UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
COMMISSION FILE NUMBER 1-6732
DANIELSON HOLDING CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 95-6021257
(State of Incorporation) (I.R.S. Employer Identification No.)
767 Third Avenue, New York, New York 10017-2023
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 888-0347
SECURITIES REGISTERED PURSUANT TO SECTION 12 (B) OF THE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
------------------- ----------------
Common Stock, $0.10 par value............... American Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12 (G) OF THE ACT: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
At March 25, 2002, the aggregate market value of the registrant's voting
stock held by non-affiliates was $97,585,223.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
CLASS OUTSTANDING AT MARCH 25, 2002
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Common Stock, $0.10 par value 19,510,898 shares
The following documents have been incorporated by reference herein:
2001 Annual Report to Stockholders, as indicated herein (Parts I and II)
PART I
ITEM 1. BUSINESS.
INTRODUCTION
Danielson Holding Corporation ("DHC" or "Registrant") is a holding company
incorporated in Delaware, having separate subsidiaries (collectively with DHC,
the "Company") offering a variety of insurance products. It is DHC's intention
to grow by developing business partnerships and making strategic acquisitions.
As part of DHC's ongoing corporate strategy, DHC has continued to seek
acquisition opportunities which will both complement its existing operations and
enable DHC to earn an attractive return on investment. The largest subsidiary of
DHC is its indirectly wholly-owned California insurance company, National
American Insurance Company of California (together with its subsidiaries,
"NAICC").
DHC had cash and investments at the holding company level of $29.9 million
at December 31, 2001. Total liabilities of DHC at the same date were $6.6
million.
The Company expects to report, as of the close of its 2001 tax year,
aggregate consolidated net operating tax loss carryforwards ("NOLs") for Federal
income tax purposes of approximately $745 million. These losses will expire over
the course of the next 18 years unless utilized prior thereto. See Note 8 of the
Notes to Consolidated Financial Statements.
DESCRIPTION OF BUSINESSES
Set forth below is a description of DHC's business operations as of
December 31, 2001, as presented in the Consolidated Financial Statements
included in this report. The insurance operation is the only business segment.
INSURANCE BUSINESS
DHC's wholly-owned subsidiary, NAICC, is a California corporation currently
engaged in writing private passenger automobile insurance in California and
commercial automobile insurance in certain western states, primarily California.
Prior to the fourth quarter of 2001, NAICC had also been engaged in writing
non-standard private passenger automobile insurance in certain western states
outside of California, preferred private passenger automobile insurance and
workers' compensation insurance. NAICC is a second tier subsidiary of DHC. Prior
to 2001, NAICC's immediate parent corporation was KCP Holding Company ("KCP"),
which was wholly-owned by Mission American Insurance Company ("MAIC"), which was
wholly-owned by DHC. In April 2001, MAIC and KCP were merged into Danielson
Indemnity Company ("DIND"). DIND is wholly-owned by DHC.
GENERAL
NAICC's objective is to underwrite business that is expected to yield an
underwriting profit. During 2001, NAICC determined that certain lines of
insurance may not be sustainable in the current rate environment. Competitive
and regulatory pressures have resulted in a general market for premium rates in
these lines that is well below a level necessary in order to achieve a profit,
especially in light of increasingly unfavorable loss history. Rather than
continue to sustain losses, NAICC has exited the worker's compensation line of
insurance in all states, and has also exited the non-standard private passenger
automobile program written outside of California. The last workers' compensation
policy in all states other than Montana was issued in July 2001 and the last
Montana workers' compensation policy was issued in January 2002. The last new
non-standard private passenger automobile policy outside of California was
issued in September 2001. The remaining lines of insurance written by NAICC will
be non-standard private passenger automobile in California and commercial
automobile in certain western states, primarily California.
The effect of this decision will be a substantial reduction in the
underwriting operations of NAICC going forward into 2002 with a view towards
increasing overall profitability. The Company expects that its written premium
for 2002 will be about half of the amount written in 2000. However, premium
activity could change substantially if the rate environment in those lines
exited materially improves and NAICC re-enters those markets.
NAICC began writing non-standard private passenger automobile insurance in
California in July 1993, in Oregon and Washington in April 1998 and in Arizona
in 1999. NAICC writes its California business through two general agents that
use over 700 sub-agents to obtain applications for policies. Oregon, Washington
and Arizona business is written directly through appointed independent agents.
Policyholder selection is governed by underwriting guidelines established by
NAICC. NAICC began writing non-standard commercial automobile insurance in 1995
through independent agents. Non-standard risks are those segments of the driving
public which generally are not considered "preferred" business, such as drivers
with a record of prior accidents or driving violations, drivers involved in
particular occupations or driving certain types of vehicles, or those who have
been non-renewed or declined by another insurance company. Generally,
non-standard premium rates are higher than standard premium rates and policy
limits are lower than typical policy limits. NAICC's management believes that it
is able to achieve underwriting success through refinement of various risk
profiles, thereby dividing the non-standard market into more defined segments
which can be adequately priced.
The majority of automobiles owned or used by businesses are insured under
policies that provide other coverages for the business, such as commercial
multi-peril insurance. Businesses which are unable to insure a specific driver
and businesses having vehicles not qualifying for commercial multi-peril
insurance are typical NAICC commercial automobile policyholders. Examples of
these risks include drivers with more than one moving violation, one and two
vehicle accounts, and specialty haulers, such as sand and gravel, farm vehicles
and certain short-haul common carriers. The typical NAICC commercial automobile
policy covers fleets of four or fewer vehicles. NAICC does not insure long-haul
truckers, trucks hauling logs, gasoline or similar higher hazard operations. The
current average annual premium of the policies in force is approximately $3,887.
Net written premiums for all private passenger automobile programs were
$20.1 million, $27.2 million and $29.7 million in 2001, 2000 and 1999,
respectively. Net written premiums were $19.4 million, $16.7 million and $21.9
million in 2001, 2000 and 1999, respectively, for the non-standard private
passenger automobile program. Net written premiums for preferred private
passenger automobile policies were $0.7 million, $10.5 million and $7.8 million
in 2001, 2000 and 1999, respectively.
The primary reason for the overall decrease in private passenger automobile
premiums in 2001 is the cancellation of the California preferred private
passenger automobile program in early 2001, and the cancellation of non-standard
private passenger automobile coverage outside of California later that year.
Both of these lines had proven to be unprofitable. The decrease in 2000
California non-standard private passenger automobile premiums was due to
increased competition in the California marketplace.
Until January 1, 1999, NAICC ceded 25 percent of its California
non-standard private passenger automobile business to a major reinsurance
company under a quota share reinsurance agreement. Effective January 1, 1999,
the ceding percentage was reduced to 10%. NAICC's Oregon and Washington
non-standard automobile, California preferred automobile, and commercial
automobile businesses are reinsured on an excess of loss basis, where the
Company retains the first $250,000.
Net written premiums for commercial automobile were $38.4 million, $23.1
million and $12.6 million in 2001, 2000 and 1999 respectively. The increase in
2001 is attributable to increased production as a result of increased marketing
efforts, particularly during the first nine months of the year.
NAICC wrote workers' compensation insurance in California and four other
western states. Workers' compensation insurance policies provide coverage for
statutory benefits which employers are required to pay to employees who are
injured in the course of employment including, among other things, temporary or
permanent disability benefits, death benefits, medical and hospital expenses and
expenses for vocational rehabilitation. Policies are issued having a term of no
more than one year. In response to continuing adverse developments affecting the
market for workers' compensation insurance, including worsening loss experience,
NAICC decided to exit the workers' compensation line of business. The last
California workers' compensation policy was issued in July and the last policy
issued outside of California was issued in January 2002. Net written premiums
for workers' compensation were $21.7 million, $22.3 million, and $13.1 million
in 2001, 2000, and 1999, respectively. The decrease in 2001 was mitigated by the
increase in premiums in Montana. NAICC acquired Valor Insurance Company,
Incorporated ("Valor") in June 1996. Valor is a Montana domiciled specialty
insurance company that wrote workers' compensation policies. Net written
premiums for Valor workers' compensation were $11.1 million, $9.9 million, and
$6.6 million in 2001, 2000, and 1999, respectively. Valor began non-renewing its
policies in December 2001 and was placed into run-off effective January 2002.
NAICC does not write any business through managing general agents. Its
California non-standard private passenger automobile program, representing 14.8%
of net written premiums in 2001, is produced through one general agent. In 2001,
NAICC discontinued its unprofitable California preferred private passenger
automobile program in California which had been produced through another general
agent and which represented 14.4% of net written premiums in 2000.
UNDERWRITING
Insurers admitted in California are required to obtain advance approval
from the California Department of Insurance for coverage rate and/or form
changes. Many of the states in which NAICC does business have similar
requirements. Rates and policy forms are developed by NAICC and filed with the
regulators in each of the relevant states, depending upon each state's
requirements. NAICC relies upon its own, as well as industry experience, in
establishing rates.
Private passenger automobile policy limits vary by state. In California,
non-standard policies provide maximum coverage up to $15,000 per person, $30,000
per accident for liability and bodily injury and $10,000 per accident for
property damage. In Arizona, Oregon and Washington, non-standard policies
provide minimum coverage of $25,000 per person, $50,000 per accident for
liability and bodily injury and $10,000 per accident for property damage, and
can provide coverage to a maximum of $250,000 per person, $500,000 per accident
for liability and bodily injury and $25,000 per accident for property damage. In
general, preferred policies provide coverage to a maximum of $250,000 per
person, $500,000 per accident for liability and bodily injury and $25,000 per
accident for property damage. The maximum non-standard commercial automobile
policy limit provided by NAICC is $1 million bodily injury and property damage
combined single limit of liability for each occurrence. NAICC retains the first
$250,000 bodily injury and property damage combined single limit of liability
for each occurrence, with losses in excess of $250,000, per occurrence, being
ceded to its reinsurers.
Workers' compensation rates, rating plans, policyholder dividend plans and
policy forms were developed and filed with the appropriate regulatory agency in
each state in which NAICC operated. NAICC relied principally upon rates
promulgated by either the Workers' Compensation Insurance Rating Bureau in
California or the National Council on Compensation Insurance, the statistical
agent for other western states in which NAICC marketed insurance. NAICC
maintained a disciplined approach to risk selection and pricing. In accordance
with this policy, NAICC selected each prospective policyholder based on the
characteristics of such risk and established premiums based on loss experience
and risk exposure. NAICC's pricing policy was not driven by market share
considerations.
NAICC retained the first $200,000 of each workers' compensation loss and
has purchased reinsurance for up to $49.8 million in excess of its retention, of
which the first $9.5 million were placed with three major reinsurance companies,
with the remaining $40.3 million being provided by 16 other companies. In April
2000, NAICC entered into a workers' compensation excess of loss reinsurance
agreement with SCOR Re Insurance Company that provides coverage down to
$200,000. In May 2001, NAICC entered into a workers' compensation excess of loss
reinsurance agreement with PMA RE Insurance Company that provides 50% coverage
down to $200,000.
In January 1999, NAICC entered into a workers' compensation reinsurance
agreement with Reliance Insurance Company (the "Reliance Agreement") with a term
of two years. The Reliance Agreement provided excess of loss coverage down to
$10,000 and a 20% quota share below the excess retention resulting in a maximum
net loss to NAICC of $18,000 per claim. In the fourth quarter of 1999, NAICC
executed an agreement to rescind the Reliance Agreement. The terms of the
rescission include the return of amounts paid by NAICC during the nine month
period the Reliance Agreement was active plus a settlement fee to terminate the
Reliance Agreement. NAICC recognized a gain of $8,317,000 in the fourth quarter
of 1999 as a result of this rescission.
MARKETING
During 2001, NAICC closed its Fresno, California and its Portland, Oregon
offices. Based on the decision to exit certain lines of business, NAICC reduced
its marketing personnel in both its Long Beach and Concord, California offices.
NAICC now maintains two sales offices located in Phoenix, Arizona and Concord,
California, each with a single marketing representative.All other functions of
policyholder service, renewal underwriting, policy issuance, premium collection
and record retention are performed centrally at NAICC's home office in Long
Beach, California.
NAICC currently markets its non-standard private passenger automobile
insurance in California through one general agent. NAICC wrote non-standard
private passenger automobile insurance directly through 128 independent agents
in Arizona, Idaho, Nevada, Oregon and Washington. During 2001 it was decided to
cease writing new policies for non-standard private passenger automobile outside
of California. The appointed independent agents were reduced accordingly. NAICC
also began a preferred private passenger automobile program in California in
February 1998 marketed through a second general agent. This program was
discontinued in 2001. During 2001, NAICC marketed its non-standard commercial
automobile insurance through approximately 700 independent agents located in
Arizona, California, Idaho, Nevada, Oregon, Utah and Washington. At the end of
2001 NAICC reduced its appointed agents to approximately 400 in order to gain
greater control over its underwriting standards.
NAICC wrote workers' compensation business primarily in the states of
California, Oregon, Arizona, Idaho and Montana through more than 800 independent
agents. In July 2001, NAICC ceased writing policies in California, Arizona, and
Nevada. NAICC stopped writing Oregon and Idaho policies in December 2001.
NAICC's subsidiary, Valor Insurance Company, marketed workers' compensation
insurance to Montana employers. All business was produced and serviced through
its home office in Billings, Montana. NAICC targeted employers having operations
that are classified as low to moderate hazard and that generally have payrolls
under $1 million. Typically, annual premium for employers in this payroll
category are less than $25,000. Valor wrote workers' compensation for employers
of a wide range of hazard classifications, from banks to construction
businesses, and targeted the larger employers in the state of Montana. Valor
ceased renewing its policies in December 2001 and was placed into run-off
effective January 2002.
CLAIMS
All automobile claims are handled by employees of NAICC at its home office
in Long Beach, California. Claims are reported by agents, insureds and claimants
directly to NAICC. Claims involving suspected fraud are referred to an in-house
special investigation unit ("SIU") which manages a detailed investigation of
these claims using outside investigative firms. When evidence of fraudulent
activity is identified, the SIU works with the various state departments of
insurance, the National Insurance Crime Bureau and local law enforcement
agencies in handling the claims.
Workers' compensation claims are received, reviewed and processed by NAICC
employees located in claims service offices in Long Beach, California. Most of
NAICC's policyholders are not of sufficient size or type to make a more
specialized managed care approach to medical cost containment more cost
effective.
The California Automobile Assigned Risk Plan provides for state mandated
minimum levels of automobile liability coverage to drivers whose driving
records, or other relevant characteristics, make it difficult for them to obtain
insurance coverage in the voluntary market. NAICC does not expect to receive a
material number of assignments arising from this program and does not believe
that the assignments will have a material adverse effect on its profitability.
LOSSES AND LOSS ADJUSTMENT EXPENSES
NAICC's unpaid losses and loss adjustment expenses ("LAE") represent the
estimated indemnity cost and loss adjustment expenses necessary to cover the
ultimate net cost of investigating and settling claims. Such estimates are based
upon estimates for reported losses, historical company experience of losses
reported by reinsured companies for insurance assumed, and actuarial estimates
based upon historical company and industry experience for development of
reported and unreported claims (incurred but not reported). Any changes in
estimates of ultimate liability are reflected in current operating results.
Inflation is assumed, along with other factors, in estimating future claim costs
and related liabilities. NAICC does not discount any of its loss reserves.
The ultimate cost of claims is difficult to predict for several reasons.
Claims may not be reported until many years after they are incurred. Changes in
the rate of inflation and the legal environment have created forecasting
complications. Court decisions may dramatically increase liability in the time
between the dates on which a claim is reported and its resolution. Punitive
damages awards have grown in frequency and magnitude. The courts have imposed
increasing obligations on insurance companies to defend policyholders. As a
result, the frequency and severity of claims have grown rapidly and
unpredictably.
NAICC has claims for environmental clean-up against policies issued prior
to 1970 and which are currently in run-off. The principal exposure arises from
direct excess and primary policies of business in run-off, the obligations of
which were assumed by NAICC in 1985. These direct excess and primary claims are
relatively few in number and have policy limits of between $50,000 and
$1,000,000, with reinsurance generally above $50,000. NAICC also has
environmental claims associated with participations in excess of loss
reinsurance contracts assumed by NAICC. These reinsurance contracts have
relatively low limits, generally less than $25,000, and estimates of unpaid
losses are based on information provided by the primary insurance company.
The unpaid loss and LAE related to environmental cleanup is established
considering facts currently known and the current state of the law and coverage
litigation. Liabilities are estimated for known claims (including the cost of
related litigation) when sufficient information has been developed to indicate
the involvement of a specific contract of insurance or reinsurance and
management can reasonably estimate its liability. Estimates for unknown claims
and development of reported claims are included in NAICC's loss and LAE. The
liability for development of reported claims is based on estimates of the range
of potential losses for reported claims in the aggregate. Estimates of
liabilities are reviewed and updated continually and there is the potential that
NAICC's exposure could be materially in excess of amounts that are currently
recorded. Management does not expect that liabilities associated with these
types of claims will result in a material adverse effect on future liquidity or
financial position. However, liabilities such as these are based upon estimates
and there can be no assurance that the ultimate liability will not exceed, or
even materially exceed, such estimates. As of December 31, 2001 and 2000,
NAICC's net unpaid losses and LAE relating to environmental claims were
approximately $7.6 million and $7.6 million, respectively.
Due to the factors discussed above and others, the process used in
estimating unpaid losses and loss adjustment expenses cannot provide an exact
result. Management believes that the provisions for unpaid losses and loss
adjustment expenses are adequate to cover the net cost of losses and loss
expenses incurred to date; however, such liability is necessarily based on
estimates and there can be no assurance that the ultimate liability will not
exceed, or even materially exceed, such estimates.
ANALYSIS OF LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of NAICC's unpaid losses and
LAE (in thousands):
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
2001 2000 1999
---- ---- ----
Net unpaid losses and LAE at January 1 $79,389 $ 79,306 $ 77,466
Incurred related to:
Current year 68,848 55,269 43,301
Prior years 7,646 5,254 2,491
---------- ----------- -----------
Total incurred 76,494 60,523 45,792
---------- ----------- -----------
Paid Related to:
Current year (28,632) (26,147) (16,527)
Prior years (39,239) (34,293) (27,425)
---------- ----------- -----------
Total paid (67,871) (60,440) (43,952)
---------- ----------- -----------
Net unpaid losses and LAE at
December 31 88,012 79,389 79,306
Plus: reinsurance recoverables on unpaid
losses 17,733 20,641 15,628
---------- ----------- -----------
Gross unpaid losses and LAE at
December 31 $ 105,745 $ 100,030 $ 94,934
========== =========== ===========
The losses and LAE incurred during 2001 related to prior years is
attributable to adverse developments on certain private passenger automobile
lines and the California workers' compensation line in the amount of $4.4
million. All of the workers' compensation lines and private passenger automobile
programs that caused higher than expected losses and increasingly unfavorable
loss history were placed in run-off during 2001. The losses and LAE incurred
during 2000 related to prior years is attributable to developments on the
commercial automobile lines and certain lines in run-off. The losses and LAE
incurred during 1999 related to prior years is primarily attributable to
development on the California workers' compensation line. NAICC increased its
bulk unpaid liabilities related to these policies, as it has become evident that
the loss costs associated with these claims would be greater than previously
anticipated.
The following table indicates the manner in which unpaid losses and LAE at
the end of a particular year change as time passes. The first line reflects the
liability as originally reported, net of reinsurance, at the end of the stated
year. Each calendar year-end liability includes the estimated liability for that
accident year and all prior accident years comprising that liability. The second
section shows the original recorded net liability as of the end of successive
years adjusted to reflect facts and circumstances that are later discovered. The
next line, cumulative (deficiency) or redundancy, compares the adjusted net
liability amount to the net liability amount as originally established and
reflects whether the net liability as originally recorded was adequate to cover
the estimated cost of claims or redundant. The third section reflects the
cumulative amounts related to that liability that were paid, net of reinsurance,
as of the end of successive years.
Analysis of Net Losses and Loss Adjustment Expense ("LAE") Development (dollars
in thousands):
YEAR ENDED DECEMBER 31
----------------------
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Net unpaid losses and LAE at end of
year
$ 97,810 $104,825 $119,223 $128,625 $116,294 $97,105 $ 85,762 $ 77,466 $79,306 $79,389
Net unpaid losses and LAE re- estimated as of:
One year later 94,364 105,658 119,607 131,748 126,414 98,045 85,762 79,957 84,560 87,035 88,012
Two years later 99,875 111,063 123,039 141,602 126,796 97,683 85,684 82,778 88,001
Three years later 107,945 117,756 136,735 141,787 127,621 98,545 87,613 83,778
Four years later 116,018 138,877 140,076 144,491 129,792 102,053 88,238
Five years later 136,269 142,423 142,537 146,827 133,985 102,949
Six years later 139,493 144,457 144,556 151,784 134,992
Seven years later 141,467 145,370 147,916 152,764
Eight Years later 142,031 148,052 148,523
Nine Years later 144,936 148,636
Ten Years later 145,437
Cumulative (deficiency) redundancy (47,627) (43,811) (29,300) (24,139) (18,698) (5,844) (2,476) (6,312) (8,695) (7,646)
Cumulative net amounts paid as of:
One year later 39,131 39,650 42,264 46,582 46,132 35,696 31,317 43,090 51,608 64,599
Two years later 63,483 68,025 71,702 80,515 74,543 54,815 43,855 62,577 71,151
Three years later 81,485 88,038 95,525 101,726 90,818 63,290 56,968 74,267
Four years later 94,238 106,431 110,163 114,424 97,900 74,306 66,015
Five years later 108,923 118,136 119,474 119,310 108,061 82,568
Six years later 118,397 125,218 122,296 128,117 115,721
Seven years later 124,569 126,362 129,378 135,013
Eight years later 125,256 132,482 134,792
Nine years later 130,963 137,163
Ten years later 135,320
The following table reflects the same information as the preceding table gross
of reinsurance (dollars in thousands):
Years ended December 31,
1993 1994 1995 1996 1997 1998 1999 2000 2001
---- ---- ---- ---- ---- ---- ---- ---- ----
Gross unpaid losses and LAE at
end of year: $ 137,479 $ 146,330 $ 137,406 $120,651 $ 105,947 $ 95,653 $ 94,934 $100,030 $105,745
Gross unpaid losses and LAE
re-estimated as of:
One year later 137,898 149,815 149,416 121,787 107,060 99,314 103,166 115,611
Two years later 141,737 161,731 150,106 121,335 106,543 100,893 105,313
Three years later 158,263 162,246 150,815 122,369 110,091 103,012
Four years later 162,697 165,111 153,509 126,736 112,841
Five years later 165,077 168,045 159,164 127,881
Six years later 167,702 174,811 160,538
Seven years later 172,768 176,192
Eight years later 173,728
Gross cumulative deficiency: (36,249) (29,862) (23,132) (7,230) (6,894) (7,359) (10,379) (15,581)
Gross cumulative amount paid as of:
One year later 53,634 53,798 54,901 47,835 36,542 55,245 61,397 69,061
Two years later 88,930 92,991 92,422 21,794 56,948 99,185 83,113
Three years later 116,605 122,095 110,498 37,092 93,694 112,892
Four years later 138,924 136,448 124,153 71,414 104,621
Five years later 148,928 146,803 157,591 81,525
Six years later 157,196 178,827 167,089
Seven years later 187,373 187,556
Eight years later 193,957
Gross unpaid losses and LAE latest
re-estimate 173,728 176,192 160,538 127,881 112,841 103,012 105,313 115,611
Reinsurance recoverable latest
re-estimate 25,205 23,429 25,546 24,932 24,603 19,234 17,312 32,276
----------------------------------------------------------------------------------------------
Net unpaid losses and LAE latest
re-estimate 148,523 152,764 134,992 102,949 88,238 83,778 88,001 83,335
----------------------------------------------------------------------------------------------
The cumulative deficiencies as of December 31, 1998 through 2000 on a net
basis of $6.3 million, $8.7 million, and $3.9 million, respectively, are due to
the strengthening of the unpaid losses and ALAE by $6.6 million in 2001,
primarily for workers' compensation and private passenger automobile. The
increase in 2001 was attributable to adverse development.
The cumulative deficiency as of December 31, 1995 on a net basis of $18.7
million is due to the strengthening of the unpaid losses and ALAE of pre-1980
businesses assumed by NAICC in 1985 and which are in run-off. NAICC increased
these run-off claim liabilities by $10 million in 1996. The pre-1980 run-off
liabilities include claims relating to environmental clean-up for policies
issued prior to 1970.
The cumulative deficiency on a net basis of $43.8 million and $47.6 million
as of December 31, 1992 and 1991, respectively, is also attributable to both
adverse development of workers' compensation loss experience in the 1990 and
1991 loss years and development in certain lines in run-off. The California
workers' compensation industry, including NAICC, experienced adverse development
of those loss years. The adverse development was the result of a significant
increase in frequency in workers' compensation claims that was brought on by a
downturn in the California economy, an increase in unemployment and a dramatic
increase in stress and post-termination claims. The adverse development in 1990
and 1991 was significantly offset by favorable workers' compensation loss
experience and development in the 1992 through 1995 loss years.
