not expect that the adoption will have a material impact on its consolidated financial statements. 24 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 10. RECENTLY ISSUED ACCOUNTING STANDARDS (CONTINUED) SFAS NO. 157 In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." The statement defines fair value, establishes a framework for measuring fair value, expands disclosures about fair value measurements and does not require any new fair value measurements. SFAS No. 157 will become effective for the Company on January 1, 2008 (the first fiscal year beginning after November 15, 2007). In February 2008, the FASB decided to issue final Staff Positions that will partially defer the effective date of SFAS No. 157 for one year for certain nonfinancial assets and nonfinancial liabilities and remove certain leasing transactions from the scope of SFAS No. 157. The Company is currently evaluating the impact of adopting SFAS No. 157 but does not expect that the adoption will have a material impact on its consolidated financial statements 11. FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practical to estimate that value: o Cash and cash equivalents - The carrying amounts approximate fair value because of the short maturity of these instruments. o Restricted cash - The carrying amounts approximate fair value because of the short maturity of these instruments. o Long-term debt - As a result of the bankruptcy filing, the fair value of the Company's long-term debt as of August 9, 2007 cannot be estimated. As a result, the fair value is presented at its carrying value. Debt obligations with a short remaining maturity are valued at the carrying amount. 25 Premier Entertainment Biloxi LLC and Subsidiary Debtor-In-Possession Notes to Consolidated Financial Statements (continued) 11. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) The estimated carrying amounts and fair values of the Company's financial instruments at August 9, 2007 are as follows:

-------------------------------------- CARRYING FAIR AMOUNT VALUE -------------------------------------- FINANCIAL ASSETS: Cash and cash equivalents $ 17,158,856 $ 17,158,856 Restricted cash 40,662,134 40,662,134 FINANCIAL LIABILITIES: 10 3/4% First mortgage notes 160,000,000 160,000,000 15% Junior subordinated note 16,730,358 16,730,358 IGT note payable 12,870,932 12,870,932 Senior secured reducing line of credit facility 1,250,000 1,250,000 BHR note payable 9,084,267 9,084,267

26 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ----------------------------- Debtor-In-Possession -------------------- Consolidated Statement of Financial Position - Unaudited December 31, 2006

Assets Current assets: Cash $ 858,072 Accounts receivable, net of doubtful accounts of $34,775 551,708 Prepaid insurance 2,504,357 Prepaid expenses - other 887,598 Other current assets 9,100 --------------- Total current assets 4,810,835 Property and equipment, net 134,094,320 Other noncurrent assets: Restricted cash 134,242,459 Other assets, net 862,638 --------------- Total assets $ 274,010,252 ===============

2 December 31, 2006

Liabilities and member's equity Liabilities not subject to compromise: Current liabilities: Accounts payable $ 366,039 Accounts payable - construction in progress (includes related party amounts of $7,192,872) 7,341,775 Accrued interest (includes related party amount of $1,495,435) 1,495,435 Other accrued liabilities (includes related party amount of $4,090,136) 7,217,936 Notes payable 8,100,000 --------------- Total current liabilities 24,521,185 Long-term debt, less current maturities 14,430,810 Liabilities subject to compromise (Note 1) 206,721,281 --------------- Total liabilities 245,673,276 Member's contributed capital 52,775,215 Deficit accumulated during development stage (24,438,239) --------------- Total member's equity 28,336,976 --------------- Total liabilities and member's equity $ 274,010,252 =============== See accompanying notes.

3 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ----------------------------- Debtor-In-Possession -------------------- Consolidated Statements of Operations and Member's Equity - Unaudited

Period From Inception on Year Ended March 27, 2003 December 31, through 2006 December 31, 2006 -------------- ------------------ Preopening expenses $ 13,860,298 $ 23,255,609 Hurricane-related expenses and write-downs 1,087,695 113,154,633 Insurance recoveries (42,370,737) (160,897,837) Depreciation and amortization 796,450 1,245,371 ------------- -------------- (Income) loss from operations (26,626,294) (23,242,224) ------------- -------------- Other income (expense): Interest expense (21,727,344) (47,744,085) Interest income 1,879,338 4,929,513 ------------- -------------- Total other income (expense) (19,848,006) (42,814,572) ------------- -------------- Income (loss) before reorganization items 6,778,288 (19,572,348) Reorganization items, net (Note 1) (4,865,891) (4,865,891) ------------- -------------- Net income (loss) 1,912,397 (24,438,239) Member's equity at beginning of the period 26,424,579 -- Capital contribution from AA Capital -- 52,775,215 ------------- -------------- Member's equity at end of the period $ 28,336,976 $ 28,336,976 ============= ============== See accompanying notes.

4 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ----------------------------- Debtor-In-Possession -------------------- Consolidated Statements of Cash Flows - Unaudited

Period From Inception on Year Ended March 27, 2003 December 31, Through December 31, 2006 2006 -------------- ------------------ Operating activities Net income (loss) $ 1,912,397 $ (24,438,239) Depreciation and amortization 796,450 1,245,371 Amortization of deferred financing costs, discount and repayment premium 958,434 3,606,924 Reorganization items 6,479,361 6,479,361 Property and equipment write-downs 30,994 96,200,268 Other hurricane-related write-downs -- 638,473 Insurance recoveries (42,370,737) (160,897,837) Changes in prepaid assets (1,872,375) (3,831,217) Changes in other operating assets and liabilities 4,364,995 11,194,928 ------------ ------------- Net cash used in operating activities (29,700,481) (69,801,968) ------------ ------------- Investing activities Purchases of property and equipment (22,849,142) (174,094,721) Insurance recoveries received 135,247,837 160,897,837 Purchases of government securities -- (32,946,442) Sales of government securities 8,332,711 33,451,651 Acquisition of intangibles -- (965,672) Change in restricted cash (100,051,158) (133,730,124) ------------ ------------- Net cash provided by (used in) investing activities 20,680,248 (147,387,471) ------------ ------------- Financing activities Refunds of (payments for) deferred financing costs 31,301 (8,179,344) Increase in line of credit -- 1,250,000 Proceeds from long-term debt -- 202,713,590 Proceeds from short-term borrowings 8,100,000 8,100,000 Capital contribution -- 15,180,810 Change in restricted cash -- (1,017,545) ------------ ------------- Net cash provided by financing activities 8,131,301 218,047,511 ------------ ------------- Net change in cash (888,932) 858,072 Cash at beginning of period 1,747,004 -- ------------ ------------- Cash at end of period $ 858,072 $ 858,072 ============== ============= Cash paid during the period for: Interest, net of capitalized interest $ 16,825,099 $ 34,944,752 ============== ============= Supplemental schedule of noncash investing and financing activities: Construction costs funded through accounts payable and liabilities subject to compromise $ 27,085,853 $ 27,085,853 ============== ============= Purchase of property and equipment funded through notes payable $ -- $ 14,120,932 ============== ============= Unpaid interest reclassified to principal related to Junior Subordinated Note $ 1,933,324 $ 4,356,293 ============== ============= See accompanying notes.

5 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited 1. Nature of Business and Summary of Significant Accounting Policies Premier Entertainment Biloxi LLC, a Delaware limited liability company, (Premier Entertainment or the Company) is a development stage company and was established to own, construct and manage the operations of the Hard Rock Hotel & Casino Biloxi (Hard Rock Biloxi). The personal liability of the member and officers of the Company is limited to the maximum amount permitted under the laws of the state of Delaware. Premier Finance Biloxi Corp. (Premier Finance) was incorporated in October 2003 as a Delaware corporation and is a wholly owned subsidiary of Premier Entertainment. Under Mississippi law, certain expenditures are exempt from sales tax if purchased with proceeds from industrial development revenue bonds issued by the Mississippi Finance Corporation. Premier Finance was formed to fund the capital expenditures that qualify for the tax-exempt status. The Company has incurred a net loss of $24.4 million for the period from commencement of operations on March 27, 2003 through December 31, 2006. Construction of the property was originally completed in August 2005. However, on August 29, 2005, the Company's casino was destroyed and the casino related facilities, low-rise building, hotel tower and parking garage sustained significant damage as a result of Hurricane Katrina. Reconstruction of the property began in June 2006 and the Company commenced operations on June 30, 2007. As of that date, the Company ceased to be a development-stage company. Basis of Presentation The Company's accounting policies and its standards of financial disclosure are in conformity with United States generally accepted accounting policies. Capital Structure On January 23, 2004, GAR LLC (GAR) received 100 Class A common units representing a 55% membership interest in the Company. AA Capital Equity Fund, L.P., and AA Capital Biloxi Co-Investment Fund, L.P. (together AA), received 100 Class B common units and 100 Class A preferred units representing the remaining 45% membership interest in exchange for $52.8 million of members' equity through conversion of the unpaid principal and accrued interest on a loan and security agreement plus an incremental cash contribution of $15.2 million. On January 24, 2005, the LLC Operating Agreement was amended to establish 100 Class C common non-voting units, a new Class of membership interest in the Company. On this same date, sixty-six and two-thirds (66 2/3) of the Class C common units were granted to Joseph Billhimer, the Company's President and Chief Operating Officer. 6 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 1. Nature of Business and Summary of Significant Accounting Policies (continued) Change of Control On April 25, 2006, LUK-Ranch Entertainment, LLC, (LRE), a Delaware limited liability company and an indirect subsidiary of Leucadia National Corporation (Leucadia), indirectly acquired a controlling interest in the Company by making a capital contribution to GAR. GAR used this capital contribution to acquire one-hundred percent (100%) of the equity interest held by AA in the Company for an aggregate cash purchase price of $89 million. The acquisition was made upon receipt of Mississippi Gaming Commission approval of the acquisition of control, pursuant to a Unit Purchase Agreement by and among GAR, AA, Leucadia, and HRHC Holdings, LLC dated as of April 6, 2006. Pursuant to the agreement, GAR acquired all of AA's equity interest in the Company, which, when added to GAR's existing equity interest in the Company, represented 98% of the common equity of the Company on a fully diluted basis and 100% of the voting equity of the Company (the Transaction). LRE funded GAR's acquisition of AA's equity interest in the Company by purchasing (i) 100% of the Class B Common Units of GAR, representing approximately 45% of the total common units of GAR and (ii) 100% of the Class A Preferred Units of GAR (approximately $75.7 million at April 25, 2006), representing 100% of the preferred units in GAR for aggregate cash consideration of $89 million. Under the terms of the GAR operating agreement, LRE controls the Board of Managers of GAR and, as a result, under the Company's operating agreement, LRE controls the board of managers of the Company. In June 2006, GAR increased its ownership to 100% of the common equity of the Company by purchasing 100% of the Class C Common Units from Joseph Billhimer at fair value. As a result of the consummation of the Transaction, on May 5, 2006, BHR Holdings, Inc. (BHR), a wholly owned indirect subsidiary of Leucadia and the parent company of LRE, commenced a tender offer (the Offer) for all of the outstanding $160 million principal amount of the Company's 10 3/4% First Mortgage Notes due February 1, 2012 (the Notes) at a price equal to 101% of the par value of the Notes, plus accrued and unpaid interest to the date of payment. The Offer, which expired at noon on June 9, 2006, satisfied the Company's obligation under the Indenture to make such an offer upon the occurrence of a change of control as defined in the Indenture. In connection with the Offer, GAR agreed to cause Premier to pay BHR a fee of $2.0 million, which will be paid only to the extent distributions from the Company are available for such purpose. A liability has been recorded for this fee and is included in other accrued liabilities on the December 31, 2006 consolidated statement of financial position. 7 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 1. Nature of Business and Summary of Significant Accounting Policies (continued) In addition, the members of the Board of Managers of Premier are entitled to be paid an annual management fee in an aggregate amount of $2.0 million which will be paid by Premier to the extent distributions from the Company are available for such purpose. The Company began accruing for this fee as of the date of the Transaction and accrued $1.4 million for this management fee in other accrued liabilities on the December 31, 2006 consolidated statement of financial position. Bankruptcy Filing On September 19, 2006 (the Petition Date), the Company filed voluntary petitions for reorganization under chapter 11 of title 11 of the United States Code, before the United States Bankruptcy Court (the Court) for the Southern District of Mississippi, Southern Division (Case No. 06-50975 (ERG)). The Company sought the Court's assistance in gaining access to Hurricane Katrina - related insurance proceeds over which U.S. Bank National Association, in its capacity as trustee and disbursement agent (trustee and disbursement agent) for the Notes and a group of majority holders of the Notes had denied access. Under Chapter 11, certain claims against the Company in existence prior to the filing of the petitions were stayed while the Company continued business operations as a debtor-in-possession. As a debtor-in-possession, the Company followed the guidance of Statement of Position 90-7, Financial Reporting by Entities in Reorganization Under the Bankruptcy Code. Accordingly, certain of the stayed claims which were impaired under the plan are reflected in the December 31, 2006 consolidated statement of financial position as "liabilities subject to compromise." Certain revenues and expenses resulting from the reorganization are reported as reorganization items in the December 31, 2006 statement of operations and member's equity. On December 11, 2006, the Company filed with the Court a plan of reorganization (the Plan) and subsequently filed an amended Plan with the Court on February 22, 2007. 8 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 1. Nature of Business and Summary of Significant Accounting Policies (continued) On July 30, 2007, the Court entered an order confirming the Plan, subject to a modification which the Company filed on August 1, 2007. On August 10, 2007, Premier Entertainment and Premier Finance emerged from bankruptcy when the Plan was substantially consummated (the Effective Date). As such, Premier Entertainment and Premier Finance are no longer classified as debtors-in-possession. The Court continues to retain jurisdiction of certain matters including the ultimate resolution of the disputed escrow amount as described below and resolution of certain other disputed claims. Under the Plan, as approved by the Court, Noteholders received principal of $160 million and accrued unpaid interest of $9.1 million in cash on the Effective Date. In addition, the Company placed $14.7 million in escrow with U.S. Bank. $13.7 million of this amount represents a prepayment premium or penalty, which the Noteholders may be entitled. The Company disputes that any prepayment premium or penalty is due the Noteholders and as such the disputed amount has been placed in escrow pending resolution by the Court. In addition, the Company placed $1 million in escrow for fees and expenses which may be incurred by the trustee in conjunction with the dispute resolution. On the Effective Date, Peoples Bank, holder of the senior secured reducing line of credit facility received $1.3 million of principal plus interest at a reduced rate of 7% from the Petition Date through the Effective Date. Holders of other secured claims received 100% of their allowed claim, including contractual interest on the Effective Date. Holders of general unsecured claims received 50% of their allowed claim plus post petition interest at the federal judgment rate of 5.02% on the Effective Date and received the balance, with interest, on October 10, 2007. The Plan was funded by a $180 million senior secured credit facility dated August 10, 2007 provided by BHR, an affiliate of the Company and a $20 million loan and security agreement dated August 10, 2007 provided by International Game Technology (IGT). 9 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 1. Nature of Business and Summary of Significant Accounting Policies (continued) The BHR credit facility will mature February 2012, bears interest at 10 3/4%, is prepayable at any time without penalty, and contains other covenants, terms and conditions similar to those contained in the indenture that governed the Notes (see Note 5). On the Effective Date, $160 million was advanced to the Company under this facility. As of October 11, 2007, the full $180 million had been advanced. The IGT loan was funded on the Effective Date and is secured by certain IGT slot machines, slot system, and non-IGT ancillary equipment and is payable in thirty-five consecutive monthly installments based on a sixty-month amortization with a balloon payment on the thirty-sixth month of the outstanding remaining principal balance. Interest accrues at the "high Wall Street Journal prime lending rate," currently 7.5% and the first payment of principal and interest was due September 20, 2007. The loan also included a 2% loan fee of $139,332 for the portion of the loan representing the non-IGT ancillary equipment. On August 2, 2007, certain of the Noteholders filed a notice of appeal of the confirmation order and a motion for stay of the confirmation order pending resolution of the appeal. On August 10, 2007, the motion for stay of the confirmation was denied by both the Court and the United States District Court for the Southern District of Mississippi. The Company has filed a motion to dismiss the appeal on the basis of equitable mootness due to the fact that the Plan has been substantially carried out. A hearing date on the appeal has not been set although the Company believes the appeal is without merit, and intends to vigorously contest the appeal. Liabilities Subject to Compromise The following table summarizes the components of liabilities subject to compromise included on the consolidated statement of financial position as of December 31, 2006:

Senior note in default including accrued interest $ 167,166,667 F&E financing in default including accrued interest 15,559,469 Accounts payable and other accrued liabilities (a) 23,995,145 ------------- Total liabilities subject to compromise $ 206,721,281 =============

10 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 1. Nature of Business and Summary of Significant Accounting Policies (continued) (a) Accounts payable and other accrued liabilities include $14.2 million payable to affiliated parties (see Note 6). Liabilities subject to compromise refers to pre-petition obligations that may have been impacted by the Chapter 11 reorganization process. The amounts represented the Company's estimate at December 31, 2006 of known or potential obligations to be resolved in connection with the Chapter 11 proceedings. In 2007 the resolution of liabilities recorded as of December 31, 2006 and claims filed has resulted in a $1.3 million net reduction in those liabilities. Such amount has been recognized as a gain in 2007. Reorganization Items, Net The following table summarizes the components included in reorganization items, net on the consolidated statement of operations and member's equity for the year ended December 31, 2006:

Professional fees $ (362,956) Write-off of deferred financing costs and original issue discount (6,479,361) Interest income 1,976,426 --------------- Total reorganization items, net $ (4,865,891) ===============