Conditions and trends that have affected the development of these
liabilities in the past may not necessarily recur in the future, especially
considering that those lines that have experienced the greatest adverse
development have been placed in run-off in 2001.
REINSURANCE
In its normal course of business NAICC reinsures a portion of its exposure
with other insurance companies so as to effectively limit its maximum loss
arising out of any one occurrence. Contracts of reinsurance do not legally
discharge the original insurer from its primary liability. Estimated reinsurance
receivables arising from these contracts of reinsurance are, in accordance with
generally accepted accounting principles, reported separately as assets.
Premiums for reinsurance ceded by NAICC in 2001 were 9.4 percent of written
premiums.
As of December 31, 2001, General Reinsurance Corporation (GRC), and Mitsui
Marine & Fire Insurance Company, Ltd. ("MMF"), were the only reinsurers that
comprised more than 10 percent of NAICC's reinsurance recoverable on paid and
unpaid claims. NAICC monitors all reinsurers, by reviewing A.M. Best reports and
ratings, information obtained from reinsurance intermediaries and analyzing
financial statements. At December 31, 2001, NAICC had reinsurance recoverables
on paid and unpaid claims of $8.7 million and $2.5 million from GRC and MMF,
respectively. Both GRC and MMF have an A.M. Best rating of A+ or better. The
unsecured balance from MMF is approximately $1.2 million. The paid and unpaid
recoverable amounts ceded to MMF relate to business in run-off and assumed by
NAICC. See Note 2 of the Notes to Consolidated Financial Statements for further
information on reinsurance.
NAICC and two of its subsidiaries participate in an inter-company pooling
and reinsurance agreement under which Danielson Insurance Company ("DICO") and
Danielson National Insurance Company ("DNIC") cede 100% of their net liability,
defined to include premiums, losses and allocated loss adjustment expenses, to
NAICC to be combined with the net liability for policies of NAICC in formation
of a "Pool". NAICC simultaneously cedes to DICO and DNIC 10% of the net
liability of the Pool. DNIC commenced participation in July, 1993 and DICO
commenced participation in January, 1994. Additionally, both DICO and DNIC
reimburse NAICC for executive services, professional services, and
administrative expenses based on designated percentages of net premiums written
for each line of business.
REGULATION
Insurance companies are subject to insurance laws and regulations
established by the states in which they transact business. The agencies
established pursuant to these state laws have broad administrative and
supervisory powers relating to the granting and revocation of licenses to
transact insurance business, regulation of trade practices, establishment of
guaranty associations, licensing of agents, approval of policy forms, premium
rate filing requirements, reserve requirements, the form and content of required
regulatory financial statements, periodic examinations of insurers' records,
capital and surplus requirements and the maximum concentrations of certain
classes of investments. Most states also have enacted legislation regulating
insurance holding company systems, including acquisitions, extraordinary
dividends, the terms of affiliate transactions and other related matters. The
Company and its insurance subsidiaries have registered as holding company
systems pursuant to such legislation in California and routinely report to other
jurisdictions. The National Association of Insurance Commissioners has formed
committees and appointed advisory groups to study and formulate regulatory
proposals on such diverse issues as the use of surplus debentures, accounting
for reinsurance transactions and the adoption of risk-based capital
requirements. It is not possible to predict the impact of future state and
federal regulation on the operations of the Company or its insurance
subsidiaries.
Effective January 1, 2001 the Association's codified statutory accounting
principles ("SAP") has been adopted by all U.S. insurance companies. The purpose
of such codification is to provide a comprehensive basis of accounting and
reporting to insurance departments. Although codification is expected to be the
foundation of a state's statutory accounting practice, it may be subject to
modification by practices prescribed or permitted by a state's insurance
commissioner. Therefore, statutory financial statements will continue to be
prepared on the basis of accounting practices prescribed or permitted by the
insurance department of the state of domicile. The Company has determined that
the application of the codification did not have a material impact on the
statutory capital of its insurance subsidiaries upon adoption.
NAICC is an insurance company domiciled in the State of California and is
regulated by the California Department of Insurance for the benefit of
policyholders. The California Insurance Code does not permit the payment of an
extraordinary shareholder dividend without prior approval from the Insurance
Commissioner. Dividends are considered extraordinary if they exceed the greater
of net income or 10% of statutory surplus as of the prior December 31. As of
December 31, 2001 NAICC did not have sufficient accumulated unassigned surplus,
as defined for dividend purposes, to pay dividends in 2002 without prior
regulatory approval.
RISK-BASED CAPITAL
A model for determining the risk-based capital ("RBC) requirements for
property and casualty insurance companies was adopted in December 1993.
Insurance companies are required to report their RBC ratios based on their 1994
annual statements. NAICC has calculated its RBC requirement under the most
recent RBC model and it has sufficient capital in excess of any regulatory
action level.
The RBC model sets forth four levels of increasing regulatory intervention:
(1) Company Action Level (200% of an insurer's Authorized Control Level) at
which the insurer must submit to the regulator a plan for increasing such
insurer's capital; (2) Regulatory Action Level (150% of an insurer's Authorized
Control Level), at which the insurer must submit a plan for increasing its
capital to the regulator and the regulator may issue corrective orders; (3)
Authorized Control Level (a multi-step calculation based upon information
derived from an insurer's most recent filed statutory annual statement), at
which the regulator may take action to rehabilitate or liquidate the insurer;
and (4) Mandatory Control Level (70% of an insurer's Authorized Control Level),
at which the regulator must rehabilitate or liquidate the insurer.
At December 31, 2001, the RBC of NAICC was 186% greater than the Company
Action Level. NAICC currently has no plans to take any action designed to
significantly affect its RBC level.
HOLDING COMPANY BUSINESS
DHC is a holding company incorporated under the General Corporation Law of
the State of Delaware. As of December 31, 2001, DHC had the following material
assets and no material liabilities:
(i) ownership of its DIND subsidiary, an insurance company that owns, directly
or indirectly, all of the stock of NAICC, DNIC, DICO, Valor, and one other
insurance subsidiary which may commence writing insurance lines in the
future; and
(ii) approximately $29.9 million in cash and investments.
TAX LOSS CARRYFORWARD
At the close of 2001, the Company had a consolidated net operating loss
carryforward of approximately $745 million for Federal income tax purposes. This
estimate is based upon Federal consolidated income tax losses for the periods
through December 31, 2000 and an estimate of the 2001 taxable results. Some or
all of the carryforward may be available to offset, for Federal income tax
purposes, the future taxable income, if any, of DHC and its wholly-owned
subsidiaries. The Internal Revenue Service ("IRS") has not audited any of the
Company's tax returns for any of the years during the carryforward period
including those returns for the years in which the losses giving rise to the net
operating loss carryforward were reported. The net operating loss carryforward
is currently fully reserved, for valuation purposes, on the Company's financial
statements. The amount of the deferred asset considered realizable could be
increased in the near term if estimates of future taxable income during the
carryforward period are increased.
The Company's net operating tax loss carryforwards will expire, if not
used, in the following approximate amounts in the following years (dollars in
thousands):
Year Ending Amount of Carryforwards
December 31, Expiring
------------ --------
2002 139,613
2003 60,849
2004 69,947
2005 106,225
2006 92,355
2007 89,790
2008 31,688
2009 39,689
2010 23,600
2011 19,755
2012 38,255
2019 33,636
The Company's ability to utilize its net operating tax loss carryforwards
would be substantially reduced if DHC were to undergo an "ownership change"
within the meaning of Section 382(g)(1) of the Internal Revenue Code. We will be
treated as having had an "ownership change" if there is more than 50% increase
in stock ownership during a 3 year "testing period" by "5% stockholders." For
this purpose, stock ownership is measured by value, and does not include
so-called "straight preferred" stock. In an effort to reduce the risk of an
ownership change, DHC has imposed restrictions on the ability of holders of five
percent or more of the common stock of DHC, par value $0.10 per share ("Common
Stock"), to transfer the Common Stock owned by them and to acquire additional
Common Stock, as well as the ability of others to become five percent
stockholders as a result of transfers of Common Stock. The transfer restrictions
were implemented in 1990, and we expect that they will remain in-force as long
as the NOL is available to us. Notwithstanding such transfer restrictions, there
could be circumstances under which an issuance by DHC of a significant number of
new shares of Common Stock or other new class of equity security having certain
characteristics (for example, the right to vote or to convert into Common Stock)
might result in an ownership change under the Internal Revenue Code.
POTENTIAL ACQUISITION
On March 15, 2002, the Company and American Commercial Lines LLC ("ACL")
executed a definitive recapitalization agreement for the acquisition of ACL by
the Company. ACL is an integrated marine transportation and service company
operating approximately 5,100 barges and 200 towboats on the inland waterways of
North and South America. ACL transports more than 70 million tons of freight
annually. Additionally, ACL operates marine construction, repair and service
facilities and river terminals.
The holders of more than two thirds of ACL's outstanding senior notes,
substantially all the indirect preferred and common members of ACL and the
management of ACL have agreed to support the recapitalization plan. ACL's senior
lenders have executed forbearance agreements pending the negotiation and
execution of definitive documentation relating to the amendment and restatement
of ACL's senior secured credit facility.
Under the terms of the recapitalization agreement, the Company will acquire
100% of the membership interests of American Commercial Lines Holdings LLC,
ACL's parent holding company. ACL's present indirect preferred equity holders
(that are not members of ACL management) will receive $7.0 million in cash.
ACL's management will receive approximately $1.7 million of restricted common
stock of the Company. In addition, the Company will deliver $25.0 million in
cash, which will be used to reduce borrowings under ACL's senior credit
facility, and approximately $58.5 million of ACL's outstanding senior notes to
ACL Holdings in connection with the transaction. The recapitalization is
expected to close in the second quarter of 2002.
The transaction will result in a reduction of ACL's senior secured bank
debt by $25.0 million. In addition, the parties will seek to restructure ACL's
10 1/4% senior notes due 2008 through an exchange offer and consent
solicitation. Upon the successful completion of the exchange offer and consent
solicitation, up to approximately $236.5 million of ACL's outstanding senior
notes (all notes held by parties other than Danielson) will be exchanged for
$120.0 million of new 11 1/4% cash pay senior notes due January 1, 2008 and
approximately $116.5 million of new 12% pay-in-kind senior subordinated notes
due July 1, 2008. ACL will also issue additional new cash pay senior notes in an
aggregate principal amount (not to exceed $20.0 million) equal to the accrued
and unpaid interest on its outstanding senior notes, other than those held by
Danielson, and to the extent that such accrued and unpaid interest exceeds $20.0
million, additional pay-in-kind senior subordinated notes in an amount equal to
such excess would be issued in full satisfaction of such accrued and unpaid
interest.
In connection with these transactions, the Company expects to effect a $42
million rights offering to its existing security holders, the proceeds of which
will be used to fund the Company's cash contribution for the recapitalization
and for general corporate purposes. Consummation of the recapitalization
agreement is not conditioned on the successful completion of the rights
offering. Under the terms of the rights offering, holders of the Company's
common stock will be entitled to purchase additional shares of common stock, at
a subscription price of $5.00 per share, up to such holders' pro rata share of
the rights offering. The March 18th announcement did not constitute notice of
the commencement of the rights offering. Further information regarding the terms
and conditions for the expected rights offering will be announced prior to the
commencement of the rights offering.
The recapitalization agreement provides that the exchange offer and consent
solicitation will be made in reliance on a registration exemption provided by
Section 3(a)(9) under the Securities Act of 1933, conditioned on the minimum
participation of 95% of the outstanding principal amount of ACL's outstanding
senior notes, as to which noteholders holding more than two thirds of the
outstanding principal amount of such notes have agreed to tender. In the event
that the exchange offer and consent solicitation is not consummated by June 15,
2002, the recapitalization agreement provides for the implementation of the
recapitalization through a voluntary prepackaged bankruptcy plan under Chapter
11 of the Bankruptcy Code, as to which noteholders holding more than two thirds
of the outstanding principal amount of ACL's outstanding senior notes have
agreed to accept.
The Company has filed a copy of the press release referenced above along
with a copy of the recapitalization agreement in its filing on Form 8-K dated
March 27, 2002.
STATEMENT CONCERNING FORWARD-LOOKING INFORMATION
This Item 1 to the Report on Form 10-K, together with Items 2, 3, 7, and 8,
contain forward-looking statements, including statements concerning plans,
capital adequacy, adequacy of reserves, utilization of tax losses, goals, future
events or performance and underlying assumptions and other statements which are
other than statements of historical facts. Such forward-looking statements may
be identified, without limitation, by the use of the words "believes",
"anticipates", "expects", "intends", "plans" and other similar expressions. All
such statements represent only current estimates or expectations as to future
results and are subject to risks and uncertainties which could cause actual
results to materially differ from current estimates or expectations. See "RISK
FACTORS THAT MAY AFFECT FUTURE RESULTS" in Item 7 for further information
concerning certain of those risks and uncertainties.
EMPLOYEES
As of December 31, 2001, the number of employees of DHC and its
consolidated subsidiaries was approximately as follows:
NAICC 110
DHC (holding company only) 7
---
Total 117
None of these employees is covered by any collective bargaining agreement. DHC
believes that the staffing levels are adequate to conduct future operations.
ITEM 2. PROPERTIES.
DHC leases a minimal amount of space for use as administrative and
executive offices. DHC's lease has a term of approximately five years which is
scheduled to expire in 2003. DHC believes that the space available to it is
adequate for DHC's current and foreseeable needs.
NAICC's headquarters are located in a leased office facility in Rancho
Dominguez, California, pursuant to a five-year lease which is scheduled to
expire in 2004. In addition, NAICC has entered into short term leases in
connection with its operations in various locations on the west coast of the
United States. NAICC believes that the foregoing leased facilities are adequate
for NAICC's current and anticipated future needs.
See Note 10 of the Notes to Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS.
NAICC is a party to various legal proceedings which are considered routine
and incidental to its insurance business and are not material to the financial
condition and operation of such business.
Danielson Reinsurance Corporation ("Danielson Re"), an indirect wholly
owned subsidiary of DHC (the "Registrant"), is the grantor of the Mission
Reinsurance Corporation Trust (the "Trust"). The Trust was one of several
created in connection with the insolvency and reorganization of Mission
Insurance Group, Inc. and its subsidiaries from which the Company emerged. In
connection with the liquidation of the Trust by the Missouri Department of
Insurance (the "Insurance Department"), a surplus existed from which the
Insurance Department sought to pay interest to the claimants of the Trust. DHC
challenged the Insurance Department's plan to pay interest in the Circuit Court
of Jackson County, Missouri, which is overseeing the liquidation of the Trust,
arguing that any surplus belonged to Danielson Re as the grantor of the Trust.
The Circuit Court upheld the plan and DHC appealed that decision.
On June 22, 1999, the Missouri Court of Appeals reversed the decision of
the Circuit Court and remanded the matter to the Circuit Court, ruling that no
interest can be paid to claimants of insolvent insurance companies under the
Missouri Insurance Code. As a result of that decision, Danielson Re would have
been entitled to any surplus remaining in the Trust after payment of all claims
and expenses of the Trust, which was believed to approximate $14 million. The
Insurance Department appealed the decision of the Court of Appeals to the
Missouri Supreme Court, which reversed the decision of the Court of Appeals. As
a result, the Insurance Department is permitted to pay interest on claims, and
it is anticipated that there will be no surplus remaining in the Trust after
payment of the interest.
See Note 11 of the Notes to Consolidated Financial Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
"Stock Market Prices" on page 26 of DHC's 2001 Annual Report to
Stockholders (included as an exhibit hereto) is incorporated herein by
reference.
ITEM 6. SELECTED FINANCIAL DATA.
"Selected Consolidated Financial Data" on page 2 of DHC's 2001 Annual
Report to Stockholders (included as an exhibit hereto) is incorporated
herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
"Management's Discussion and Analysis of Financial Condition and
Results of Operations" on pages 3 through 8 of DHC's 2001 Annual Report
to Stockholders (included as an exhibit hereto) is incorporated herein
by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
"Market Risk" on pages 5 through 7 of DHC's 2001 Annual Report to
Stockholders (included as an exhibit hereto) is incorporated herein by
reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Consolidated Financial Statements of DHC and its subsidiaries,
together with the Notes thereto, and "Quarterly Financial Data,"
included on pages 9 through 12, 13 through 24, and 26, respectively, of
DHC's 2001 Annual Report to Stockholders (included as an exhibit
hereto), are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
DIRECTORS.
The Directors of DHC are listed on the following pages with brief
statements of their principal occupations and other information. A listing of
the Directors' and officers' beneficial ownership of Common Stock appears on
subsequent pages under the heading "Item 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT." All of the Directors were elected to their
present terms of office by the stockholders at the Annual Meeting of
Stockholders of DHC held on September 4, 2001. The term of office of each
Director continues until the election of Directors to be held at the next Annual
Meeting of Stockholders or until his successor has been elected. There is no
family relationship between any Director and any other Director or executive
officer of DHC.
DHC, Martin J. Whitman and SZ Investments, LLC ("SZ") have entered into an
agreement pursuant to which, as long as SZ continues to directly or indirectly
own at least 1,000,000 shares of Common Stock, (i) SZ will have the right to
continue to nominate two members of DHC's Board of Directors (which nominees
were Samuel Zell and William Pate) and (ii) Mr. Whitman has agreed to vote and
use his best efforts to cause to be voted the shares of Common Stock owned or
controlled by him in favor of SZ's designees. In addition, SZ has agreed that,
so long as Third Avenue Trust and/or Mr. Whitman directly or indirectly own
500,000 shares of Common Stock and Mr. Whitman continues to be affiliated with
Third Avenue Trust in the same or substantially similar manner as his current
affiliation (so long as such entities continue to exist), SZ will vote the
shares owned by it for the election of Mr. Whitman and one other designee of Mr.
Whitman (which nominee was David Barse).
The information set forth below concerning the Directors has been furnished
by such Directors to DHC.
DIRECTOR
DIRECTOR AGE PRINCIPAL OCCUPATION SINCE
- - -------- --- -------------------- -----
Martin J. Whitman 77 Chief Executive Officer of the Company 1990
David M. Barse 39 President and Chief Operating Officer of the 1996
Company
Samuel Zell 60 Chairman of Equity Group Investments, L.L.C. 1999
Eugene M. Isenberg 72 Chairman of the Board and Chief Executive 1990
Officer of Nabors Industries, Inc.
Joseph F. Porrino 57 Counselor to the President of New School 1990
University; Senior Consultant, Powers Global
Strategies, LLC
Frank B. Ryan 65 Professor of Mathematics at Rice University 1990
Wallace O. Sellers 72 Vice Chairman and Director of Enhance Financial 1995
Services Group, Inc.
Stanley J. Garstka 58 Deputy Dean and Professor in the Practice of 1996
Management at Yale University School of
Management
William Pate 38 Director of Mergers and Acquisitions of Equity 1999
Group Investments, L.L.C.
Mr. Whitman is the Chief Executive Officer and a Director of the Company.
Since 1974, Mr. Whitman has been the President and controlling stockholder of
M.J. Whitman & Co., Inc. (now known as Martin J. Whitman & Co., Inc.) ("MJW&Co")
which, until August 1991, was a registered broker-dealer. Since March 1990, Mr.
Whitman has been the Chairman of the Board and Chief Executive Officer (and,
from January 1991 to May 1998, the President) of Third Avenue Trust and its
predecessor, Third Avenue Value Fund, Inc. (together with its predecessor,
"Third Avenue Trust"), an open-end management investment company registered
under the Investment Company Act of 1940 (the "40 Act") and containing four
investment series. Since July 1999, Mr. Whitman has been the Chairman of the
Board and Chief Executive Officer of Third Avenue Variable Series Trust
("Variable Trust"), an open-end management investment company registered under
the 40 Act and containing one investment series. Since March 1990, Mr. Whitman
has been Chairman of the Board and Chief Executive Officer (and, until February
1998, the President) of EQSF Advisers, Inc. ("EQSF"), the investment adviser of
Third Avenue Trust and Variable Trust. Until April 1994, Mr. Whitman also served
as the Chairman of the Board and Chief Executive Officer of Equity Strategies
Fund, Inc., previously a registered investment company. Mr. Whitman was a
Principal of Whitman Heffernan Rhein & Co., Inc. ("WHR"), an investment and
financial advisory firm which he helped to found during the first quarter of
1987 and which ceased operations in December 1996. Since March 1991, Mr. Whitman
has served as a Director of Nabors Industries, Inc. ("Nabors"), a
publicly-traded oil and gas drilling company listed on the American Stock
Exchange ("AMEX"). From August 1997 to May 2001 Mr. Whitman served as a director
of Tejon Ranch Co., an agricultural and land management company listed on the
New York Stock Exchange ("NYSE"). From May 2000 through December 2001, Mr.
Whitman served as a director for Stewart Information Services Corporation, a
title insurance company publicly traded on the NYSE. From March 1993 through
February 1996, Mr. Whitman served as a director of Herman's Sporting Goods,
Inc., a retail sporting goods chain, which filed a voluntary petition under
Chapter 11 of the United States Bankruptcy Code on April 26, 1996. Mr. Whitman
also serves as a Director of the Company's principal operating subsidiary,
National American Insurance Company of California ("NAICC"). Mr. Whitman
co-authored the book The Aggressive Conservative Investor and is the author of
Value Investing: A Balanced Approach. From 1972 through June 2000, Mr. Whitman
was a Distinguished Faculty Fellow in Finance at the Yale University School of
Management ("Yale School of Management") and from January 2001 through December
2001, an adjunct professor at the Columbia University School of Business. Mr.
Whitman graduated from Syracuse University magna cum laude in 1949 with a
Bachelor of Science degree and received his Masters degree in Economics from the
New School for Social Research in 1956. Mr. Whitman is a Chartered Financial
Analyst.
Mr. Barse has been the President, Chief Operating Officer and a Director of
the Company since July 1996 and a director of NAICC since August 1996. Since
June 1995, Mr. Barse has been a Director, President (and, since July 1999, Chief
Executive Officer) of M.J. Whitman, Inc. ("MJWI"), a securities broker-dealer,
and M.J. Whitman Advisers, Inc. ("MJWA"), a registered investment adviser. From
April 1995 until February 1998 he served as the Executive Vice President and
Chief Operating Officer of Third Avenue Trust and EQSF, henceforth assuming the
position of President. Since July 1999, Mr. Barse has been the President and
Chief Operating Officer of Variable Trust. In 2001, Mr. Barse became a Trustee
of Third Avenue Trust and Variable Trust. Mr. Barse joined the predecessor of
MJWI in December 1991 as General Counsel. Mr. Barse also presently serves as a
director of CGA Group, Ltd., a Bermuda based financial services company, and
American Capital Access Holdings, a financial insurance company. Mr. Barse was
previously an attorney with the law firm of Robinson Silverman Pearce Aronsohn &
Berman LLP. Mr. Barse received a Bachelor of Arts in Political Science from
George Washington University in 1984 and a Juris Doctor from Brooklyn Law School
in 1987.
A native Chicagoan, Samuel Zell is a graduate of the University of Michigan
and the University of Michigan Law School. Mr. Zell began his career in real
estate while an undergraduate at the University by managing apartment buildings
throughout Southeast Michigan. He continued his interests in real estate with
the founding of Equity Group Investments, LLC, (formerly known as Equity
Financial and Management Company) an entrepreneurial real estate investment firm
based in Chicago where he currently serves as Chairman of the Board. Mr. Zell
maintains substantial interest and serves as Chairman of the Board of various
corporations which include Anixter International (AXE), a value-added provider
of integrated networking and cabling solutions that support business information
and network infrastructure requirements; Chart House Enterprises, Inc. (CHT), an
owner and operator of restaurants; Manufactured Home Communities, Inc. (MHC), a
self-administered and self-managed equity Real Estate Investment Trust which
owns and operates manufactured home communities in 26 states, Equity Residential
Properties Trust (EQR), the largest apartment real estate investment trust in
the United States, Equity Office Properties Trust (EOP), the largest office
portfolio of any publicly traded, full service office company in the United
States, Capital Trust (CT), a specialized real estate finance company; and
Danielson Holding Corporation (DHC), a financial services and investment
company. All of these companies are publicly traded companies. Mr. Zell recently
completed a two-year term as Chairman of the National Association of Real Estate
Investment Trusts (NAREIT). He serves as Trustee of the Field Museum in Chicago.
He serves on the President's Advisory Board at the University of Michigan, the
Visitor's Committee at the University of Michigan Law School, and with the
combined efforts of the University of Michigan Business School, established the
Zell/Lurie Entrepreneurial Award Program, an innovative attempt to fund
entrepreneurial awareness and sensitivity. Mr. Zell's continual assistance to
the MBA program has also enhanced the Business School's Polish Studies Program.
He was appointed a DeRoy Visiting Professor in Honors at the College of
Literature, Science and the Arts at the University of Michigan. He is a long
standing supporter of the University of Pennsylvania Wharton Real Estate Center
and has endowed the Samuel Zell/Robert Lurie Real Estate Center at Wharton. Mr.