Insurance Recoveries On August 15, 2005, the Company purchased a comprehensive blanket insurance policy providing up to $181.1 million in coverage for damage to real and personal property, including business interruption coverage. The insurance was comprised of a $25.0 million primary layer underwritten by Industrial Risk Insurers, a $25.0 million first excess layer underwritten by several insurance carriers, and a second excess layer comprising $131.1 million underwritten by several insurance carriers. The syndicated coverage was spread over twelve different insurance carriers. The Company had a 3.0% deductible on its coverage, but purchased three additional insurance policies to reduce the Company's exposure related to that deductible. 11 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 1. Nature of Business and Summary of Significant Accounting Policies (continued) As of December 31, 2006 the Company had reached final settlements with all but one of its carriers under its blanket insurance policies and had collected a total of $160.9 million. Only $12.6 million of $14.0 million face value of insurance policies remained unsettled at December 31, 2006. In January 2008, the Company settled the remaining insurance claim and by February 21, 2008 the Company had collected an additional $11.4 million. The Company recognized insurance recoveries of $42.4 million in 2006 and a total of $160.9 million from the period of inception through December 31, 2006. Principles of Consolidation The consolidated financial statements include the accounts of Premier Entertainment and its wholly owned subsidiary, Premier Finance Biloxi Corp. All significant inter-company accounts and transactions have been eliminated. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Property and Equipment Property and equipment are stated at cost. The Company capitalizes the cost of purchases of property and equipment and capitalizes the cost of improvements to property and equipment that increase the value or extend the useful life of the asset. Maintenance and repairs are charged to expense as incurred. Depreciation is computed using the straight-line method over the following estimated useful lives of the assets: Building 40 years Furniture, fixtures, and equipment 5-10 years 12 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 1. Nature of Business and Summary of Significant Accounting Policies (continued) The Company has included in the consolidated statements of operations and members' equity depreciation expense related to office space and equipment that was placed in service after Hurricane Katrina. In accordance with SFAS No. 34, Capitalization of Interest Cost (SFAS No. 34), the Company capitalizes the interest cost associated with major development and construction projects as part of the cost of the project. Interest is typically capitalized on amounts expended on the project using the weighted-average cost of outstanding borrowings. Capitalization of interest starts when construction activities, as defined in SFAS No. 34, begin and ceases when construction is substantially complete or development activity is suspended for more than a brief period. Accordingly, the Company suspended the capitalization of interest after Hurricane Katrina and resumed capitalization of interest in third quarter 2006 when construction of the facility recommenced. Long-Lived Assets Long-lived assets to be held and used by the Company are reviewed to determine whether any events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. Factors that might indicate a potential impairment may include, but are not limited to, significant decreases in the market value of the long-lived asset, a significant change in the long-lived asset's physical condition, a change in industry conditions or a reduction in cash flows associated with the use of the long-lived asset. If these or other factors indicate the carrying amount of the asset may not be recoverable, the Company determines whether an impairment has occurred through the use of an undiscounted cash flow analysis of the asset at the lowest level for which identifiable cash flows exist. If an impairment has occurred, the Company recognizes a loss for the difference between the carrying amount and the fair value of the asset. The fair value of the asset is measured using market prices or, in the absence of market prices, is based on an estimate of discounted cash flows. The Company has included an impairment charge in its consolidated statements of operations and members' equity of $1.1 million and $113.2 million for the year ended December 31, 2006 and the period from inception through December 31, 2006, respectively, as a result of the damage caused by Hurricane Katrina. 13 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 1. Nature of Business and Summary of Significant Accounting Policies (continued) Intangible Assets The Company has a license agreement with Hard Rock Hotel Licensing, Inc., which provides for an initial term of twenty years and the option to renew for two successive ten-year terms. Under the license agreement, the Company has the exclusive right to use and develop the "Hard Rock" brand name in connection with a hotel and casino resort in Biloxi, Mississippi. As consideration for the licensed rights as provided in the license agreement, the Company paid a one-time territory fee of $500,000. This cost was capitalized and is recorded as other assets on the consolidated statement of financial position and is being amortized over a 20-year period that began in September 2005. Deferred Financing Costs and Debt Discount The costs of issuing long-term debt are capitalized as other assets and, along with the original issue discount, are amortized over the term of the related debt. At September 19, 2006 in conjunction with the bankruptcy filing previously described, the Company wrote off the unamortized balance of the cost of issuing the Notes in the amount of $4.9 million and the related original issue discount of $1.6 million. These costs were written off to accurately adjust the amount of the Notes allowed by the Bankruptcy Court as a claim against the Company and have been classified on the consolidated statements of operations and members' equity as reorganization items. Self-Insurance Prior to July 1, 2006, the Company was self-insured for employee medical insurance coverage up to an individual stop loss of $15,000. Self-insurance liabilities are estimated based on the Company's claims experience and are included in other accrued liabilities on the consolidated statement of financial positions. Such amounts are immaterial at December 31, 2006. Effective July 1, 2006, the Company changed to a fully insured plan. 14 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 1. Nature of Business and Summary of Significant Accounting Policies (continued) Preopening Costs Preopening costs are expensed as incurred, consistent with Statement of Position 98-5, Reporting on the Costs of Start-up Activities (SOP 98-5). Expenses incurred include payroll and payroll related expenses, marketing expenses, rental expenses, outside services, legal and professional fees, and other expenses related to the start-up phase of operations. Income Taxes As a limited liability company, the Company has elected to be treated as a partnership for income tax purposes; accordingly, any tax related to the Company's income is the obligation of its members and no federal or state income tax provision has been recorded in the Company's consolidated financial statements. New Accounting Pronouncement Effective January 1, 2006, the Company adopted the provision of FASB Statement No. 123(R), Share-Based Payment, which is a revision of SFAS 123 and supersedes APB Opinion No. 25. The effect of adopting this new standard had no effect on the Company's accounting for its 2004 Membership Interest Appreciation Rights Plan which allow for the receipt of an award based on the increase in value of the Company. The plan was terminated in June 2006 and no other awards or grants are outstanding. 2. Restricted Cash The net proceeds from the issuance of the Notes, a portion of the equity investment and the proceeds from the junior subordinated note were deposited into a construction disbursement account and a tidelands lease reserve account pursuant to the disbursement agreement of the Notes and utilized to construct the property which was substantially completed in August 2005 and subsequently damaged by Hurricane Katrina. The insurance proceeds related to Hurricane Katrina totaling $160.9 million have been deposited into the restricted accounts held by the trustee. These accounts were pledged to the trustee and disbursement agent as security for the Company's obligations under the Notes, and could only be released to the Company in accordance with the disbursement agreement or approval from the Court (see Note 1). 15 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 2. Restricted Cash (continued) The Company also has a $1.0 million certificate of deposit which is pledged as security for the Company's obligations under the Hard Rock license agreement. In the accompanying consolidated statement of financial position, restricted cash is classified as noncurrent as it is primarily designated for the reconstruction of property and purchases of equipment. Restricted cash includes the following:

Construction disbursement $ 117,047,468 Tidelands lease reserve 1,045,240 Insurance proceeds in escrow (a) 15,149,751 -------------- Cash restricted by the Notes 133,242,459 Certificate of deposit restricted by the Hard Rock license agreement 1,000,000 -------------- Total restricted cash $ 134,242,459 ==============

(a) Includes $1.3 million escrowed on behalf of Peoples Bank and $13.8 million escrowed on behalf of IGT pending determination of their rights, if any to the insurance proceeds. 3. Property and Equipment Property and equipment held at December 31, 2006 consisted of the following:

Land $ 30,991,578 Building 50,707,794 Equipment 12,643,492 Construction in progress 40,848,974 -------------- 135,191,838 Less accumulated depreciation 1,097,518 -------------- Property and equipment, net $ 134,094,320 ==============

Depreciation expense totaled $771,450 in 2006. Interest capitalized totaled $0.5 million in 2006 and $16.9 million for the period from inception through December 31, 2006. 16 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 4. Other Noncurrent Assets

Other assets, net consisted of the following: Hard Rock license fee, net of accumulated amortization of $33,334 $ 466,666 Deferred financing costs, net of accumulated amortization of $151,823 273,177 Deposit 122,795 ------------ Other assets, net $ 862,638 ============

Amortization expense for the Hard Rock license fee and the leasehold contract was $25,000 in 2006. For the Hard Rock license fee, the estimated amortization expense per year for the next five years is $25,000. 5. Long-Term Debt and Loan and Security Agreement

Long-term debt as of December 31, 2006 is as follows: 10 3/4% First Mortgage Notes due 2012 in default, net $ 160,000,000 15% Junior Subordinated Note due 2012 in default, net 14,430,810 Variable rate IGT note payable in default 12,870,932 Variable rate Senior Secured Reducing Line of Credit Facility in default 1,250,000 Fixed rate BHR note payable in default 8,100,000 --------------- 196,651,742 --------------- Less debt and loan agreements classified as liabilities subject to compromise 174,120,932 Less notes payable current 8,100,000 --------------- Long-term debt $ 14,430,810 ===============

17 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 5. Long-Term Debt and Loan and Security Agreement (continued) 10 3/4% First Mortgage Notes due 2012 On January 23, 2004, the Company issued $160 million of 10 3/4% First Mortgage Notes due February 1, 2012 in a private placement offering which were subsequently exchanged in an exchange offer registered on Form S-4. The unamortized discount of $1.6 million, which was being amortized over the term of the Notes was written off during the year ended December 31, 2006 as a result of the bankruptcy filing. The Notes were senior to all existing and future senior unsecured indebtedness, but were subordinated to $14.1 million of senior secured indebtedness incurred to finance the acquisition and installation of furniture, fixtures, and equipment. The Notes were secured by a pledge of the Company's membership interests and substantially all of the existing and future assets, except for assets securing certain other indebtedness. In addition, the trustee and disbursement agent was named as a loss payee on behalf of the noteholders under the Company's insurance policies. Interest on the Notes was payable semiannually on each February 1 and August 1 through maturity. Under the governing indenture, the Notes may have been redeemed, in whole or in part, at any time on or after February 1, 2008 at the redemption prices (expressed as percentages of principal amount) set forth below, plus accrued and unpaid interest, to the applicable redemption date, if redeemed during the 12-month period beginning on February 1 of the years indicated below: Year Percentage -------------------- -------------- 2008 105.38% 2009 102.69% 2010 and thereafter 100.00% In addition, up to 35% of the Notes may have been redeemed at a premium on or prior to February 1, 2007 with the net cash proceeds of an initial public offering. Deferred financing costs, net of accumulated amortization of $4.9 million, which were incurred in connection with the issuance were written off at September 19, 2006 as a result of the bankruptcy filing. Prior to the write-off, these deferred financing costs had been included in other assets and were being amortized over the term of the related long-term debt. As a result of the bankruptcy, the Notes are classified as liabilities subject to compromise in the accompanying consolidated statement of financial positions. The notes were paid in full on August 10, 2007 in accordance with the Company's confirmed plan of reorganization (see Note 1). 18 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 5. Long-Term Debt and Loan and Security Agreement (continued) 15% Junior Subordinated Note due 2012 Concurrently with the issuance of the Notes, the Company borrowed $10.0 million in the form of a junior subordinated note due August 1, 2012 from Rank America, Inc., an affiliate of The Rank Group Plc, and owner of Hard Rock Hotel Licensing, Inc. Interest on the junior subordinated note accrues at a rate of 15% per annum and will be paid semiannually. If the Company had opened as planned, the first interest payment would have been due on February 1, 2006. Accrued interest at each semi annual interest payment date prior to opening is added to the principal balance. The Company will be required to pay a repayment premium of 3% of the principal amount of the junior subordinated note when it is repaid. Such premium is being accrued over the term of the junior subordinated note. On April 25, 2006, LRE, an affiliated company, acquired the junior subordinated note from Rank America, Inc. IGT Note Payable On January 5, 2005, the Company entered into a Commercial Sales and Security Agreement (the IGT Agreement) with IGT for the financing of certain gaming devices and systems. Pursuant to the IGT Agreement, the Company purchased approximately 1,100 slot devices from IGT, as well as software licenses and related equipment for the gaming system. Under the IGT Agreement, interest accrued at the "high Wall Street Journal prime lending rate" (8.25% at December 31, 2006) and payments were based on a 60-month amortization payable in thirty-six monthly installments of principal and accrued interest with the balance due on the thirty-seventh month (November 2008). IGT was named as a loss payee under the Company's insurance policies. As a result of the bankruptcy, the amount due under the IGT Agreement is classified as liabilities subject to compromise in the accompanying consolidated statement of financial position. In accordance with the Company's confirmed plan of reorganization, $7.6 million of principal, accrued pre-petition interest at the contract rate, and post-petition accrued interest at the reduced rate of 5.02% was paid on August 10, 2007. The remaining balance of principal and accrued interest was paid October 10, 2007 (see Note 1). 19 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 5. Long-Term Debt and Loan and Security Agreement (continued) Senior Secured Reducing Line of Credit Facility On August 26, 2005, the Company received a $1.3 million loan from The Peoples Bank pursuant to a $10.0 million Senior Secured Reducing Line of Credit Facility (the Credit Facility). The Credit Facility was secured by a security interest in certain collateral purchased by the Company and the lender was named as a loss payee under the Company's blanket insurance policies. The Credit Facility had a term of 66 months that included an initial funding period that ended on December 31, 2005. Interest on the Credit Facility accrued at the rate of 9.6659% at December 31, 2006, based on twelve-month LIBOR plus 4.25%. On December 31, 2005, the outstanding balance of the Credit Facility was converted into a fully amortizing, five-year term loan due December 31, 2010, requiring quarterly payments of principal and interest. As a result of the bankruptcy, the amounts due under the credit facility are classified as liabilities subject to compromise in the accompanying consolidated statement of financial position. In accordance with the Company's confirmed plan of reorganization, the credit facility was paid in full, with post petition accrued interest at the reduced rate of 7% per annum on August 10, 2007. BHR Holdings, Inc. Note Payable On May 23, 2006, the Company received an $8.0 million loan from BHR, an affiliated company. An additional $0.1 million was received in September 2006. The note bears interest at 12% per annum and the principal balance and all accrued and unpaid interest is due on the earlier of May 23, 2007 or the date on which sufficient insurance proceeds received from certain insurance carriers become available to repay the note. Other On July 1, 2005, the Company obtained an Irrevocable Letter of Credit from The Peoples Bank in favor of Hard Rock Hotel Licensing, Inc. in the amount of $1.0 million to comply with the terms and conditions of the Licensing Agreement with Hard Rock Hotel Licensing, Inc. The Letter of Credit is secured by a certificate of deposit in the amount of $1.0 million for a term of 90 days and will automatically renew. 20 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 6. Related Party Transactions Roy Anderson, III a member of GAR is the President, Chief Executive Officer and majority stockholder of Roy Anderson Corp. (RAC), the Company's general contractor. Pursuant to a guaranteed maximum price construction agreement, dated December 24, 2003, (the Initial Construction Agreement), as amended, RAC had constructed the Hard Rock Casino and Hotel facilities (the Project). Total payments for construction of the Project for the period from the commencement of operations on March 27, 2003 through December 31, 2006 were $89.5 million, of which $71.1 million was paid directly to RAC. Post-Katrina remedial work was performed by RAC and payments in respect thereof through December 31, 2006 were $7.5 million; $2.9 million was outstanding and reflected in liabilities subject to compromise in the December 31, 2006 consolidated statement of financial position. In accordance with the Company's confirmed plan of reorganization, this amount was paid in full on September 30, 2007 (see Note 1). On June 16, 2006, the Initial Contract was amended and restated (the Amended Construction Agreement) to provide for rebuilding the casino portion of the Hard Rock Biloxi and renovating and repairing the existing hotel tower, low-rise building, parking garage and pool and deck area that were severely damaged by Hurricane Katrina. Pursuant to the terms of the Amended Construction Agreement, the Company agreed to pay RAC the cost of the work performed plus a contractor's fee, with the aggregate of such amounts not to exceed the guaranteed maximum price of $78.3 million. Deductive change orders were issued on October 25, 2006, May 25, 2007, and October 10, 2007, reducing the amount of the guaranteed maximum price to $73.0 million. At December 31, 2006, work performed by RAC under the Amended Construction Agreement was $33.6 million, of which $26.4 million was paid to RAC and $7.2 million is outstanding and reflected in accounts payable in the December 31, 2006 consolidated statement of financial position. The Company believes that the terms of the amendments to the Amended Construction Agreement are no less favorable to the Company than the terms of the Initial Construction Agreement. On June 16, 2006, the Company entered into a receivables purchase agreement with BHR and RAC. Pursuant to the terms of the receivables purchase agreement, BHR agreed to purchase up to $40.0 million of receivables due to RAC by the Company under the amended construction contract if such receivables are past due for more than ten days. At December 31, 2006, $11.3 million of the amount paid to RAC was paid under this purchase agreement. The Company has reflected these amounts owing to BHR as liabilities subject to compromise in the December 31, 2006 consolidated statement of financial position. In accordance with the Company's confirmed plan of reorganization, this amount was paid in full on October 10, 2007 (see Note 1). In March 2006, the Company entered into an agreement with RAC to provide additional services at the property required as a result of the damage caused by Hurricane Katrina. The Company agreed to pay RAC the cost of the work performed plus a contractor's fee in an amount not to exceed the guaranteed maximum price of $1.4 million. At December 31, 2006, total amount billed and paid under this agreement was $1.4 million. 21 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) 7. 2004 Membership Interest Appreciation Rights Plan On June 13, 2006, the Company entered into agreements with the employees who were participants in the Company's Membership Interest Appreciation Rights Plan, to terminate such plan. As a result of the plan termination, payments aggregating $198,400 were made to plan participants and are included in preopening expenses in the consolidated statement of operations and members' equity for the year ended December 31, 2006. 8. Commitments Operating Leases The Company is committed under various operating lease agreements which were assumed in the bankruptcy proceedings primarily related to property, submerged tidelands and equipment. Generally, these leases include renewal provisions and rental payments, which may be adjusted for taxes, insurance and maintenance related to the property. Future minimum rental commitments under noncancelable operating leases are as follows: 2007 $ 806,697 2008 1,291,660 2009 1,291,660 2010 1,289,440 2011 1,285,000 Thereafter 28,061,163 --------------- $ 34,025,620 =============== Total rent expense for these long-term lease obligations was $219,900 in 2006, and $695,513 for the period from inception through December 31, 2006. In October 2003, the Company entered into an agreement with the State of Mississippi for the lease and use of approximately 5 acres of submerged tidelands. The term of the lease is for a period of 30 years. For the initial period commencing on October 27, 2003 until the opening date as defined in the agreement, the Company was required to pay annual rent of $21,900. From the opening date through the remainder of the lease term, the lease rate was to be determined as fair value on that date. In conjunction with the opening of the casino, the revised lease rate is $985,000 annually. This rate will be adjusted annually based on the CPI change for the period. In November 2003, the Company entered into an agreement with the City of Biloxi, Mississippi to lease property and the related airspace for a period of 40 years. For the initial three years of the lease beginning in October 2004, the Company must pay monthly rent of $12,500. The rent will increase by the Consumer Price Index beginning on the fifth anniversary date of execution of the lease and continuing on each fifth anniversary date. Under the Hard Rock licensing agreement, the Company is obligated to pay an annual lease fee of $150,000 for memorabilia displayed at the Hard Rock Biloxi. The annual lease fee is fixed for the first two years and then adjusts thereafter by the greater of 3% or an adjustment based on the inflation index, but in no event shall such adjustment exceed 5% annually. 22 Premier Entertainment Biloxi LLC -------------------------------- (A Development-Stage Company) ---------------------------- Debtor-In-Possession -------------------- Notes to Consolidated Financial Statements - Unaudited (continued) Other Commitments Under the Hard Rock licensing agreement, the Company is obligated to pay an annual fee of $1.1 million which increases to $1.5 million over five years and increases annually thereafter based on the consumer price index, plus fees based on future non-gaming revenues. The Company will pay a "Continuing Fee" equal to three percent (3%) of the Licensing Fee Revenues and a marketing fee equal to one percent (1%) of the Licensing Fee Revenues during the term of the agreement. In no event shall these fees be construed so as to allow licensor to share in any revenue generated by the Company's gaming operations. In April 2006, the Company agreed to accrue $150,000 per month in lieu of any other fees due under the terms of the license agreement until such time that the operations commence. At December 31, 2006, $2.5 million has been accrued and recorded in other accrued liabilities in the accompanying consolidated statement of financial position. Such amounts were subsequently paid in November 2007. 9. Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practical to estimate that value: o Cash and cash equivalents - The carrying amounts approximate fair value because of the short maturity of these instruments. o Restricted cash - The carrying amounts approximate fair value because of the short maturity of these instruments. o Long-term debt - As a result of the bankruptcy filing, the fair value of the Company's long-term debt as of December 31, 2006 cannot be estimated. As a result, the fair value is presented at its carrying value. Debt obligations with a short remaining maturity are valued at the carrying amount. The estimated carrying amounts and fair values of the Company's financial instruments at December 31, 2006 are as follows:

Carrying Amount Fair Value ------------------- ------------- Financial assets: Cash and cash equivalents $ 858,072 $ 858,072 Restricted cash 134,242,459 134,242,459 Financial liabilities: 10 3/4% First mortgage notes 160,000,000 160,000,000 15% Junior subordinated note 14,430,810 14,430,810 IGT note payable 12,870,932 12,870,932 Senior secured reducing line of credit facility 1,250,000 1,250,000 BHR note payable 8,100,000 8,100,000

23 HFH ShortPLUS FUND, L.P. (In Liquidation) Statement of Financial Condition Year Ended December 31, 2008 (Unaudited) --------------------------------------------------------------------------------

Assets Investment in HFH ShortPLUS Master Fund, Ltd. (In Liquidation), at fair value $ 40,625,051 Cash 2,673 ------------- $ 40,627,724 ============= Liabilities and partners' capital Liabilities Capital withdrawals payable $ 19,969,871 Accrued expenses 134,999 ------------- Total liabilities 20,104,870 Partners' capital 20,522,854 ------------- $ 40,627,724 =============

1 See accompanying notes to financial statements HFH ShortPLUS FUND, L.P. (In Liquidation) Statement of Operations Year Ended December 31, 2008 (Unaudited) --------------------------------------------------------------------------------

Net investment income (loss) allocated from HFH ShortPLUS Master Fund, Ltd. (In Liquidation) Interest income $ 2,542,190 Interest expense (864,798) Professional fees and other (227,559) Administrative fee (40,223) ------------------ Total net investment income (loss) allocated from HFH ShortPLUS Master Fund, Ltd. (In Liquidation) 1,409,610 ------------------ Fund income Interest 1,912 ------------------ Fund expenses Management fee 601,176 Professional fees and other 125,733 ------------------ Total Fund expenses 726,909 ------------------ Net investment income 684,613 ------------------ Realized and unrealized gain (loss) on investments allocated from HFH ShortPLUS Master Fund, Ltd. (In Liquidation) Net realized gain (loss) on securities (2,200,823) Net realized gain (loss) on credit default swap contracts 59,941,394 Net change in unrealized appreciation or (depreciation) on securities (887,582) Net change in unrealized appreciation or (depreciation) on credit default swap contracts (45,623,955) Net gain (loss) from foreign exchange transactions (23,115) ------------------ Net gain (loss) on investments 11,205,919 ------------------ Net income 11,890,532 Less reallocation to the General Partner 1,246,505 ------------------ Net income available for distribution to all partners $ 10,644,027 ==================

2 See accompanying notes to financial statements HFH ShortPLUS FUND, L.P. (In Liquidation) Statement of Changes in Partners' Capital Year Ended December 31, 2008 (Unaudited) --------------------------------------------------------------------------------

General Limited Partner Partners Total ------- -------- ----- Partners' capital, beginning of year $ 6,565,358 $ 83,295,107 $ 89,860,465 Early withdrawal fees 13 210,664 210,677 Capital withdrawals (7,260,220) (74,178,600) (81,438,820) Allocation of net income Pro rata allocation 6,126 11,884,406 11,890,532 Reallocation to General Partner 1,246,505 (1,246,505) -- -------------- ------------- -------------- 1,252,631 10,637,901 11,890,532 -------------- ------------- -------------- Partners' capital, end of year $ 557,782 $ 19,965,072 $ 20,522,854 ============== ============= ==============

3 See accompanying notes to financial statements HFH ShortPLUS FUND, L.P. (In Liquidation) Statement of Cash Flowsl Year Ended December 31, 2008 (Unaudited) --------------------------------------------------------------------------------

Cash flows from operating activities Net income $ 11,890,532 Adjustments to reconcile net income to net cash provided by operating activities: Net income allocated from HFH ShortPLUS Master Fund, Ltd. (In Liquidation) (12,615,529) Changes in operating assets and liabilities: Proceeds from the sales of shares from HFH ShortPLUS Master Fund, Ltd. (In Liquidation) 55,914,309 Other assets 140 Accrued expenses 112,498 ----------------- Net cash provided by operating activities 55,301,950 ---------------- Net cash flows used in financing activities, Capital withdrawals, net of capital withdrawals payable and early withdrawal fees (61,258,272) ---------------- Net change in cash (5,956,322) Cash, beginning of year 5,958,995 ---------------- Cash, end of year $ 2,673 ================

4 See accompanying notes to financial statements HFH ShortPLUS FUND, L.P. (IN LIQUIDATION) Notes to Financial Statements (Unaudited) -------------------------------------------------------------------------------- 1. Nature of operations and summary of significant accounting policies Nature of Operations HFH ShortPLUS Fund, L.P. (the "Partnership") is a Delaware limited partnership and commenced operations on January 2, 2007. The Partnership invests substantially all of its investable assets through a "master-feeder" structure in HFH ShortPLUS Master Fund, Ltd. (the "Master Fund"), a Cayman Islands exempted company that invests and trades a short-biased portfolio of asset-backed securities ("ABS") that the Investment Manager believes are most likely to produce high returns during periods of adverse credit performance for residential mortgages, and for mortgage-backed securities ("MBS") and ABS. Returns will come from two principal sources: (i) market value changes, arising from changes in credit spreads on the Master Fund's short positions; and (ii) credit default payments from counterparties on credit default swaps ("CDS") or other derivatives in credit sensitive mortgage and asset-backed securities, consumer debt and other assets. The Partnership's investment objective is the same as that of the Master Fund. The financial statements of the Master Fund are included elsewhere in this report and should be read in conjunction with the Partnership's financial statements. Highland Financial Holdings, LLC (the "General Partner") serves as the General Partner and Highland Financial Holdings Group, LLC ("Investment Manager") serves as the investment manager of the Partnership. The Master Fund is also managed by the Investment Manager. Valuation of the investments held by the Master Fund is discussed in the notes to the financial statements of the Master Fund included elsewhere in this report. The percentage of the Master Fund's net assets owned by the Partnership at December 31, 2008 was approximately 21.5%. In accordance with the Partnership's documents, the General Partner has formalized a plan of liquidation to liquidate the Partnership in an orderly manner, and as a result, changed its basis of accounting from the going concern to the liquidation basis whereby assets and liabilities are stated at their estimated settlement amounts and all costs of liquidation have been recognized. The adoption of the liquidation basis of accounting did not have a material effect on the carrying values of assets and liabilities as of December 31, 2008. The residual 50% of the capital held by the remaining investors in the Partnership will be distributed on or about March 31, 2009. The distribution amount which dollars and shares are not currently fixed and determinable approximate $19,970,000. In addition, a new entity, HFH ShortPLUS Master Fund Liquidating Trust was established for purposes of receiving cash flows on securities that were distributed in-kind. Basis of Presentation The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. Valuation of Investment in HFH ShortPLUS Master Fund, Ltd. The Partnership records its investment in the Master Fund at fair value based on the net asset value of the Master Fund. Valuation of instruments held by the Master Fund is discussed in Note 1 of the Master Fund's financial statements. 5 HFH ShortPLUS FUND, L.P. (IN LIQUIDATION) Notes to Financial Statements -------------------------------------------------------------------------------- 1. Nature of operations and summary of significant accounting policies (continued) Income and Expense Recognition The Partnership records its proportionate share of the Master Fund's investment income/loss, expenses and realized and unrealized gains and losses. The Master Fund's income and expense recognition and allocation policies are discussed in Note 1 of the Master Fund's financial statements. Interest income of the Partnership's cash balance is accrued as earned. Expenses that are directly attributable to the Partnership are recorded on the accrual basis as incurred. Income Taxes The Partnership is not a taxable entity for federal, state or local income tax purposes; such taxes are the responsibility of the individual partners. Accordingly, no provision has been made in the accompanying financial statements for any federal, state or local income taxes. On December 30, 2008, the FASB issued FIN 48-3, Effective Date of FASB Interpretation No. 48 for Certain Nonpublic Enterprises ("FSP"), which allows the Partnership to defer the adoption of FIN 48 until periods beginning after December 15, 2008. The General Partner has elected to take advantage of this deferral. Based on its continued analysis, the General Partner has determined that the adoption of FIN 48 will not have a material impact on the Partnership's financial statements. However, the General Partner's conclusions regarding FIN 48 may be subject to review and adjustment at a later date based on factors including, but not limited to, further implementation guidance and on-going analyses of tax laws, regulations and interpretations thereof. The Partnership's accounting policy for evaluating uncertain tax positions during financial statement periods subject to the deferral of FIN 48 is based on the recognition and disclosure criteria for loss contingencies under SFAS No. 5 "Accounting for Contingencies". FIN 48 requires the General Partner to determine whether a tax position of the Partnership is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement which could result in the Partnership recording a tax liability that would reduce net assets. FIN 48 must be applied to all existing tax positions upon initial adoption and the cumulative effect, if any, is to be reported as an adjustment to partners' capital upon adoption. Use of Estimates The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts and disclosures in the financial statements. Actual results could differ from these estimates. 6 HFH ShortPLUS FUND, L.P. (IN LIQUIDATION) Notes to Financial Statements -------------------------------------------------------------------------------- 2. Partners' capital The minimum initial and subsequent capital contributions (each a "Capital Contribution") in the Partnership are $5,000,000 and $1,000,000, respectively. The Investment Manager may waive or reduce the minimum capital contributions in its sole discretion. The General Partner admitted new Limited Partners and permitted Limited Partners to make additional capital contributions as of the first business day of each calendar month, or at any other time in the General Partner's sole discretion. Subject to the lock-up period and early withdrawal fee, Limited Partners had the right to require the Partnership to withdraw all or any portion of their investment by delivering written notice to the General Partner not less than 90 days prior to the end of any calendar quarter, or at such other times as the General Partner determined in its sole discretion. The General Partner reserved the right to waive or reduce the notice period in its sole discretion. Notwithstanding anything to the contrary, a Limited Partner could not withdraw each capital contribution (and any appreciation thereon) until after the 12 month period (the "Lock-up Period") following the date of such contribution, without the prior consent of the General Partner, which may have been granted or denied in the General Partner's sole discretion. Limited Partners who withdraw a Capital Contribution after the Lock-up Period with respect to such Capital Contribution but less than 24 months after purchasing such capital contribution will be charged an early withdrawal fee equal to 5% of the withdrawal amount. Any early withdrawal fee will be payable to the Partnership and is subject to the incentive allocation described in Note 3. The General Partner reserves the right, in its sole discretion, to waive or reduce the early withdrawal fee on a case-by-case basis. Subject to the Partnership's right to establish reserves, a minimum of 95% of the withdrawals proceeds will generally be paid to the withdrawing Limited Partner within 15 business days after the corresponding withdrawal date, with the balance payable (without interest) within 90 days of the corresponding withdrawal date. However, payments to withdrawing Limited Partners may be subject to further delay or may be suspended. In the event that withdrawal requests are received representing in the aggregate more than 10% of the total Net Asset Value of the Partnership on any withdrawal date, the Partnership is entitled to reduce ratably and pro rata amongst all Limited Partners seeking to withdraw interests on the withdrawal date and to carry out only sufficient withdrawals, which in the aggregate, amount to 10% of the total Net Asset Value of the Partnership on such withdrawal date. 3. Allocation of net income (loss) and incentive allocation Net investment income and gains and losses are allocated to the partners on a monthly basis, based on the partners' proportionate share of capital in the Partnership at the beginning of the month. The General Partner receives an incentive allocation equal to 20% of net capital appreciation (as defined in the limited partnership agreement) credited to the capital account of each limited partner, less management fees. The incentive allocation will be deducted from the capital account of such limited partner and reallocated to the General Partner's capital account. At the discretion of the General Partner, this rate may be reduced for certain Limited Partners. If there is a loss for the fiscal period, such loss is carried forward to future periods and no incentive allocations will be made to the General Partner until prior fiscal period losses are recovered. For the year ended December 31, 2008, the General Partner was allocated $1,246,505 in incentive allocations. 7 HFH ShortPLUS FUND, L.P. (IN LIQUIDATION) Notes to Financial Statements -------------------------------------------------------------------------------- 4. Management fee and other related party transactions The Investment Manager receives a quarterly management fee in arrears, equal to 0.50% (2% per annum) of each Limited Partner's capital account. At the discretion of the General Partner, this rate may be reduced for certain Limited Partners and affiliated fund investments. For the year ended December 31, 2008, the Investment Manager earned a management fee of $601,176 from the Partnership. 5. Off-balance sheet risk, leverage and concentration of credit risks Off-balance sheet risk, leverage and concentration of credit risks are discussed in the Master Fund's financial statements. Due to the nature of the master fund/feeder fund structure, the Partnership could be materially affected by significant subscriptions and redemptions of the other feeder fund. From time to time, the Partnership may have a concentration of partners holding a significant percentage of the Partnership's partners' capital. Investment activities of these partners could have a material impact on the Partnership. At December 31, 2008, one partner owned 97% of the total partners' capital of the Partnership 6. Capital withdrawals payable In accordance with FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, as effected by FASB Staff Position No. FAS 150-3, withdrawals are recognized as liabilities by the Partnership, net of incentive allocations, when the amount requested in the withdrawal notice becomes fixed. This generally occurs either at the time of the receipt of the notice, or on the last day of a fiscal period, depending on the nature of the request. As a result, withdrawals paid after the end of the year, but based upon year-end capital balances are reflected as capital withdrawals payable at December 31, 2008. Withdrawal notices received for which the dollar amount is not fixed remains in capital until the amount is determined. Withdrawals payable may be treated as capital for purposes of allocations of gains/losses pursuant to the Partnership's governing documents. On December 31, 2008, the General Partner of the Partnership passed a resolution to wind-up the operations of the Fund and a compulsorily redeem 50% of the net asset value of the Fund (approximately $19,970,000) which is included in redemptions payable at December 31, 2008. 7. Commitments and contingencies In the normal course of business, the Partnership enters into contracts that contain a variety of representations, warranties and general indemnifications. The Partnership's maximum exposure under these arrangements, including future claims that may be made against the Partnership that have not yet occurred, is unknown. However, based on the experience of the General Partner, the Partnership expects the risk of loss associated with such contracts to be remote. 8 HFH ShortPLUS FUND, L.P. (IN LIQUIDATION) Notes to Financial Statements -------------------------------------------------------------------------------- 8. Administrative fee Admiral Administration, Ltd. (Cayman Islands) (the "Administrator") serves as the Partnership's Administrator and performs certain administrative and clerical services on behalf of the Partnership. 9. Financial highlights Financial highlights for the year ended December 31, 2008 are as follows: Total Return Total return before reallocation to General Partner 16.6% Reallocation to General Partner (1.7) ----- Total return after reallocation to General Partner (a) 14.9% ===== Ratio to average limited partners' capital Expenses (including interest) (b) 3.3% Reallocation to General Partner 2.2 ----- Expenses and reallocation to General Partner 5.5% ===== Expenses excluding interest expense (c) 1.8% ===== Net investment income (d) 1.2% ===== (a) Total return is calculated for aggregate limited partners' capital, exclusive of the General Partner, taken as a whole and adjusted for cash flows related to capital contributions and withdrawals during the year. An individual limited partner's return may differ depending on the timing of contributions and withdrawals, as well as varying fee structures. (b) The operating expense ratio is based on the expenses allocated to each partner prior to the effects of any incentive allocation. For the purpose of this calculation, operating expenses include expenses incurred by the Partnership directly as well as expenses allocated from the Master Fund. Expense ratios are calculated over average net assets. Expense ratio excluding the effect of allocated expenses from the Master Fund would be 1.3%. The expense ratios attributable to an individual partner's account may vary based on different management fee and incentive allocation arrangements and the timing of capital transactions. (c) The expenses excluding interest expense ratio is based on the expenses allocated to each partner. For the purpose of this calculation, operating expenses include expenses incurred by the Partnership directly as well as expenses allocated from the Master Fund, excluding interest expense and the reallocation to the General Partner. Expense ratios are calculated over average net assets. The expense ratios attributable to an individual partner's account may vary based on different management fee arrangements and the timing of capital transactions. (d) The net investment income ratio is based on the net investment income allocated to a limited partner prior to the effect of an incentive allocation and is exclusive of unrealized and realized gains and losses. The net investment income ratio attributable to an individual partner's account may vary based on timing of capital transactions and different management fee arrangements. 9 HFH ShortPLUS FUND, L.P. (IN LIQUIDATION) Notes to Financial Statements -------------------------------------------------------------------------------- 9. Subsequent events As of February 2, 2009, the Custodian for the Partnership changed from J.P. Morgan to Wells Fargo Bank, N.A. 10 HFH ShortPLUS MasterFund, Ltd. (In Liquidation) Statement of Assets and Liabilities (Expressed in United States Dollars) -------------------------------------------------------------------------------- Year Ended December 31, 2008 (Unaudited)

Assets Investments in securities, at fair value (cost $69,721,286) $ 5,812,984 Credit default swap contracts, at fair value (upfront fee payments $9,912,500) 22,081,724 Securities purchased under agreements to resell, at fair value 32,338,000 Cash and cash equivalents 144,185,058 Margin cash paid to counterparties 11,986,130 Other assets 65,455 -------------- Total assets 216,469,351 -------------- Liabilities Margin cash received from counterparties 12,088,168 Credit default swap contracts, at fair value (upfront fee receipts $6,300,000) 14,685,603 Accrued expenses and other payables 441,484 Due to broker 33,439 -------------- Total liabilities 27,248,694 -------------- Net assets $ 189,220,657 ============== Net asset value per share, based on net assets of $189,220,657 and 468.89 shares outstanding $ 403,554.21 ==============

1 See accompanying notes to financial statements. HFH ShortPLUS MasterFund, Ltd. (In Liquidation) Statement of Operations (Expressed in United States Dollars) -------------------------------------------------------------------------------- Year Ended December 31, 2008 (Unaudited)

Investment income Interest $ 9,210,975 -------------- Expenses Interest 3,071,390 Professional fees and other 890,215 Administrative fee 158,920 -------------- Total expenses 4,120,525 -------------- Net investment income (loss) 5,090,450 -------------- Realized and unrealized gain (loss) on investments Net realized gain (loss) on securities (9,307,178) Net realized gain (loss) on credit default swap contracts 225,379,191 Net change in unrealized appreciation or (depreciation) on securities (2,534,158) Net change in unrealized appreciation or (depreciation) on credit default swap contracts (174,353,921) Net gain (loss) from foreign exchange transactions (107,994) -------------- Net gain (loss) on investments 39,075,940 -------------- Net change in net assets resulting from operations $ 44,166,390 ==============

2 See accompanying notes to financial statements. HFH ShortPLUS MasterFund, Ltd. (In Liquidation) Statement of Changes in Net Assets (Expressed in United States Dollars) -------------------------------------------------------------------------------- Year Ended December 31, 2008 (Unaudited)

Operations Net investment income (loss) $ 5,090,450 Net realized gain (loss) on securities (9,307,178) Net realized gain (loss) on credit default swaps 225,379,191 Net change in unrealized appreciation or (depreciation) on securities (2,534,158) Net change in unrealized appreciation or (depreciation) on credit default swap contracts (174,353,921) Net gain (loss) from foreign exchange transactions (107,994) -------------- Net change in net assets resulting from operations 44,166,390 -------------- Capital share transactions Issuance of shares 304,492 Redemption of shares (176,552,945) -------------- Net change in net assets resulting from capital share transactions (176,248,453) -------------- Net change in net assets (132,082,063) Net assets, beginning of year 321,302,720 -------------- Net assets, end of year $ 189,220,657 ===============

3 See accompanying notes to financial statements. HFH ShortPLUS MasterFund, Ltd. (In Liquidation) Statement of Cash Flows (Expressed in United States Dollars) -------------------------------------------------------------------------------- Year Ended December 31, 2008 (Unaudited)