Zell is a member of the Visiting Committee of the University of Chicago's School
of Public Policy. Mr. Zell is an avid skier, racquetball player and enjoys
riding motorcycles. He is a frequent contributor of articles to various real
estate publications and is often heard as a keynote speaker throughout the
United States and Europe.
Mr. Isenberg, since 1987, has been Chairman and Chief Executive Officer of
Nabors Industries, Inc., the world's largest land and offshore platform drilling
company. Mr. Isenberg presently serves as a director of the American Stock
Exchange, the National Association of Securities Dealers, Inc., and is a member
of the National Petroleum Council. From 1969 to 1982, Mr. Isenberg was Chairman
of the Board and principal stockholder of Genimar Inc., a steel trading and
building products manufacturing company. From 1955 to 1968, he was employed in
various management capacities with the Exxon Corp. Mr. Isenberg is the principal
sponsor of the Parkside School for children with learning disabilities in New
York City. Mr. Isenberg graduated from the University of Massachusetts in 1950
with a Bachelor of Arts degree in Economics and from Princeton University in
1952 with a Masters degree in Economics. The University of Massachusetts'
"Eugene M. Isenberg School of Management" is named in recognition of his
generous contributions towards new facilities, the funding of scholarships, and
the endowment of a professorship.
Mr. Porrino has been the Counselor to the President of the New School for
Social Research (the "New School") since February 1998. He is also a Senior
Consultant at Powers Global Strategies, a government relations and strategic
planning firm. He was the Executive Vice President of the New School from
September 1991 to February, 1998. Prior to that time, Mr. Porrino was a partner
in the New York law firm of Putney, Twombly, Hall & Hirson, concentrating his
practice in the area of labor law. Mr. Porrino received a Bachelor of Arts
degree from Bowdoin College in 1966, and was awarded a Juris Doctor degree from
Fordham University School of Law in 1970.
Dr. Ryan was Professor of Mathematics at Rice University from August 1990
through July 1996. From August 1990 to July 1995, Dr. Ryan also served as Vice
President-External Affairs at Rice University. Since November 1996, Dr. Ryan has
served as a Director of Siena Holdings, Inc., a real estate and health
management company, the capital stock of which is traded over-the-counter. From
March 1996 through September 1999, Dr. Ryan has served as a Director of Texas
Micro, Inc., a computer systems company that was merged in September 1999 with
Radisys Corporation, a computer systems company the capital stock of which is
traded on NASDAQ. Until 1998, Dr. Ryan served as a Director of America West
Airlines, Inc., a publicly-traded company listed on the NYSE. For two years
ending August 1990, Dr. Ryan was the President and Chief Executive Officer of
Contex Electronics Inc., a subsidiary of Buffton Corporation, the capital stock
of which is publicly traded on the AMEX. Prior to that, and beginning in 1977,
Dr. Ryan was a Lecturer in Mathematics at Yale University, where he was also the
Associate Vice President in charge of institutional planning. Dr. Ryan obtained
a Bachelor of Arts degree in Physics in 1958 from Rice University, a Masters
degree in Mathematics from Rice in 1961, and a Doctorate in Mathematics from
Rice in 1965.
Mr. Sellers was the President and Chief Executive Officer of Enhance
Financial Services Group, Inc. ("Enhance Group"), a financial services
corporation, and of its principal subsidiaries, Enhance Reinsurance Company and
Asset Guaranty Insurance Company, from their inception in 1986 and 1988,until
his retirement in 1994. Subsequently he served as Vice Chairman of the Enhance
Group until its purchase by Radian Mortgage in 2001. From 1987 until 1994, Mr.
Sellers served as a Director, and from 1992 to 1993 as the Chairman, of the
Association of Financial Guaranty Insurers. Prior to the Enhance Group, Mr.
Sellers spent 35 years with Merrill Lynch, where he served, among other
positions, as Director, Municipal and Corporate Bond Division, Director,
Securities Research Division and Director of Strategic Development. Mr. Sellers
received a Bachelor of Arts degree from the University of New Mexico in 1951 and
a Masters degree in Economics from New York University in 1956. Mr. Sellers
attended the Advanced Management Program at Harvard University in 1975 and is a
Chartered Financial Analyst. He is presently Chairman of the Board of Natural
Gas Services Group, Inc., in Midland Texas and is a member of the Board of
Trustees of the Hudson Institute, Chairman of its Finance Committee and a member
of its Executive Committee.
Mr. Garstka has been Deputy Dean at the Yale School of Management since
November, 1995 and has been a Professor in the Practice of Management at the
Yale School of Management since 1988. Mr. Garstka was the Acting Dean of the
Yale School of Management from August 1994 to October 1995, and an Associate
Dean of the Yale School of Management from 1984 to 1994. Mr. Garstka has served
on the Board of Trustees of MBA Enterprises Corps, a non-profit organization
(1991-1999) and on the Board of Trustees of The Foote School in New Haven,
Connecticut from 1995 to 1998. From 1988 to 1990, Mr. Garstka served as a
director of Vyquest, Inc., a publicly-traded company listed on the AMEX. Mr.
Garstka was a Professor in the Practice of Accounting from 1983 to 1988, and an
Associate Professor of Organization and Management from 1978 to 1983, at the
Yale School of Management. Mr. Garstka has also authored numerous articles on
accounting and mathematics. Mr. Garstka received a Bachelor of Arts degree in
Mathematics from Wesleyan University in Middletown, Connecticut in 1966, a
Masters degree in Industrial Administration in 1968 from Carnegie Mellon
University and a Doctorate in Operations Research in 1970 from Carnegie Mellon
University.
Mr. Pate has served as a Managing Director of EGI since 1999, and has been
employed by EGI or its predecessor for more than five years. Since 1999, Mr.
Pate has also served as a director of Davel Communications, Inc., a provider of
public pay telephone services.
EXECUTIVE OFFICERS.
The executive officers of DHC are as follows:
NAME AGE PRINCIPAL POSITION WITH REGISTRANT
- - ---- --- ----------------------------------
Martin J. Whitman 77 Chief Executive Officer and a Director
David M. Barse 39 President, Chief Operating Officer
and a Director
Michael T. Carney 48 Chief Financial Officer and Treasurer
W. James Hall 37 General Counsel and Secretary
For additional information about Messrs. Whitman and Barse, see "DIRECTORS"
above.
Mr. Carney was the Chief Financial Officer ("CFO") of DHC from August 1990
until March 1996 and has been the CFO of the Company and a director of NAICC
since August 1996. Since 1990, Mr. Carney has served as Treasurer and CFO of
Third Avenue Trust and EQSF and, since 1989, as CFO of MJW&Co., MJWI and their
predecessors. Since July 1999, Mr. Carney has served as Treasurer and CFO of
Variable Trust. From 1990 through April 1994, Mr. Carney also served as CFO of
Carl Marks Strategic Investments, L.P.; from 1989 through December, 1996 Mr.
Carney served as CFO of WHR; and from 1989 through April 1994, Mr. Carney served
as Treasurer and CFO of Equity Strategies Fund. From 1988 to 1989, Mr. Carney
was the Director of Accounting of Smith New Court, Carl Marks, Inc., and, from
1986 to 1988, Mr. Carney served as the Controller of Carl Marks & Co., Inc. Mr.
Carney graduated from St. John's University in 1981 with a Bachelor of Science
degree in Accounting. Mr. Carney is a Certified Public Accountant.
Mr. Hall has been the General Counsel and Secretary of DHC since December
2000. Mr. Hall has also served as General Counsel and Secretary of MJWI since
June 2000, of Third Avenue Trust and EQSF since September 2000 and of Variable
Trust since September 2000. Prior to June of 2000, Mr. Hall was an associate at
Paul, Weiss, Rifkind, Wharton & Garrison LLP from February 2000. Mr. Hall served
as an Associate at Morgan, Lewis Bockius LLP from November 1996 to January 2000
and an associate for Gibson, Dunn and Crutcher LLP from March 1992 though June
1996. Mr. Hall served as a Captain in the U.S. Army Reserve from 1986 through
1992. Mr. Hall graduated from the University of Pennsylvania School of Law in
1991 and the Massachusetts Institute of Technology in 1986 with Bachelor of
Science degrees in Biology and Aeronautical/Astronautical Engineering.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires DHC's
Directors and executive officers, and persons who own more than ten percent of a
registered class of the DHC's equity securities, to file with the Securities and
Exchange Commission and the American Stock Exchange initial reports of ownership
and reports of changes in ownership of Common Stock and other equity securities
of DHC. Officers, Directors and greater than ten-percent stockholders are
required by Federal securities regulations to furnish DHC with copies of all
Section 16(a) forms they file.
To DHC's knowledge, based solely upon review of the copies of such reports
furnished to DHC and written representations that no other reports were
required, all Section 16(a) filing requirements applicable to DHC's officers,
Directors and greater than ten percent beneficial owners were complied with for
the fiscal year ended December 31, 2001.
ITEM 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following Summary Compensation Table presents certain information
relating to compensation paid by DHC for services rendered in 2001 by the Chief
Executive Officer and each other executive officer of DHC who had cash
compensation for such year in excess of $50,000. Only those columns which call
for information applicable to DHC or the individual named for the periods
indicated have been included in such table.
LONG TERM
ANNUAL COMPENSATION COMPENSATION
-------------------------- ------------
AWARDS
------------
SECURITIES
UNDERLYING ALL OTHER
YEAR SALARY (a) BONUS OPTIONS COMPENSATION
NAME AND PRINCIPAL POSITION ($) ($) (#) ($)
- - ----------------------------------------------------------------------------------------------------------------
Martin J. Whitman 2001 $ 200,000 -0- -0- -0-
CHAIRMAN OF THE BOARD & CHIEF EXECUTIVE OFFICER 2000 $ 200,000 -0- -0- -0-
1999 $ 200,000 -0- -0- -0-
- - ----------------------------------------------------------------------------------------------------------------
David M. Barse 2001 $ 75,000 -0- 100,000 -0-
PRESIDENT AND CHIEF OPERATING OFFICER 2000 $ 75,000 $150,000 50,000 -0-
1999 $ 75,000 80,000 50,000 -0-
- - ----------------------------------------------------------------------------------------------------------------
Michael Carney 2001 $ 75,000 -0- 25,000 -0-
TREASURER AND CHIEF FINANCIAL OFFICER 2000 $ 75,000 $ 50,000 25,000 -0-
1999 $ 75,000 40,000 25,000 -0-
- - ----------------------------------------------------------------------------------------------------------------
W. James Hall 2001 $50,000 $ 25,000 10,000 -0-
GENERAL COUNSEL AND SECRETARY
- ------------------------------------------------------------------------------------------------------------------
OPTION/SAR GRANTS IN LAST FISCAL YEAR
The following table presents certain information relating to the
grants of stock options made during 2001 to the named executive officers of DHC.
The options were granted under DHC's 1995 Stock and Incentive Plan. Pursuant to
rules of the Securities and Exchange Commission, the table also shows the value
of the options granted at the end of the option term if the stock price were
to appreciate annually by 5% and 10%, respectively. There is no assurance that
the stock price will appreciate at the rates shown in the table. Only those
tabular columns which call for information applicable to DHC or the named
individuals have been included in such table.
- - ----------------------------------------------------------------------------------------------------
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF
STOCK PRICE
APPRECIATION FOR
INDIVIDUAL GRANTS OPTION TERM
- - ----------------------------------------------------------------------------------------------------
NUMBER OF PERCENT OF
SECURITIES TOTAL
UNDERLYING OPTIONS/SARS
OPTIONS/ GRANTED TO
SARS EMPLOYEES IN EXERCISE OR EXPIRATION
GRANTED FISCAL YEAR BASE PRICE DATE
NAME (#)(1) ($/Sh) 5%($) 10%($)
- - ----------------------------------------------------------------------------------------------------
David M. Barse 100,000 56.0 3.37 12/11/11 211,937 537,091
- - -----------------------------------------------------------------------------------------------------
Michael Carney 25,000 14.0 3.37 12/11/11 52,984 134,273
- - ----------------------------------------------------------------------------------------------------
(1) One-half of these options become exercisable on June 11, 2002 and one-
third of the balance of the options become exercisable on each of the
first three anniversaries of the date of grant.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
The following table presents certain information relating to the value of
unexercised stock options as of the end of 2001, on an aggregated basis, owned
by the named executive officers of DHC as of the last day of the fiscal year.
Such officers did not exercise any of such options during 2001. Only those
tabular columns which call for information applicable to DHC or the named
individuals have been included in such table.
- - ----------------------------------------------------------------------------------------------
NUMBER OF SECURITIES VALUE OF UNEXERCISED IN-THE-
UNDERLYING UNEXERCISED MONEY OPTIONS
OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END
(#) ($)
- - ----------------------------------------------------------------------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- - ----------------------------------------------------------------------------------------------
David M. Barse 224,999 125,001 $ 53,854 $114,333
- - ----------------------------------------------------------------------------------------------
Michael Carney 157,501 37,499 $ 34,765 $ 30,417
- - ----------------------------------------------------------------------------------------------
COMPENSATION OF DIRECTORS
During 2001, each Director who was not an officer or employee of the
Company or its subsidiaries received compensation of $2,500 for each Board
meeting attended, whether in person or by telephone. For attendance at Board
meetings during 2001, each Director received $5,000, plus, in each case,
reimbursement of reasonable expenses. Directors who are officers or employees
of the Company or its subsidiaries receive no fees for service on the Board. No
attendance fee is paid to any Directors with respect to any committee meetings.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During 2001, none of the persons who served as members of the Compensation
Committee of DHC's Board of Directors also was, during that year or previously,
an officer or employee of DHC or any of its subsidiaries or had any other
relationship requiring disclosure herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth the beneficial ownership of Common Stock as
of March 25, 2002 of (a) each Director, (b) each executive officer, and (c)
each person known by DHC to own beneficially more than five percent of the
outstanding shares of Common Stock. DHC believes that, except as otherwise
stated, the beneficial holders listed below have sole voting and investment
power regarding the shares reflected as being beneficially owned by them.
AMOUNT AND NATURE OF
BENEFICIAL OWNERSHIP PERCENT OF CLASS (1)
-------------------- --------------------
PRINCIPAL STOCKHOLDERS
SZ Investments, LLC 3,900,437 (2)(3) 18.2
2 N. Riverside Plaza
Chicago, IL 60606
Commissioner of Insurance 1,803,235 (2)(4) 9.2
of the State of California
Mission Insurance Companies' Trusts
425 Market Street, 23rd Floor
San Francisco, CA 94105
Martin J. Whitman 1,281,143 (2)(5) 6.6
c/o Danielson Holding Corporation
767 Third Avenue
New York, NY 10017-2023
OFFICERS AND DIRECTORS
Martin J. Whitman 1,281,143 (2)(5) 6.6
David M. Barse 224,999 (6) *
Samuel Zell 3,900,437 (7) 18.2
Joseph F. Porrino 82,033 (8) *
Frank B. Ryan 75,333 (8) *
Eugene M. Isenberg 96,591 (9) *
Wallace O. Sellers 76,666 (10) *
Stanley J. Garstka 77,674 (11) *
William Pate 60,200 (12) *
Michael Carney 157,501 (13) *
W. James Hall 6,667 (14) *
All Officers and Directors
as a Group (11 persons) 6,039,244 (15) 27.2
- - -----------------------------
* Percentage of shares beneficially owned does not exceed one percent of the
outstanding Common Stock.
(1) Share percentage ownership is rounded to nearest tenth of one percent and
reflects the effect of dilution as a result of outstanding options and warrants
to the extent such options and warrants are, or within 60 days will become,
exercisable. As of February 26, 2002 (the date as of which this table was
prepared), there were exercisable options outstanding to purchase 1,228,084
shares of Common Stock and exercisable warrants to purchase 2,002,568 shares of
Common Stock. Shares underlying any option or warrant which was exercisable on
February 26, 2002 or becomes exercisable within the next 60 days are deemed
outstanding only for purposes of computing the share ownership and share
ownership percentage of the holder of such option or warrant.
(2) In accordance with provisions of DHC's Certificate of Incorporation, all
certificates representing shares of Common Stock beneficially owned by holders
of five percent or more of the Common Stock are owned of record by DHC, as
escrow agent, and are physically held by DHC in that capacity.
(3) Includes shares underlying a Warrant to purchase 1,900,437 shares of Common
Stock at an exercise price of $4.74391 per share.
(4) Beneficially owned by the Commissioner of Insurance of the State of
California in his capacity as trustee for the benefit of holders of certain
deficiency claims against certain trusts which assumed liabilities of certain
present and former insurance subsidiaries of the Company.
(5) Includes 803,669 shares beneficially owned by Third Avenue Value Fund Series
("TAVF") of the Third Avenue Trust, an investment company registered under the
Investment Company Act of 1940; 104,481 shares beneficially owned by Martin J.
Whitman & Co., Inc. ("MJW&Co"), a private investment company; and 84,358 shares
beneficially owned by Mr. Whitman's wife and three adult family members. Mr.
Whitman may be deemed to control the investment adviser of TAVF, and may be
deemed to own beneficially a five percent equity interest in TAVF. Mr. Whitman
is the principal stockholder in MJW&Co, and may be deemed to own beneficially
the shares owned by MJW&Co. Mr. Whitman disclaims beneficial ownership of the
shares of Common Stock owned by TAVF and Mr. Whitman's family members.
(6) Includes shares underlying currently exercisable options to purchase an
aggregate of 50,000 shares of Common Stock at an exercise price of $5.6875 per
share, 50,000 shares of Common Stock at an exercise price of $7.0625 per share,
50,000 shares of Common Stock at an exercise price of $3.65625 per share, 41,666
shares of Common Stock at an exercise price of $5.3125 per share and 33,333
shares of Common Stock at an exercise price of $4.00 per share. Does not include
shares underlying options to purchase an aggregate of 8,334 shares of Common
Stock at an exercise price of $5.3125 per share or 16,667 shares of Common Stock
at an exercise price of $4.00 per share or 100,000 shares of Common Stock at an
exercise price of $3.37 per share which are not currently exercisable nor become
exercisable within the next 60 days.
(7) Includes 2,000,000 shares of Common Stock owned by SZ Investments, L.L.C.
("SZ"), a company controlled by Mr. Zell, and 1,900,437 shares of Common Stock
issuable upon exercise of a Warrant owned by SZ.
(8) Includes shares underlying currently exercisable options to purchase an
aggregate of 46,667 shares of Common Stock at an exercise price of $3.63 per
share and 26,666 shares of Common Stock at an exercise price of $4.00. Does not
include shares underlying options to purchase an aggregate of 13,334 shares of
Common Stock at an exercise price of $4.00 which are not currently exercisable
nor become exercisable within the next 60 days.
(9) Includes 20,088 shares owned by Mentor Partnership, a partnership controlled
by Mr. Isenberg, and 28 shares owned by Mr. Isenberg's wife. Also includes
shares underlying currently exercisable options to purchase an aggregate of
46,666 shares of Common Stock at an exercise price of $3.63 per share and 26,666
shares of Common Stock at an exercise price of $4.00. Does not include shares
underlying options to purchase an aggregate of 13,334 shares of Common Stock at
an exercise price of $4.00 which are not currently exercisable nor become
exercisable within the next 60 days.
(10) Includes shares underlying currently exercisable options to purchase an
aggregate of 40,000 shares of Common Stock at an exercise price of $7.00 per
share and 26,666 shares of Common Stock at an exercise price of $4.00. Does not
include shares underlying options to purchase an aggregate of 13,334 shares of
Common Stock at an exercise price of $4.00 which are not currently exercisable
nor become exercisable within the next 60 days.
(11) Includes shares underlying currently exercisable options to purchase an
aggregate of 40,000 shares of Common Stock at an exercise price of $5.50 per
share and 26,666 shares of Common Stock at an exercise price of $4.00. Does not
include shares underlying options to purchase an aggregate of 13,334 shares of
Common Stock at an exercise price of $4.00 which are not currently exercisable
nor become exercisable within the next 60 days.
(12) Includes shares underlying currently exercisable options to purchase an
aggregate of 15,200 shares of Common Stock at an exercise price of $4.00. Does
not include shares underlying options to purchase an aggregate of 7,600 shares
of Common Stock at an exercise price of $4.00 per share which are not currently
exercisable nor become exercisable within the next 60 days.
(13) Includes shares underlying currently exercisable options to purchase an
aggregate of 50,000 shares of common stock at an exercise price of $5.6875 Per
share, 35,000 shares of common stock at an exercise price of $7.0625 Per share,
35,000 shares of common stock at an exercise price of $3.65625 Per share, 20,834
shares of common stock at an exercise price of $5.3125 Per share and 16,667
shares of common stock at an exercise price of $4.00. Does not include shares
underlying options to purchase an aggregate of 4,166 shares of common stock at
an exercise price of $5.3125 Per share or 8,333 shares of common stock at an
exercise price of $4.00 Per share or 25,000 shares of common stock at an
exercise price of $3.37 Which are not currently exercisable nor become
exercisable within the next 60 days.
14) Includes shares underlying currently exercisable options to purchase an
aggregate of 6,667 shares of Common Stock at an exercise price of $4.00. Does
not include shares underlying options to purchase an aggregate of 3,333 shares
at an exercise price of $4.00 or 10,000 shares at an exercise price of $3.37
which are not currently exercisable nor become exercisable within the next 60
days.
(15) In calculating the percentage of shares owned by officers and Directors as
a group, the shares of Common Stock underlying all options which are
beneficially owned by officers and Directors and which are currently exercisable
or become exercisable within the next 60 days are deemed outstanding.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
DHC shares certain personnel and facilities with several affiliated and
unaffiliated companies (including M.J. Whitman, Inc., a broker-dealer of which
Mr. Barse is the Chairman, Chief Executive Officer and President), and thus,
certain expenses are allocated among the various entities accordingly. Personnel
costs are allocated based upon actual time spent on DHC's business, or upon
fixed percentages of compensation. Costs relating to office space and equipment
are allocated based upon fixed percentages. Inter-company balances are
reconciled and reimbursed on a monthly basis.
In connection with the purchase of Common Stock by SZ, DHC has entered into
a non-exclusive investment advisory agreement with Equity Group Investments, LLC
("EGI"), a company controlled by Mr. Zell, pursuant to which EGI has agreed to
provide, at the request of DHC, certain investment banking services to the
Company in connection with potential transactions. For these services, DHC pays
an annual fee of $125,000 to EGI. In the event that any transaction is
consummated for which the Acquisition Committee of DHC's Board of Directors
determines that EGI provided material services, DHC will pay to EGI a fee in the
amount of 1% of the aggregate consideration in connection with such transaction.
In the case of the potential acquisition of ACL described in more detail in Item
1. "Potential Acquisition", DHC and EGI have agreed that the fee for EGI shall
be $3 million. SZ has also reached an agreement with the Company to provide a
standby commitment to purchase any Company shares that may be unsubscribed in
the rights offering that the Company anticipates conducting as part of its
proposed acquisition of ACL. The Company has paid SZ a fee of $250,000 for this
commitment and will pay SZ an additional $750,000 upon the commencement of any
rights offering. Mr. Zell and Mr. Pate are members of the Acquisition Committee,
along with Mr. Whitman and Mr. Barse. DHC has also agreed to reimburse, upon
request, EGI's out-of-pocket expenses related to the investment advisory
agreement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this Report:
(1) Financial Statements -- see Index to Consolidated Financial
Statements and Financial Statement Schedules appearing on
Page F-1.
(2) Financial Statement Schedules -- see Index to Consolidated
Financial Statements and Financial Statement Schedules
appearing on Page F-1.
(3) Exhibits:
EXHIBIT NO. (1) NAME OF EXHIBIT
- - --------------- ---------------
ORGANIZATIONAL DOCUMENTS:
------------------------
2.1 Recapitalization Agreement by and among Danielson
Corporation, American Commercial Lines Holdings LLC,
American Commercial Lines LLC, the Preferred Unitholders
signatory thereto and the Management Unitholders
signatory thereto dated as of March 15, 2002 (incorporated
by reference to Exhibit 1 0.23 to ACL's Current Report on
Form 8-K, filed March 27, 2002). The exhibits and schedules
referenced in the Recapitalization Agreement have been
omitted in accordance with Item 601(b)(2) of Regulation
S-K. A copy of any omitted exhibit and/or schedule
will be furnished supplementally to the Securities and
Exchange Commission upon request.
3.1 Restated Certificate of Incorporation of Registrant.
3.2 Bylaws of Registrant.
MATERIAL CONTRACTS--MISCELLANEOUS:
---------------------------------
10.1 * Stock Purchase and Sale Agreement dated as of April 14,
1999 between Samstock, L.L.C. and Danielson Holding
Corporation. (Filed with Report on Form 10-Q dated June
30, 1999, Exhibit 10.1.)
10.2 * Amendment No. 1, Assignment and Consent to Assignment of
Stock Purchase and Sale Agreement dated May 7, 1999 among
Samstock, L.L.C., S.Z. Investments, L.L.C. and Danielson
Holding Corporation. (Filed with Report on Form 10-Q dated
June 30, 1999, Exhibit 10.2.)
10.3 * Investment Agreement dated as of April 14, 1999 among
Danielson Holding Corporation, Samstock, L.L.C. and Martin
J. Whitman. (Filed with Report on Form 10-Q dated June 30,
1999, Exhibit 10.3.)