Cash flows from operating activities Net change in net assets resulting from operations $ 44,166,390 Adjustments to reconcile net change in net assets resulting from operations to net cash provided by operating activities: Net realized gain (loss) on securities 9,307,178 Net change in unrealized appreciation or (depreciation) on securities 2,534,158 Changes in operating assets and liabilities: Purchases of investments in securities, at fair value (41,515,670) Proceeds from sales of investments in securities, at fair value 36,188,013 Credit default swap contracts, at fair value 210,366,456 Securities purchased under agreements to resell, at fair value 26,836,000 Margin cash paid to counterparties (10,185,886) Dividends and interest receivable (1,811,299) Other assets 23,679 Margin cash received from counterparties (206,559,962) Due to broker (62,044) Accrued expenses 207,734 ----------------- Net cash provided by operating activities 69,494,747 ----------------- Cash flows from financing activities Proceeds from issuance of shares 304,492 Payments for redemption of shares (176,552,945) ----------------- Net cash used in financing activities (176,248,453) ----------------- Net change in cash and cash equivalents (106,753,706) Cash and cash equivalents, beginning of year 250,938,764 ----------------- Cash and cash equivalents, end of year $ 144,185,058 =================

4 See accompanying notes to financial statements. HFH ShortPLUS MasterFund, Ltd. (In Liquidation) Condensed Schedule of Investments (Expressed in United States Dollars) -------------------------------------------------------------------------------- December 31, 2008 (Unaudited)

Current Face / Coupon Maturity Percentage of Fair Notional Rates % Date Range Net Assets Value -------- ------- ---------- ---------- ----- Asset-Backed Securities, at fair value Fixed Rate Home Equity TMTS 04-8HES B2 (cost $407,368) $ 446,131 8.000% 6/25/34 0.07 % $ 131,312 ------- -------------- Floating Rate Home Equity Bayview Financial TR 2004-D $ 1,893,329 2.971 8/28/44 0.10 190,220 Morgan Stanley Cap 2007-NC A2A $ 1,615,661 0.551 6/25/37 0.62 1,181,957 ------- -------------- Total Floating Rate Home Equity 0.72 1,372,177 ------- -------------- (cost $3,294,809) Floating Rate Business Loans BAYC 05-3A B3 $ 594,122 3.471 11/25/35 0.13 243,915 Bayview Coml Mtg TR 2006-SP1 $ 7,060,000 4.471 4/25/36 0.76 1,438,475 ------- -------------- Total Floating Rate Business Loans (cost $7,325,808) 0.89 1,682,390 ------- -------------- Home Equity Residuals Option One Mtg LN TR 2007-4 20370425 FL (cost $2,874,362) $ 3,090,711 0.561 4/25/37 1.39 2,627,105 ------- -------------- Other (cost $55,818,939)* $46,136,708 0-8.500% 1/15/35-9/08/51 -- -- ------- -------------- Total Asset-Backed Securities, at fair value (cost $69,721,286) 3.07 % $ 5,812,984 -====== ==============

* Fifteen (15) bonds with a cost of $55,818,939 had fair values of -0- at December 31, 2008. 5 See accompanying notes to financial statements. HFH ShortPLUS MasterFund, Ltd. (In Liquidation) Condensed Schedule of Investments (Continued) (Expressed in United States Dollars) -------------------------------------------------------------------------------- December 31, 2008 (Unaudited)

Notional Termination Percentage of Fair Amount Date Net Assets Value ------ ---- ---------- ----- Swap contracts, at fair value Credit default swap contracts United States JPMAC 2005-OPTI M9 (pay 3.00%) $ 5,595,354 6/25/2035 2.80 % $ 5,288,265 RFC06NC3 M9 (pay CITI 7.50%) $ 4,000,000 3/25/2036 2.10 3,921,978 SAIL 2006-4 M4 (pay CS 3.75%) $ 10,000,000 7/25/2036 5.10 9,708,523 Nevada GO CDS (pay .98%) $ 10,000,000 3/1/2017 0.50 971,094 New Jersey GO CDS (pay .87%) $ 10,000,000 7/1/2019 0.50 906,641 SHIPO 3 A2 (pay 2.60%) $ 13,971,000 1/18/2050 0.70 1,285,223 ------- ------------- Total credit default swap contracts 11.70 22,081,724 ------- ------------- (upfront fee payments $9,912,500) Credit default swap contracts United States SAIL 2006-4 M4 (JP Morgan (Bear) pays 5.80%) $(10,000,000) 7/25/2036 (5.20) (9,819,978) RFC06NC3 M8 (CITI pays 5.00%) $ (5,000,000) 3/25/2036 (2.60) (4,865,625) ----- ------------- Total credit default swap contracts (7.80) (14,685,603) ----- ------------- (upfront fee receipts $6,300,000) Total swap contracts, at fair value 3.90 % $ 7,396,121 ======= ============= Securities purchased under agreements to resell, at fair value J.P. Morgan, 1.74% - 6.00%, 4/15/2032 - 6/16/2038 (cost $32,338,000) 17.10 % $ 32,338,000 ======= =============

6 See accompanying notes to financial statements. HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) (Unaudited) -------------------------------------------------------------------------------- 1. Nature of operations and summary of significant accounting policies Nature of Operations HFH ShortPLUS Master Fund, Ltd. (In Liquidation) (the "Fund") is a Cayman Islands exempted company incorporated in accordance with the Companies Law (2004 revision) which commenced operations on January 2, 2007. The Fund's strategy is to assemble a short-biased portfolio of asset-backed securities ("ABS") that the Investment Manager believes are most likely to produce high returns during periods of adverse credit performance for residential mortgages, and for mortgage-backed securities ("MBS") and ABS. Returns will come from two principal sources: (i) market value changes arising from changes in credit spreads on the Fund's short positions; and (ii) credit default payments from counterparties on credit default swaps ("CDS") or other derivatives. In accordance with the Fund's documents, the board of directors have formalized a plan of liquidation to liquidate the Fund in an orderly manner, and as a result, changed its basis of accounting from the going concern to the liquidation basis whereby assets and liabilities are stated at their estimated settlement amounts and all costs of liquidation have been recognized. The adoption of the liquidation basis of accounting did not have a material effect on the carrying values of assets and liabilities as of December 31, 2008. The shares held by the remaining investors will be distributed on March 31, 2009. In addition, a new entity called HFH ShortPLUS Master Fund Liquidating Trust was established for purposes of receiving cash flows on securities that were distributed in-kind. Highland Financial Holdings Group, LLC ("Investment Manager") serves as the investment manager of the Fund. The Investment Manager manages and invests the Fund's assets and effects all security transactions on behalf of the Fund. The Fund operates under a "master fund/feeder fund" structure. HFH ShortPLUS, Ltd. and HFH ShortPLUS Fund, L.P. (collectively, the "Feeder Funds") invest substantially all of their investable assets in the Fund. Basis of Presentation The financial statements are expressed in United States dollars and have been prepared in conformity with accounting principles generally accepted in the United States of America. Cash and Cash Equivalents Cash and cash equivalents consist principally of cash, margin cash received from counterparties, and short term investments (treasury bills), which are readily convertible into cash and have original maturities of three months or less. Valuation of Investments in Securities at Fair Value - Definition and Hierarchy The Fund adopted the provisions of SFAS No. 157, "Fair Value Measurements" ("SFAS No. 157"), effective January 1, 2008. Under SFAS No. 157, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the "exit price") in an orderly transaction between market participants at the measurement date. 7 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 1. Nature of operations and summary of significant accounting policies (continued) Valuation of Investments in Securities at Fair Value - Definition and Hierarchy (continued) In determining fair value, the Fund uses various valuation approaches. SFAS No. 157 establishes a fair value hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are those that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Fund. Unobservable inputs reflect the Fund's assumptions about the inputs market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The fair value hierarchy is categorized into three levels based on the inputs as follows: Level 1 - Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Fund has the ability to access. Valuation adjustments and block discounts are not applied to Level 1 securities. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these securities does not entail a significant degree of judgment. Level 2 - Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement. The availability of valuation techniques and observable inputs can vary from security to security and is affected by a wide variety of factors including, the type of security, whether the security is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Those estimated values do not necessarily represent the amounts that may be ultimately realized due to the occurrence of future circumstances that cannot be reasonably determined. Because of the inherent uncertainty of valuation, those estimated values may be materially higher or lower than the values that would have been used had a ready market for the securities existed. Accordingly, the degree of judgment exercised by the Fund in determining fair value is greatest for securities categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls, is determined based on the lowest level input that is significant to the fair value measurement. Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Fund's own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. The Fund uses prices and inputs that are current as of the measurement date, including periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many securities. This condition could cause a security to be reclassified to a lower level within the fair value hierarchy. 8 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 1. Nature of operations and summary of significant accounting policies (continued) Valuation of Investments in Securities at Fair Value - Definition and Hierarchy (continued) Valuation Techniques The Investment Manager will use its reasonable discretion to value each investment by using, as a guide, a combination of (i) independent, third-party pricing sources; (ii) indications from one or more financial institutions engaged in trading the investments or securities similar to the investments being valued; (iii) transactions in the market of the same or similar securities; and (iv) in-house models the Investment Manager maintains (the "Highland Model"). In cases where the number of indications is limited, the Investment Manager will review other factors such as the previous month's value, whether such indication is from the same counterparty, the delta between the current value and the previous month value, relevant market data or news, the value of similar securities, recent trading information and any other information which may be deemed relevant at the discretion of the Investment Manager. With respect to credit default swaps ("CDS"), the Investment Manager may use, if considered representative of the value of CDS positions, margin marks from the actual counterparty with whom the security was traded, or from counterparties of a similar CDS position to estimate the valuation. However, if the Investment Manager believes the exit price will be either greater or less than the current margin mark, the Investment Manager has the discretion to revise the value accordingly. Fair value determinations based on indications from financial institutions or margin marks from counterparties may be based on as few as a single indication/margin mark, or may be calculated as the average of more than one such indication/margin mark, which average may include recent transactions in the market or ignore outlying indications/margin marks based on the Investment Manager's discretion. The Investment Manager may use observable transactions in the market in determining the fair value of investments if, at the discretion of the Investment Manager, prioritization of such transactions is considered more relevant given market conditions or other factors. The Highland Model is a proprietary system that is used to generate a price/yield based on key inputs. Cash flows for the Fund's securities that are projected through the Highland Model, incorporate assumptions regarding potential future rates of delinquency, prepayments, defaults, collateral losses, and interest rates. On a monthly basis, each security's actual cash flows are compared to the previously projected cash flows. Assumptions can be modified based on significant deviations between actual cash flows and cash flows from previous projections. Discount rates may be changed based on market observations for prices and discount rates of similar securities trading in the secondary market. The following outlines the key inputs that are reevaluated on a monthly basis: i. Constant Default Rate (CDR) - an annualized rate of default on a group of mortgages within a collateralized product (i.e. MBS). It represents the percentage of outstanding principal balances in the pool that are in default, which typically equates to the home being past 60-day and 90-day notices and in the foreclosure process. ii. Constant Prepayment Rate (CPR) - A loan prepayment rate that is equal to the proportion of the principal of a pool of loans that is assumed to be paid off prematurely in each period. The calculation of this estimate is based on a number of factors such as historical prepayment rates for previous loans that are similar to ones in the pool and on the future economic outlook. iii. Loss Severity - costs (expressed as a %) to foreclose and liquidate a home securing a defaulted mortgage, as well as any decline in property value. 9 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 1. Nature of operations and summary of significant accounting policies (continued) Valuation of Investments in Securities at Fair Value - Definition and Hierarchy (continued) Valuation Techniques (continued) iv. Delinquency - monthly mortgage payments that are 30, 60, or more than 60 days past due. v. Yield - the yield is obtained from the "Matrix" which is updated on a monthly basis. The Matrix associates yields based on various groups of securities and market conditions. The Fund will also determine fair value for MBS and ABS securities that are not based on the Highland Model price. The following represent additional price sources: Transaction based - Represents a recent transaction utilized as the price source if the transaction occurred within 30 days of the valuation date. Trader based - Represents a price determined by a portfolio manager. The portfolio manager will determine the proper valuation for a particular security utilizing a combination of observable and unobservable inputs. In determining the valuation the portfolio manager will rely upon third party broker quotes, pricing services, recent transactions of the security or similar securities, inquiries with marker-makers and industry expertise. The Fund will use this valuation technique if the responsible portfolio manager determines that the Highland Model does not accurately reflect certain idiosyncratic factors for a specific security. Third party quotes - Represents a valuation that is received externally from either a pricing service or dealer price. The Fund will utilize this price if the responsible portfolio manager determines that this price accurately reflects fair value and for various reasons the Highland Model price (e.g. model inadequacies, non-current data, etc.) is less accurate than the third party price. The following table summarizes the pricing sources used to determine fair value of the securities owned by the Fund at December 31, 2008: Pricing Source % of Portfolio Priced Third party quotes 39.8% Trader based 32.9% Transaction based 14.1% Highland Model 13.2% ABS and MBS and Credit Default Swaps on ABS and MBS securities are generally categorized in Level 3 of the fair value hierarchy. Derivative Instruments and Hedging Activities --------------------------------------------- The Fund recognizes the value of all derivative instruments as either assets or liabilities in the Statement of Assets and Liabilities and measures those instruments at fair value. 10 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 1. Nature of operations and summary of significant accounting policies (continued) Valuation of Investments in Securities at Fair Value - Definition and Hierarchy (continued) Valuation Techniques (continued) Interest Rate and Index Swaps ----------------------------- The Fund may enter into interest rate and index swaps as part of its investment strategies. Swaps involve the exchange by the Fund with another party of respective commitments to pay or receive interest, effective return, or total return throughout the lives of the agreements. The Fund may be required to deliver or receive cash or securities as collateral upon entering into swap transactions. Movements in the relative value of the swap transactions may require the Fund or the counterparty to post additional collateral. Interest rate swaps change in value with movements in interest rates. During the term of the swap contracts, changes in value and accrued interest payments are recognized as unrealized gains or losses by marking the contracts to the market. These unrealized gains and losses are reported as an asset or liability, respectively, on the Statement of Assets and Liabilities. When contracts are terminated, the Fund will realize a gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the Fund's basis in the contract, if any. Credit Default Swaps -------------------- The Fund adopted FASB Staff Position FAS 133-1 and FIN 45-4, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45, as of December 31, 2008, which requires additional disclosures about credit derivatives. The Fund enters into credit default swaps to simulate long and short bond positions that are either unavailable or considered to be less attractively priced in the bond market. The Fund uses these swaps to attempt to reduce risk where the Fund has exposure to the issuer, or to take an active long or short position with respect to the likelihood of the issuer's default. There is no certainty that the objectives of holding credit default swaps will be achieved. The buyer of a credit default swap is obligated to pay the seller a periodic stream of payments over the term of the contract in return for a contingent payment upon the occurrence of a credit event, with respect to an underlying reference obligation. Generally, a credit event means bankruptcy, failure to pay, obligation accelerated or modified restructuring. If a credit event occurs, the seller typically must pay the contingent payment to the buyer, which is typically the par value (full notional value) of the reference obligation. The contingent payment may be a cash settlement or by a physical delivery of the reference obligation in return for payment of the face amount of the obligation. If the Fund is a buyer and no credit event occurs, the Fund may lose its investment and recover nothing. However, if a credit event occurs, the buyer typically receives full notional value and interest for a reference obligation that may have little or no value. As a seller, the Fund receives a fixed rate of income throughout the term of the contract, provided that no credit event occurs. If a credit event occurs, the seller may pay the buyer the full notional value and interest of the reference obligation. Upfront payments made and/or received by the Fund are recorded as an asset and/or liability on the Statement of Assets and Liabilities and are recorded as a realized gain or loss on the termination date. As of December 31, 2008, the Fund has eight open credit default swaps. The Fund is the buyer on six of these swaps ("receiving protection" on a total notional amount of approximately $53.6 million) and is the seller on the remaining two ("providing protection" on a total notional amount of $15 million). 11 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 1. Nature of operations and summary of significant accounting policies (continued) Valuation of Investments in Securities at Fair Value - Definition and Hierarchy (continued) Credit Default Swaps (continued) -------------------------------- Credit default swaps involve greater risks than if the Fund had invested in the reference obligations directly. In addition to general market risks, credit default swaps are subject to liquidity risk and counterparty credit risk. A buyer also may lose its investment and recover nothing should a credit event not occur. If a credit event did occur, the value of the reference obligation received by the seller, coupled with the periodic payments previously received, may be less than the full notional value it pays to the buyer, resulting in a loss of value. At December 31, 2008, the two credit default swaps sold held by the Fund were referenced to mortgage-backed securities. Both credit default swaps sold expire in 2036. The current status of the performance risk of both credit default swaps sold are classified by the external Standard & Poor's credit ratings of the reference obligations as CC. In the event that certain specified credit events occur, the maximum potential amount of future undiscounted payments that the Fund would be required to pay under the credit default swaps sold would be approximately $15,000,000. However, if the Fund was required to make payments under the credit default swaps sold, it would be entitled to certain assets owned by the reference entities that collateralize the reference obligations. The Fund is unable to estimate the approximate extent of which the proceeds from liquidation can be applied towards the maximum potential amount of future payments under the credit default swaps sold. The fair value of open swaps reported in the statement of assets and liabilities may differ from that which would be realized in the event the Fund terminated its position in the contract. Risks may arise as a result of the failure of the counterparty to the swap contract to comply with the terms of the swap contract. The loss incurred by the failure of a counterparty is generally limited to the aggregate of the unrealized gain on the swap contracts in an unrealized gain position as well as any collateral posted with the counterparty. Therefore, the Fund considers the creditworthiness of each counterparty to a swap contract in evaluating potential credit risk. Additionally, risks may arise from unanticipated movements in the fair value of the underlying securities and the lack of market liquidity to unwind the positions at current fair values. The Fund's credit default swap contracts are subject to International Swaps and Derivatives Association (ISDA) Master Agreements which contain certain covenants and other provisions. During the year ended December 31, 2008, the decline of the Fund's net asset value resulted in an additional termination event as defined in two of these agreements. As a result, the Fund's counterparties have the right to terminate these agreements and the related derivative contracts. The Fund closed one of the contracts subsequent to year end. The swap contract had a fair value of approximately $1,285,000 at December 31, 2008. The Fund is in the process of closing the remaining swap in connection with the liquidation of the Fund. As of December 31, 2008, the value of this swap was approximately $9,846,000 and the Fund held collateral from the counterparty in the amount of approximately $3,488,000. In January 2009, the counterparty posted an additional $6,360,000 of collateral with the Fund. The Fund has not received any notice from its counterparty to terminate this agreement. The fair values of the credit default swaps sold referenced to mortgage-backed securities were approximately $14,686,000 as of December 31, 2008. 12 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 1. Nature of operations and summary of significant accounting policies (continued) Valuation of Investments in Securities at Fair Value - Definition and Hierarchy (continued) Futures ------- A futures contract is an agreement between two parties to buy or sell a financial instrument for a set price on a future date. Initial margin deposits are made upon entering into futures contracts and can be either cash or securities. During the period the futures contract is open, changes in the value of the contract are recognized as unrealized gains or losses by marking to market on a daily basis to reflect the fair value of the contract at the end of each day's trading. When the contract is closed, the Fund records a realized gain or loss equal to the difference between the proceeds of the closing transaction and the Fund's basis in the contract. Purchased Options ----------------- The Fund may purchase put or call options. When the Fund purchases an option, an amount equal to the premium paid is recorded as an asset and is subsequently marked-to-market. Premiums paid for purchasing options that expire unexercised are recognized on the expiration date as realized losses. If an option is exercised, the premium paid is subtracted from the proceeds of the sale or added to the cost of the purchase to determine whether the Fund has realized a gain or loss on the related investment transaction. When the Fund enters into a closing transaction, the Fund will realize a gain or loss depending upon whether the amount from the closing transaction is greater or less than the premium paid. Written Options --------------- The Fund may write put or call options. When the Fund writes an option, an amount equal to the premium received is recorded as a liability and is subsequently marked-to-market. Premiums received for writing options that expire unexercised are recognized on the expiration date as realized gains. If an option is exercised, the premium received is subtracted from the cost of the purchase or added to the proceeds of the sale to determine whether the account has realized a gain or loss on the related investment transaction. When the Fund enters into a closing transaction, the Fund will realize a gain or loss depending upon whether the amount from the closing transaction is less or greater than the premium received. Short Sales ----------- When the Fund sells short, it may borrow the security sold short and deliver it to the broker-dealer through which it sold short as collateral for its obligation to deliver the security upon conclusion of the sale. Additionally, the Fund generally is required to deliver cash or securities as collateral for the Fund's obligation to return the borrowed security. The Fund may have to pay a fee to borrow the particular securities and may be obligated to pay over any payments received on such borrowed securities. A gain, limited to the price at which the Fund sold the security short, or a loss, unlimited as to dollar amount, will be recognized upon the termination of a short sale if the exit price is less or greater than the proceeds originally received. 13 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 1. Nature of operations and summary of significant accounting policies (continued) Valuation of Investments in Securities and Securities Sold Short at Fair Value - Definition and Hierarchy (continued) Financing Transactions ---------------------- The Fund enters into repurchase agreements as a borrower (securities sold under agreements to repurchase) and as a lender (securities purchased under agreements to resell). All repurchase agreements are carried at their contractual amounts on the Statement of Assets and Liabilities, and the accrued income (expense) is recorded separately. Securities sold under agreements to repurchase include sell-buy financing transactions while securities purchased under agreements to resell include buy-sell financing transaction. Securities Sold Under Agreements to Repurchase ---------------------------------------------- The Fund monitors collateral fair values relative to the amounts due under the agreements, including accrued interest, throughout the lives of the agreements, and when necessary, requires transfer of cash or securities in order to manage exposure and liquidity. In connection with such agreements, if the counterparty defaults or enters an insolvency proceeding, realization or return of the collateral to the Fund may be delayed or limited. At December 31, 2008, the Fund had no securities sold under agreements to repurchase. Securities Purchased Under Agreements to Resell ----------------------------------------------- Transactions involving purchases of securities under agreements to resell are treated as collateralized financial transactions and are recorded at their contracted resell amounts. Securities purchased under agreements to resell are generally collateralized principally by U.S. government and agency securities. The Fund takes possession of such underlying collateral, monitors its fair value relative to the amounts due under the agreements, including accrued interest, throughout the lives of the agreements, and when necessary, may require a transfer of additional cash or securities in order to manage exposure and liquidity. In connection with such agreements, if the counterparty defaults or enters an insolvency proceeding, realization or return of the funds to the Fund may be delayed or limited. At December 31, 2008, the Fund had securities purchased under agreements to resell totaling $32,338,000. The Fund received collateral in the form of various FNMA MBS pools under a held in custody agreement with an interest rate of 0.035% and a maturity of two days. The value of the securities, including accrued interest, received as collateral by the Fund that it was permitted to sell or repledge was approximately $33,294,000. Translation of Foreign Currency Assets and liabilities denominated in foreign currencies are translated into United States dollar amounts at the year-end exchange rates. Transactions denominated in foreign currencies, including purchases and sales of investments, and income and expenses, are translated into United States dollar amounts on the transaction date. Adjustments arising from foreign currency transactions are reflected in the statement of operations. The Fund does not isolate that portion of the results of operations arising from the effect of changes in foreign exchange rates on investments from fluctuations arising from changes in market prices of investments held. Such fluctuations are included in net gain (loss) on investments in the statement of operations. 14 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 1. Nature of operations and summary of significant accounting policies (continued) Investment Transactions and Related Investment Income Investment transactions are accounted for on a trade-date basis. Interest is recognized on the accrual basis. Offsetting of Amounts Related to Certain Contracts The Fund has elected not to offset fair value amounts recognized for cash collateral receivables and payables against fair value amounts recognized for net derivative positions executed with the same counterparty under the same master netting arrangement. At December 31, 2008, the Fund had no cash collateral receivables and payables with derivative counterparties covered under the same master netting arrangement. Income Taxes The Fund is a Cayman Islands exempted company. Under the current laws of the Cayman Islands, there are no income, estate, transfer, sale or other taxes payable by the Fund. The Fund is taxed as a partnership for U.S. Federal income tax purposes, and as such, is not subject to income taxes; each investor may be individually liable for income taxes, if any, on its share of the Fund's net taxable income. The Fund trades securities for its own account and, as such, investors are generally not subject to U.S. tax on such earnings (other than certain withholding taxes indicated below). The Investment Manager intends to conduct the business of the Fund to the maximum extent practicable so that the Fund's activities do not constitute a U.S. trade or business. Interest and other income received by the Fund from sources within the United States may be subject to, and reflected net of, United States withholding tax at the rate of 30%. Interest, dividend and other income realized by the Fund from non-U.S. sources and capital gains realized on the sale of securities of non-U.S. issuers may be subject to withholding and other taxes levied by the jurisdiction in which the income is sourced. The Fund has adopted FASB Staff Position No. FIN 48-3, which allows certain nonpublic entities to defer the effective date of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"), until the annual financial statements for fiscal years beginning after December 15, 2008. The Investment Manager has elected to take advantage of this deferral. Based on its continued analysis, the Investment Manager has determined that the adoption of FIN 48 will not have a material impact to the Fund's financial statements. However, the Investment Manager's conclusions regarding FIN 48 may be subject to review and adjustment at a later date based on factors including, but not limited to, further implementation guidance, and on-going analyses of tax laws, regulations and interpretations thereof. The Fund's accounting policy for evaluating uncertain tax positions during financial statement periods subject to the deferral of FIN 48 is based on the recognition and disclosure criteria for loss contingencies under SFAS No. 5 "Accounting for Contingencies". FIN 48 requires the Investment Manager to determine whether a tax position of the Fund is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement which could result in the Fund recording a tax liability that would reduce net assets. FIN 48 must be applied to all existing tax positions upon initial adoption and the cumulative effect, if any, is to be reported as an adjustment to net assets upon adoption. 15 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 1. Nature of operations and summary of significant accounting policies (continued) Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Fund's management to make estimates and assumptions that affect the amounts disclosed in the financial statements. Actual results could differ from those estimates. 2. Fair value measurements The Fund's assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy in accordance with SFAS No. 157. See Note 1 for a discussion of the Fund's policies. The following table presents information about the Fund's assets and liabilities measured at fair value as of December 31, 2008 (in thousands):