10.4 * Assignment and Consent to Assignment of Investment
Agreement dated May 7, 1999 among Danielson Holding
Corporation, Martin J. Whitman and S.Z. Investments,
L.L.C.. (Filed with Report on Form 10-Q dated June 30,
1999, Exhibit 10.4.)
10.5 * Letter Agreement dated April 14, 1999 between Equity Group
Investments, L.L.C. and Danielson Holding Corporation.
(Filed with Report on Form 10-Q dated June 30, 1999,
Exhibit 10.5.)
10.6 * Amendment dated June 2, 1999 to letter agreement dated
April 14, 1999 between Equity Group Investments, L.L.C. and
Danielson Holding Corporation. (Filed with Report on Form
10-Q dated June 30, 1999, Exhibit 10.6.)
MATERIAL CONTRACTS--EXECUTIVE COMPENSATION PLANS AND
ARRANGEMENTS:
--------------------------------------------------------------
10.7 * 1995 Stock and Incentive Plan. (Included as Amended
Appendix B to Proxy Statement filed on August 2, 2000.)
10.8 * Employment Agreement dated April 14, 1999 between
Danielson Holding Corporation and David Barse.
(Filed with Report on Form 10-Q dated June 30, 1999,
Exhibit 10.7.)
10.9 * Employment Agreement dated April 14, 1999 between
Danielson Holding Corporation and Michael Carney.
(Filed with Report on Form 10-Q dated June 30, 1999,
Exhibit 10.8.)
- - -------------
(1) Exhibit numbers are referenced to Item 601 of Regulation S-K under the
Securities Exchange Act of 1934.
* Asterisk indicates an exhibit previously filed with the Securities and
Exchange Commission and incorporated herein by reference.
ANNUAL REPORT TO SECURITY-HOLDERS:
---------------------------------
13.1 2001 Annual Report of Danielson Holding Corporation.
(To be included herewith at page 34.)
SUBSIDIARIES:
------------
21 * Subsidiaries of Danielson Holding Corporation. (Filed with
Report on Form 10-K for the fiscal year ended December 31,
1996, Exhibit 21.)
CONSENT OF EXPERTS
------------------
(b) During the fiscal year ended December 31, 2001 for which this Report is
filed, DHC filed one report on Form 8-K dated December 26, 2001.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Danielson Holding Corporation has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
DANIELSON HOLDING CORPORATION
(Registrant)
By /s/ Martin J. Whitman
--------------------------------
Martin J. Whitman
Chief Executive Officer
Date: April 1, 2002
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of Danielson Holding
Corporation and in the capacities and on the dates indicated.
Date: April 1, 2002 By /s/ MARTIN J. WHITMAN
-----------------------------------
Martin J. Whitman
Chief Executive Officer and a
Director
Date: April 1, 2002 By /s/ DAVID M. BARSE
-----------------------------------
David M. Barse
President and Chief Operating
Officer and a Director
Date: April 1, 2002 By /s/ MICHAEL T. CARNEY
-----------------------------------
Michael T. Carney
Chief Financial Officer
Date: April 1, 2002 By /s/ SAMUEL ZELL
-----------------------------------
Samuel Zell
Chairman of the Board Director
Date: April 1, 2002 By /s/ JOSEPH F. PORRINO
-----------------------------------
Joseph F. Porrino
Director
Date: April 1, 2002 By /s/ FRANK B. RYAN
-----------------------------------
Frank B. Ryan
Director
Date: April 1, 2002 By /s/ EUGENE M. ISENBERG
-----------------------------------
Eugene M. Isenberg
Director
Date: April 1, 2002 By /s/ WALLACE O. SELLERS
-----------------------------------
Wallace O. Sellers
Director
Date: April 1, 2002 By /s/ STANLEY J. GARSTKA
-----------------------------------
Stanley J. Garstka
Director
Date: April 1,2002 By /s/ WILLIAM PATE
-----------------------------------
William Pate
Director
DANIELSON HOLDING CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Independent Auditors' Report.............................................................................. F-2
Danielson Holding Corporation and Consolidated Subsidiaries:
Statements of Operations - For the years ended December 31, 2001, 2000 and 1999.................. *
Balance Sheets - December 31, 2001 and 2000........................................................... *
Statements of Stockholders' Equity - For the years ended December 31, 2001, 2000 and 1999 *
Statements of Cash Flows - For the years ended December 31, 2001, 2000 and 1999...................... *
Schedule II - Condensed Financial Information of the Registrant.................................... S-1-3
Schedule V - Valuation and Qualifying Accounts.................................................... S-4
Schedule III - Supplemental Information Concerning Property-Casualty
and VI Insurance Operations................................................................. S-5
Schedules other than those listed above are omitted because either they are
not applicable or not required or the information required is included in the
Company's Consolidated Financial Statements.
- - ----------
* Incorporated by reference to DHC's 2001 Annual Report to Stockholders.
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Danielson Holding Corporation:
Under date of March 5, 2002, except for note 15, which is as of March 15,
2002, we reported on the consolidated balance sheets of Danielson Holding
Corporation and subsidiaries as of December 31, 2001 and 2000, and the related
consolidated statements of operations, stockholders' equity and comprehensive
income, and cash flows for each of the years in the three-year period ended
December 31, 2001, as contained in the 2001 annual report to stockholders. These
consolidated financial statements and our report thereon are included in the
annual report on Form 10-K for the year 2001. In connection with our audits of
the aforementioned consolidated financial statements, we also audited the
related consolidated financial statement schedules as listed in the accompanying
index. These financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statement schedules based on our audits.
In our opinion, such financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.
/S/ KPMG LLP
----------------------------
KPMG LLP
New York, New York
March 28, 2002
F-2
SCHEDULE II
DANIELSON HOLDING CORPORATION
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
(Parent Company Only)
STATEMENTS OF OPERATIONS
(In thousands)
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2001 2000 1999
---- ---- ----
REVENUES:
Net investment income $ 1,717 $ 1,584 $ 504
Net realized investment gains 281 322 3
--------- --------- ---------
TOTAL REVENUES 1,998 1,906 507
--------- --------- ---------
EXPENSES:
Employee compensation and benefits 1,156 1,295 1,251
Professional fees 454 403 379
Other general and administrative fees 951 839 598
--------- --------- ---------
TOTAL EXPENSES 2,561 2,537 2,228
--------- --------- ---------
Loss before provision for
income taxes (563) (631) (1,721)
Income tax provision 50 45 16
--------- --------- ---------
Loss before equity in net income of
subsidiaries (613) (676) (1,737)
Equity in net income of subsidiaries* (13,721) 1,706 2,992
--------- --------- ---------
NET INCOME (LOSS) $(14,334) $ 1,030 $ 1,255
========= ========= =========
*Eliminated in consolidation.
See accompanying auditors' report.
S-1
SCHEDULE II, CONTINUED
DANIELSON HOLDING CORPORATION
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
(Parent Company Only)
BALANCE SHEETS
(In thousands, except share and per share information)
DECEMBER 31,
-------------------------
2001 2000
---- ----
ASSETS:
Cash $ (12) $ 2,586
Fixed maturities:
Available-for-sale at fair value
(Cost: $25,100 and $15,780) 26,865 14,795
Short term investments, at cost which approximates
fair value 3,082 3,615
----------- -----------
TOTAL CASH AND INVESTMENTS 29,935 20,996
Investment in subsidiaries* 50,626 60,337
Accrued investment income 67 176
Other assets 441 167
----------- -----------
TOTAL ASSETS $ 81,069 $ 81,676
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Payable for securities sold not yet purchased (proceeds: $2,264) 2,247 --
Intercompany note payable* 4,030 --
Other liabilities $ 329 $ 346
----------- -----------
TOTAL LIABILITIES 6,606 346
Preferred Stock ($0.10 par value; authorized 10,000,000
shares; none issued and outstanding) -- --
Common Stock ($0.10 par value; authorized 150,000,000
shares and 100,000,000 shares; issued 19,516,694 shares and
19,306,694 shares; outstanding
19,505,952 shares and 19,295,954 shares) 1,952 1,931
Additional paid-in capital 63,115 62,449
Accumulated other comprehensive income (loss) 5,716 (1,064)
Retained earnings 3,746 18,080
Treasury stock (Cost of 10,742 shares and 10,740 shares) (66) (66)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 74,463 81,330
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 81,069 $ 81,676
=========== ===========
*Eliminated in consolidation.
See accompanying auditors' report.
S-2
SCHEDULE II, CONTINUED
DANIELSON HOLDING CORPORATION
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
(Parent Company Only)
STATEMENTS OF CASH FLOWS
(In thousands)
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2001 2000 1999
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(14,334) $ 1,030 $ 1,255
Adjustments to reconcile net income (loss)to
net cash used in operating activities:
Net realized investment gains (281) (322) (3)
Change in accrued investment income 109 (91) (25)
Depreciation and amortization 25 (450) (79)
Equity in net income of subsidiaries 13,721 (1,706) (2,992)
Change in accrued expenses (4) 28 (1)
Other, net (180) 42 (15)
-------- --------- ---------
Net cash used in operating activities (944) (1,469) (1,860)
-------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments purchased:
Fixed income maturities available-for-sale (20,865) (34,980) (12,723)
Equity securities -- (510) (560)
Proceeds from sales:
Fixed income maturities available-for-sale 12,634 16,656 741
Equity securities -- 1,353 --
Investments, matured or called
Fixed income maturities available-for-sale 1,456 14,562 7,273
Purchases of property and equipment (99) (15) (1)
-------- --------- ---------
Net cash used in
investing activities (6,874) (2,934) (5,270)
-------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of options to purchase
Common Stock 630 -- --
Proceeds from issuance of Common Stock -- 3,040 13,109
Modification of Common Stock options 57 -- --
Dividends from subsidiaries -- 1,500 --
Loan from subsidiaries 4,000
-------- --------- ---------
Net cash provided by
financing activities 4,687 4,540 13,109
-------- --------- ---------
Net increase (decrease) in cash and
short term investments (3,131) 137 5,979
Cash and short term investments at
beginning of year 6,201 6,064 85
-------- --------- ---------
CASH AND SHORT TERM INVESTMENTS AT
END OF YEAR $ 3,070 $ 6,201 $ 6,064
======== ========= =========
See accompanying auditors' report.
S-3
SCHEDULE V
DANIELSON HOLDING CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
ADDITIONS
BALANCE AT CHARGED TO COSTS CHARGED TO BALANCE AT
BEGINNING OF PERIOD AND EXPENSES OTHER ACCOUNTS DEDUCTIONS END OF PERIOD
------------------- ------------ -------------- ---------- -------------
Allowance for premiums
and fees receivable
For the year ended December 31,
2001 $ 587 $ 1,094 $ $ 250 $ 1,431
========= ========= ========= ======== =======
2000 $ 274 $ 726 $ 25 $ 438 $ 587
========= ========= ========= ======== =======
1999 $ 136 $ 444 $ -- $ 306 $ 274
========= ========= ========= ======== =======
Allowance for uncollectable
reinsurance on paid losses
For the year ended December 31,
2001 $ 623 $ 12 $ $ -- $ 635
========= ========= ========= ======== =======
2000 $ 402 $ 221 $ -- $ -- $ 623
========= ========= ========= ======== =======
1999 $ 374 $ 28 $ -- $ -- $ 402
========= ========= ========= ======== =======
Allowance for uncollectable
reinsurance on unpaid losses
For the year ended December 31,
2001 $ 101 $ 17 $ -- $ -- $ 118
========= ========= ========= ======== =======
2000 $ 246 $ -- $ -- $ 145 $ 101
========= ========= ========= ======== =======
1999 $ 559 $ -- $ -- $ 313 $ 246
========= ========= ========= ======== =======
See accompanying auditors' report.
S-4
SCHEDULES III AND VI
DANIELSON HOLDING CORPORATION
SUPPLEMENTAL INFORMATION
CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS
(in thousands)
OTHER
AFFILIATION DEFERRED RESERVES FOR UNPAID DISCOUNT FROM POLICY CLAIMS
WITH ACQUISITION CLAIMS AND CLAIM RESERVES FOR UNEARNED AND BENEFITS NET EARNED INVESTMENT
REGISTRANT COSTS ADJUSTMENT EXPENSES UNPAID CLAIMS PREMIUMS PAYABLE PREMIUMS INCOME
---------- ----- ------------------- ------------- -------- ------- -------- ------
Consolidated
Property-Casualty
Entities:
AS OF AND FOR THE YEAR
ENDED 12/31/01 $2,209 $ 105,745 $ $ 21,117 $ 81,854 $ 7,731
====== ========== ======== ======== ======== ======== =========
As of and for the year
ended 12/31/00 $3,665 $ 100,030 $ -- $ 23,207 -- $ 67,034 $ 7,741
====== ========== ======== ======== ======== ======== =========
As of and for the year
ended 12/31/99 $2,522 $ 94,934 $ -- $ 16,239 -- $ 54,040 $ 7,273
====== ========== ======== ======== ======== ======== =========
CLAIMS AND CLAIM
AFFILIATION ADJUSTMENT EXPENSES AMORTIZATION OTHER PAID CLAIMS
WITH INCURRED RELATED TO OF DEFERRED OPERATING AND CLAIM NET WRITTEN
REGISTRANT CURRENT YEAR PRIOR YEARS ACQUISITION COSTS EXPENSES ADJUSTMENT EXPENSES PREMIUMS
---------- ------------ ----------- ----------------- --------- ------------------- --------
Consolidated
Property-Casualty
Entities:
AS OF AND FOR THE YEAR
ENDED 12/31/01 $ 68,848 $ 7,646 $16,174 $ 4,621 $67,871 $ 80,355
======== ======= ======= ======= ======= ========
As of and for the year
ended 12/31/00 $ 55,269 $ 5,254 $12,153 $ 4,283 $60,440 $ 73,141
======== ======= ======= ======= ======= ========
As of and for the year
ended 12/31/99 $ 43,301 $ 2,491 $10,070 $ 3,794 $43,952 $ 56,605
======== ======= ======= ======= ======= ========
See accompanying auditors' report.
S-5
2001 Annual Report
As of and for the years
ended December 31,
----------------------------------
(IN THOUSANDS, EXCEPT SHARE AND
PER SHARE AMOUNTS, STOCK PRICES AND EMPLOYEES) 2001 2000 1999
- - ------------------------------------------------------------------------------
RESULTS OF OPERATIONS
Earned premiums ........................ $ 81,854 $ 67,034 $ 54,040
Total revenues ......................... $ 94,102 $ 86,237 $ 71,158
Net income (loss)....................... $ (14,334) $ 1,030 $ 1,255
Net cash provided by (used in) continuing
operating activities ................. $ (4,748) $ 6,644 $ (6,478)
Net income (loss)per diluted share
of Common Stock ...................... $ (0.74) $ 0.05 $ 0.07
Combined ratio ......................... 129.4% 123.1% 125.2%
================================================================================
BALANCE SHEET AND OTHER DATA
Total investments ...................... $ 157,203 $ 154,130 $ 140,391
Policyholder liabilities ............... $ 126,862 $ 123,601 $ 111,987
Stockholders' equity ................... $ 74,463 $ 81,330 $ 76,226
Book value per share of Common Stock ... $ 3.82 $ 4.21 $ 4.13
Common Stock price range
High ................................. $ 5.05 $ 7 3/8 $ 7 1/2
Low .................................. $ 3.34 $ 3 9/16 $ 2 7/8
Shares of Common Stock
outstanding at year end .............. 19,505,952 19,295,954 18,476,265
Employees of continuing
operations at year end ............... 117 156 138
FINANCIAL TABLE OF CONTENTS
- ---------------------------
Selected Consolidated Financial Data ....................................... 2
Management's Discussion and Analysis of
Financial Condition and Results of Operations ............................ 3
Consolidated Statements of Operations ...................................... 8
Consolidated Balance Sheets ................................................ 9
Consolidated Statements of Stockholders' Equity ............................ 10
Consolidated Statements of Cash Flows ...................................... 11
Notes to Consolidated Financial Statements ................................. 12
Independent Auditors' Report ............................................... 23
Responsibility for Financial Reporting ..................................... 23
Quarterly Financial Data ................................................... 24
Stock Market Prices ........................................................ 24
1
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
SELECTED CONSOLIDATED FINANCIAL DATA
---------------------------
The following selected financial data of Danielson Holding Corporation and
its subsidiaries should be read in conjunction with the Consolidated Financial
Statements and Notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations, included elsewhere in this
Report.
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------
(IN THOUSANDS, EXCEPT SHARE AND
PER SHARE AMOUNTS) 2001 2000 1999 1998 1997
- - ------------------------------------------------------------------------------------------------------------
A. RESULTS OF OPERATIONS
Total revenues ..................$ 94,102 $ 86,237 $ 71,158 $ 64,744 $ 65,746
Net income (loss) ...............$ (14,334) $ 1,030 $ 1,255 $ 2,301 $ 4,589
Diluted earnings (loss) per share
of Common Stock................$ (0.74) $ 0.05 $ 0.07 $ 0.14 $ 0.28
B. BALANCE SHEET DATA
Invested assets .................$ 157,203 $ 154,130 $ 140,391 $ 134,859 $ 142,823
Total assets ....................$ 208,871 $ 210,829 $ 194,752 $ 180,895 $ 187,773
Unpaid losses and loss adjustment
expenses ......................$ 105,745 $ 100,030 $ 94,934 $ 95,653 $ 105,947
Stockholders' equity ............$ 74,463 $ 81,330 $ 76,226 $ 63,273 $ 63,920
Shares of Common Stock
outstanding.................... 19,505,952(1) 19,295,954(1) 18,476,265(1) 15,576,276(1) 15,576,287(1)
(1) Does not give effect to currently exercisable options and, in 2001,
2000 and 1999, warrants to purchase shares of Common Stock.
2
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------
GENERAL
Danielson Holding Corporation ("DHC") is organized as a holding company
with substantially all of its operations conducted by subsidiaries (collectively
with DHC, the "Company"). DHC, on a parent-only basis, has limited continuing
expenditures for rent and administrative expenses and derives revenues primarily
from investment return on portfolio securities. Therefore, the analysis of the
Company's financial condition is generally best done on an operating subsidiary
basis. For additional information relating to the Company's organization, see
Note 1 of the Notes to Consolidated Financial Statements.
The Company does not currently pay regular Federal income tax due to its
net operating loss carryforwards and the recognition of losses from several
trusts that assumed various liabilities of certain present and former
subsidiaries of DHC. It is expected that the Company's 2001 consolidated Federal
income tax return will report a cumulative net operating loss carryforward
currently estimated at $745 million, which will expire in various amounts, if
not used, between 2002 and 2019. Exclusive of the trusts' activities, the
Company has generated cumulative taxable losses both historically and during the
prior three years. Over the past several years, the Company's insurance
operations have been generating losses exclusive of net investment income, net
realized gains and the trusts' activities. DHC has historically generated losses
at the holding company level. Therefore, these tax loss attributes are currently
fully reserved, for valuation purposes, on the Company's financial statements.
See Note 8 of the Notes to Consolidated Financial Statements.
This Management's Discussion and Analysis of Financial Condition and
Results of Operations, and certain Notes to Consolidated Financial Statements
contain forward-looking statements, including statements concerning plans,
capital adequacy, adequacy of reserves, utilization of tax losses, goals, future
events or performance and underlying assumptions and other statements which are
other than statements of historical facts. Such forward-looking statements may
be identified, without limitation, by use of the words "believes",
"anticipates", "expects", "intends", "plans", "estimates" and similar
expressions. All such statements represent only current estimates or
expectations as to future results and are subject to risks and uncertainties
which could cause actual results to materially differ from current estimates or
expectations. See "RISK FACTORS THAT MAY AFFECT FUTURE RESULTS."
RESULTS OF NAICC'S OPERATIONS
The operations of the Company's principal subsidiary, National American
Insurance Company of California (NAICC), are in property and casualty insurance.
NAICC's objective is to underwrite business that is expected to yield an
underwriting profit. During 2001, NAICC determined that certain lines of
insurance may not be sustainable in the current rate environment. Competitive
and regulatory pressures have resulted in a general market for premium rates in
these lines that is well below a level necessary in order to achieve a profit,
especially in light of increasingly unfavorable loss history. Rather than
continue to sustain losses, NAICC has exited the worker's compensation line of
insurance in all states, and has also exited the non-standard private passenger
automobile program written outside of California. The last workers' compensation
policy outside Montana was issued in July 2001 and the last Montana workers'
compensation policy was issued in January 2002. The last new non-standard
private passenger automobile policy outside of California was issued in
September 2001. The remaining lines of insurance written by NAICC will be
non-standard private passenger automobile in California and commercial
automobile in certain western states, primarily California.
The effect of this decision will be a substantial reduction in the
underwriting operations of NAICC going forward into 2002 with a view towards
increasing overall profitability. The Company expects that its written premium
for 2002 will be about half of the amount written in 2000. However, premium
activity could change substantially if the rate environment in those lines
exited materially improves and NAICC re-enters those markets. Costs incurred in
2001 attributable to the contraction process were approximately $1.25 million
and include the write-off of goodwill and employees' severances.
PROPERTY AND CASUALTY INSURANCE OPERATIONS
Net premiums earned were $81.9 million, $67.0 million and $54.0 million in
2001, 2000 and 1999, respectively. The change in net premiums earned were
directly related to the change in net written premiums. Net written premiums
were $80.4 million, $73.1 million and $56.6 million in 2001, 2000, and 1999,
respectively. Net earned premiums exceeded net written premiums in 2001 due to
the decision to cease writing in several lines of business as noted above.
The overall increase in net written premiums in 2001 was attributable to
growth in our commercial automobile insurance business, especially during the
first nine months of 2001. However, in keeping with NAICC's objective of
underwriting only business that is expected to yield an underwriting profit,
NAICC, beginning in September 2001, initiated efforts to reduce the overall
commercial automobile premium production through a temporary moratorium on new
business, eliminating certain states and terminating agency appointments.
Consequently, the growth in premiums noted during 2001 for this product line
will not continue.
Workers' compensation net written premiums decreased by $0.7 million during
2001 over the comparable year to date period in 2000 due to decreased
production, primarily in California. The commercial automobile net written
premiums grew from $23.1 million in 2000 to $38.4 million in 2001 due to
increased production, primarily in California. Net written premiums for personal
automobile insurance decreased during 2001 primarily due to the termination of
certain private passenger automobile programs as noted above.
Premiums and fees receivable, net of allowances, decreased by $0.7 million
or 4.3%. The decrease is attributable to the decision to reduce NAICC's
underwriting operations. Prior to that decision, NAICC experienced significant
growth in installment premiums related to its commercial automobile program. The
Company does not expect this trend to continue in 2002. The Company's automobile
programs have installment features on policy terms in excess of six months.
Premiums from the automobile program that generally offer policy terms less than
six months and do not utilize installment plans increased slightly in 2001. The
effect of these trends was to mitigate the overall decrease in installment
premium receivable during 2001. It is expected that the decrease in premium
receivable will be much greater in 2002.
The increase in the allowance for premiums and fees receivable during 2001
of $844,000 was attributable to the increase in installment premiums during 2001
prior to the decision to decrease underwriting operations. In conjunction with
the increase in installment premiums, the Company experienced an increase in
collection efforts relating to such premiums, especially non-standard private
passenger automobile policies outside of California. As a result, the Company
increased both its allowance for premiums and the amount of write-offs against
such allowance. The Company does not expect this trend to continue in 2002.
Net investment income was $7.7 million, $7.7 million and $7.3 million in
2001, 2000, and 1999, respectively. As of December 31, 2001 and 2000, the
average yield on NAICC's portfolio was 5.8 percent and 6.6 percent,
respectively. Net investment income has remained flat despite the decrease in
the portfolio yield due to the write-off of $1.0 million of accrued interest
related to our investment in American Commercial Lines LLC Senior Notes which
were in default at December 31, 2001. See Results of DHC's Operations "Liquidity
and Capital Resources". Had the write-off not been required the portfolio yield
would have been 8.3%. The fixed-income invested assets increased by only $0.9
million in 2001 compared to an increase of $9.1 million in 2000. The relatively
flat activity during this year is attributable to maturities and paydowns in
excess of purchases in the fourth quarter of $7.8 million. The increase in
invested assets in 2000 was attributable to the receipt of the Reliance
settlement. The estimated average maturity of the portfolio at December 31, 2001
was 3.2 years compared to 3.3 years at December 31, 2000.
In January 1999, NAICC entered into a workers' compensation reinsurance
agreement with Reliance Insurance Company ("Reliance Agreement") with a term of
two years. The Reliance Agreement provided excess of loss coverage down to
$10,000 and a 20 percent quota share below the excess retention resulting in a
maximum net loss to NAICC of $18,000 per claim. During 1999, Reliance initiated
efforts to rescind their workers' compensation reinsurance agreements with
several insurance companies, including NAICC. NAICC was originally offered $5
million as a settlement, which was negotiated to $8 million. In determining
whether the $8 million proposed settlement amount was reasonable, an antiicpated
loss ratio was calculated based on existing reserves, which resulted in an
estimated $8 to $9 million that would have been recoverable under the Reliance
Agreement, and therefore management believed that the $8 million in present
value was a reasonable settlement amount. Management believed it was in the best
interest of the Company to accept the offer and agree to rescind the agreement
based on several factors: (1) the projected premium and losses for 2000, (2) the
negative press Reliance was beginning to receive in the summer of 1999 regarding
certain underwriting pools, and, most importantly, (3) the potential for future
credit risk of Reliance if the offer was rejected. Reliance did not provide the
Company with any estimates of amounts reported under the initial agreements, did
not disclose how they arrived at the additional compensation included in the
overall settlement amount, and did not provide their reason for requesting
rescission of the agreements as of their effective date.
In the fourth quarter of 1999, NAICC executed an agreement to rescind the
Reliance Agreement retroactive to its effective date. The terms of the
rescission included the return of amounts paid during the nine month period the
Reliance Agreement was active plus the settlement fee of $8.0 million paid by
Reliance to eliminate further obligations under the contract. NAICC recognized a
gain of $8,317,000 in the fourth quarter of 1999 as a result of this rescission.
The gain represented the difference between the proceeds received of $11.5
million and the reinsurance recoverable balances due from Reliance at September
30, 1999. The results of operations include ceded premiums of $3,875,000, net of
ceding commissions, and $417,000 of paid losses and loss adjustment expenses
during the nine months the agreement was active. The gain realized should not be
considered as an indication of an understatement of reserves or negative trends
in this business.
3
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------
(CONTINUED)
Net losses and loss adjustment expenses (LAE) were $76.5 million, $60.5
million, and $45.8 million in 2001, 2000, and 1999, respectively. The resulting
net loss and LAE ratios were 93.5 percent, 90.3 percent and 84.7 percent in
2001, 2000 and 1999, respectively. The increase in the loss and LAE ratio during
2001 was attributable to higher than expected losses in the non-California
private passenger automobile programs, and significant adverse development in
the California workers' compensation line. Adverse development on prior accident
years recognized for workers' compensation in 2001 totaled $4.4 million. The
adverse development for prior accident years related to the private passenger
automobile lines placed in run-off was $2.4 million. The increase in the loss
and LAE ratio in 2000 over 1999 was due to higher than expected losses in our
private passenger automobile programs and additional developments on certain
businesses in run-off.
Policy acquisition costs were $20.8 million, $16.4 million, and $13.9
million in 2001, 2000, and 1999, respectively. As a percentage of net premiums
earned, policy acquisition expenses were 25.3 percent, 24.5 percent, and 25.7
percent in 2001, 2000, and 1999, respectively. Policy acquisition costs include
expenses directly related to premium volume (i.e., commissions, premium taxes
and state assessments) as well as certain underwriting expenses which are fixed
in nature. The increase in the policy acquisition expense ratio in 2001,
compared to 2000, is due to the increased acquisition costs in the
non-California private passenger automobile business. The increase was caused by
a reduction in the deferral rate as compared to the prior year caused by
increased losses as compared to the prior year. The decline in the policy
acquisition expense ratio in 2000 compared to 1999 was due primarily to an
increase in our workers' compensation business which has a lower commission cost
than our automobile programs.
General and administrative expenses were $7.8 million, $5.5 million, and
$5.8 million in 2001, 2000, and 1999, respectively. As a percent of net premiums
earned, general and administrative expenses were 10.7 percent, 8.5 percent, and
10.7 percent, in 2001, 2000 and 1999, respectively. General and administrative
expenses have increased in 2001 due to increased production for the first nine
months of 2001 and an additional $1.25 million of costs associated with the
decision to reduce NAICC's underwriting operations. Those costs include both
severances to terminated employees of approximately $500,000 and the write-off
of goodwill of approximately $690,000. These costs added 1.53 percent to the
2001 ratio. The decrease seen in 2000 is the result of cost saving measures
implemented by the Company at the end of 1999.
Policyholder dividends incurred were $(80,984), $(144,817), and $2.2
million in 2001, 2000, and 1999, respectively. The negative policyholder
dividends in 2001 and 2000 were attributable to less participating business on
the Montana workers' compensation policies which resulted in the adjustment of
prior accruals to reflect aniticipated payments based on experience. The
policyholder dividends incurred during 1999 were attributable to the increase in
our Montana workers' compensation policyholder dividends that historically have
loss ratios well below those recorded in California.
Combined underwriting ratios were 129.4 percent, 123.1 percent, and 125.2
in 2001, 2000, and 1999, respectively. The increase in the combined ratio in
2001 was primarily the result of increased loss costs and increased costs
associated with the decision to contract NAICC's underwriting operations as
discussed above. The decrease in the combined ratio in 2000 was due to premium
growth and reduced costs associated with producing such premiums.
The insurance operations had a loss from operations of $13.7 million in
2001, compared to income from operations of $1.7 million and $3.0 million, in
2000 and 1999, respectively. The decrease in income for 2001 was primarily
attributable to increases in loss and loss adjustment expenses primarily in the
non-California private passenger automobile and workers' compensation lines of
business. The decrease for 2001 was also attributable to costs associated with
the reduction of insurance operations. The decrease for 2000 was attributable to
an increase in loss and loss adjustment expenses, which was offset in part by
realized gains of $8.4 million.
LIQUIDITY AND CAPITAL RESOURCES
The Company's insurance subsidiaries require both readily liquid assets and
adequate capital to meet ongoing obligations to policyholders and claimants, as
well as to pay ordinary operating expenses. The primary sources of funds to meet
these obligations are premium revenues, investment income, recoveries from
reinsurance and, if required, the sale of invested assets. NAICC's investment
policy guidelines require that all liabilities be matched by a comparable amount
of investment grade assets. Management believes that NAICC has both adequate
capital resources and sufficient reinsurance to meet any unforeseen events such
as natural catastrophes, reinsurer insolvencies, or possible reserve
deficiencies.
The Company meets both its short-term and long-term liquidity requirements
through operating cash flows that include premium receipts, investment income,
and reinsurance recoveries. To the extent operating cash flows do not provide
sufficient cash flow, the Company relies on the sale of invested assets. Cash
used in insurance operations was $3.8 million in 2001. Cash provided by
insurance operations was $8.1 million in 2000 and cash used in insurance
operations was $4.6 million in 1999. Cash used in operations during 2001 results
primarily from deteriorating underwriting results caused by adverse development
in those lines placed into run-off during 2001 as noted above. The increase in
cash provided by insurance operations for 2000 was primarily attributable to
amounts received for the rescission of certain reinsurance treaties of $11.5
million offset by an increase in claim payments made under the commercial and
private passenger automobile programs. Had the funds related to the rescission
not been received in 2000 the cash used in operations would have been
approximately $3.4 million. The increase in cash used in insurance operations
for 1999 was primarily due to the decline in our non-standard private passenger
written premiums, and to the timing difference in receiving payment on the
Reliance settlement of $11.5 million in 2000. Had those funds been received in
1999, operations would have provided approximately $6.9 million in cash.
Due to premium growth during the first nine months of the year, the Company
was able to meet its short-term cash needs primarily through premium receipts.
In light of the decision to reduce NAICC's underwriting operations, funds
provided from premium receipts will decrease significantly in 2002. Further,
because workers' compensation and automobile liability claims are paid over the
course of several years, NAICC will experience a condition in which claim
payments related to the lines placed into run-off in 2001 will exceed expected
premium receipts from those lines. Such negative cash flow will require the sale
of invested assets to meet obligations as they arise. Management expects this
trend to continue for several years until premium growth in the remaining lines
of business becomes sufficient to support current operations.
The National Association of Insurance Commissioners provides minimum
solvency standards in the form of risk-based capital requirements (RBC). The RBC
model for property and casualty insurance companies requires companies to report
their RBC ratios based on their statutory annual statements as filed with the
regulatory authorities. NAICC has calculated its RBC requirement under the RBC
model and believes that it has sufficient capital for its operations. Further,
the NAIC has developed the Insurance Regulatory Information System ("IRIS").
IRIS identifies eleven ratios for property/casualty insurance companies. IRIS
specifies a range of "usual values" for each ratio. Departure from the "usual
value" range on four or more ratios may lead to increased regulatory oversight
from individual state insurance commissioners. As a result of the losses
recognized in 2001, NAICC expects that it will fail three of those regulatory
ratios relating to loss development and surplus change. The failure of such
ratios subjects the Company to increased regulatory inquiry. Based on the
differential between reported surplus and the surplus level requiring further
regulatory action, NAICC believes that the failure of those ratios will not have
an adverse impact on the operations of the Company.
RESULTS OF DHC'S OPERATIONS
CASH FLOW FROM PARENT-ONLY OPERATIONS
Operating cash flow of DHC on a parent-only basis is primarily dependent
upon the rate of return achieved on its investment portfolio and the payment of
general and administrative expenses incurred in the normal course of business.
For the years ended December 31, 2001, 2000, and 1999, cash used in parent-only
operating activities was $0.9 million, $1.5 million, and $1.9 million,
respectively. Cash used in operations is primarily attributable to the
parent-only net loss from operations for each year, adjusted for non-cash
charges such as depreciation and amortization, and the operating working capital
requirements of the holding company's business. For information regarding the
Company's operating subsidiaries' cash flow from operations, see "RESULTS OF
NAICC'S OPERATIONS, PROPERTY AND CASUALTY INSURANCE OPERATIONS."
4
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2001, cash and investments of DHC were approximately
$29.9 million. As previously described, the primary use of funds was the payment
of general and administrative expenses in the normal course of business. In
2001, DHC borrowed $4 million from NAICC at an annual interest rate of 6
percent, to be repaid by 2004. In 2000 and 1999, DHC received cash in the amount
of $3.1 million and $13.1 million, respectively, from the sale of newly issued
common stock.
DHC's sources of funds are its investments as well as dividends received
from its subsidiaries. Various state insurance requirements restrict the amounts
that may be transferred to DHC in the form of dividends from its insurance
subsidiaries without prior regulatory approval. In 2000, NAICC received
regulatory approval and paid a $1.5 million dividend to DHC. See Note 4 of the
Notes to Consolidated Financial Statements.
The Company and its subsidiaries use office space and data processing
equipment under leases expiring at various dates through 2006. These leases are
considered operating leases for financial reporting purposes. The terms of the
operating leases generally contain renewal options and escalation clauses based
on increases in operating expenses and other factors. Future minimum lease
payments are $1.7 million in 2002, $1.1 million in 2003, $700,000 in 2004,
$127,000 in 2005 and $74,000 thereafter.
The Company's insurance subsidiary pledges assets and posts letters of
credit for the benefit of other insurance companies they do business with in the
event that the Company is not able to pay their reinsurers. The Company has
assets pledged and letters of credit of $9.1 million at December 31, 2001 and
2000.
The Company's domestic insurance companies are regulated by the insurance
regulatory agencies of the states in which they are authorized to do business.
Many aspects of the Company's insurance business are subject to regulation. For
example, minimum capitalization must be maintained; certain forms of policies
must be approved before they may be offered; reserves must be established in
relation to the amounts of premiums earned and losses incurred; and, in some
cases, schedules of premium rates must be approved.
In compliance with state insurance laws and regulations, securities with a
fair value of approximately $45 million, $44 million and $41 million at December
31, 2001, 2000, and 1999, respectively, were on deposit with various states or
governmental regulatory authorities. In addition, at December 31, 2001, 2000,
and 1999, respectively, investments with a fair value of $6.6 million, $6.5
million and $6.6 million were held in trust or as collateral under the terms of
certain reinsurance treaties and letters of credit.
On March 15, 2002, the Company and American Commercial Lines LLC ("ACL")
executed a definitive recapitalization agreement for the acquisition of ACL by
the Company. ACL is an integrated marine transportation and service company
operating approximately 5,100 barges and 200 towboats on the inland waterways of
North and South America. ACL transports more than 70 million tons of freight
annually. Additionally, ACL operates marine construction, repair and service
facilities and river terminals.
The holders of more than two thirds of ACL's outstanding senior notes,
substantially all the indirect preferred and common members of ACL and the
management of ACL have agreed to support the recapitalization plan. ACL's senior
lenders have executed forbearance agreements pending the negotiation and
execution of definitive documentation relating to the amendment and restatement
of ACL's senior secured credit facility.
Under the terms of the recapitalization agreement, the Company will acquire
100% of the membership interests of American Commercial Lines Holdings LLC,
ACL's parent holding company. ACL's present indirect preferred equity holders
(that are not members of ACL management) will receive $7.0 million in cash.
ACL's management will receive approximately $1.7 million of restricted common
stock of the Company. In addition, the Company will deliver $25.0 million in
cash, which will be used to reduce borrowings under ACL's senior credit
facility, and approximately $58.5 million of ACL's outstanding senior notes to
ACL Holdings in connection with the transaction. The recapitalization is
expected to close in the second quarter of 2002.
The transaction will result in a reduction of ACL's senior secured bank
debt by $25.0 million. In addition, the parties will seek to restructure ACL's
10 1/4% senior notes due 2008 through an exchange offer and consent
solicitation. Upon the successful completion of the exchange offer and consent
solicitation, up to approximately $236.5 million of ACL's outstanding senior
notes (all notes held by parties other than Danielson) will be exchanged for
$120.0 million of new 11 1/4% cash pay senior notes due January 1, 2008 and
approximately $116.5 million of new 12% pay-in-kind senior subordinated notes
due July 1, 2008. ACL will also issue additional new cash pay senior notes in an
aggregate principal amount (not to exceed $20.0 million) equal to the accrued
and unpaid interest on its outstanding senior notes, other than those held by
Danielson, and to the extent that such accrued and unpaid interest exceeds $20.0
million, additional pay-in-kind senior subordinated notes in an amount equal to
such excess would be issued in full satisfaction of such accrued and unpaid
interest.
In connection with these transactions, the Company expects to effect a $42
million rights offering to its existing security holders, the proceeds of which
will be used to fund the Company's cash contribution for the recapitalization
and for general corporate purposes. Consummation of the recapitalization
agreement is not conditioned on the successful completion of the rights
offering. Under the terms of the rights offering, holders of the Company's
common stock will be entitled to purchase additional shares of common stock, at
a subscription price of $5.00 per share, up to such holders' pro rata share of
the rights offering. The March 18th announcement did not constitute notice of
the commencement of the rights offering. Further information regarding the terms
and conditions for the expected rights offering will be announced prior to the
commencement of the rights offering.
The recapitalization agreement provides that the exchange offer and consent
solicitation will be made in reliance on a registration exemption provided by
Section 3(a)(9) under the Securities Act of 1933, conditioned on the minimum
participation of 95% of the outstanding principal amount of ACL's outstanding
senior notes, as to which noteholders holding more than two thirds of the
outstanding principal amount of such notes have agreed to tender. In the event
that the exchange offer and consent solicitation is not consummated by June 15,
2002, the recapitalization agreement provides for the implementation of the
recapitalization through a voluntary prepackaged bankruptcy plan under Chapter
11 of the Bankruptcy Code, as to which noteholders holding more than two thirds
of the outstanding principal amount of ACL's outstanding senior notes have
agreed to accept.
The Company has filed a copy of the press release referenced above along
with a copy of the recapitalization agreement in its filing on Form 8-K dated
March 27, 2002.
THE COMPANY'S INVESTMENTS
The amount and type of certain of the Company's investments are regulated
by California and Montana insurance laws and regulations. The Company's
investment portfolio is composed primarily of fixed maturities and is weighted
heavily toward investment grade short and medium term securities. See Notes 1(B)
and 5 of the Notes to Consolidated Financial Statements.
The following table sets forth a summary of the Company's investment
portfolio at December 31, 2001, by investment grade (dollars in thousands):
Cost Fair Value
- - ------------------------------------------------------------------------------
Investment by investment grade:
Fixed maturities
U.S. Government/Agency ............................ $ 21,283 $ 22,239
Mortgage-backed ................................... 31,256 32,016
Corporates (AAA to A) ............................. 39,495 40,642
Corporates (BBB to B) ............................. 38,363 41,490
-------------------------
Total fixed maturities .......................... 130,397 136,387
Equity securities ................................... 12,416 12,125
-------------------------
Total available for sale ........................ $142,813 $148,512
-------------------------
Securities sold but not yet purchased (BBB)........ (2,264) (2,247)
-------------------------
Total investments................................. $140,549 $146,265
=========================
The following table sets forth a summary of the Company's equity securities
portfolio at December 31, 2001 (dollars in thousands):
Cost Fair Value
- - ------------------------------------------------------------------------------
Equity securities by type:
U.S. domestic securities .......................... $10,405 $11,357
Foreign securities ................................ 2,011 768
------------------------
Total equity securities ......................... $12,416 $12,125
========================
At December 31, 2001 the Company held $58,493,000 face amount of ACL Senior
Notes 10.25%, due 6/30/08 at a cost of $30,025,578 and a fair value of
$31,951,801, representing 42.9 percent of stockholders' equity. As of December
31, 2001, ACL was in default of its December 31, 2001 interest payment
obligation. There were no investments with a carrying value greater than ten
percent of stockholders' equity as of December 31, 2000 or 1999.
The Company has entered into an agreement with ACL whereby, among other
things, DHC will surrender its ACL Senior Notes and receive 100% of the equity
interests of ACL. For a more full description of this anticipated transaction,
see Results of DHC's Operations, "Liquidity and Capital Resources".
5
MARKET RISK
The Company's objectives in managing its investment portfolio are to
maximize investment income and investment returns while minimizing overall
credit risk. Investment strategies are developed based on many factors including
underwriting results, overall tax position, regulatory requirements, and
fluctuations in interest rates. Investment decisions are made by management and
approved by the Board of Directors. Market risk represents the potential for
loss due to adverse changes in the fair value of securities. The market risks
related to the Company's fixed maturity portfolio are primarily interest rate
risk and prepayment risk. The market risks related to the Company's equity
portfolio are foreign currency risk and equity price risk.
The Company's investment in ACL is in high yield lower grade debt. The
market value for higher yielding debt securities tends to be more sensitive to
economic conditions and individual corporate developments than those of higher
rated securities. In addition, the secondary market for these securities is
generally less liquid.
RISKS RELATED TO FIXED MATURITIES
The Company's fixed maturities are subject to interest rate risk. The
Company's primary interest rate risk exposure is to changes in short-term U.S.
prime interest rates. Interest rate risk is the price sensitivity of fixed
maturities to changes in interest rates. Management views these potential
changes in price within the overall context of asset and liability matching.
Management estimates the payout patterns of the Company's liabilities, primarily
loss reserves, to determine their duration. Management sets duration targets for
the Company's fixed income portfolio after consideration of the duration of its
liabilities, which management believes mitigates the overall interest rate risk.
Fixed maturities of the Company include Mortgage-Backed Securities (MBS)
representing 23.5 percent and 30.5 percent of total fixed maturities at December
31, 2001 and December 31, 2000, respectively. All MBS held by the Company are
issued by the Federal National Mortgage Association (FNMA) or the Federal Home
Loan Mortgage Corporation (FHLMC), which are both rated Aaa by Moody's Investors
Services. Both FNMA and FHLMC are corporations that were created by Acts of
Congress. FNMA and FHLMC guarantee the principal balance of their securities.
FNMA guarantees timely payment of principal and interest.
One of the risks associated with MBS is the timing of principal payments on
the mortgages underlying the securities. The principal an investor receives
depends upon amortization schedules and the termination pattern (resulting from
prepayments or defaults) of the individual mortgages included in the underlying
pool of mortgages. The principal is guaranteed but the yield and cash flow can
vary depending on the timing of the repayment of the principal balance.
Securities that have an amortized cost greater than par, which are backed by
mortgages that repay faster (or slower) than expected, will incur a decrease (or
increase) in yield. Those securities that have an amortized cost lower than par
that repay faster (or slower) than expected will generate an increase (or
decrease) in yield. The degree to which a security is susceptible to changes in
yield is influenced by the difference between its amortized cost and par, the
relative sensitivity to repayment of the underlying mortgages backing the
securities in a changing interest rate environment, and the repayment priority
of the securities in the overall securitization structure. The Company attempts
to limit repayment risk by purchasing MBS whose costs are below or do not
significantly exceed par, and by primarily purchasing structured securities with
repayment protection to provide a more certain cash flow to the investor. There
are various types of bonds that may comprise a MBS and they can have differing
interest rates and maturities, as well as priorities to the cash flows of the
underlying mortgages or assets. MBS with sinking fund schedules are known as
Planned Amortization Classes (PAC) and Targeted Amortization Classes (TAC). The
structures of PACs and TACs attempt to increase the certainty of the timing of
prepayment and thereby minimize the prepayment and interest rate risk.
MBS, as well as callable bonds, have a greater sensitivity to market value
declines in a rising interest rate environment than to market value increases in
a declining interest rate environment. This is primarily due to the ability and
the incentive of the payor to prepay the principal or the issuer to call the
bond in a declining interest rate scenario. NAICC's MBS by type of instrument
are as follows (in thousands):
2001 2000
---------------------------------------------
AMORTIZED PERCENT Amortized Percent
COST OF TOTAL Cost of Total
- - ------------------------------------------------------------------------------
Non-PAC/TAC ..................... $16,116 52% $19,774 53%
PAC/TAC ......................... 15,140 48% 17,818 47%
---------------------------------------------
$31,256 100% $37,592 100%
=============================================
The following table provides information about the Company's fixed maturity
investments at December 31, 2001 that are sensitive to changes in interest
rates. The table presents expected cash flows of principal amounts and related
weighted average interest rate by expected maturity dates. The expected maturity
date for other than mortgage-backed securities is the earlier of call date or
maturity date, and for mortgage-backed securities is based on expected payment
patterns. Actual cash flows could differ, and potentially materially differ from
expected amounts considering the weighting of the Company's portfolio towards
mortgage-backed securities.
(IN THOUSANDS) 2002 2003 2004 2005 2006 after Total
- - -------------------------------------------------------------------------------------
U.S. Government/Agency $ 5,250 $ 1,955 $ 3,528 $2,500 $4,945 $ 2,685 $ 20,863
Average interest rate 7.82% 6.83% 5.62% 7.46% 5.37% 6.29%
Mortgage-backed 4,552 3,231 2,451 3,167 3,234 14,601 31,236
Average interest rate 6.87% 6.98% 6.93% 6.98% 6.76% 6.66%
Corporates (AAA to A) 1,835 7,500 12,875 7,575 5,502 4,307 39,594
Average interest rate 7.08% 6.16% 6.10% 6.22% 5.22% 6.15%
Corporates (BBB to B) 1,200 1,175 648 66,493 69,516
Average interest rate 7.08% 7.28% 5.63% 10.18%
----------------------------------------------------------------
Total $12,837 $13,861 $19,502 $13,242 13,681 $88,086 $161,209
================================================================
6
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
Management believes that the interest and prepayment risks generally inherent in
the Company's fixed maturity portfolio are not significant at December 31, 2001.
RISKS RELATED TO EQUITY SECURITIES
The Company classifies all of its equity securities, including the foreign
exchange listed component, in the reporting category: "available for sale."
These securities are marked to the market at the closing U.S. dollar denominated
price on the various exchanges and over-the-counter pricing systems.
Since the portfolio includes both domestic and foreign securities, the
portfolio is subject to foreign currency risk. Foreign currency risk is the
sensitivity to exchange rate fluctuations of the market value and investment
income related to foreign denominated financial instruments. At December 31,
2001, NAICC held approximately $10.3 million of yen denominated equity
securities. See Note 6 of the Notes to Consolidated Financial Statements.
Equity price risk is the potential loss arising from changes in the value
of equity securities. Typically, equity securities have more price volatility
than medium term investment grade fixed maturity instruments.
CERTAIN RISKS AND UNCERTAINTIES RELATING TO CRITICAL ACCOUNTING POLICIES
The Company's financial statements disclose in footnotes its significant
accounting policies. Certain of these policies are critical to the portrayal of
the Company's financial condition and results of operations since they require
management to establish estimates based on complex and subjective judgments,
often including the interplay of specific uncertainties with related accounting
policies including loss reserves and valuation of investments, which are further
described below:
Unpaid Loss and Loss Adjustment Expenses
NAICC maintains reserves for losses and loss expenses to cover the
estimated liability for unpaid claims, including legal and other fees as well as
a portion of our general expenses, for reported and unreported claims incurred
as of the end of each accounting period. Reserve estimates do not represent an
exact calculation of the liability. Rather, reserves represent an estimate of
what we expect the ultimate settlement and administration of claims will cost.
Such estimates are based upon estimates for reported losses, historical company
and industry experience for development.
The ultimate cost of claims is difficult to predict for several reasons.
The variables described above are affected by both internal and external events,
such as changes in rates of inflation and the legal environment, which has
created forecasting complications. Court decisions may dramatically increase
liability in the time between the dates on which a claim is reported and its
resolution. Punitive damage awards have grown in frequency and magnitude. The
courts have imposed increasing obligations on insurance companies to defend
policyholders. As a result, the frequency and severity of claims have grown
rapidly and unpredictably.
NAICC has claims for environmental clean-up against policies issued prior
to 1970. The unpaid loss and loss adjustment expenses related to environmental
cleanup is established considering facts currently known and the current state
of the law and coverage litigation.