Quoted Prices Significant in Active Other Significant Balance Markets for Observable Unobservable as if Identical Assets Inputs Inputs December 31 (Level 1) (Level 2) (Level 3) 2008 ---------------- ----------- ------------ ----------- Assets Investments in securities, at fair value $ -- $ -- $ 5,813 $ 5,813 Credit default swap contracts, at fair value -- -- 22,082 22,082 ---------- ---------- --------- --------- $ -- $ -- $ 27,895 $ 27,895 ========== ========== ========= ========= Liabilities Credit default swap contracts, at fair value $ -- $ -- $ 14,686 $ 14,686 ========== ========== ========= =========

16 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 2. Fair value measurements (continued) The following table presents additional information about Level 3 assets and liabilities measured at fair value. Both observable and unobservable inputs may be used to determine the fair value of positions that the Fund has classified within the Level 3 category. As a result, the unrealized gains and losses for assets and liabilities within the Level 3 category may include changes in fair value that were attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs. Changes in Level 3 assets and liabilities measured at fair value for the year ended December 31, 2008 (in thousands) are as follows:

Level 3 ------------------------------------------------------------------------------------------- Change in Unrealized Gains (Losses) Beginning Realized & Purchases Net Ending for Investments Balance Unrealized Sales Transfers Balance still held at January 1 Gains and In and/or December 31, December 31, 2008 (Losses) Settlements (Out) of 2008 2008 ---------- ------------- ----------- ----------- ----------- ------------- Assets Investments in securities, at fair value $ 12,297 $ (10,658) $ 4,174 $ -- $ 5,813 $ (2,737) Credit default swap contracts, at fair value 271,422 66,112 (315,452) -- 22,082 5,271 --------- ---------- ---------- -------- -------- --------- $ 283,719 $ 55,454 $ (311,278) $ -- $ 27,895 $ 2,534 ========= ========== ========== ======== ======== ========= Liabilities Credit default swap contracts, at fair value 54,613 8,658 (48,585) -- 14,686 (4,430) --------- ---------- ---------- -------- -------- --------- $ 54,613 $ 8,658 $ (48,585) $ -- $ 14,686 $ (4,430) ========= ========== ========== ======== ======== =========

Realized and unrealized gains and losses are included in net gain (loss) on securities in the statement of operations. The change in unrealized gains (losses) for the year ended December 31, 2008 for investments still held at December 31, 2008 of ($2,737) and ($841) are reflected in unrealized appreciation or depreciation of securities and unrealized appreciation or depreciation on credit default swap contracts, respectively, in the statement of operations. 17 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 3. Due to broker Amounts due to broker represent margin borrowings that are collateralized by certain securities. In the normal course of business, substantially all of the Fund's securities transactions, money balances and security positions are transacted with a broker. The Fund is subject to credit risk to the extent any broker with which it conducts business is unable to fulfill contractual obligations on its behalf. The Fund's management monitors the financial condition of such brokers and does not anticipate any losses from these counterparties. Throughout 2008, the Fund primarily transacted with the following brokers J.P. Morgan, Goldman Sachs, Deutsche Bank, Citibank, Credit Suisse and Merrill Lynch. 4. Financial instruments with off-balance sheet risk and other risks The Fund invests on a leveraged basis in various financial instruments and is exposed to market risks resulting from changes in the fair value of the instruments. The Statement of Assets and Liabilities may include the fair value of contractual commitments involving forward settlements, futures contracts and swap transactions as well as investments in securities sold short. These instruments involve elements of market risk in excess of amounts reflected on the Statement of Assets and Liabilities. Derivative financial statements are used by the Fund to help manage such market risk and to take an active long or short position in the market. Should interest rates move unexpectedly, the Fund may not achieve the anticipated benefits of the hedging instruments and may realize a loss. Further, the use of such derivative instruments involves the risk of imperfect correlation in movements in the price of the instruments, interest rates and the underlying hedged assets. The investment characteristics of mortgage-backed and asset-backed securities differ from traditional debt securities. Among the major differences are that interest and principal payments are made more frequently, usually monthly, and that the underlying residential or commercial mortgage loans or other assets generally may be prepaid at any time. Maturities on mortgage-backed and asset-backed securities represent stated maturity dates. Actual maturity dates may differ based on prepayment dates. The Fund is exposed to credit-related losses in the event of nonperformance by counterparties to financial instruments. The maximum credit exposure related to the derivative financial instruments of the Fund is equal to the fair value of the contracts with positive fair values as of December 31, 2008. It is the policy of the Fund to transact the majority of its securities and contractual commitment activity with broker-dealers, banks and regulated exchanges that the Investment Manager considers to be well established. The Fund's short-biased strategy depends in large measure upon the ability of the Investment Manager to identify ABS that experience future credit losses arising from the defaults by obligors on the related mortgage loans. This is the opposite approach from that employed in traditional long-bias credit investment strategies that generally seek to avoid credit losses on investments purchased on the basis of fundamental credit analysis, or on other bases. 18 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 4. Financial instruments with off-balance sheet risk and other risks (continued) There can be no assurance that the Investment Manager's assessments of the likelihood of default and losses on specific ABS transactions will be accurate or that the predictive strengths of the Investment Manager's models and practices will not decline in the future. Even if ABS default and loss rates increase generally in the future relative to the rates observed in the past, the Fund's return objectives will not be met if the Fund has bought credit protection or otherwise shorted securities that do not experience such higher default and loss rates. The Fund's strategy also includes long investments that are intended to generate positive income during the first several years of the Fund, in order to partially offset the negative carry of the short positions. Losses on these long positions could produce losses for the Fund and could result in the failure of the Fund to achieve the intended purpose of offsetting the CDS premium costs. An investment in the Fund entails risk. There can be no assurance that the Fund will achieve its investment objective or that the Fund's strategies will be successful. There exists a possibility that an investor could suffer a substantial loss as a result of an investment in the Fund. The success of any investment activity is influenced by general economic conditions that may affect the level and volatility of equity prices, credit spreads, interest rates and the extent and timing of investor participation in the markets for both equity and interest-rate-sensitive securities. Unexpected volatility or illiquidity in the markets in which the Fund directly or indirectly holds positions could impair the Fund's ability to carry out its business and could cause the Fund to incur losses. Depending on market conditions, reliable pricing information will not always be available from any source. Prices quoted by different sources are subject to material variation. Credit-sensitive tranches of ABS are exposed to credit risk arising from possible defaults of the underlying loans and recovery rates on those liquidated loans. The default rates of loans backing these securities is dependent on a number of factors including the quality and characteristics of the loans, national and regional economic growth, real estate values, the level of interest rates, changes in the availability of mortgage financing and other factors. Recovery values following a default will be dependent largely on regional and national real estate values among other things; although real estate values may depend on other economic variables. The rate of prepayments on the loans collateralizing a subordinate ABS tranche will generally have a significant effect on the amount of obligor defaults such a tranche can face before suffering losses of interest or principal. The Investment Manager believes it is impossible to accurately predict prepayment rates because prepayment rates are heavily influenced by equally unpredictable interest rates. Consequently, while the Investment Manager seeks to explore the potential effects of a wide range of possible prepayment rates for securities or CDS it purchases or sells, there can be no assurance that this analysis will exhaust the possible paths prepayments could take, or that the effects of any particular prepayment rate scenario will be evaluated correctly in respect of a specific ABS tranche or CDS. 19 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 4. Financial instruments with off-balance sheet risk and other risks (continued) A decline in the fair value of the Fund's portfolio of assets may limit the Investment Manager's ability to borrow, or may result in lenders initiating margin calls (i.e., requiring a pledge of cash or additional assets to re-establish the ratio of the amount of the borrowing to the value of the collateral). The Investment Manager could be required to sell assets at distressed prices under adverse market conditions in order to satisfy the requirements of the lenders. A default by the Fund under its collateralized borrowings could also result in a liquidation of the collateral by the lender, including any cross-collateralized assets, and a resulting loss of the difference between the value of the collateral and the amount borrowed. As discussed in Note 1, the Fund's investors are two Feeder Funds managed by the Investment Manager. The Fund could be materially affected by significant subscriptions and redemptions from the underlying investors of these Feeder Funds. 5. Capital share transactions The authorized share capital of the Fund consists of 5,000,000 shares having a par value of $0.01 (U.S.) per share. At December 31, 2008, 468.89 shares were issued and outstanding. Common shares are offered at an offering price equal to the net asset value per common share as of the close of business on the immediately preceding business day. Any holder of common shares has the right, in accordance with and subject to the applicable provisions of the memorandum of association of the Fund and the laws of the Cayman Islands, to have all or a portion of their shares redeemed on a date determined by the Directors. At December 31, 2008, all outstanding shares are held by the Feeder Funds. The following table reconciles share transactions for the year ended December 31, 2008: Shares ------ Shares outstanding, beginning of year 931.50 Shares issues 0.88 Shares redeemed (463.49) ------- Shares outstanding, end of year 468.89 ======= Shareholders have redemption rights which contain certain restrictions with respect to rights of redemption of shares as specified in the offering memorandum. 20 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 6. Director fee The following persons are independent non-executive Directors of the Fund: o David Bree o Peter Burnim All members of the Board of Directors are reimbursed for their out-of-pocket expenses incurred in connection with the performance of their duties and each receives an annual fee of approximately $5,000. No Directors have a shareholder interest in the Fund or have an interest, direct or indirect, in any transaction affecting the Fund during the year ended December 31, 2008, which is unusual in nature or significant to the business of the Fund. No Director has any contracts of significance with the Fund. 7. Administrative fee Admiral Administration, Ltd. (Cayman Islands) (the "Administrator") serves as the Fund's Administrator and performs certain administrative and clerical services on behalf of the Fund. 8. Financial highlights Financial highlights for the year ended December 31, 2008 are as follows: Shares ------------ Per share operating performance Net asset value, beginning of year $344,929.53 ----------- Income (loss) from investment operations: Net invesmtent income (loss) 8,875.78 Net gain (loss) on investments 49,748.90 ----------- Total from investment operations 58,624.68 ----------- Net asset value,e nd of year $403,554.21 =========== Total return 17.0% =========== Ratio to averate net assets Total operating expenses 1.8% =========== Total operating expenses excluding interest expense 0.5% =========== Net investment income (loss) 2.3% =========== 21 HFH ShortPLUS MASTER FUND, LTD. (In Liquidation) Notes to Financial Statements (Expressed in United States Dollars) -------------------------------------------------------------------------------- 8. Financial highlights (continued) Financial highlights are calculated for common shares. An individual investor's return and ratios may vary based on participation in new issues, private investments, and the timing of capital share transactions. 9. Subsequent events As of February 2, 2009, the Custodian for the Fund's securities changed from J.P. Morgan to Wells Fargo Bank, N.A. 22 HFH SHORTPLUS FUND, L.P. (A DELAWARE LIMITED PARTNERSHIP) FINANCIAL STATEMENTS DECEMBER 31, 2007 A CLAIM OF EXEMPTION FROM CERTAIN REGULATORY REQUIREMENTS HAS BEEN MADE TO THE COMMODITY FUTURES TRADING COMMISSION PURSUANT TO COMMISSION REGULATION 4.7 BY THE COMMODITY POOL OPERATOR OF HFH SHORTPLUS FUND, L.P. HFH SHORTPLUS FUND, L.P. (A DELAWARE LIMITED PARTNERSHIP) INDEX DECEMBER 31, 2007 -------------------------------------------------------------------------------- 11 PAGE(S) REPORT OF INDEPENDENT AUDITORS.............................................1 FINANCIAL STATEMENTS Statement of Assets, Liabilities and Partners' Capital.....................2 Statement of Operations and Special Allocation.............................3 Statement of Changes in Partners' Capital..................................4 Statement of Cash Flows....................................................5 Financial Highlights.......................................................6 Notes to Financial Statements...........................................7-10 Affirmation of the Commodity Pool Operator................................11 REPORT OF INDEPENDENT AUDITORS To the General Partner and Limited Partners of HFH ShortPLUS Fund, L.P. In our opinion, the accompanying statement of assets, liabilities, and partners' capital and the related statements of operations and special allocation, of changes in partners' capital, of cash flows and financial highlights present fairly, in all material respects, the financial position of HFH ShortPLUS Fund, L.P. (the "Partnership") at December 31, 2007, and the results of its operations, the changes in its partners' capital, its cash flows and the financial highlights for the year then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereinafter referred to as the "financial statements") are the responsibility of the General Partner. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these financial statements in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by the General Partner, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. /s/ PricewaterhouseCoopers March 17, 2008 1 HFH SHORTPLUS FUND, L.P. (A DELAWARE LIMITED PARTNERSHIP) STATEMENT OF ASSETS, LIABILITIES AND PARTNERS' CAPITAL DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars) ASSETS Investment in HFH ShortPLUS Master Fund, Ltd. $83,923,831 Cash and cash equivalents 5,958,995 Other assets 140 ----------- Total assets $89,882,966 =========== LIABILITIES Accrued expenses and other liabilities $ 22,501 ----------- Total liabilities 22,501 ----------- PARTNERS' CAPITAL 89,860,465 ----------- Total liabilities and partners' capital $89,882,966 =========== The accompanying notes are an integral part of these financial statements. 2 HFH SHORTPLUS FUND, L.P. (A DELAWARE LIMITED PARTNERSHIP) STATEMENT OF OPERATIONS AND SPECIAL ALLOCATION YEAR ENDED DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars)