Due to the factors discussed above and others, the process used in
estimating unpaid losses and loss adjustment expenses cannot provide an exact
result. The Company's results of operations for each of the past three years
have been adversely affected by development related to prior years of 7,646,
5,254 and 2,491 for 2001, 2000 and 1999, respectively.
Investments
Certain of our investments are in illiquid securities for which the fair
value is not readily determinable. Such valuations may differ significantly from
the values that would have been used had ready markets existed and the
differences could be material. See Note 5 of the Notes to Consolidated Financial
Statements.
AUTHORITATIVE ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities"("FAS 133"). FAS 133 is effective for fiscal
years beginning after June 15, 2000 and establishes standards for the reporting
for derivative instruments. It requires changes in the fair value of a
derivative instrument and the changes in fair value of the assets or liabilities
hedged by that instrument to be included in income. The Company adopted FAS 133
on January 1, 2001 and such adoption did not have a material effect on the
Company's results of operations or financial condition.
In September 2000, the FASB issued FAS Statement 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
(a replacement of FAS 125)" ("FAS 140"). FAS 140 revises the standards for
accounting for securitizations and other transfers of financial assets and
collateral and requires certain disclosures. The statement requires the Company
to reclassify certain financial assets pledged as collateral and to disclose
certain information about its collateral activities. The Company has implemented
FAS 140 as of December 31, 2000. There was no impact on the financial results of
the Company other than the reclassification and/or disclosure about certain
financial assets pledged or accepted as collateral.
Effective January 1, 2001, NAICC was required to record its statutory
amounts pursuant to the Accounting Practices and Procedures Manual issued by the
National Association of Insurance Commissioners ("SSAPs"). The effect of
adoption of the SSAPs did not have a material effect on NAICC's statutory
surplus.
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142"), which
establishes the accounting for goodwill and other intangible assets following
their recognition. SFAS No. 142 is effective beginning January 1, 2002. The
Company is currently evaluating the impact of the adoption of SFAS No. 142.
In August 2001, the FASB issued Statement No. 143, Accounting for Asset
Retirement Obligations, which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. Statement No. 143 is effective for financial
statements issued for fiscal years beginning after June 15, 2002. The Company is
currently evaluating the impact of the adoption of SFAS No. 143.
In October 2001, the FASB issued Statement No. 144 Accounting for the
Impairment or Disposal of Long-Lived Assets, which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
Statement No. 144 is effective for fiscal years beginning after December 15,
2001. The Company is currently evaluating the impact of the adoption of SFAS No.
144.
ECONOMIC CONDITIONS
The operating results of a property and casualty insurer are influenced by
a variety of factors including general economic conditions, competition,
regulation of insurance rates, weather, and frequency and severity of losses.
The markets in which NAICC operates have experienced long periods of rate
inadequacy coupled with increased competition. The general economic conditions
in California, where NAICC writes approximately 59 percent of its current
business, are currently competitive.
The competition, rate regulation and loss experience in the California
automobile markets are currently such that NAICC believes it is able to write
its premium volume in its remaining lines profitably. As part of Proposition
103, the California Department of Insurance issued new regulations for private
passenger automobile rates requiring that the three mandatory rating factors of
(1) driving safety record, (2) number of miles driven annually, and (3) years of
driving experience have the first, second and third greatest weights,
respectively. Geographic location and other characteristics may still be used as
optional rating factors; however, the combined weight of all such optional
rating factors may not be greater than the third mandatory rating factor of
years of driving experience. Previously, insurers could use geographic location
as the primary rating factor. NAICC has made the appropriate modifications to
its rating plans in order to comply with the latest regulations. However, the
competition, rate regulation and loss experience in the non-California
automobile markets are currently such that NAICC is not able to write in those
states profitably, and as a result has exited those markets.
The California workers' compensation market, where NAICC had historically
written a significant amount of its premium, continues to be very price
competitive. Workers' compensation premium volume in 2001, prior to the decision
to exit the market, decreased slightly as competitors have begun to raise rates
during 2001. Despite current rate increases, the Company believes that
competitors continue to price policies at rates well below a level necessary to
achieve an underwriting profit. Coupled with an industry-wide increase in
adverse loss experience, NAICC believes that its decision to exit the workers'
compensation line is mandated by economic conditions.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
As noted above, the foregoing discussion and the Notes to Consolidated
Financial Statements may include forward-looking statements that involve risks
and uncertainties. In addition to other factors and matters discussed elsewhere
herein, some of the important factors that, in the view of the Company, could
cause actual results to differ materially from those discussed in the
forward-looking statements include the following:
1. The insurance products sold by the Company are subject to intense
competition from many competitors, many of whom have substantially greater
resources than the Company. There can be no assurance that the Company will be
able to successfully compete in these markets and generate sufficient premium
volume at attractive prices to be profitable.
2. In order to implement its business plan, the Company has been seeking to
enter into strategic partnerships and/or make acquisitions of businesses that
would enable the Company to earn an attractive return on investment.
Restrictions on the Company's ability to issue additional equity in order to
finance any such transactions exist which could significantly affect the
Company's ability to finance any such transaction. The Company may have limited
other resources with which to implement its strategy and there can be no
assurance that any transaction will be successfully consummated.
3. The insurance industry is highly regulated and it is not possible to predict
the impact of future state and federal regulation on the operations of the
Company.
4. Unpaid losses and loss adjustment expenses ("LAE") are based on estimates of
reported losses, historical Company experience of losses reported by reinsured
companies for insurance assumed from such insurers, and estimates based on
historical Company and industry experience for unreported claims. Such liability
is, by necessity, based upon estimates which may change in the near term, and
there can be no assurance that the ultimate liability will not exceed, or even
materially exceed, such estimates.
7
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
---------------------------
For the years ended December 31,
-------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION) 2001 2000 1999
REVENUES:
- - -------------------------------------------------------------------------------------
Gross premiums earned................... $90,767 $73,888 $63,710
Ceded premiums earned................... (8,913) (6,854) (9,670)
--------------------------------------
Net premiums earned..................... 81,854 67,034 54,040
Net investment income................... 9,448 9,326 7,777
Net realized investment gains (losses).. 1,558 8,765 (152)
Gain on reinsurance treaty rescission... -- -- 8,317
Other income............................ 1,242 1,112 1,176
--------------------------------------
TOTAL REVENUES........................ 94,102 86,237 71,158
LOSSES AND EXPENSES:
Gross losses and loss adjustment expenses 78,295 71,524 57,610
Ceded losses and loss adjustment expenses (1,801) (11,001) (11,818)
---------------------------------------
Net losses and loss adjustment expenses 76,494 60,523 45,792
Policyholder dividends.................. (81) (145) 2,217
Policy acquisition expenses............. 20,795 16,436 13,864
General and administrative expenses..... 11,155 8,259 7,989
--------------------------------------
TOTAL LOSSES AND EXPENSES............. 108,363 85,073 69,862
--------------------------------------
Income (loss) before provision for income tax (14,261) 1,164 1,296
Income tax provision...................... 73 134 41
======================================
NET INCOME (LOSS)......................... $(14,334) $ 1,030 $ 1,255
======================================
EARNINGS (LOSS) PER SHARE OF COMMON STOCK:
Basic.................................. .. $ (0.74) $ 0.06 $ 0.08
Diluted................................... $ (0.74) $ 0.05 $ 0.07
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
8
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
---------------------------
December 31,
-----------------------
(IN THOUSANDS, EXCEPT SHARE INFORMATION) 2001 2000
- - --------------------------------------------------------------------------------------------------------------------------------
ASSETS:
Fixed maturities at fair value (Cost: $130,397 and $123,667)............. $136,387 123,213
Equity securities at fair value (Cost: $12,416 and $25,064).............. 12,125 24,454
Short term investments, at cost which approximates fair value............ 8,691 6,463
-----------------------
TOTAL INVESTMENTS.................................................... 157,203 154,130
Cash..................................................................... 9,175 6,082
Accrued investment income................................................ 1,548 1,782
Premiums and fees receivable, net of allowances of $1,431 and $588....... 14,876 15,555
Reinsurance recoverable on paid losses, net of allowances of $636 and $623 2,142 4,020
Reinsurance recoverable on unpaid losses, net of allowances of $118 and $101 17,733 20,641
Prepaid reinsurance premiums............................................... 2,078 2,629
Property and equipment, net of accumulated depreciation of $9,790 and $8,748 957 1,325
Deferred acquisition costs............................................... 2,209 3,665
Other assets............................................................. 950 1,000
-----------------------
TOTAL ASSETS......................................................... $208,871 $210,829
=======================
LIABILITIES AND STOCKHOLDERS' EQUITY:
Unpaid losses and loss adjustment expenses............................... $105,745 $100,030
Unearned premiums........................................................ 21,117 23,207
Policyholder dividends................................................... -- 364
Reinsurance premiums payable............................................. 763 1,630
Funds withheld on ceded reinsurance...................................... 1,666 1,666
Payable for securities sold but not yet purchased at fair value
(Proceeds: $2,264)....................................................... 2,247 --
Other liabilities........................................................ 2,870 2,602
-----------------------
TOTAL LIABILITIES.................................................... 134,408 129,499
Preferred Stock ($0.10 par value; authorized 10,000,000 shares;
none issued and outstanding)........................................... -- --
Common Stock ($0.10 par value; authorized 150,000,000 shares and
100,000,000;issued 19,516,694 shares and 19,306,694 shares;
outstanding 19,505,952 shares and 19,295,954 shares)................... 1,952 1,931
Additional paid-in capital............................................... 63,115 62,449
Retained earnings........................................................ 3,746 18,080
Accumulated other comprehensive income (loss)............................ 5,716 (1,064)
Treasury stock (Cost of 10,742 shares and 10,740 shares)................. (66) (66)
-----------------------
TOTAL STOCKHOLDERS' EQUITY........................................... 74,463 81,330
-----------------------
Commitments and contingencies
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........................... $208,871 $210,829
=======================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
9
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
---------------------------
For the years ended December 31,
-----------------------------------------------------------------
(IN THOUSANDS, EXCEPT SHARE AMOUNTS) 2001 2000 1999
- - ---------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK
Balance, beginning of year.................... $ 1,931 $ 1,849 $ 1,559
Exercise of options to purchase Common Stock.. 21 -- --
Issuance of Common Stock..................... -- 82 290
--------- --------- ---------
Balance, end of year......................... 1,952 1,931 1,849
--------- --------- ---------
ADDITIONAL PAID-IN CAPITAL
Balance, beginning of year.................. 62,449 59,491 46,673
Exercise of options to purchase Common Stock.. 609 -- --
Modification of Common Stock options.......... 57 -- --
Issuance of Common Stock.................... -- 2,958 12,818
--------- --------- ---------
Balance, end of year........................ 63,115 62,449 59,491
--------- --------- ---------
RETAINED EARNINGS
Balance, beginning of year................... 18,080 17,050 15,795
Net income (loss)............................ (14,334) (14,334) 1,030 $1,030 1,255 $1,255
--------- ------ --------- ------ --------- ------
Balance, end of year....................... 3,746 18,080 17,050
--------- --------- ---------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Balance, beginning of year.................. (1,064) (2,098) (688)
Net unrealized gain (loss) on available-
for-sale securities $6,780, $1,034,and
$(1,410) pre-tax, in 2001, 2000, and
1999 respectively)(1).................. 6,780 1,034 (1,410)
------ ------ -------
Other comprehensive income (loss)......... 6,780 6,780 1,034 1,034 (1,410) (1,410)
--------- ------ --------- ------ --------- -------
Total comprehensive income (loss) $(7,554) $2,064 $ (155)
====== ======= =======
Balance, end of year...................... 5,716 (1,064) (2,098)
--------- --------- ---------
TREASURY STOCK
Balance, beginning and end of year........ (66) (66) (66)
--------- --------- ---------
Total stockholders' equity............. $ 74,463 $ 81,330 $ 76,226
========= ========= =========
- - -------------------------------------------------------------------------------------------------------------
COMMON STOCK, SHARES
Balance, beginning of year................. 19,306,694 18,486,994 15,586,994
Exercise of options to purchase Common Stock 210,000 -- --
Issuance of Common Stock................... -- 819,700 2,900,000
---------- ---------- ----------
Balance, end of year....................... 19,516,694 19,306,694 18,486,994
========== ========== ==========
TREASURY STOCK, SHARES
Balance, beginning of year................. 10,740 10,729 10,718
Purchased during year...................... 2 11 11
---------- ---------- ----------
Balance, end of year....................... 10,742 10,740 10,729
========== ========== ==========
- - ----------
(1) Disclosure of reclassification amount
2001 2000 1999
------- ------- -------
Unrealized holding gains (losses)
Arising during the period $ 8,338 $ 9,799 $ (1,562)
Less: reclassification adjustment
for net (gains) losses included
in net income (1,558) (8,765) 152
------- ------- -------
Net unrealized gains (losses) on securities $ 6,780 $ 1,034 $ (1,410)
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
10
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31,
---------------------------------------
(IN THOUSANDS) 2001 2000 1999
- - -------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Income (loss) from continuing operations............................ $(14,334) $ 1,030 $ 1,255
Adjustments to reconcile income (loss) from continuing operations to
net cash (used in) provided by operating activities:
Net realized investment (gains) losses.......................... (1,558) (8,765) 152
Depreciation and amortization................................... 1,601 384 654
Change in accrued investment income............................. 234 (283) (72)
Change in premiums and fees receivable.......................... 679 (3,936) (1,647)
Change in reinsurance recoverables.............................. 1,878 2,040 1,654
Change in reinsurance recoverable on unpaid losses ............. 2,908 (5,013) 2,559
Change in prepaid reinsurance premiums.......................... 551 (862) (99)
Change in deferred acquisition costs............................ 1,456 (1,143) (141)
Change in unpaid losses and loss adjustment expenses............ 5,715 5,096 (719)
Change in unearned premiums..................................... (2,090) 6,968 2,534
Change in policyholder dividends payable........................ (364) (450) 633
Change in reinsurance payables and funds withheld............... (867) 683 (972)
Change in receivable on reinsurance treaty rescission........... -- 11,459 (11,459)
Other, net...................................................... (557) (564) (810)
---------------------------------------
Net cash (used in) provided by operating activities........... (4,748) 6,644 (6,478)
---------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales:
Fixed income maturities available-for-sale........................ 12,634 16,656 741
Equity securities................................................. 19,570 26,735 --
Investments, matured or called:
Fixed income maturities available-for-sale........................ 29,599 21,829 29,995
Investments purchased:
Fixed income maturities available-for-sale........................ (46,450) (48,077) (32,255)
Equity securities................................................. (5,712) (22,462) (560)
Purchases of property and equipment................................. (259) (159) (370)
---------------------------------------
Net cash provided by (used in) investing activities........... 9,382 (5,478) (2,449)
---------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of options to purchase Common Stock.......... 630 -- --
Proceeds from issuance of Common Stock.............................. -- 3,040 13,109
Modification of Common Stock options................................ 57 -- --
---------------------------------------
Net cash provided by financing activities..................... 687 3,040 13,109
---------------------------------------
Net increase in cash and short term investments........................ 5,321 4,206 4,182
Cash and short term investments at beginning of year................... 12,545 8,339 4,157
---------------------------------------
Cash and short term investments at end of year..........................$ 17,866 12,545 8,339
=======================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
11
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 2001, 2000, AND 1999
1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
FORMATION AND ORGANIZATION
Danielson Holding Corporation ("DHC") is a holding company organized under
the General Corporation Law of the State of Delaware. DHC owns all of the voting
stock of Danielson Indemnity Company ("DIND"). DIND owns 100 percent of the
common stock of National American Insurance Company of California, DHC's
principal operating insurance subsidiary, which owns 100 percent of the common
stock of Danielson Insurance Company, Danielson National Insurance Company, and
Valor Insurance Company, Incorporated ("Valor") (National American Insurance
Company of California and its subsidiaries being collectively referred to as
"NAICC").
The operations of NAICC are in property and casualty insurance. NAICC
writes non-standard and preferred private passenger and commercial automobile,
homeowners' and workers compensation insurance in the western United States,
primarily California. NAICC writes approximately 59 percent of its insurance in
California and 13 percent of its insurance in Montana. For the years ended
December 31, 2001, 2000 and 1999, personal lines direct written premiums,
representing 16 percent, 28 percent and 36 percent, respectively, of total
direct written premiums, were produced through two general agents of NAICC.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. BASIS OF PRESENTATION
The accompanying Consolidated Financial Statements of DHC and subsidiaries
(collectively with DHC, the "Company") have been prepared in accordance with
accounting principles generally accepted in the United States of America. All
material transactions among consolidated companies have been eliminated. Certain
prior year amounts have been reclassified to conform with the current year's
financial statement presentation.
B. INVESTMENTS
The Company classifies its debt and equity securities in one of three
categories: trading, available-for-sale or held- to-maturity. Securities that
are classified as "trading" are bought and held principally to sell in the near
term. Securities which are classified as "held-to-maturity" are securities which
the Company has the ability and intent to hold until maturity. All other
securities, which are not classified as either trading or held-to-maturity, are
classified as "available-for-sale."
Fixed maturities classified as available-for-sale are recorded at fair
value. Fixed maturities classified as held-to-maturity are recorded at amortized
cost, adjusted for the amortization or accretion of premiums or discounts.
Amortization and accretion of premiums and discounts on collateralized mortgage
obligations are adjusted for principal paydowns and changes in expected
maturities. Net unrealized gains or losses on fixed maturities classified as
available-for-sale are excluded from earnings and are reported as a separate
component of accumulated other comprehensive income (loss) in stockholders'
equity until realized. No deferred tax liability has been provided for
unrealized appreciation due to the anticipated availability of the Company's net
operating tax loss carryforwards, and other various deferred tax assets.
A decline in the market value of any security below cost which is deemed to
be other than temporary is charged to earnings, resulting in the establishment
of a new cost basis for such security.
Premiums and discounts of fixed maturities are amortized or accreted based
on the effective interest method. Dividend and interest income are recognized
when earned. The cost of securities sold is determined using the specific
identification method.
Equity securities are stated at fair value, and any increase or decrease
from cost is reported as accumulated other comprehensive income (loss) in
stockholders' equity as unrealized gain or loss.
Short term investments are stated at cost which approximates fair value.
Investments having an original maturity of three months or less from the time of
purchase have been classified as "short term investments."
C. REVENUE RECOGNITION
Earned premium income is recognized ratably over the contract period of an
insurance policy. A liability is established for unearned insurance premiums
representing the portion of premiums received that is applicable to the
unexpired terms of policies in force. Premiums earned include an estimate for
earned but unbilled workers' compensation premiums. Workers' compensation
premiums earned but unbilled and included in premiums receivable were $397,000
and $1.2 million at December 31, 2001 and 2000, respectively. The Company
estimates its earned but unbilled workers' compensation premium based on past
history of additional premiums billed as a result of payroll audits. Payroll
audits are conducted between 30 and 60 days after the coverage period. The
decrease in earned but unbilled premiums reflects the decision to exit the
workers' compensation business during 2001.
D. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Unpaid losses and loss adjustment expenses ("LAE") are based on estimates
of reported losses, historical Company experience of losses reported by
reinsured companies for insurance assumed from such insurers, and estimates
based on historical Company and industry experience for unreported claims.
Management believes that the provisions for unpaid losses and LAE are adequate
to cover the cost of losses and LAE incurred to date. However, such liability
is, by necessity, based upon estimates, which may change in the near term, and
there can be no assurance that the ultimate liability will not exceed, or even
materially exceed, such estimates.
E. REINSURANCE
In the normal course of business, the Company seeks to reduce the loss that
may arise from catastrophes or other events which cause unfavorable underwriting
results by reinsuring certain levels of risk in various areas of exposure with
other insurance enterprises or reinsurers.
The Company accounts for its reinsurance contracts which provide
indemnification by reducing premiums earned by the amounts paid to the reinsurer
and establishing recoverable amounts for paid and unpaid losses and LAE ceded to
the reinsurer. Amounts recoverable from reinsurers are estimated in a manner
consistent with the claim liability associated with the reinsured policy.
Contracts pursuant to which it is not reasonably possible that the reinsurer may
realize a significant loss from the insurance risk generally do not meet
conditions for reinsurance accounting and are accounted for as deposits. For the
years ended December 31, 2001 and 2000, the Company had no reinsurance contracts
which were accounted for as deposits.
F. DEFERRED ACQUISITION COSTS
Deferred acquisition costs, consisting principally of commissions and
premium taxes paid at the time of issuance of a policy, are deferred and
amortized over the period during which the related premiums are earned. Deferred
acquisition costs are limited to the estimated future profit, based on the
anticipated losses and LAE (based on historical experience), maintenance costs,
policyholder dividends, and anticipated investment income. The amortization of
deferred acquisition costs charged to operations in 2001, 2000 and 1999 was
$16.2 million, $12.2 million and $10.1 million, respectively.
G. POLICYHOLDER DIVIDENDS
Policyholder dividends represent management's estimate of amounts to be
paid on participating policies which share in positive underwriting results,
based on the type of policy plan. Participating policies represent approximately
1.0 percent, 2.7 percent and 6.1 percent of workers' compensation direct written
premiums for the years ended December 31, 2001, 2000 and 1999, respectively. An
estimated provision for policyholder dividends is accrued during the period in
which the related premium is earned. These estimated dividends do not become
legal liabilities unless and until declared by the Board of Directors of NAICC.
No dividends were declared and unpaid as of December 31, 2001.
H. PROPERTY AND EQUIPMENT
Property and equipment, which include data processing hardware and software
and leasehold improvements, are carried at historical cost less accumulated
depreciation. Depreciation of property and equipment is provided over the
estimated useful lives of the respective assets. Leasehold improvements are
amortized on a straight-line basis over the estimated useful lives of the assets
or over the term of the leases, whichever is shorter. The useful lives of all
property and equipment range from three to 12 years.
I. INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and the respective tax basis
thereof. Deferred tax assets and liabilities are measured using enacted tax
rates which are expected to apply to taxable income in the years in which those
temporary differences are anticipated to be recovered or settled, and are
limited, through a valuation allowance, to the amount estimated to be
realizable.
12
J. PER SHARE DATA
Per share data is based on the weighted average number of shares of common
stock of DHC, par value $0.10 per share ("Common Stock") outstanding during each
year. Diluted earnings per share computations, as calculated under the treasury
stock method, include the average number of shares of additional outstanding
Common Stock issuable for stock options and warrants, whether or not currently
exercisable. Such average shares were 18,841,925 and 16,793,873, for the years
ended December 31, 2000 and 1999, respectively. Average shares for 2001 are not
included as amounts are anti-dilutive. Basic earnings per share and loss per
share are calculated using only the average number of outstanding shares of
Common Stock and disregarding the average number of shares issuable for stock
options. Such average shares outstanding were 19,465,104, 18,482,980 and
16,356,821, for the years ended December 31, 2001, 2000 and 1999, respectively.
K. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties.
The carrying values of the Company's cash and short term investments approximate
fair value because of the short term maturity of those investments. The fair
values of the Company's debt security instruments and equity security
investments are based on quoted market prices as of December 31, 2001. The fair
value of all other financial instruments approximates their respective carrying
value.
L. USE OF ESTIMATES
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
as of the date of the financial statements as well as the reported amounts of
revenues and expenses during the reporting period. Therefore, actual results
could differ from such estimates.
M. STOCK INCENTIVE COMPENSATION PLANS
The Company measures stock-based compensation cost using the intrinsic
value based method of accounting prescribed by APB Opinion 25. Accordingly, the
Company discloses pro forma net income and earnings per share as if the fair
value based method of accounting prescribed by Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" had been
applied.
N. AUTHORITATIVE ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities"("FAS 133"). FAS 133 is effective for fiscal
years beginning after June 15, 2000 and establishes standards for the reporting
for derivative instruments. It requires changes in the fair value of a
derivative instrument and the changes in fair value of the assets or liabilities
hedged by that instrument to be included in income. The Company adopted FAS 133
on January 1, 2001 and such adoption did not have a material effect on the
Company's results of operations or financial condition.
In September 2000, the FASB issued FAS Statement 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
(a replacement of FAS 125)" ("FAS 140"). FAS 140 revises the standards for
accounting for securitizations and other transfers of financial assets and
collateral and requires certain disclosures. The statement requires the Company
to reclassify certain financial assets pledged as collateral and to disclose
certain information about its collateral activities. The Company has implemented
FAS 140 as of December 31, 2000. There was no impact on the financial results of
the Company other than the reclassification and/or disclosure about certain
financial assets pledged or accepted as collateral.
Effective January 1, 2001, NAICC was required to record its statutory
amounts pursuant to the Accounting Practices and Procedures Manual issued by the
National Association of Insurance Commissioners ("SSAPs"). The effect of
adoption of the SSAPs did not have a material effect on NAICC's statutory
surplus.
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142"), which
establishes the accounting for goodwill and other intangible assets following
their recognition. SFAS No. 142 is effective beginning January 1, 2002. The
Company is currently evaluating the impact of the adoption of SFAS No. 142.