NET INVESTMENT INCOME ALLOCATED FROM HFH SHORTPLUS MASTER FUND, LTD. Income $ 3,798,885 Expense (1,523,828) ------------ 2,275,057 ------------ PARTNERSHIP INVESTMENT INCOME Interest 10,538 ------------ Total income 2,285,595 PARTNERSHIP EXPENSES Management fee 416,360 Professional fees 30,000 ------------ Total expenses 446,360 ------------ Net investment income 1,839,235 ------------ REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS ALLOCATED FROM HFH SHORTPLUS MASTER FUND, LTD. Net realized gains on investments and derivatives 26,147,378 Net change in unrealized appreciation on investments and derivatives 38,016,188 ------------ Net realized and unrealized gains on investments and derivatives 64,163,566 ------------ Net increase in partners' capital resulting from operations 66,002,801 Profit Reallocation to General Partner 6,561,910 ------------ Net income available for pro-rata distribution to all partners $ 59,440,891 ============

The accompanying notes are an integral part of these financial statements. 3 HFH SHORTPLUS FUND, L.P. (A DELAWARE LIMITED PARTNERSHIP) STATEMENT OF CHANGES IN PARTNERS' CAPITAL YEAR ENDED DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars)

GENERAL LIMITED PARTNER PARTNERS TOTAL ------------ ------------ ------------ Balance, January 2, 2007 $ -- $ -- $ -- Capital contributions 1,000 39,965,569 39,966,569 Capital withdrawals -- (16,108,905) (16,108,905) Increase in partners' capital resulting from operations Pro rata allocation 2,448 66,000,353 66,002,801 Incentive allocation 6,561,910 (6,561,910) -- ------------ ------------ ------------ BALANCE, DECEMBER 31, 2007 $ 6,565,358 $ 83,295,107 $ 89,860,465 ============ ============ ============

The accompanying notes are an integral part of these financial statements. 4 HFH SHORTPLUS FUND, L.P. (A DELAWARE LIMITED PARTNERSHIP) STATEMENT OF CASH FLOWS YEAR ENDED DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars)

Net increase in partners' capital resulting from operations $ 66,002,801 Adjustments to reconcile net increase in partners' capital resulting from operations to net cash used in operating activities Investment in HFH ShortPLUS Master Fund, Ltd. (39,961,486) Withdrawal from HFH ShortPLUS Master Fund, Ltd. 22,476,276 Income from Master Fund (66,438,621) Increase in other assets (140) Increase in accrued expenses and other liabilities 22,501 ------------ Net cash used in operating activities (17,898,669) ------------ Cash provided from financing activities Partners' capital contributions 39,966,569 Partners' capital withdrawals (16,108,905) ------------ Net cash provided by financing activities 23,857,664 Net increase in cash and cash equivalents 5,958,995 Cash Beginning of year -- ------------ End of year $ 5,958,995 ============

The accompanying notes are an integral part of these financial statements. 5 HFH SHORTPLUS FUND, L.P. (A DELAWARE LIMITED PARTNERSHIP) FINANCIAL HIGHLIGHTS YEAR ENDED DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars) The financial highlights table represents the Partnership's financial performance for the year ended December 31, 2007 as follows: LIMITED PARTNERS Total return before incentive allocation 242.28% Incentive allocation (34.15) ---------- Total return after incentive allocation(a) 208.13% ========== Net investment income ratio(b) 3.51% Operating expense ratio(c) (3.77)% Incentive allocation (12.54) ---------- Total expenses and incentive allocation (16.31)% ========== Operating expense ratio excluding interest expense(d) (1.20)% ========== (a) Total return is calculated for aggregate limited partners' capital, exclusive of the General Partner, taken as a whole and adjusted for cash flows related to capital contributions and withdrawals during the year. An individual limited partner's return may differ depending on the timing of contributions and withdrawals, as well as varying fee structures. (b) The net investment income ratio is based on the net investment income allocated to a limited partner prior to the effect of an incentive allocation and is exclusive of unrealized and realized gains and losses. The net investment income ratio attributable to an individual partner's account may vary based on timing of capital transactions. (c) The operating expense ratio is based on the expenses allocated to each partner prior to the effects of any incentive allocation. For the purpose of this calculation, operating expenses include expenses incurred by the Partnership directly as well as expenses allocated from the Master Fund. Expense ratios are calculated over average net assets. Expense ratio excluding the effect of allocated expenses from the Master Fund would be (0.85%). The expense ratios attributable to an individual partner's account may vary based on different management fee and incentive allocation arrangements and the timing of capital transactions. (d) The operating expense ratio is based on the expenses allocated to each partner. For the purpose of this calculation, operating expenses include expenses incurred by the Partnership directly as well as expenses allocated from the Master Fund, excluding interest expense. Expense ratios are calculated over average net assets. The expense ratios attributable to an individual partner's account may vary based on different fee arrangements and the timing of capital transactions. The accompanying notes are an integral part of these financial statements. 6 HFH SHORTPLUS FUND, L.P. (A DELAWARE LIMITED PARTNERSHIP) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- 1. ORGANIZATION Highland ShortPLUS Fund, L.P. (the "Partnership") is a Delaware limited partnership and commenced operations on January 2, 2007. The Partnership invests substantially all of its investable assets through a "master-feeder" structure in HFH ShortPLUS Master Fund, Ltd. ("Master Fund"), a Cayman Islands exempted company that invests and trades a short-biased portfolio of asset-backed securities ("ABS") that the Investment Manager believes are most likely to produce high returns during periods of adverse credit performance for residential mortgages, and for mortgage-backed securities ("MBS") and ABS. Returns will come from two principal sources: (i) market value changes, arising from changes in credit spreads on the Master Fund's short positions; and (ii) credit default payments from counterparties on credit default swaps ("CDS") or other derivatives in credit sensitive mortgage and asset-backed securities, consumer debt and other assets. The Partnership's investment objective is the same as that of the Master Fund. The financial statements of the Master Fund are included elsewhere in this report and should be read in conjunction with the Partnership's financial statements. Highland Financial Holdings, LLC (the "General Partner") serves as the general partner and Highland Financial Holdings Group, LLC ("Investment Manager") serves as the investment manager of the Partnership. The Master Fund is also managed by the Investment Manager. Valuation of the investments held by the Master Fund is discussed in the notes to the financial statements included elsewhere in this report. The percentage of the Master Fund's net assets owned by the Partnership at December 31, 2007 was approximately 26.1%. 2. SUMMARY OF SELECTED SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts and disclosures in the financial statements. Actual results could differ from these estimates. BASIS OF ACCOUNTING The Fund records security and contractual transactions, if any, on a trade/contractual date basis. CASH AND CASH EQUIVALENTS Cash and cash equivalents consist principally of cash and short term investments (overnight bank investments), which are readily convertible into cash and have original maturities of three months or less. VALUATION The Partnership records its investment in the Master Fund at fair value based on the net asset value of the Master Fund. Valuation of financial instruments by the Master Fund is discussed in Note 2 of the Master Fund's Notes. INCOME AND EXPENSE RECOGNITION The Partnership records its proportionate share of the Master Fund's investment income/loss, expenses and realized and unrealized gains and losses. The Master Fund's income and expense recognition and allocations policies are discussed in Note 2 of the Master Fund's Notes. 7 HFH SHORTPLUS FUND, L.P. (A DELAWARE LIMITED PARTNERSHIP) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- Interest income of the Partnership's cash balance is accrued as earned. Expenses that are directly attributable to the Partnership are recorded on the accrual basis as incurred. INCOME TAXES The Partnership is not a taxable entity for federal, state or local income tax purposes; such taxes are the responsibility of individual partners. Accordingly, no provision has been made in the accompanying financial statements for any federal, state or local income taxes. On February 1, 2008, FASB issued FIN 48-2, Effective Date of FASB Interpretation No. 48 for Certain Nonpublic Enterprises ("FSP"), which allows the Partnership to defer the adoption of FIN 48 until periods beginning after December 15, 2007. The General Partner has elected to take advantage of this deferral. Based on its analysis, the General Partner has determined that the adoption of FIN 48 will not have a material impact to the Partnership's financial statements. However, the General Partner's conclusions regarding FIN 48 may be subject to review and adjustment at a later date based on factors including, but not limited to, further implementation guidance, and on-going analyses of tax laws, regulations and interpretations thereof. FIN 48 requires the General Partner to determine whether a tax position of the Partnership is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement which could result in the Partnership recording a tax liability that would reduce partners' capital. FIN 48 must be applied to all existing tax positions upon initial adoption and the cumulative effect, if any, is to be reported as an adjustment to partners' capital upon adoption. 3. CONTRIBUTIONS AND WITHDRAWALS The minimum initial and subsequent capital contributions (each a "Capital Contribution") in the Partnership are $5,000,000 and $1,000,000, respectively. The Investment Manager may waive or reduce the minimum Capital Contributions in its sole discretion. The General Partner may admit new Limited Partners and permit Limited Partners to make additional Capital Contributions as of the first business day of each calendar month, or at any other time in the General Partner's sole discretion. Subject to the lock-up period and early withdrawal fee, Limited Partners shall have the right to require the Partnership to withdraw all or any portion of their investment by delivering written notice to the General Partner not less than 90 days prior to the end of any calendar quarter, or at such other times as the General Partner determines in its sole discretion. The General Partner reserves the right to waive or reduce the notice period in its sole discretion. Notwithstanding anything to the contrary, a Limited Partner may not withdraw each Capital Contribution (and any appreciation thereon) until after the 12 month period (the "Lock-up Period") following the date of such contribution, without the prior consent of the General Partner, which may be granted or denied in the General Partner's sole discretion. Limited Partners who withdraw a Capital Contribution after the Lock-up Period with respect to such Capital Contribution but less than 24 months after purchasing such Capital Contribution will be charged an early withdrawal fee equal to 5% of the withdrawal amount. Any early withdrawal fee will be payable to the Partnership. The General Partner reserves the right, in its sole discretion, to waive or reduce the early withdrawal fee on a case-by-case basis. Subject to the Partnership's 8 HFH SHORTPLUS FUND, L.P. (A DELAWARE LIMITED PARTNERSHIP) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- right to establish reserves, a minimum of 95% of the withdrawals proceeds will generally be paid to the withdrawing Limited Partner within 15 business days after the corresponding withdrawal date, with the balance payable (without interest) within 90 days of the corresponding withdrawal date. The General Partner, at its discretion, reserves the right to suspend or limit redemptions. In the event that withdrawal requests are received representing in the aggregate more than 10% of the total Net Asset Value of the Partnership on any withdrawal date, the Partnership is entitled to reduce ratably and pro rata amongst all Limited Partners seeking to withdraw interests on the withdrawal date and to carry out only sufficient withdrawals, which in the aggregate, amount to 10% of the total Net Asset Value of the Partnership on such withdrawal date. 4. ALLOCATION OF NET INCOME (LOSS) AND INCENTIVE ALLOCATION Net investment income and gains and losses are allocated to the partners on a monthly basis, based on the partners' proportionate share of capital in the Partnership at the beginning of the month. The General Partner receives an incentive allocation equal to 20% of such net income (includes net realized and unrealized gains and losses) which will be deducted from the capital account of such limited partner and reallocated to the General Partner's capital account. Such incentive allocation is earned at December 31 of each year or when withdrawals occur. At the discretion of the General Partner, this rate may be reduced for certain Limited Partners. If there is a loss for the fiscal period, such loss is carried forward to future periods and no allocations will be made to the General Partner until prior fiscal period losses are recovered. For the year ended December 31, 2007, the General Partner was allocated $6,561,910 in incentive allocations. 5. MANAGEMENT FEE AND OTHER RELATED PARTY TRANSACTIONS The Investment Manager receives a quarterly management fee prospectively, equal to 0.50% (2% per annum) of each Limited Partner's capital account. At the discretion of the General Partner, this rate may be reduced for certain Limited Partners and affiliated fund investments. For the year ended December 31, 2007, the Investment Manager earned a management fee of $416,360 from the Partnership. For the year ended December 31, 2007, an affiliated party contributed $13,365,569 of capital and made $16,108,905 of withdrawals. At December 31, 2007, the principal officers and employees of the Investment Manager, either directly or through family members and affiliated entities, had $296,785 invested in the Partnership. 6. OFF-BALANCE SHEET RISK, LEVERAGE AND CONCENTRATION OF CREDIT RISKS Off-balance sheet risk, leverage and concentration of credit risks are discussed in the Master Fund's Notes. Due to the nature of the master fund/feeder fund structure, the Partnership could be materially affected by significant subscriptions and redemptions of the other feeder fund. From time to time, the Partnership may have a concentration of partners holding a significant percentage of the Partnership's partners' capital. Investment activities of these partners could have a material impact on the Partnership. At December 31, 2007, one partner individually owned approximately 95% of the total partners' capital. 9 HFH SHORTPLUS FUND, L.P. (A DELAWARE LIMITED PARTNERSHIP) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- 7. WITHDRAWALS PAYABLE In accordance with FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, as effected by FASB Staff Position No. FAS 150-3, withdrawals are recognized as liabilities by the Partnership, net of incentive allocations, when the amount requested in the withdrawal notice becomes fixed. This generally occurs either at the time of the receipt of the notice, or on the last day of a fiscal period, depending on the nature of the request. As a result, withdrawals paid after the end of the year, but based upon year-end capital balances are reflected as withdrawals payable at December 31, 2007. Withdrawal notices received for which the dollar amount is not fixed remains in capital until the amount is determined. Withdrawals payable may be treated as capital for purposes of allocations of gains/losses pursuant to the Partnership's governing documents. The Partnership has received withdrawal notices for which the dollar amounts are not fixed as of December 31, 2007. As such, associated amounts have remained in capital and are not reflected as withdrawals payable. There is no capital subject to withdrawal notices for amounts that are fixed and determinable as of December 31, 2007. 8. CONTINGENCIES AND COMMITMENTS In the normal course of business, the Partnership enters into contracts that contain a variety of representations, warranties and general indemnifications. The Partnership's maximum exposure under these arrangements, including future claims that may be made against the Partnership that have not yet occurred, is unknown. However, based on experience of the General Partner, the Partnership expects the risk of loss associated with such contracts to be remote. 9. SUBSEQUENT EVENTS As of December 31, 2007 and through March 1, 2008, the Partnership received requests for withdrawals, including amounts which are not currently fixed and determinable, amounting to approximately $4,000,938. All these withdrawal requests will be recorded subsequent to March 1, 2008, in accordance with the Partnership's withdrawal notice requirements. In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 applies to reporting periods beginning after November 15, 2007. The adoption of SFAS 157 is not expected to have a material impact on the Fund's financial statements. 10 AFFIRMATION OF COMMODITY POOL OPERATOR To the best of my knowledge and belief the information contained herein pertaining to HFH ShortPLUS Fund, L.P. is accurate and complete. Highland Financial Holdings, LLC Commodity Pool Operator /s/ Paul Ullman ------------------------------------------- By Paul Ullman President of Highland Financial Holdings, LLC, General Partner of HFH ShortPLUS Fund, L.P. 11 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) FINANCIAL STATEMENTS DECEMBER 31, 2007 A CLAIM OF EXEMPTION FROM CERTAIN REGULATORY REQUIREMENTS HAS BEEN MADE TO THE COMMODITY FUTURES TRADING COMMISSION PURSUANT TO COMMISSION REGULATION 4.7 BY THE COMMODITY POOL OPERATOR OF HFH SHORTPLUS MASTER FUND, LTD. HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) INDEX DECEMBER 31, 2007 -------------------------------------------------------------------------------- PAGE(S) REPORT OF INDEPENDENT AUDITORS..............................................1 FINANCIAL STATEMENTS Statement of Assets and Liabilities.........................................2 Schedule of Investments...................................................3-7 Statement of Operations.....................................................8 Statement of Changes in Net Assets..........................................9 Statement of Cash Flows....................................................10 Financial Highlights.......................................................11 Notes to Financial Statements...........................................12-20 Affirmation of the Commodity Pool Operator.................................21 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Shareholders of HFH ShortPLUS Master Fund, Ltd. In our opinion, the accompanying statement of assets and liabilities, including the schedule of investments, and the related statements of operations, of changes in net assets, of cash flows and financial highlights present fairly, in all material respects, the financial position of HFH ShortPLUS Master Fund, Ltd. (the "Fund") at December 31, 2007, and the results of its operations, the changes in its net assets, its cash flows and the financial highlights for the year then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereinafter referred to as the "financial statements") are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these financial statements in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. /s/ PricewaterhouseCoopers March 17, 2008 1 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) STATEMENT OF ASSETS AND LIABILITIES DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars)

ASSETS Investments, at value $ 12,296,717 ------------ Total investments, at value (cost $ 73,670,861) 12,296,717 Cash and cash equivalents 250,938,764 Margin cash paid to counterparties 1,800,244 Securities purchased under agreements to resell 59,174,000 Credit default swap contracts, at value (upfront fee payments $79,349,003) 271,421,697 Interest receivable 126,085 Other assets 89,134 ------------ Total assets $595,846,641 ------------ LIABILITIES Margin cash received from counterparties $218,648,130 Credit default swap contracts, at value (upfront fee receipts $39,723,958) 54,612,639 Due to brokers (Note 3) 95,483 Interest payable on margin cash 953,919 Accrued expenses and other liabilities 233,750 ------------ Total liabilities 274,543,921 ------------ Net assets (5,000,000 common shares authorized, $0.01 par value; 931.50 shares issued and outstanding) $321,302,720 ============

Net asset value per share disclosures are made in the financial highlights. The accompanying notes are an integral part of these financial statements. 2 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) SCHEDULE OF INVESTMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars)

CURRENT FACE / COUPON NOTIONAL DESCRIPTION RATE MATURITY VALUE Asset Backed Securities - Fixed Rate Home Equity (0.27%) $ 707,099 TMTS 04-8HES B2 8.000% 6/25/2034 $ 595,872 1,990,000 MASD 07-1 B1 5.250% 1/25/2037 104,475 3,482,000 MASD 07-1 B2 5.250% 1/25/2037 182,805 ----------- Total Asset Backed Securities - Fixed Rate Home Equity (cost $ 5,306,332) 883,152 ----------- ASSET BACKED SECURITIES - FLOATING RATE HOME EQUITY (0.21%) 1,977,237 BAYVIEW FINANCIAL TR 2004-D 8.355% 8/28/2044 284,426 1,893,631 QUEST 2006-X1 M5 7.365% 3/25/2036 94,682 2,476,000 QUEST 2006-X2 M9 7.365% 8/25/2036 173,320 2,539,341 QUEST 2006-X2 M10 7.365% 8/25/2036 126,967 ----------- Total Asset Backed Securities - Floating Rate Home Equity (cost $ 8,263,205) 679,395 ----------- ASSET BACKED SECURITIES - FIXED RATE HOME EQUITY NIM (0.40%) 2,218,243 CWALN 2006-0C8 N 7.750% 2/25/2037 420,539 6,171,417 GSAMP 07 FM1N N1 6.000% 12/25/2036 433,323 4,950,000 HASCN 06-OPT1 B 8.000% 12/26/2035 80,437 5,740,685 NHELN 07-2 N1 NIM 7.385% 1/25/2037 287,034 5,900,000 SBFT 05-HE3 N2 144A * 6.500% 9/25/2035 77,466 ----------- Total Asset Backed Securities - Fixed Rate Home Equity NIM (cost $ 23,132,410) 1,298,799 ----------- ASSET BACKED SECURITIES - FLOATING RATE BUSINESS LOANS (2.41%) 738,720 BAYC 05-3A B3 7.865% 11/25/2035 470,587 7,060,000 BAYVIEW COML MTG TR 2006-SP1 8.865% 4/25/2036 3,591,775 4,178,000 LBSBN 2007-1 N2 8.500% 3/27/2037 3,676,640 ----------- Total Asset Backed Securities - Floating Rate Business Loans (cost $ 11,414,997) 7,739,002 ----------- PREFERRED ASSET BACKED SECURITIES - FLOATING SHARES RATE CDO (0.03%) 2,000,000 BUCKINGHAM CDO III LTD 2007-3 0.000% 9/5/2051 20,000 8,000 CITATION HGH GRD ABS CDO I LTD PFD 3C7 144A *# 6.000% 1/15/2035 80,000 ----------- Total Asset Backed Securities - Floating Rate CDO (cost $ 6,981,641) 100,000 -----------