In August 2001, the FASB issued Statement No. 143, Accounting for Asset
Retirement Obligations, which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. Statement No. 143 is effective for financial
statements issued for fiscal years beginning after June 15, 2002. The Company is
currently evaluating the impact of the adoption of SFAS No. 143.
In October 2001, the FASB issued Statement No. 144 Accounting for the
Impairment or Disposal of Long-Lived Assets, which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
Statement No. 144 is effective for fiscal years beginning after December 15,
2001. The Company is currently evaluating the impact of the adoption of SFAS No.
144.
2) REINSURANCE
Reinsurance is the transfer of risk, by contract, from one insurance
company to another for consideration (premium). Reinsurance contracts do not
relieve an insurance company of its obligations to policyholders. The failure of
reinsurers to honor their obligations could result in losses to NAICC;
consequently, allowances are established for amounts which are deemed
uncollectable. NAICC evaluates the financial condition of its reinsurers and
monitors concentrations of credit risk arising from similar geographic regions,
activities, or economic characteristics of the reinsurers to minimize its
exposure to significant losses from reinsurer insolvencies.
NAICC has reinsurance under both excess of loss and quota share treaties.
NAICC cedes reinsurance on an excess of loss basis for workers' compensation
risks in excess of $500,000 prior to April 2000 and $200,000 thereafter.
Beginning in May 2001, NAICC retained 50 percent of the loss between $200,000
and $500,000. For risks other than worker's compensation NAICC cedes reinsurance
on an excess of loss basis for risks in excess of $250,000. Effective January 1,
1999, the private passenger automobile quota share ceded percentage was reduced
from 25 percent to 10 percent. The effect of reinsurance on premiums written
reflected in the Company's Consolidated Financial Statements is as follows
(dollars in thousands):
For the years ended December 31,
------------------------------------------
2001 2000 1999
- - ------------------------------------------------------------------------------
Direct ........................... $ 88,716 $ 80,856 $ 66,375
Ceded ............................ (8,361) (7,715) (9,770)
------------------------------------------
Net premium ...................... $ 80,355 $ 73,141 $ 56,605
==========================================
In November 1999, NAICC paid $2.1 million in losses relating to a
settlement on an environmental claim filed by Hughes Aircraft (the Hughes-Tucson
II Claim). The Hughes-Tucson II Claim also alleged that environmental damage
occurred continuously over a period of many years. NAICC assumed certain
policyholder obligations of a general liability policy issued to Hughes Aircraft
for a portion of those years. The Hughes-Tucson II Claim liability is reinsured
under various contracts involving numerous reinsurance companies under which
NAICC ceded $3.9 million, which includes loss adjustment expenses not previously
ceded of $2.1 million. During 2000 and 2001, NAICC collected approximately $2.7
million and $0.5 million, respectively, as settlement on the Hughes-Tucson II
claim from almost all the participants. At this time the reinsurers have not
disputed the submission of amounts ceded and no proceedings are in progress.
NAICC believes that the ultimate disposition of the Hughes-Tucson II Claim will
not have a material adverse impact on the financial condition of the Company.
In February 2000, NAICC paid $1 million in losses relating to settlement on
an environmental claim filed by Public Service of Indiana (PSI Claim). The PSI
Claim alleged that environmental claim damage occurred continuously over a
period of many years. NAICC assumed certain policyholder obligations of a
general liability policy issued to PSI for a portion of those years. The PSI
Claim liability is reinsured under various contracts involving numerous
reinsurance companies under which NAICC ceded $1.2 million, which includes loss
adjustment expenses not previously ceded of $295,000. During 2001, NAICC
collected approximately $0.7 million as settlement on the PSI Claim from almost
all the participants. At this time reinsurers have not disputed the unpaid
amount ceded in the submission, and no proceedings are in progress. NAICC
believes that the ultimate dispositon of the PSI Claim will not have a material
adverse impact on the financial condition of the Company.
As of December 31, 2001, General Reinsurance Corporation ("GRC") and Mitsui
Marine & Fire Insurance Company, Ltd. ("MMF") were the only reinsurers that
comprised more than 10 percent of NAICC's reinsurance recoverable on paid and
unpaid claims. NAICC monitors all reinsurers, by reviewing A.M. Best reports and
ratings, information obtained from reinsurance intermediaries and analyzing
financial statements. At December 31, 2001, NAICC had reinsurance recoverables
on paid and unpaid claims of $8.7 million and $2.5 million from GRC and MMF,
respectively. Both GRC and MMF have an A.M. Best rating of A+ or better. The
unsecured balance from MMF is approximately $1.4 million.
In January 1999, NAICC entered into a workers' compensation reinsurance
agreement with Reliance Insurance Company ("Reliance Agreement") with a term of
two years. The Reliance Agreement provided excess of loss coverage down to
$10,000 and a 20 percent quota share below the excess retention resulting in a
maximum net loss to NAICC of $18,000 per claim. In the fourth quarter of 1999,
NAICC executed an agreement to rescind the Reliance Agreement retroactive to its
effective date. The terms of the rescission included the return of amounts paid
during the nine month period the Reliance Agreement was active plus a settlement
fee of $8.0 million paid by Reliance to eliminate further obligations under the
contract. When considering Reliance's settlement offer, management looked at
several factors: (1) the projected premium and losses for 2000, (2) the negative
press Reliance was beginning to receive in the summer of 1999 regarding certain
underwriting pools, and, most importantly, (3) the potential for future credit
risk of Reliance if the offer was rejected. NAICC recognized a gain of
$8,317,000 in the fourth quarter of 1999 as a result of this rescission. The
gain represented the difference between the proceeds received of $11.5 million
and the reinsurance recoverable balances due from Reliance at September 30,
1999. The results of operations include ceded premiums of $3,875,000, net of
ceding commissions, and $417,000 of paid losses and loss adjustment expenses
during the nine months the agreement was active.
13
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 2001, 2000, AND 1999
(CONTINUED)
3) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
The following chart summarizes the activity in NAICC's liability for unpaid
losses and LAE during the three most recent fiscal years (dollars in thousands):
For the years ended December 31,
2001 2000 1999
- - ------------------------------------------------------------------------------
Net unpaid losses and
LAE at January 1 .................... $ 79,389 $ 79,306 $ 77,466
Incurred related to:
Current year ........................ 68,848 55,269 43,301
Prior years ......................... 7,646 5,254 2,491
--------------------------------------
Total incurred ........................ 76,494 60,523 45,792
--------------------------------------
Paid related to:
Current year ........................ (28,632) (26,147) (16,527)
Prior years ......................... (39,239) (34,293) (27,425)
--------------------------------------
Total paid ............................ (67,871) (60,440) (43,952)
--------------------------------------
Net unpaid losses and
LAE at December 31 .................. 88,012 79,389 79,306
Plus: reinsurance
recoverables ........................ 17,733 20,641 15,628
--------------------------------------
Gross unpaid losses and
LAE at December 31 .................. $105,745 $100,030 $ 94,934
======================================
The losses and LAE incurred during 2001 related to prior years is
attributable to adverse development on both the California workers' compensation
line totalling $4.4 million and certain private passenger automobile programs.
All of the workers' compensation lines and the private passenger automobile
programs that caused higher than expected losses and increasingly unfavorable
loss history were placed in run-off during 2001.
The losses and LAE incurred during 2000 related to prior years is
attributable to adverse developments on the commercial automobile lines and
certain lines in run-off. The losses and LAE incured during 1999 related to
prior years is primarily attributable to adverse development in the California
workers' compensation line. NAICC increased its bulk unpaid liabilities as it
has become evident that the loss costs associated with these claims would be
greater than previously anticipated.
NAICC has claims for environmental clean-up against policies issued prior
to 1980 and which are currently in run-off. The principal exposure from these
claims arises from direct excess and primary policies of businesses in run-off,
the obligations of which were assumed by NAICC. These excess and primary claims
are relatively few in number and have policy limits of between $50,000 and
$1,000,000, with reinsurance generally above $50,000. NAICC also has
environmental claims primarily associated with participation in excess of loss
reinsurance contracts assumed by NAICC. These reinsurance contracts have
relatively low limits, generally less than $25,000, and estimates of unpaid
losses are based on information provided by the primary insurance company.
The unpaid losses and LAE related to environmental cleanup is established
based upon facts currently known and the current state of the law and coverage
litigation. Liabilities are estimated for known claims (including the cost of
related litigation) when sufficient information has been developed to indicate
the involvement of a specific contract of insurance or reinsurance and
management can reasonably estimate its liability. Liabilities for unknown claims
and development of reported claims are included in NAICC's unpaid losses. The
liability for the development of reported claims is based on estimates of the
range of potential losses for reported claims in the aggregate. Estimates of
liabilities are reviewed and updated continually and there is the potential that
NAICC's exposure could be materially in excess of amounts which are currently
recorded. Management does not expect that liabilitiies associated with these
types of claims will result in a material adverse effect on the future liquidity
or financial position of NAICC. However, claims such as these are based upon
estimates and there can be no assurance that the ultimate liability will not
exceed or even materially exceed such estimates. As of December 31, 2001 and
2000, NAICC's net unpaid losses and LAE relating to environmental claims were
approximately $7.6 million and $7.6 million, respectively.
4) REGULATION, DIVIDEND RESTRICTIONS AND STATUTORY SURPLUS
DHC's insurance subsidiaries are regulated by various states. For
regulatory purposes, separate financial statements which are prepared in
accordance with statutory accounting principles are filed with these states.
NAICC prepares its statutory financial statements in accordance with accounting
practices prescribed or permitted by the California Department of Insurance (the
"CDI"). Prescribed statutory accounting practices include a variety of
publications of the National Association of Insurance Commissioners (the
Association"), as well as state laws, regulations and general administrative
rules. Permitted statutory accounting practices encompass all accounting
practices not so prescribed. The Company has not applied any permitted
accounting practices in its statutory financial statements. As of December 31,
2001 and 2000, DHC's operating insurance subsidiaries had statutory capital and
surplus of $36.6 million and $50.4 million, respectively. The combined statutory
net income (loss) for DHC's operating insurance subsidiaries, as reported to the
regulatory authorities for the years ended December 31, 2001, 2000 and 1999, was
$(10.7) million, $0.6 million and $2.5 million, respectively. The CDI has
examined the statutory basis financial statements of NAICC through December 31,
1998. No adjustments were proposed to the statutory basis financial statements
of NAICC or its subsidiaries. The CDI is scheduled to perform an examination of
the statutory basis financial statements through December 31, 2001 during 2002.
The Montana Department of Insurance has completed its examination of the
statutory basis financial statements of Valor though December 31, 1999. As a
result of that examination Valor's surplus was reduced by $197,000 during 2000.
In December 1993, the Association adopted a model for determining the
risk-based capital ("RBC") requirements for property and casualty insurance
companies. Under the RBC model, property and casualty insurance companies are
required to report their RBC ratios based on their latest statutory annual
statements as filed with the regulatory authorities. NAICC has calculated its
RBC requirement under the Association's model, and has capital in excess of any
regulatory action or reporting level.
Insurance companies are subject to insurance laws and regulations
established by the states in which they transact business. The agencies
established pursuant to these state laws have broad administrative and
supervisory powers relating to the granting and revocation of licenses to
transact insurance business, regulation of trade practices, establishment of
guaranty associations, licensing of agents, approval of policy forms, premium
rate filing requirements, reserve requirements, the form and content of required
regulatory financial statements, periodic examinations of insurers' records,
capital and surplus requirements and the maximum concentrations of certain
classes of investments. Most states also have enacted legislation regulating
insurance holding company systems, including with respect to acquisitions,
extraordinary dividends, the terms of affiliate transactions and other related
matters. DHC and its insurance subsidiaries have registered as a holding company
system pursuant to such legislation in California and routinely report to other
jurisdictions. The Association has formed committees and appointed advisory
groups to study and formulate regulatory proposals on such diverse issues as the
use of surplus debentures, accounting for reinsurance transactions and the
adoption of RBC requirements. It is not possible to predict the impact of future
state and federal regulation on the operations of the Company. Effective January
1, 2001 the Association's codified statutory accounting principles ("SAP") has
been adopted by all U.S. insurance companies. The purpose of such codification
is to provide a comprehensive basis of accounting and reporting to insurance
departments. Although codification is expected to be the foundation of a state's
statutory accounting practice, it may be subject to modification by practices
prescribed or permitted by a state's insurance commissioner. Therefore,
statutory financial statements will continue to be prepared on the basis of
accounting practices prescribed or permitted by the insurance department of the
state of domicile. The Company has determined that the application of the
codification did not have a material impact on the statutory capital of its
insurance subsidiaries upon adoption.
Under the California Insurance Code, NAICC is prohibited from paying, other
than from accumulated earned surplus, shareholder dividends which exceed the
greater of net income or ten percent of statutory surplus without prior approval
of the Insurance Department. During 2000, NAICC paid an ordinary dividend of
$1,500,000 to DHC from NAICC's accumulated surplus within the limits specified
under the California Insurance Code. As of December 31, 2001, NAICC did not have
sufficient accumulated earned surplus, as defined by the CDI, to pay further
ordinary dividends.
14
5) INVESTMENTS
The cost or amortized cost, unrealized gains, unrealized losses and fair
value of the Company's investments at December 31, 2001 and 2000, categorized by
type of security, were as follows (dollars in thousands):
DECEMBER 31, 2001
--------------------------------------------
COST OR
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
- --------------------------------------------------------------------------------
Fixed maturities:
U.S. Government/
Agency ......................... $ 21,283 $ 983 $ 27 $ 22,239
Mortgage-backed ................ 31,256 768 8 32,016
Corporate ...................... 77,858 4,446 172 82,132
-------- ------ ------ --------
Total fixed
maturities ............... 130,397 6,197 207 136,387
-------- ------ ------ --------
Equity securities ................ 12,416 2,055 2,346 12,125
-------- ------ ------ --------
Total available-for-sale ......... $142,813 $8,252 $2,553 $148,512
-------- ------ ------ --------
Securities sold but not yet
purchased....................... (2,264) 17 -- (2,247)
-------- ------ ------ --------
Total Investments................ $140,549 $8,269 $2,553 $146,265
======== ====== ====== ========
December 31, 2000
--------------------------------------------
COST OR
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
- --------------------------------------------------------------------------------
Fixed maturities:
U.S. Government/
Agency ......................... $ 34,167 $ 637 $ 122 $ 34,682
Mortgage-backed ................ 37,592 214 166 37,640
Asset-backed ................... 1,967 7 -- 1,974
Corporate ...................... 49,941 372 1,396 48,917
-------- ------ ------ --------
Total fixed
maturities ............... 123,667 1,230 1,684 123,213
-------- ------ ------ --------
Equity securities ................ 25,064 1,520 2,130 24,454
-------- ------ ------ --------
Total available-for-sale ......... $148,731 $2,750 $3,814 $147,667
======== ====== ====== ========
Fixed maturities of the Company include mortgage-backed securities ("MBS")
representing 23.5 percent and 30.5 percent of the Company's total fixed
maturities at December 31, 2001 and 2000, respectively. All MBS held by the
Company are issued by the Federal National Mortgage Association ("Fannie
15
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 2001, 2000 AND 1999
(CONTINUED)
Mae") or the Federal Home Loan Mortgage Corporation ("Freddie Mac"), both of
which are rated "Aaa" by Moody's Investors Services. MBS and callable bonds, in
contrast to other bonds, are more sensitive to market value declines in a rising
interest rate environment than to market value increases in a declining interest
rate environment. This is primarily because of payors' increased incentive and
ability to prepay principal and issuers' increased incentive to call bonds in a
declining interest rate environment. Management does not believe that the
inherent prepayment risk in its portfolio is significant. However, management
believes that the potential impact of the interest rate risk on the Company's
Consolidated Financial Statements could be significant because of the greater
sensitivity of the MBS portfolio to market value declines and the classification
of the entire portfolio as available-for-sale. The Company has no MBS
concentrations in any geographic region.
The expected maturities of fixed maturity securities, by amortized cost and
fair value, at December 31, 2001, are shown below. Expected maturities may
differ from contractual maturities due to borrowers having the right to call or
prepay their obligations with or without call or prepayment penalties. Expected
maturities of mortgage-backed securities are estimated based upon the remaining
principal balance, the projected cash flows and the anticipated prepayment rates
of each security (dollars in thousands):
Amortized Fair
Maturity Cost Value
- - ------------------------------------------------------------------------------
Available-for-sale:
One year or less ................................. $ 10,669 $ 10,874
Over one year to five years ...................... 78,705 82,288
Over five years to ten years ..................... 37,308 39,534
More than ten years .............................. 3,715 3,691
------------------------
Total fixed maturities ......................... $130,397 $136,387
========================
The following reflects the change in net unrealized gain (loss) on
available-for-sale securities included as a separate component of accumulated
other comprehensive income (loss) in stockholders' equity (dollars in
thousands):
For the years ended
December 31,
--------------------------------
2001 2000 1999
- - ------------------------------------------------------------------------------
Fixed maturities $ 6,461 $ 2,346 $ (5,352)
Equity securities 319 (1,312) 3,942
--------------------------------
$ 6,780 1,034 $ (1,410)
================================
Net realized investment gains (losses) in 2001, 2000, and 1999 were as
follows (dollars in thousands):
For the years ended
December 31,
---------------------------
2001 2000 1999
- - ------------------------------------------------------------------------------
Fixed maturities ................................ $ 346 $ 43 $ 3
Equity securities ............................... 1,212 8,722 (155)
---------------------------
Net realized investment gains (losses) ......... $1,558 $8,765 $(152)
===========================
Gross realized gains relating to fixed maturities were $370,000, $60,000
and $3,000 for the years ended December 31, 2001, 2000 and 1999, respectively.
Gross realized losses relating to fixed maturities were $24,000 and $17,000 for
the years ended December 31, 2001 and 2000, respectively. There were no gross
realized losses relating to fixed maturities for the year ended December 31,
1999 Gross realized gains relating to equity securities were $2,427,000 and
$8,734,000 for the years ended December 31, 2001 and 2000, respectively. There
were no gross realized gains relating to equity securities for the year ended
December 31, 1999. Gross realized losses relating to equity securities were
$1,215,000, $12,000 and $155,000 for the years ended December 31, 2001, 2000 and
1999, respectively.
Net investment income for the past three years was as follows (dollars in
thousands):
For the years ended
December 31,
--------------------------------
2001 2000 1999
- - ------------------------------------------------------------------------------
Fixed maturities ........................... $8,724 $8,621 $7,454
Short term investments ..................... 302 410 247
Dividend income............................. 154 214 116
Other, net ................................. 405 212 61
--------------------------------
Total investment income .................. 9,585 9,457 7,878
Less: Investment expense ................... 137 131 101
--------------------------------
Net investment income .................... $9,448 $9,326 $7,777
================================
At December 31, 2001 the Company held $58,493,000 face amount of American
Commercial Lines LLC ("ACL") Senior Notes 10.25%, due 6/30/08 at a cost of
$30,025,578 and a fair value of $31,951,801, representing 42.9 percent of
stockholders' equity. As of December 31, 2001, ACL was in default of its
December 31, 2001 interest payment obligation. There were no investments with a
carrying value greater than ten percent of stockholders' equity as of December
31, 2000 or 1999.
In compliance with state insurance laws and regulations, securities with a
fair value of approximately $45 million, $44 million and $41 million at December
31, 2001, 2000, and 1999, respectively, were on deposit with various states or
governmental regulatory authorities. In addition, at December 31, 2001, 2000,
and 1999, respectively, investments with a fair value of $6.6 million, $6.5
million and $6.6 million were held in trust or as collateral under the terms of
certain reinsurance treaties and letters of credit.
16
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
6) FOREIGN CURRENCY TRANSLATION AND FOREIGN INVESTMENTS
During 1998, NAICC invested approximately $10.3 million in Japanese yen
based equity securities. During the second quarter of 1998, NAICC purchased a
foreign currency option at a cost of $155,000 to sell Japanese yen at a fixed
price on a given date in April 1999. The foreign currency option expired in
April 1999, resulting in a realized loss of $155,000. The foreign currency
option is considered a derivative instrument. Foreign currency translation gain
(loss) as of December 31, 2001, 2000 and 1999 was $(14,500), $1.1 million and $2
million, respectively.
Assets and liabilities relating to investments in foreign corporations are
translated into U.S. dollars using current exchange rates; revenues and
expenses, if any, are translated into U.S. dollars using the average exchange
rate for the month when incurred. Translation gains and losses, net of
applicable taxes, are excluded from net income and included in net unrealized
loss, reported as accumulated other comprehensive income (loss) in stockholders'
equity.
7) STOCKHOLDERS' EQUITY
On August 12, 1999, pursuant to a Stock Purchase and Sale Agreement with
Samstock, L.L.C. ("Samstock"), which agreement was assigned with the
Company's consent by Samstock to its sole member, SZ Investments, L.L.C. ("SZ"),
pursuant to an amendment and assignment agreement (such Purchase and Sale
Agreement, as amended and assigned, the "Purchase Agreement"), the Company sold
to SZ, for consideration of $9 million, 2,000,000 shares of Common Stock and a
four year warrant (subject to extension in certain circumstances) to purchase an
additional 2,000,000 shares of Common Stock at $4.75 per share. The warrant is
subject to two types of downward price adjustments: (1) A pro-rata price
adjustment if DHC issues additional shares for less than $4.75; (2) A formulaic
adjustment to the warrant purchase price if certain insurance liabilities are
actually paid in excess of $5 million of what was reported on the balance sheet
at December 31, 1998. In order to provide sufficient available shares of Common
Stock for this transaction, on July 20, 1999, DHC's stockholders approved an
amendment to DHC's Certificate of Incorporation increasing DHC's authorized
common stock from 20,000,000 shares to 100,000,000 shares. The stockholders also
approved amendments to eliminate cumulative voting for Directors and to
eliminate a prohibition on issuing non-voting equity securities.
On December 29, 2000 and 1999, the Company sold, for aggregate cash
consideration of $3,073,875 and $4,162,500, respectively, 819,700 and 900,000
newly issued shares of Common Stock, respectively. The sales were private
placements to accredited investors made pursuant to Regulation D under the
Securities Act of 1933. In 2000 and 1999, brokerage commissions of $33,900 and
$54,000, respectively, were paid to M.J. Whitman, Inc., an affiliate of DHC, in
connection with the placement of certain of those shares by M.J. Whitman, Inc.
On September 4, 2001, DHC's stockholders approved an amendment to DHC's
Certificate of Incorporation increasing DHC's authorized common stock from
100,000,000 shares to 150,000,000 shares.
As of December 31, 2001, there were 19,516,694 shares of Common Stock
issued of which 19,505,952 were outstanding; the remaining 10,742 shares of
Common Stock issued but not outstanding are held as treasury stock. In
connection with efforts to preserve the Company's net operating tax loss
carryforwards, DHC has imposed restrictions on the ability of holders of five
percent or more of DHC Common Stock to transfer the Common Stock owned by them
and to acquire additional Common Stock, as well as the ability of others to
become five percent stockholders as a result of transfers of Common Stock.
8) INCOME TAXES
DHC files a Federal consolidated income tax return with its subsidiaries.
DHC's Federal consolidated income tax return includes the taxable results of
certain grantor trusts. These trusts were established by certain state insurance
regulators and the courts as part of the 1990 reorganization from which the
Mission Insurance Group, Inc. ("Mission") emerged from Federal bankruptcy and
various state insolvency court proceedings as DHC. These trusts were created for
the purpose of assuming various liabilities of their grantors, certain present
and former subsidiaries of DHC (the "Mission Insurance Subsidiaries"). This
allowed the state regulators to administer the continuing run-off of Mission's
insurance business, while DHC and the Mission Insurance Subsidiaries were
released, discharged and dismissed from the proceedings free of any claims and
liabilities of any kind, including any obligation to provide further funding to
the trusts. The agreements establishing the trusts provide the grantor of each
trust with a certain "administrative power" which, as specified in Section
675(4)(C) of the Internal Revenue Code, requires that DHC include the income and
deductions of each trust on its consolidated Federal income tax returns. This
was to ensure that DHC's net operating loss carryforward would remain available
to offset any post-restructuring taxable income of the trusts, thereby
maximizing the amounts available for distribution to trust claimants. The
Insurance Commissioner of the State of California and the Director of the
Division of Insurance of the State of Missouri, as the trustees, have sole
management authority over the trusts. Neither DHC nor any of its subsidiaries
has any power to control or otherwise influence the management of the trusts nor
do they have any rights with respect to the selection or replacement of the
trustees. At the present time, it is not anticipated that any of the Mission
Insurance Subsidiaries will receive any distribution with regard to their
residual interests in the existing trusts. Since DHC does not have a controlling
financial interest in these trusts, they are not consolidated with DHC for
financial statement purposes.
As of the close of 2001 the Company had a consolidated net operating loss
carryforward of approximately $745 million for Federal income tax purposes. This
estimate is based upon Federal consolidated income tax losses for the periods
through December 31, 2000 and an estimate of 2001 taxable results. The net
operating loss carryforward will expire in various amounts, if not used, between
2002 and 2019. The Internal Revenue Service has not audited any of the Company's
tax returns for any of the years during the carryforward period including those
returns for the years in which the losses giving rise to the net operating loss
carryforward were reported.