The accompanying notes are an integral part of these financial statements. 3 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) SCHEDULE OF INVESTMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars)

NOTIONAL/ PREFERRED COUPON SHARES DESCRIPTION RATE MATURITY VALUE ASSET BACKED SECURITIES - HOME EQUITY RESIDUALS (0.50%) $ 2,351,781 CMLTI 2006-HE1 CE 0.000% 1/25/2036 $ 250,000 18 CMLTI 2006-HE1 P 0.000% 1/25/2036 275,000 24,000 GSAMP 2006 RES - PREFERRED 0.000% N/A 999,999 2,469,540 MANM 07-1 1N2 5.873% 1/25/2047 71,370 5,514,200 MANM 07-1 1N3 7.373% 1/25/2047 - ------------ Total Asset Backed Securities - Home Equity Residuals (cost $ 18,572,276) 1,596,369 ------------ Total Investments (cost $ 73,670,861) $ 12,296,717 ------------ * 144A securities are exempt from registration under Rule 144A of the Securities Act of 1933. These securities may only be resold to qualified institutional buyers. # Citation is an entity that is advised by Highland Financial Holdings Group, LLC, the Fund's Investment Manager, and accordingly is considered an affiliate. CREDIT DEFAULT SWAP NOTIONAL TERMINATION CONTRACTS, AMOUNT CREDIT DEFAULT SWAP CONTRACTS, AT VALUE (-17.00%) DATE AT VALUE $(10,000,000) SAIL 2006-4 M4 (BEAR pays 5.80%) 6/25/2036 $ (6,851,192) (10,000,000) RAMP 2005-EFC6 M9 (BEAR pays 5.85%) 11/25/2035 (6,576,706) (7,500,000) BNC07001 M8 (UBS pays 5.75%) 3/25/2037 (5,232,031) (6,000,000) HASC 2006 -OPT1 M9 (DB pays 7.45%) 12/25/2035 (4,291,400) (5,000,000) RFC06NC3 M8 (CITI pays 5.00%) 3/25/2036 (3,759,223) (5,000,000) SAST 06-1 B3 (GS pays 6.55%) 3/25/2036 (3,086,684) (5,000,000) RFC05KS9 M8 (UBS pays 5.60%) 10/25/2035 (2,772,204) (5,000,000) WLT05WC1 M9 (GS pays 7.30%) 10/25/2035 (2,762,035) (5,000,000) SABR 2005-FR2 B2 (LEH pays 3.20%) 3/25/2035 (2,815,630) (5,000,000) LBML0502 M8 (GS pays 4.90%) 4/25/2035 (2,589,105) (5,000,000) CWL 2006 -15 (CS pays 6.25%) 8/25/2042 (2,879,129) (5,000,000) RFC06KS2 M8 (GS pays 5.75%) 3/25/2036 (3,661,476) (5,000,000) CMLTI 2006-HE1 M8 (DB pays 2.11%) 1/25/2036 (3,807,247) (5,000,000) WMLT 2005-WMC1 M9 (CS pays 7.30%) 10/25/2035 (2,778,257) (2,000,000) FFML 2005-FF2 B3 (GS pays 3.75%) 3/25/2035 (750,320) ------------ Credit Default Swap Contracts, at Value - (upfront fee receipts: $ 39,723,958) $(54,612,639)

The accompanying notes are an integral part of these financial statements. 4 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) SCHEDULE OF INVESTMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars)

CREDIT DEFAULT SWAP NOTIONAL TERMINATION CONTRACTS, AMOUNT CREDIT DEFAULT SWAP CONTRACTS, AT VALUE (84.48%) DATE AT VALUE $ 2,000,000 FFML 2005-FF2 B3 (Pay GS 1.70%) 3/25/2035 $ 751,087 3,350,000 JPMAC 2005-FRE1 MP (Pay DB 7.00%) 10/25/2035 1,978,175 4,000,000 FFML 2004-FF8 B3 (Pay CS 2.00%) 10/25/2034 596,458 4,000,000 RFC06NC3 M9 (Pay CITI 7.50%) 3/25/2036 2,604,830 4,000,000 RFC06KS8 M5 (Pay GS 1.10%) 10/25/2036 2,739,291 4,000,000 FFML06F5 M9 (Pay CITI 3.35%) 4/25/2036 3,309,590 5,000,000 SAMI 2006-AR1 B6 (Pay CS 3.00%) 2/25/2036 3,035,000 5,000,000 CWE0626 M7 (Pay UBS 2.30%) 5/25/2037 2,877,000 5,000,000 HEAT0607 B1 (Pay CS 5.35%) 1/25/2037 3,820,443 5,000,000 FFML 2006 - FF12 M9 (Pay CITI 3.00%) 9/25/2036 4,161,633 5,000,000 ARS06W01 M9 (Pay GS 2.42%) 3/25/2036 3,924,809 5,000,000 RFC06NC2 M9 (Pay GS 2.42%) 2/25/2036 4,137,900 5,000,000 NFHE0603 M6 (Pay GS 0.98%) 10/25/2036 3,505,230 5,000,000 NFHE0603 M8 (Pay UBS 2.23%) 10/25/2036 3,739,510 5,000,000 RASC 2006-KS3 M9 (Pay GS 2.42%) 4/25/2036 4,074,810 5,000,000 NCHET 2005-D M8 (Pay GS 1.70%) 2/25/2036 2,991,500 5,000,000 ACE 06-OP1 M8 (Pay GS 2.25%) 3/25/2036 4,076,989 5,000,000 MSAC 2006-HE2 B3 (Pay GS 2.42%) 3/25/2036 4,331,125 5,000,000 BSABS 2006-EC2 M9 (Pay GS 3.50%) 2/25/2036 3,987,429 5,000,000 MAB06AM2 M9 (Pay CS 4.50%) 6/25/2036 4,210,759 5,000,000 MLMI 2005-HE1 B3 (Pay GS 1.24%) 3/25/2037 4,015,848 5,000,000 SABR 2005-FR2 B2 (Pay UBS 1.92%) 3/25/2035 2,822,047 5,000,000 LBML0502 M8 (Pay CITI 2.40%) 4/25/2035 2,601,605 5,000,000 CMLTI 2006-HE1 M8 (Pay GS 2.11%) 1/25/2036 3,820,448 5,000,000 RFC05KS9 M8 (Pay UBS 3.50%) 10/25/2035 2,782,715 5,000,000 CWHE0615 B (Pay ML 4.75%) 10/25/2046 2,886,629 5,000,000 CHEC06A M9 (Pay CITI 2.87%) 6/25/2036 3,097,201 5,000,000 SAST 06-1 B3 (Pay UBS 4.30%) 3/25/2036 3,097,934 5,000,000 RFC06EM8 M5 (Pay GS 1.50%) 10/25/2036 3,173,000 5,000,000 ACCT0601 M9 (Pay GS 2.17%) 4/25/2036 3,217,315 5,000,000 ACCT0601 M9 (Pay CS 3.72%) 4/25/2036 3,209,565 5,000,000 CWHE0614 M8 (Pay CITI 6.90%) 2/25/2037 3,315,500 5,000,000 CWHE0610 MV9 (Pay CITI 8.50%) 9/25/2046 3,440,023 5,000,000 SVHE06E1 M9 (Pay CITI 5.75%) 10/25/2036 3,511,748 5,000,000 FFM07FF1 B1 (Pay CITI 3.10%) 1/25/2038 3,627,912 5,000,000 RFC06KS2 M8 (Pay CITI 2.50%) 3/25/2036 3,677,726 5,000,000 RASC 2007-KS2 M8 (Pay GS 2.80%) 2/25/2037 3,740,497 5,000,000 BSABS 2007-HE2 2M8 (Pay GS 3.25%) 3/25/2037 3,873,094 5,000,000 GSA06HE7 M9 (Pay CITI 5.50%) 10/25/2036 3,888,971 5,000,000 FFML 06-FF6 M6 (Pay GS 2.65%) 4/25/2036 3,934,604 5,000,000 RASC 2007-KS2 M8 (Pay GS 3.25%) 2/25/2037 3,950,383 5,000,000 ACE06OP1 M9 (Pay DB 3.25%) 4/25/2036 4,109,693 5,000,000 GSA06HE7 M9 (Pay GS 5.80%) 10/25/2036 4,120,351

The accompanying notes are an integral part of these financial statements. 5 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) SCHEDULE OF INVESTMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars)

CREDIT DEFAULT SWAP NOTIONAL TERMINATION CONTRACTS, AMOUNT CREDIT DEFAULT SWAP CONTRACTS, AT VALUE (84.48%) DATE AT VALUE $ 5,000,000 CWHE0619 M9 (Pay CITI 3.35%) 3/25/2037 $ 4,216,615 6,000,000 CWL 2006-26 M9 (Pay CS 4.79%) 6/25/2037 4,762,222 6,000,000 HSA06OP1 M9 (Pay GS 3.80%) 12/25/2035 4,323,348 6,250,000 RFC06EF1 M8 (Pay UBS 2.45%) 4/25/2036 4,047,188 7,500,000 CWL 2006 - 22 M8 (Pay CS 5.00%) 5/25/2037 5,876,598 7,500,000 CWABS INC 2006-26 (Pay GS 2.75%) 8/25/2037 5,697,813 7,500,000 OOMLT0503 M9 (Pay GS 10.25%) 8/25/2035 4,562,982 7,500,000 BNC07001 M8 (Pay UBS 3.53%) 3/25/2037 5,223,525 7,500,000 FFM07FF1 B2 (Pay UBS 5.25%) 1/25/2038 5,255,116 7,500,000 FFM06F17 M8 (Pay UBS 5.53%) 12/25/2036 6,018,409 7,500,000 FFM06F15 M8 (Pay CITI 5.43%) 11/25/2036 6,261,120 10,000,000 FFM07FF1 B2 (Pay UBS 3.10%) 1/25/2038 5,429,476 10,000,000 NOVASTAR MTG FDG TR 2006-5 (Pay UBS 3.14%) 11/25/2036 7,167,728 10,000,000 SAIL 2006-4 M4 (Pay CS 3.75%) 7/25/2036 6,849,220 10,000,000 WLT05WC1 M9 (Pay BEAR 5.05%) 10/25/2035 5,546,570 10,000,000 RFC05EF6 M9 (Pay CITI 3.80%) 11/25/2035 6,537,957 10,000,000 CWHE0610 MV9 (Pay BEAR 8.25%) 9/25/2046 6,951,296 10,000,000 OOMLT0603 M8 (Pay UBS 4.78%) 2/25/2037 7,741,132 10,000,000 SAS06EQ1 M8 (Pay UBS 1.60%) 7/25/2036 7,834,000 10,000,000 FFM06F17 M8 (Pay DB 2.90%) 12/25/2036 8,187,489 10,000,000 FFM06F12 M8 (Pay UBS 5.42%) 9/25/2036 8,163,516 ------------ Credit Default Swap Contracts, at Value - (upfront fee payments: $ 79,349,003) $271,421,697 ------------ Total Net Credit Default Swap Contracts, at Value $216,809,058 ------------

The accompanying notes are an integral part of these financial statements. 6 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) SCHEDULE OF INVESTMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars) SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL DAYS TO REPURCHASE COUNTERPARTY RATE MATURITY AGREEMENT TOTAL Bear Stearns 4.60% 2 $ 59,174,000 ------------- Total $ 59,174,000 ------------- The accompanying notes are an integral part of these financial statements. 7 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars)

INVESTMENT INCOME Interest (includes interest from an affiliated investment of $427,870) $ 11,304,208 Dividends 1,257,011 ------------- Total investment income 12,561,219 INVESTMENT EXPENSE Interest 4,935,004 ------------- OTHER EXPENSES Custody fees 62,530 Professional fees 308,250 Administration fees 141,333 Director fees 17,160 Other expenses 6,352 ------------- Total other expenses 535,625 ------------- Total expenses 5,470,629 ------------- Net investment income 7,090,590 ------------- NET REALIZED AND UNREALIZED GAIN (LOSS) Net realized gain (loss) on Investments (8,247,891) Swap contracts 107,929,188 ------------- Net realized gain 99,681,297 ------------- Net change in unrealized appreciation/(depreciation) on Investments (includes depreciation from an affiliated investment of $5,160,391) (61,374,144) Swap contracts 178,219,519 ------------- Net change in unrealized appreciation 116,845,375 ------------- Net realized and unrealized gain 216,526,672 ------------- Net increase in net assets resulting from operations $ 223,617,262 =============

The accompanying notes are an integral part of these financial statements. 8 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) STATEMENT OF CHANGES IN NET ASSETS YEAR ENDED DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars)

FROM OPERATIONS Net investment income $ 7,090,590 Net realized gain 99,681,297 Net change in unrealized appreciation 116,845,375 ------------- Net increase in net assets resulting from operations 223,617,262 ------------- FROM CAPITAL SHARE TRANSACTIONS Subscriptions 135,380,623 Redemptions (37,695,165) ------------- Net increase in net assets resulting from capital share transactions 97,685,458 ------------- Total increase in net assets 321,302,720 NET ASSETS Beginning of year -- ------------- End of year $ 321,302,720 -------------

The accompanying notes are an integral part of these financial statements. 9 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) STATEMENT OF CASH FLOWS YEAR ENDED DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars)

NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 223,617,262 Adjustments to reconcile net increase in net assets resulting from operations to net cash provided from operating activities Purchase of investment securities (111,312,492) Purchase of credit default swaps (87,793,098) Proceeds from dispositions of investment securities (including paydowns) 29,393,740 Proceeds from dispositions of credit default swaps 156,097,241 Net realized (gain)/loss on investments 8,247,891 Net realized (gain)/loss on swap contracts (107,929,188) Net change in unrealized depreciation on investments 61,374,144 Change in net value of swap contracts (177,184,013) Change in margin cash received from counterparties 218,648,130 Change in margin cash paid to counterparties (1,800,244) Change in securities purchased under agreements to resell (59,174,000) Change in interest receivable (126,085) Change in interest payable on margin cash 953,919 Change in accrued expenses and other liabilities 233,750 Change in due to brokers 95,483 Change in other assets (89,134) ------------- Net cash provided from operating activities 153,253,306 ------------- CASH PROVIDED FROM FINANCING ACTIVITIES Capital subscriptions 135,380,623 Capital redemptions (37,695,165) ------------- Net cash provided from financing activities 97,685,458 ------------- Net change in cash and cash equivalents 250,938,764 CASH AND CASH EQUIVALENTS Beginning of year -- ------------- End of year $ 250,938,764 ============= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest paid $ 3,981,085 =============

The accompanying notes are an integral part of these financial statements. 10 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) FINANCIAL HIGHLIGHTS YEAR ENDED DECEMBER 31, 2007 -------------------------------------------------------------------------------- (expressed in U.S. dollars) Results of operations for a share outstanding for the year ended December 31, 2007 are as follows: Per share operating performance(a) NET ASSET VALUE PER SHARE, BEGINNING OF YEAR $ 100,000.00 Net investment income 7,873.42 Net realized and unrealized gain 237,056.11 -------------- NET ASSET VALUE PER SHARE, END OF YEAR $ 344,929.53 ============== Total return(b) 244.93% RATIOS TO AVERAGE NET ASSETS Operating expense(c) (3.34)% Operating expense excluding interest expense(c) (0.33)% Net investment income(c) 4.33% (a) Per share operating performance is computed based upon the monthly outstanding shares. (b) Total return is calculated for a share outstanding the entire year. An individual shareholder's return may differ depending on the timing of subscriptions and redemptions. (c) The operating expense and net investment income ratios are calculated for the Fund taken as a whole. An individual shareholder's ratio may vary from these ratios based on the timing of capital transactions. The accompanying notes are an integral part of these financial statements. 11 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- 1. ORGANIZATION AND INVESTMENT OBJECTIVE HFH ShortPLUS Master Fund, Ltd. (the "Fund") is a Cayman Islands exempted company incorporated in accordance with the Companies Law (2004 revision) which commenced operations on January 2, 2007. The Fund's strategy is to assemble a short-biased portfolio of asset-backed securities ("ABS") that the Investment Manager believes are most likely to produce high returns during periods of adverse credit performance for residential mortgages, and for mortgage-backed securities ("MBS") and ABS. Returns will come from two principal sources: (i) market value changes arising from changes in credit spreads on the Fund's short positions; and (ii) credit default payments from counterparties on credit default swaps ("CDS") or other derivatives. Highland Financial Holdings Group, LLC ("Investment Manager") serves as the investment manager of the Fund. The Investment Manager manages and invests the Fund's assets and effects all security transactions on behalf of the Fund. The Fund operates under a "master fund/feeder fund" structure. HFH ShortPLUS Fund, Ltd. and HFH ShortPLUS Fund, L.P. (collectively, the "Feeder Funds") invest substantially all of their investable assets in the Fund. The following Feeder Funds were invested in the Fund at December 31, 2007: HFH ShortPLUS Fund, Ltd. $237,378,889 HFH ShortPLUS Fund, L.P. 83,923,831 ------------ Total Feeder Funds' investment in the Fund $321,302,720 ------------ 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions, including estimates of fair value investments and CDS, that affect the reported amounts and disclosures in the financial statements. Actual results could differ from these estimates and those differences could be material to the financial statements. BASIS OF ACCOUNTING Transactions in securities are recorded on a trade date basis. Realized and unrealized gains/losses are calculated based on a FIFO cost basis. Interest income is recorded on an accrual basis when earned. Operating expenses, including interest on securities sold short, margin deposits, and reverse repurchase agreements, are recorded on the accrual basis as incurred. CASH AND CASH EQUIVALENTS Cash and cash equivalents consist principally of cash, margin cash received from counterparties, and short term investments (treasury bills), which are readily convertible into cash and have original maturities of three months or less. 12 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- VALUATION Investments in securities held by the Fund are carried at value. Value for such investments is estimated by the Investment Manager. The Investment Manager will use its reasonable discretion to value each investment by using, as a guide, a combination of (i) independent, third-party pricing sources; (ii) indications from one or more financial institutions engaged in trading the investments or securities similar to the investments being valued; (iii) transactions in the market of the same or similar securities; and (iv) in-house models the Investment Manager maintains. In cases where the number of indications is limited, the Investment Manager will review other factors such as the previous month's value, whether such indication is from the same counterparty, the delta between the current value and the previous month value, relevant market data or news, the value of similar securities, recent trading information and any other information which may be deemed relevant at the discretion of the Investment Manager. With respect to CDS, the Investment Manager may use, if considered representative of the value of CDS positions, margin marks from the actual counterparty with whom the security was traded, or from counterparties of a similar CDS position to estimate the valuation. However, if the Investment Manager believes the exit price will be either greater or less than the current margin mark, the Investment Manager has the discretion to revise the value accordingly. Fair value determinations based on indications from financial institutions or margin marks from counterparties may be based on as few as a single indication/margin mark, or may be calculated as the average of more than one such indication/margin mark, which average may include recent transactions in the market or ignore outlying indications/margin marks based on the Investment Manager's discretion. The Investment Manager may use observable transactions in the market in determining the fair value of investments if, at the discretion of the Investment Manager, prioritization of such transactions is considered more relevant given market conditions or other factors. Securities for which no indications are available are to be valued at such value as the Investment Manager may reasonably determine. The Investment Manager defines investments that are fair valued as those investments for which an investment is valued solely based on an in-house maintained model. As of December 31, 2007, these financial statements include investments fair valued by such in-house model totaling $4,705,836 (1.5% of net assets). In addition, the Investment Manager has determined that conditions in the 2007 asset backed securities market have impacted the extent of relevant data points that are available to estimate fair value of the Fund's investments. These market conditions include reduced liquidity, increased risk premiums for issuers, reduced investor demand for asset-backed securities, particularly those securities backed by sub-prime collateral, general financial stress and rating agency downgrades, and a general tightening of available credit. At December 31, 2007, the values for approximately $7,507,552 (2.3% of net assets) of investments, $176,174,662 (54.8% of net assets) of CDS "receiving" protection, and -$3,759,223 (-1.2% of net assets) of CDS "providing" protection were primarily estimated using one indication/margin mark obtained from an external source. Given market conditions described above, the indication/margin mark provided by financial institutions may differ from the bid or ask that market participants would be willing to transact. As a result, the range of fair value of investments and CDS positions can be significant and the values reflected in these financial statements may differ from the values that would have been realized had such investments been liquidated. Options that are listed on or admitted to trading on one or more exchanges are valued at the last sale price, if such price is equal to or is between, the "bid" and the "ask" prices (otherwise, the mean between the "bid" and "ask" prices is used). If options are not listed or admitted to trading on one or more exchanges, the fair value of such options is obtained from external parties which may include the contract 13 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- counterparty. Future contracts traded on a national exchange or market are valued at the last reported sales price on the valuation date. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES The Fund recognizes the market value of all derivative instruments as either assets or liabilities in the Statement of Assets and Liabilities and measures those instruments at fair value. INTEREST RATE AND INDEX SWAPS The Fund may enter into interest rate and index swaps as part of its investment strategies. Swaps involve the exchange by the Fund with another party of respective commitments to pay or receive interest, effective return, or total return throughout the lives of the agreements. The Fund may be required to deliver or receive cash or securities as collateral upon entering into swap transactions. Movements in the relative value of the swap transactions may require the Fund or the counterparty to post additional collateral. Swaps change in value with movements in interest rates. During the term of the swap contracts, changes in value and accrued interest payments are recognized as unrealized gains or losses by marking the contracts to the market. These unrealized gains and losses are reported as an asset or liability, respectively, on the Statement of Assets and Liabilities. When contracts are terminated, the Fund will realize a gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the Fund's basis in the contract, if any. CREDIT DEFAULT SWAPS The Fund enters into credit default swaps to simulate long and short bond positions that are either unavailable or considered to be less attractively priced in the bond market. The Fund uses these swaps to attempt to reduce risk where the Fund has exposure to the issuer, or to take an active long or short position with respect to the likelihood of the issuer's default. There is no certainty that the objectives of holding credit default swaps will be achieved. The buyer of a credit default swap is obligated to pay the seller a periodic stream of payments over the term of the contract in return for a contingent payment upon the occurrence of a credit event, with respect to an underlying reference obligation. Generally, a credit event means bankruptcy, failure to pay, obligation accelerated or modified restructuring. If a credit event occurs, the seller typically must pay the contingent payment to the buyer, which is typically the par value (full notional value) of the reference obligation. The contingent payment may be a cash settlement or by a physical delivery of the reference obligation in return for payment of the face amount of the obligation. If the Fund is a buyer and no credit event occurs, the Fund may lose its investment and recover nothing. However, if a credit event occurs, the buyer typically receives full notional value and interest for a reference obligation that may have little or no value. As a seller, the Fund receives a fixed rate of income throughout the term of the contract, provided that no credit event occurs. If a credit event occurs, the seller may pay the buyer the full notional value and interest of the reference obligation. Upfront payments made and/or received by the Fund are recorded as an asset and/or liability on the Statement of Assets and Liabilities and are recorded as a realized gain or loss on the termination date. As of December 31, 2007, the Fund has 79 open credit default swaps. The Fund is the buyer on 64 of these swaps ("receiving protection" on a total notional amount of $382.1 million) and is the seller on the remaining 15 ("providing protection" on a total notional amount of $85.5 million). Credit default swaps involve greater risks than if the Fund had invested in the reference obligations directly. In addition to general market risks, credit default swaps are subject to liquidity risk and counterparty credit risk. A buyer also may lose its investment and recover nothing should a credit event not occur. If a credit event did 14 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- occur, the value of the reference obligation received by the seller, coupled with the periodic payments previously received, may be less than the full notional value it pays to the buyer, resulting in a loss of value. The notional amounts of the swaps are not recorded in the financial statements. The swaps are carried at their estimated fair value, as determined in good faith by the Investment Manager. The change in value is recorded within unrealized appreciation (depreciation) until the occurrence of a credit event or the termination of the swap, at which time a realized gain (loss) is recorded. FUTURES A futures contract is an agreement between two parties to buy or sell a financial instrument for a set price on a future date. Initial margin deposits are made upon entering into futures contracts and can be either cash or securities. During the period the futures contract is open, changes in the value of the contract are recognized as unrealized gains or losses by marking to market on a daily basis to reflect the market value of the contract at the end of each day's trading. When the contract is closed, the Fund records a realized gain or loss equal to the difference between the proceeds of the closing transaction and the Fund's basis in the contract. PURCHASED OPTIONS The Fund may purchase put or call options. When the Fund purchases an option, an amount equal to the premium paid is recorded as an asset and is subsequently marked-to-market. Premiums paid for purchasing options that expire unexercised are recognized on the expiration date as realized losses. If an option is exercised, the premium paid is subtracted from the proceeds of the sale or added to the cost of the purchase to determine whether the Fund has realized a gain or loss on the related investment transaction. When the Fund enters into a closing transaction, the Fund will realize a gain or loss depending upon whether the amount from the closing transaction is greater or less than the premium paid. WRITTEN OPTIONS The Fund may write put or call options. When the Fund writes an option, an amount equal to the premium received is recorded as a liability and is subsequently marked-to-market. Premiums received for writing options that expire unexercised are recognized on the expiration date as realized gains. If an option is exercised, the premium received is subtracted from the cost of the purchase or added to the proceeds of the sale to determine whether the account has realized a gain or loss on the related investment transaction. When the Fund enters into a closing transaction, the Fund will realize a gain or loss depending upon whether the amount from the closing transaction is less or greater than the premium received. SHORT SALES When the Fund sells short, it may borrow the security sold short and deliver it to the broker-dealer through which it sold short as collateral for its obligation to deliver the security upon conclusion of the sale. Additionally, the Fund generally is required to deliver cash or securities as collateral for the Fund's obligation to return the borrowed security. The Fund may have to pay a fee to borrow the particular securities and may be obligated to pay over any payments received on such borrowed securities. A gain, limited to the price at which the Fund sold the security short, or a loss, unlimited as to dollar amount, will be recognized upon the termination of a short sale if the market price is less or greater than the proceeds originally received. 15 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- FINANCING TRANSACTIONS The Fund enters into repurchase agreements as a borrower (securities sold under agreement to repurchase) and as a lender (securities purchased under agreement to resell). All repurchase agreements are carried at their contractual amounts on the Statement of Assets and Liabilities, and the accrued income (expense) is recorded separately. Securities sold under agreements to repurchase include buy-sell financing transactions. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE ("REVERSE REPURCHASE AGREEMENTS") The Fund monitors collateral market values relative to the amounts due under the agreements, including accrued interest, throughout the lives of the agreements, and when necessary, requires transfer of cash or securities in order to manage exposure and liquidity. In connection with such agreements, if the counterparty defaults or enters an insolvency proceeding, realization or return of the collateral to the Fund may be delayed or limited. At December 31, 2007, the Fund had no securities sold under agreements to repurchase. SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL ("REPURCHASE AGREEMENTS") Securities purchased under agreements to resell are generally collateralized principally by U.S. government and agency securities. The Fund takes possession of such underlying collateral, monitors its market value relative to the amounts due under the agreements, including accrued interest, throughout the lives of the agreements, and when necessary, may require a transfer of additional cash or securities in order to manage exposure and liquidity. In connection with such agreements, if the counterparty defaults or enters an insolvency proceeding, realization or return of the funds to the Fund may be delayed or limited. At December 31, 2007, the Fund had securities purchased under agreements to resell totaling $59,174,000. The Fund received collateral in the form of various FNMA MBS pools under a held in custody agreement with an interest rate of 4.6% and a maturity of two days. The value of the securities, including accrued interest, received as collateral by the Fund that it was permitted to sell or repledge was $59,189,122. INCOME TAXES The Fund is a Cayman Islands exempted company. Under the current laws of the Cayman Islands, there are no income, estate, transfer, sale or other taxes payable by the Fund. The Fund is taxed as a partnership for U.S. Federal income tax purposes, and as such, is not subject to income taxes; each investor may be individually liable for income taxes, if any, on its share of the Fund's net taxable income. The Fund trades securities for its own account and, as such, investors are generally not subject to U.S. tax on such earnings (other than certain withholding taxes indicated below). The Investment Manager intends to conduct the business of the Fund to the maximum extent practicable so that the Fund's activities do not constitute a U.S. trade or business. Interest and other income received by the Fund from sources within the United States may be subject to, and reflected net of, United States withholding tax at the rate of 30%. Interest, dividend and other income realized by the Fund from non-U.S. sources and capital gains realized on the sale of securities of non-U.S. issuers may be subject to withholding and other taxes levied by the jurisdiction in which the income is sourced. On February 1, 2008, FASB issued FIN 48-2, Effective Date of FASB Interpretation No. 48 for Certain Nonpublic Enterprises ("FSP"), which allows the Fund to defer the adoption of FIN 48 until periods beginning after December 15, 2007. The Investment Manager has elected to take advantage of this deferral. Based on its analysis, the Investment Manager has determined that the adoption of FIN 48 will not have a 16 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- material impact to the Fund's financial statements. However, the Investment Manager's conclusions regarding FIN 48 may be subject to review and adjustment at a later date based on factors including, but not limited to, further implementation guidance, and on-going analyses of tax laws, regulations and interpretations thereof. FIN 48 requires the Investment Manager to determine whether a tax position of the Fund is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement which could result in the Fund recording a tax liability that would reduce net assets. FIN 48 must be applied to all existing tax positions upon initial adoption and the cumulative effect, if any, is to be reported as an adjustment to net assets upon adoption. 3. DUE TO/FROM BROKERS The Fund has brokerage agreements with various brokerage firms to carry its account as a customer. The brokers have custody of the Fund's securities and, from time to time, cash balances may be due to/from these brokers. These securities and/or cash positions serve as collateral for any amounts due to brokers or as collateral for securities sold, not yet purchased or investment securities purchased on margin. The securities and/or cash positions also serve as collateral for potential defaults of the Fund. The Fund is subject to credit risk if the brokers are unable to repay balances due or deliver securities in their custody. 4. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND OTHER RISKS The Fund may invest on a leveraged basis in various financial instruments and is exposed to market risks resulting from changes in the fair value of the instruments. The Statement of Assets and Liabilities may include the market or fair value of contractual commitments involving forward settlements, futures contracts and swap transactions as well as investments in securities sold short. These instruments involve elements of market risk in excess of amounts reflected on the Statement of Assets and Liabilities. Derivative financial statements are used by the Fund to help manage such market risk and to take an active long or short position in the market. Should interest rates move unexpectedly, the Fund may not achieve the anticipated benefits of the hedging instruments and may realize a loss. Further, the use of such derivative instruments involves the risk of imperfect correlation in movements in the price of the instruments, interest rates and the underlying hedged assets. The investment characteristics of mortgage-backed and asset-backed securities differ from traditional debt securities. Among the major differences are that interest and principal payments are made more frequently, usually monthly, and that principal may be prepaid at any time because the underlying residential or commercial mortgage loans or other assets generally may be prepaid at any time. Maturities on mortgage-backed and asset-backed securities represent stated maturity dates. Actual maturity dates may differ based on prepayment rates. The Fund is exposed to credit-related losses in the event of nonperformance by counterparties to financial instruments. The maximum credit exposure related to the derivative financial instruments of the 17 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- Fund is equal to the fair value of the contracts with positive fair values as of December 31, 2007. It is the policy of the Fund to transact the majority of its securities and contractual commitment activity with broker-dealers, banks and regulated exchanges that the Investment Manager considers to be well established. The Fund's short-biased strategy depends in large measure upon the ability of the Investment Manager to identify ABS that experience future credit losses arising from the defaults by obligors on the related mortgage loans. This is the opposite approach from that employed in traditional long-bias credit investment strategies that generally seek to avoid credit losses on investments purchased on the basis of fundamental credit analysis, or on other bases. There can be no assurance that the Investment Manager's assessments of the likelihood of default and losses on specific ABS transactions will be accurate or that the predictive strengths of the Investment Manager's models and practices will not decline. Even if ABS default and loss rates increase generally in the future relative to the rates observed in the past, the Fund's return objectives will not be met if the Fund has bought credit protection or otherwise shorted securities that do not experience such higher default and loss rates. The Fund's strategy also includes long investments that are intended to generate positive income during the first several years of the Fund, in order to partially offset the negative carry of the short positions. Losses on these long positions could produce losses for the Fund and could result in the failure of the Fund to achieve the intended purpose of offsetting the CDS premium costs. The Fund is a new enterprise with limited operating history. Accordingly, an investment in the Fund entails risk. There can be no assurance that the Fund will achieve its investment objective or that the Fund's strategies will be successful. There exists a possibility that an investor could suffer a substantial loss as a result of an investment in the Fund. The success of any investment activity is influenced by general economic conditions that may affect the level and volatility of equity prices, credit spreads, interest rates and the extent and timing of investor participation in the markets for both equity and interest-rate-sensitive securities. Unexpected volatility or illiquidity in the markets in which the Fund directly or indirectly holds positions could impair the Fund's ability to carry out its business and could cause the Fund to incur losses. Depending on market conditions, reliable pricing information will not always be available from any source. Prices quoted by different sources are subject to material variation. Credit-sensitive tranches of ABS are exposed to credit risk arising from possible defaults of the underlying loans and recovery rates on those liquidated loans. The default rates of loans backing these securities is dependent on a number of factors including the quality and characteristics of the loans, national and regional economic growth, real estate values, the level of interest rates, changes in the availability of mortgage financing and other factors. Recovery values following a default will be dependent largely on regional and national real estate values among other things; although real estate values may depend on other economic variables. The rate of prepayments on the loans collateralizing a subordinate ABS tranche will generally have a significant effect on the amount of obligor defaults a tranche can face before suffering losses of interest or principal. The Investment Manager believes it is impossible to accurately predict prepayment rates because prepayment rates are heavily influenced by equally unpredictable interest rates. Consequently, while 18 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- the Investment Manager seeks to explore the potential effects of a wide range of possible prepayment rates for securities or CDS it purchases or sells, there can be no assurance that this analysis will exhaust the possible paths prepayments could take, or that the effects of any particular prepayment rate scenario will be evaluated correctly in respect of a specific ABS tranche or CDS. A decline in the market value of the Fund's portfolio of assets may limit the Investment Manager's ability to borrow, or may result in lenders initiating margin calls (i.e., requiring a pledge of cash or additional assets to re-establish the ratio of the amount of the borrowing to the value of the collateral). The Investment Manager could be required to sell assets at distressed prices under adverse market conditions in order to satisfy the requirements of the lenders. A default by the Fund under its collateralized borrowings could also result in a liquidation of the collateral by the lender, including any cross-collateralized assets, and a resulting loss of the difference between the value of the collateral and the amount borrowed. As discussed in Note 1, the Fund's investors are two Feeder Funds managed by the Investment Manager. The Fund could be materially affected by significant subscriptions and redemptions from the underlying investors of these Feeder Funds. 5. SHARE CAPITAL The authorized share capital of the Fund consists of 5,000,000 shares having a par value of $0.01 (U.S.) per share. At December 31, 2007, 931.50 shares were issued and outstanding. Common shares are offered at an offering price equal to the net asset value per common share as of the close of business on the immediately preceding business day. Any holder of common shares has the right, in accordance with and subject to the applicable provisions of the memorandum of association of the Fund and the laws of the Cayman Islands, to have all or a portion of their shares redeemed on a date determined by the Directors. At December 31, 2007, all outstanding shares are held by the Feeder Funds. The following table reconciles share transactions for the year ended December 31, 2007: SHARES Balance, January 2, 2007 -- Shares issued 1,150.86 Shares redeemed (219.36) ----------- BALANCE, DECEMBER 31, 2007 931.50 =========== The Directors of the Fund have the sole discretion to authorize distribution of dividends. 6. DIRECTORS AND FEES The following persons are independent non-executive Directors of the Fund: o David Bree 19 HFH SHORTPLUS MASTER FUND, LTD. (A CAYMAN ISLANDS EXEMPTED COMPANY) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2007 -------------------------------------------------------------------------------- o Peter Burnim All members of the Board of Directors are reimbursed for their out-of-pocket expenses incurred in connection with the performance of their duties and each receives an annual fee of approximately $5,000. No Directors have a shareholder interest in the Fund or have an interest, direct or indirect, in any transaction affecting the Fund during the year ended December 31, 2007, which is unusual in nature or significant to the business of the Fund. No Director has any contracts of significance with the Fund. 7. CONTINGENCIES AND COMMITMENTS In the normal course of business, the Fund enters into contracts that contain a variety of representations, warranties and general indemnifications. The Fund's maximum exposure under these arrangements, including future claims that may be made against the Fund that have not yet occurred, is unknown. However, based on experience of the Investment Manager, the Fund expects the risk of loss associated with such contracts to be remote. 8. RELATED PARTY TRANSACTIONS The Investment Manager provides discretionary services to other funds that follow an investment program similar to that which was followed by the Fund. Investments may be allocated between the Fund and other funds. Also, the Fund may purchase securities from and sell securities to such other funds. No additional transaction costs are incurred by the Fund as a result of such transactions. The Investment Manager allocates certain expenses to the Fund for the day-to-day accounting and administrative services performed by its employees on behalf of the Fund. For the year-ended December 31, 2007, these costs amounted to $163,588. These costs are included in the Fund's "professional expenses" on the statement of operations. 9. SUBSEQUENT EVENTS From January 1 through March 1, 2008, the Fund had redemptions of $33,617,455. In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 applies to reporting periods beginning after November 15, 2007. The adoption of SFAS 157 is not expected to have a material impact on the Fund's financial statements. 20 AFFIRMATION OF COMMODITY POOL OPERATOR To the best of my knowledge and belief the information contained herein pertaining to HFH ShortPLUS Master Fund, Ltd. is accurate and complete. Highland Financial Holdings Group, LLC Commodity Pool Operator /s/ Paul Ullman ------------------------------------------ By Paul Ullman President of Highland Financial Holdings Group, LLC The Investment Manager of Highland ShortPLUS Master Fund, Ltd. 21