SFAS No. 109, which provides guidance on reporting for income taxes,
requires the establishment of a valuation allowance to reflect the likelihood of
realization of deferred tax assets. Pursuant to SFAS No. 109, DHC makes periodic
determinations of whether it is "more likely than not" that all or a portion of
the Company's deferred tax assets will be realized. In making these
determinations, the Company considers all of the relevant factors, both positive
and negative, which may impact upon its future taxable income including the size
and operating results of NAICC, the competitive environment in which NAICC
operates and the impact of the grantor trusts. Exclusive of the trusts'
activities, the Company has generated cumulative taxable losses on a historical
basis. Over the past several years, the Company's insurance and holding company
operations have been generating combined losses exclusive of net investment
income, net realized gains and the trusts' activities. Therefore, due to the
absence of a reliable taxable income stream, the Company has recorded a
valuation allowance for the amount by which its deferred tax assets exceed its
deferred tax liabilities and, as a result, the Company has not recorded any
liability or asset for deferred taxes.
See Note 7 "STOCKHOLDERS' EQUITY" for a description of certain restrictions
on the transfer of Common Stock.
The Company's net operating tax loss carryforwards will expire, if not
used, in the following amounts in the following years (dollars in thousands):
Year Ending Amount of Carryforward
December 31, Expiring
-------------------------------------------------------------
2002......................139,613
2003...................... 60,849
2004...................... 69,947
2005......................106,225
2006...................... 92,355
2007...................... 89,790
2008...................... 31,688
2009...................... 39,689
2010...................... 23,600
2011...................... 19,755
2012...................... 38,255
2019...................... 33,636
----------
745,402
==========
17
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 2001, 2000, AND 1999
(CONTINUED)
The Company has made provisions for certain state and other taxes. Tax
filings for these jurisdictions do not consolidate the activity of the trusts
referred to above, and reflect preparation on a separate company basis.
Tax expense consists of the following amounts (dollars in thousands):
For the years ended
December 31,
-------------------------------
2001 2000 1999
- - ------------------------------------------------------------------------------
Federal income tax ........................... $ -- $ -- $ --
State and other .............................. 73 134 41
-------------------------------
$ 73 $ 134 $ 41
===============================
The following reflects a reconciliation of income tax expense computed by
applying the applicable Federal income tax rate of 34 percent to continuing
operations for 2001, 2000 and 1999, as compared to the provision for income
taxes (dollars in thousands):
For the years ended
December 31,
-----------------------------------------
2001 2000 1999
- - ------------------------------------------------------------------------------
Computed "expected"
tax expense...................... $ (4,849) $ 396 $ 462
Change in valuation allowance ..... (50,760) (89,394) (56,837)
Decrease (increase) in losses
from the trusts.................. 17,362 30,303 (13,289)
Expiring NOL....................... 39,038 60,209 69,315
State and other tax expense........ 73 134 41
Other, net......................... (791) (1,514) 349
-----------------------------------------
Total income tax expense........... $ 73 $ 134 $ 41
=========================================
The tax effects of temporary differences that give rise to the deferred tax
assets and liabilities at December 31, 2001 and 2000, respectively, are
presented as follows (dollars in thousands):
For the years ended
December 31,
2001 2000
- - ------------------------------------------------------------------------------
Deferred tax assets
Loss reserve discounting ......................... $ 5,041 $ 5,347
Unearned premiums ................................ 1,349 1,605
Net operating loss
carryforwards .................................. 253,437 305,592
Allowance for doubtful
accounts ....................................... 493 200
Policyholder dividends ........................... -- 124
Unrealized loss on available-for-sale securities.. -- 72
Other ............................................ 220 169
AMT credit carryforward .......................... 3,140 1,986
------------------------
Total gross deferred tax asset ................... 264,452 315,095
Less: Valuation allowance ........................ (260,727) (313,616)
------------------------
Total deferred tax asset ......................... $ 2,953 $ 1,479
------------------------
Deferred tax liabilities
Unrealized gains on available-
for-sale securities ............................ 2,051 --
Deferred acquisition costs ....................... 751 1,246
Difference in tax basis
of bonds ....................................... 151 166
Difference in tax basis of
property and equipment ......................... -- 67
------------------------
Total deferred tax liability ..................... 2,953 1,479
------------------------
Net deferred tax asset ........................... $ -- $ --
========================
18
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
9) EMPLOYEE BENEFIT AND STOCK OPTION PLANS
1990 STOCK OPTION PLAN
The 1990 Stock Option Plan (the "1990 Plan") of DHC was intended to
attract, retain and provide incentives to key employees of DHC by offering them
an opportunity to acquire or increase a proprietary interest in DHC. Options
under the 1990 Plan were granted to existing officers or employees of DHC.
On September 16, 1991, the Compensation Committee of the Board of Directors
of DHC resolved that it intended to refrain from granting any additional options
under the 1990 Plan. In September 2001, 140,000 options owned by certain
directors of DHC lapsed and were reissued under the 1995 Stock and Incentive
Plan, as amended and approved by the Shareholders. The 1990 Plan terminated in
2001. The following table summarizes the options under the 1990 Plan:
1990 Stock and Incentive Plan
2001 2000 1999
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------ ------------- ------------- ------------- --------------- -----------
Outstanding at beginning of year 841,717 3.10 841,717 3.10 841,717 3.10
Exercised 210,000 3.00 - - - -
Lapsed 631,717 3.14 - - - -
------------ ------------- ------------- ------------- --------------- -----------
Outstanding at end of year - - 841,717 3.10 841,717 3.10
------------ ------------- ------------- ------------- --------------- -----------
Options exercisable at year end - 841,717 841,717
------------ ------------- ------------- ------------- --------------- ------------
Options available for future grant - 630,000 630,000
============ ============= ===============
1995 STOCK AND INCENTIVE PLAN
The 1995 Stock and Incentive Plan (the "1995 Plan") is a qualified plan
which provides for the grant of any or all of the following types of awards:
stock options, including incentive stock options and non-qualified stock
options; stock appreciation rights, whether in tandem with stock options or
freestanding; restricted stock; incentive awards; and performance awards. The
purpose of the 1995 Plan is to enable DHC to provide incentives to increase the
personal financial identification of key personnel with the long term growth of
the Company and the interests of DHC's stockholders through the ownership and
performance of DHC's Common Stock, to enhance the Company's ability to retain
key personnel, and to attract outstanding prospective employees and Directors.
The 1995 Plan became effective as of March 21, 1995. In September 2001, DHC's
stockholders approved amendments to the 1995 Plan which increases the aggregate
number of options available for grant from 1.7 million to 2.54 million, and
provides for options to be awarded to independent contractors to enable DHC to
attract, retain and give incentives to highly qualified persons who provide
valuable services to the Company. No awards may be granted under the 1995 Plan
after March 21, 2005. The 1995 Plan will remain in effect until all awards have
been satisfied or expired. The following table summarizes the options under the
1995 Plan:
1995 Stock and Incentive Plan
2001 2000 1999
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------ ------------- ------------- ---------- ----------- --------
Outstanding at beginning of year 1,246,000 5.13 873,500 5.65 781,000 5.73
Granted 472,500 3.45 402,500 4.00 142,500 5.31
Lapsed - - 30,000 5.11 50,000 5.91
Outstanding at end of year 1,718,500 4.67 1,246,000 5.13 873,500 5.65
------------ ------------- ------------- ---------- ----------- ---------
Options exercisable at year end 1,228,084 5.10 799,334 5.69 731,000 5.71
------------ ------------- ------------- ----------- ----------- ----------
Options available for future grant 821,500 454,000 826,500
============ ============= ===========
19
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 2001, 2000, AND 1999
(CONTINUED)
The Company applies APB Opinion 25 and Related Interpretations in
accounting for the Stock Option Plans. Accordingly, no compensation cost has
been recognized except $57,000 in 2001 relating to the modification of Common
Stock options to certain directors of DHC. Had compensation cost been determined
based on the fair value at the grant date of all options, consistent with the
method of SFAS Statement 123, the net income and earnings per share would have
been reduced to the pro forma amounts indicated below (dollars in thousands
except per share amounts):
2001 2000 1999
- --------------------------------------------------------------------------------
Net income
As reported ........................ $ (14,334) $1,030 $1,255
Pro forma .......................... $ (14,748) 733 987
Diluted earnings per share
As reported ........................ $ (0.74) $ 0.05 $ 0.07
Pro forma .......................... $ (0.76) 0.04 0.06
The fair value of the option grants are estimated as of the date of grant
using the Black-Scholes option pricing model with the following assumptions:
dividend yield of 0% per annum; an expected life of approximately 8 years;
expected volatility of 36%-59%; and a risk free interest rate of 6%. The pro
forma effect on net income may not be representative of the effects on net
income for future years.
EMPLOYEE BENEFIT PLANS
KCP, the former parent company of NAICC and first tier subsidiary of DHC,
maintained an Employee Stock Ownership Plan ("ESOP") of KCP and Subsidiaries
covering all of its employees. The ESOP originally acquired common stock of KCP
in February 1990, financed by a loan from KCP in the principal amount of
$998,000 bearing interest at an annual rate of ten percent. Shares of DHC Common
Stock were substituted for the KCP stock held by the ESOP as of December 31,
1991. The loan, which is guaranteed by KCP and collateralized by the DHC Common
Stock held by the ESOP, was paid in full during 1997. All shares have been
released from collateral and allocated to employees. All of the shares of Common
Stock held by the ESOP are deemed to be outstanding for earnings per share
computations. KCP has elected to include the value of the Common Stock allocated
annually to participants under the ESOP in the calculation of its matching
contribution to the NAICC Salary Deferred Plan and Trust ("401(k) Plan"). The
participating employers contributed 50 percent of the first six percent of
employee-contributed compensation to the 401(k) Plan. The shares of Common Stock
owned by the ESOP as of December 31, 2001 and 2000 were 58,977 and 60,728,
respectively. The ESOP was terminated in February 2002, and all shares held by
it were distributed to participants.
NAICC maintains a non-contributory defined benefit pension plan (the
"Pension Plan") covering substantially all of its employees. Benefits under the
Pension Plan are based on an employee's years of service and average final
compensation. The funding policy of the Pension Plan provides for the
participating employers to contribute the minimum pension costs equivalent to
the amount required under the Employee Retirement Income Security Act of 1974,
as amended, and the Internal Revenue Code of 1986, as amended. Vested benefits
under the Pension Plan are fully funded. Any liability associated with the
Pension Plan is reflected in the Company's Consolidated Financial Statements.
The following table sets forth the Pension Plan's funded status at December
31, 2001 and 2000, valued at January 1, 2002 and 2001, respectively (dollars in
thousands):
2001 2000
- - ------------------------------------------------------------------------------
Actuarial present value of benefit obligations:
Accumulated benefits obligation,
including vested benefits of $1,817
for 2001 and $1,482 for 2000 ..................... $ 2,188 $ 1,766
========================
Projected benefit obligation ....................... $ 2,188 $ 1,769
Plan assets at fair value .......................... 2,016 1,235
------------------------
Projected benefit obligation in excess
of plan assets ................................... (172) (534)
Unrecognized net loss .............................. 341 201
Unrecognized prior service cost .................... 25 41
Adjustment required to recognize
minimum liability ................................ -- --
------------------------
(Accrued) prepaid pension cost ................... $ 194 $ (292)
========================
20
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
Net pension costs for the years ended December 31, 2001, 2000, and 1999
include the following components:
For the years ended
December 31,
------------------------------
2001 2000 1999
- - ------------------------------------------------------------------------------
Service cost ................................ $ 283 $ 250 $ 243
Interest cost ............................... 112 116 112
Expected (return) loss on plan assets ....... (93) (25) (101)
Net amortization and deferral ............... 21 (65) 8
------------------------------
Net pension cost .......................... $ 323 $ 276 $ 262
==============================
The Pension Plan's assets consist of U.S. Government obligations,
registered equity mutual funds and insured certificates of deposit. The average
discount rate used in determining the actuarial present value of the projected
benefit obligation was 7.0 percent for 2001 and 7.25 percent for 2000 and 1999.
The projected long-term rate of return on assets was 7.0 percent for 2001 and
7.5 percent for 2000 and 1999. The average rate of compensation increase used in
determining the actuarial present value of the projected benefit obligation was
4.5 percent for 2001, 2000 and 1999.
The following tables provide a reconciliation of the changes in the Pension
Plan's benefit obligation and the fair value of plan assets as of December 31,
2001 and 2000 (dollars in thousands):
2001 2000
- --------------------------------------------------------------------------------
Reconciliation of Benefit Obligation
Benefit Obligation, beginning of year ............ $ 1,769 $ 1,793
Service Cost ..................................... 283 250
Interest Cost .................................... 112 116
Actuarial (gain) loss ............................ (167) 53
Benefits paid .................................... (110) (443)
Curtailments...................................... 301 --
------------------------
Benefit Obligation, end of year ............... $ 2,188 $ 1,769
========================
Reconciliation of Plan Assets
Plan Assets, beginning of year ................... $ 1,235 $ 1,399
Actual return on plan assets ..................... (41) 25
Employer contributions ........................... 932 254
Benefits paid .................................... (110) (443)
------------------------
Plan Assets, end of year ...................... $ 2,016 $ 1,235
========================
The prior service costs are amortized on a straight-line basis over the
average remaining service period of active participants. Gains and losses in
excess of 10 percent of the greater of the benefit obligation and the fair value
of related plan assets are amortized over the average remaining service period
of active participants. NAICC recognized $308,602, $281,777 and $134,745 accrued
pension benefit for the years ended December 31, 2001, 2000 and 1999,
respectively.
Effective December 31, 2001, the Company amended the Pension Plan to cease
future service credit for active employees. As a result of the curtailment of
future benefits, the Pension Plan's projected benefit obligation was reduced by
$301,435. This gain reduced the Pension Plan's unrecognized actuarial loss and
will be recognized as the related plan participants terminate.
NAICC maintains a 401(k) Plan in which all employees of NAICC are eligible
to participate. Under the 401(k) Plan, employees may elect to contribute up to
20 percent of their eligible compensation to a maximum dollar amount allowed by
the IRS. NAICC contributed 50 percent of the first six percent of
employee-contributed compensation. The participating employers have opted to
include the value of the Common Stock allocated annually to participants under
the ESOP in the calculation of their matching contribution. In 2001, 2000 and
1999, the employers' matching obligation to the 401(k) Plan was satisfied
through ESOP shares, cash and forfeitures totaling $139,000, $146,000, and
$129,000, respectively, in value.
10) LEASES
DHC and its subsidiaries and affiliates have entered into various
non-cancelable operating lease arrangements for office space and data processing
equipment. The terms of the operating leases generally contain renewal options
and escalation clauses based on increases in operating expenses and other
factors. Rent expense under operating leases was $1.6 million for each of the
years ended December 31, 2001, 2000 and 1999. At December 31, 2001, future net
minimum operating lease rental payment commitments were as follows (dollars in
thousands):
Years Ending Minimum Operating Lease
December 31, Rental Payments
- --------------------------------------------------------------------------------
2002................................................. $1,701
2003................................................. 1,093
2004................................................. 699
2005................................................. 127
2006 and thereafter.................................. 74
------
Total commitments.................................... $3,694
======
21
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 2001, 2000, AND 1999
(CONTINUED)
11) ALLOWANCES
The following table sets forth the activity related to the premiums and
fees receivable at December 31, 2001 and 2000:
2001 2000
---------------------------
Beginning Balance: $ 588 $ 274
Increase to Allowance Charges to Expenses 1,093 727
Increase to Allowance Charges to Other Accounts -- 25
Deductions (250) (438)
--------------------------
Ending Balance $1,431 $ 588
===========================
The increase in the allowance during the year is attributable to the growth
in our automobile programs that have premium installment features. In
conjunction with the increased installment premiums the Company experienced
increased collection efforts relating to such premiums, especially for
non-standard personal automobile policies outside of California.
12) COMMITMENTS AND CONTINGENCIES
NAICC is involved in litigation relating to losses arising from insurance
contracts in the normal course of business which are provided for under "unpaid
losses and loss adjustment expenses." NAICC also is involved in other litigation
relating to environmental claims as well as general corporate matters. While
litigation is by nature uncertain, management, based in part on advice from
counsel, believes that the ultimate outcome of these actions will not have a
material adverse effect on the consolidated financial position of DHC.
On June 22, 1999, the Missouri Court of Appeals reversed a decision to
award interest on claims under a plan of distribution of assets of the Mission
Reinsurance Corporation Trust (the "Trust"). The effect of the decision of the
Court of Appeals would have been to return to the Company the surplus existing
in the Trust, which was one of the trusts that had been created in connection
with the insolvency and reorganization of Mission Insurance Group, Inc. and its
subsidiaries from which the Company emerged, which surplus was believed to
approximate $14 million. The Missouri Department of Insurance appealed the
decision of the Court of Appeals and the decision was reversed by the Supreme
Court of Missouri. As a result, the Missouri Department of Insurance is
permitted to pay interest on claims, and it is anticipated that there will be no
surplus remaining in the Trust after payment of the interest.
13) RELATED PARTY TRANSACTIONS
DHC shares certain personnel and facilities with several affiliated and
unaffiliated companies who have certain common directors and officers, and
certain expenses are allocated among the various entities. Personnel costs are
allocated based upon actual time spent on DHC's business. Costs relating to
office space and equipment are allocated based upon actual usage. Management
believes the methodolgy used for allocation is appropriate. Total expenses
allocated to DHC from affiliated entitites were $1,334,189, $1,309,748 and
$1,193,941 for the years 2001, 2000 and 1999, respectively.
Samuel Zell, the Chairman of the Board of DHC is the Chairman of Equity
Group Investments, LLC ("EGI"). DHC has entered into a non-exclusive investment
advisory agreement with EGI, pursuant to which EGI has agreed to provide certain
investment banking services to the Company in connection with potential
transactions. For these services, DHC pays an annual fee of $125,000 to EGI. In
the event that any transaction is consummated for which the Acquisition
Committee of DHC's Board of Directors determines that EGI provided material
services, DHC will pay to EGI a fee in the amount of 1% of the aggregate
consideration in connection with such transaction. In the case of the potential
acquisition of ACL, DHC and EGI have agreed that the fee for EGI shall be $3
million.Samuel Zell and William Pate, who serves as Director of Mergers and
Acquisitions for EGI, are both members of DHC's four member Acquisition
Committee. DHC has also agreed to reimburse, upon request, EGI's out-of-pocket
expenses related to the investment advisory agreement.
14) REDUCTION OF INSURANCE OPERATIONS
NAICC's objective is to underwrite business that is expected to yield an
underwriting profit. NAICC has made a determination that certain lines of
insurance may not be sustainable in the current rate environment. Competitive
and regulatory pressures have resulted in a general market for premium rates in
these lines that is well below a level necessary in order to achieve a profit,
especially in light of increasingly unfavorable loss history. Rather than
continue to sustain losses, NAICC will exit the workers' compensation line in
all states and the non-standard private passenger automobile program written
outside of California. The last workers compensation policy outside Montana was
issued in July 2001 and the last Montana workers compensation policy was issued
in January 2002. Costs incurred in 2001 associated with this process totaled
approximately $1.25 million and are included in General and Administrative
Expenses. The remaining lines written by NAICC will be non-standard private
passenger automobile in the state of California and commercial automobile in
certain western states.
15) SUBSEQUENT EVENT
On March 15, 2002 the Company entered into an agreement with American
Commercial Lines LLC ("ACL") to acquire 100 percent of the membership interests
in ACL. ACL is an integrated marine transportation and service company operating
approximately 5,100 barges and 200 towboats on the inland waterways of North and
South America. ACL transports more than 70 million tons of freight annually.
Additionally, ACL operates marine construction, repair and service facilities
and river terminals. ACL has approximately $760 million in assets and a net
accumulated deficiency of $143 million at December 31, 2001. The purchase price
is expected to be approximately $81 million and will consist of cash and the
contribution of ACL debt currently held by the Company.
22
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
INDEPENDENT AUDITORS' REPORT
---------------------------
The Board of Directors and Stockholders
Danielson Holding Corporation
We have audited the accompanying consolidated balance sheets of Danielson
Holding Corporation and subsidiaries as of December 31, 2001 and 2000, and the
related consolidated statements of operations, stockholders' equity and
comprehensive income, and cash flows for each of the years in the three-year
period ended December 31, 2001. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Danielson
Holding Corporation and subsidiaries as of December 31, 2001 and 2000, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America.
/s/ KPMG LLP
New York, New York
March 5, 2002, except for note 15, which is as of March 15, 2002.
RESPONSIBILITY FOR FINANCIAL REPORTING
---------------------------
The Consolidated Financial Statements of Danielson Holding Corporation and
subsidiaries are the responsibility of the Company's management, and have been
prepared in accordance with accounting principles generally accepted in the
United States of America. To help ensure the accuracy and integrity of its
financial data, the Company maintains a strong system of internal controls
designed to provide reasonable assurances that assets are safeguarded and that
transactions are properly executed and recorded. The internal control system and
compliance therewith are monitored by the Company's financial management.
The Consolidated Financial Statements have been audited by the Company's
independent auditors, KPMG LLP. The independent auditors, whose appointment by
the Board of Directors was ratified by the Company's stockholders, express their
opinion on the fairness of presentation, in all material respects, of the
Company's Consolidated Financial Statements based on procedures which they
consider to be sufficient to form their opinion.
The Audit Committee of the Board of Directors meets periodically with
representatives of KPMG LLP and the Company's financial management to review
accounting, internal control, auditing and financial reporting matters.
23
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
QUARTERLY FINANCIAL DATA
---------------------------
(UNAUDITED)
The following table presents unaudited quarterly financial data for the
years ended December 31, 2001 and 2000. In the opinion of management, all
adjustments necessary to present fairly the results of operations for such
periods are reflected. Total revenues and net income include gains on sales of
investments. Quarterly financial results are not necessarily indicative of the
results that may be expected for the year and hence, caution should be used in
drawing conclusions from quarterly consolidated results.
(In thousands, First Second Third Fourth
except per share amounts) Quarter Quarter Quarter Quarter
- - ------------------------------------------------------------------------------
2001:
TOTAL REVENUES ....................... $22,605 $23,857 $25,996 $21,644
NET INCOME (LOSS)..................... 887 (5,579) (1,594) (8,048)
NET INCOME (LOSS) PER DILUTED SHARE .. .05 (.29) (.08) (.42)
2000:
Total revenues ....................... $20,859 $18,952 $21,389 $25,037
Net income ........................... 3,435 1,324 1,267 (4,996)
Net income per diluted share ......... .18 .07 .07 (.27)
STOCK MARKET PRICES
---------------------------
Danielson Holding Corporation Common Stock is listed and traded on the
American Stock Exchange (symbol: DHC). On March 25, 2002, there were
approximately 1,404 holders of record of Common Stock.
The following table sets forth the high, low and closing stock prices of
the Company's Common Stock for the last two years, as reported on the American
Stock Exchange Composite Tape.
2001 2000
------------------------------------------------------
HIGH LOW CLOSE High Low Close
------------------------------------------------------
First Quarter.......... 4.99 4.06 4.60 7 3/8 4 3/4 6 3/8
Second Quarter......... 5.05 3.80 4.45 6 1/4 4 5/8 4 7/8
Third Quarter.......... 4.50 3.35 3.73 5 3 7/8 4 2/16
Fourth Quarter......... 4.45 3.34 4.44 4 9/16 3 9/16 4 9/16
------------------------------------------------------
24
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
CORPORATE OFFICERS
Martin J. Whitman
Chief Executive Officer
David M. Barse
President and
Chief Operating Officer
Michael T. Carney
Chief Financial Officer and Treasurer
W. James Hall
General Counsel and Secretary
BOARD OF DIRECTORS
David M. Barse
President and
Chief Operating Officer,
Danielson Holding Corporation
Stanley J. Garstka
Deputy Dean and Professor in
the Practice of Management,
Yale University School of Management
Eugene M. Isenberg
Chairman of the Board and
Chief Executive Officer,
Nabors Industries, Inc.
William Pate
Director of Mergers and Acquisitions,
Equity Group Investments, LLC
Joseph F. Porrino
Counsellor to the President,
New School University
Frank B. Ryan
Professor of Mathematics,
Rice University
Wallace O. Sellers
Vice Chairman and Director,
Enhance Financial
Services Group, Inc.
Martin J. Whitman
Chief Executive Officer,
Danielson Holding Corporation
Samuel Zell
Chairman,
Equity Group Investments, LLC
Form 10-K
A copy of Danielson's Form 10-K as filed with the Securities and Exchange
Commission may be obtained without charge by writing to:
Danielson Holding Corporation
767 Third Avenue - Fifth Floor
New York, NY 10017-2023
Attention: Courtney Quinlan
Investor Relations
212/888-0347
Stock Transfer Agent and Registrar
American Stock Transfer and Trust Company
40 Wall Street
New York, NY 10005
718/921-8261
Independent Certified
Public Accountants
KPMG LLP
757 Third Avenue
New York, NY 10017