SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended Commission File June 30, 1994 No. 1-7361 AMERICAN FINANCIAL CORPORATION Incorporated under IRS Employer I.D. the Laws of Ohio No. 31-0624874 One East Fourth Street, Cincinnati, Ohio 45202 (513) 579-2121 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, and (2) has been subject to such filing requirements for the past 90 days. Yes X No As of August 1, 1994, there were 18,971,217 shares of the Registrant's Common Stock outstanding, all of which were privately owned. Page 1 of 16 AMERICAN FINANCIAL CORPORATION 10-Q PART I FINANCIAL INFORMATION AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (In Thousands) June 30, December 31, 1994 1993 Assets Cash and short-term investments $ 190,871 $ 167,950 Investments: Bonds and redeemable preferred stocks: Held to maturity - at amortized cost (market - $4,154,400 and $3,959,400) 4,308,379 3,788,732 Available for sale - at market (amortized cost - $1,877,558 and $2,216,328) 1,858,358 2,349,528 Other stocks - principally at market (cost - $159,354 and $207,056) 249,354 339,156 Investment in investee corporations 879,124 899,800 Loans receivable 626,838 630,932 Real estate and other investments 150,384 139,319 8,072,437 8,147,467 Recoverables from reinsurers and prepaid reinsurance premiums 819,756 756,060 Trade receivables 346,082 298,240 Other receivables 208,428 213,507 Prepaid expenses, deferred charges and other assets 368,083 320,299 Cost in excess of net assets acquired 175,967 173,965 $10,181,624 $10,077,488 Liabilities and Capital Insurance claims and reserves $ 3,579,617 $ 3,422,657 Annuity policyholders' funds accumulated 4,400,248 4,256,674 Long-term debt: Parent company 492,799 571,874 Subsidiaries 586,817 482,132 Accounts payable, accrued expenses and other liabilities 525,831 648,462 Minority interest 106,001 109,219 9,691,313 9,491,018 Capital subject to mandatory redemption 35,291 49,232 Preferred Stock (redemption value - $278,719 and $278,889) 168,428 168,588 Common Stock without par value 904 904 Retained earnings 237,388 210,846 Net unrealized gain on marketable securities, net of deferred income taxes 48,300 156,900 $10,181,624 $10,077,488 2 AMERICAN FINANCIAL CORPORATION 10-Q AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS (In Thousands) Three months ended Six months ended June 30, June 30, 1994 1993 1994 1993 Income: Property and casualty insurance premiums $338,814 $301,945 $ 651,863 $ 847,876 Investment income 143,614 141,894 284,684 317,022 Realized gains on sales of securities 8,187 23,587 23,143 40,973 Equity in net earnings (losses) of investee corporations (9,472) 38,433 12,222 53,246 Gains on sales of investee corporations 1,683 120 1,694 52,054 Provision for impairment of investments - (1,500) - (1,500) Sales of other products and services - - - 152,100 Other income 25,178 52,497 58,045 119,946 508,004 556,976 1,031,651 1,581,717 Costs and Expenses: Property and casualty insurance: Losses and loss adjustment expenses 226,360 213,130 457,377 602,772 Commissions and other underwriting expenses 102,583 103,844 206,749 256,502 Benefits to annuity policyholders 60,201 57,465 119,424 116,647 Interest on borrowed money 26,563 36,561 58,856 90,874 Cost of sales - - - 134,900 Other operating and general expenses 60,270 113,252 122,206 252,256 475,977 524,252 964,612 1,453,951 Earnings before income taxes and extraordinary items 32,027 32,724 67,039 127,766 Provision for income taxes 8,768 14,599 17,087 20,996 Earnings before extraordinary items 23,259 18,125 49,952 106,770 Extraordinary items - loss on prepayment of debt (744) - (16,437) - Net Earnings $ 22,515 $ 18,125 $ 33,515 $ 106,770 3 AMERICAN FINANCIAL CORPORATION 10-Q AMERICAN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (In Thousands) Six months ended June 30, 1994 1993 Operating Activities: Net earnings $ 33,515 $ 106,770 Adjustments: Extraordinary losses from retirement of debt 16,437 - Depreciation and amortization 8,781 24,656 Benefits to annuity policyholders 119,424 116,647 Equity in net earnings of investee corporations (12,222) (53,246) Changes in reserves on assets 10,517 9,596 Realized gains on investing activities (32,281) (101,297) Increase in reinsurance and other receivables (113,536) (193,124) Increase in prepaid expenses, deferred charges and other assets (52,849) (51,815) Increase in insurance claims and reserves 159,583 202,553 Increase (decrease) in other liabilities 704 (39,118) Increase in minority interest 2,611 31,505 Dividends from investees 10,502 15,265 Other, net (1,641) (11,460) 149,545 56,932 Investing Activities: Purchases of and additional investments in: Fixed maturity investments (980,800) (1,812,250) Equity securities (1,946) (11,272) Investees and subsidiaries (23,852) (21,938) Real estate, property and equipment (14,612) (31,582) Maturities and redemptions of fixed maturity investments 238,761 437,939 Sales of: Fixed maturity investments 504,144 862,614 Equity securities 69,592 110,614 Investee and subsidiaries 27,621 - Real estate, property and equipment 2,422 62,606 Cash and short-term investments of former subsidiary - (255,100) Decrease in other investments 10,424 1,966 Other - (1,500) (168,246) (657,903) Financing Activities: Annuity receipts 210,630 213,799 Annuity benefits and withdrawals (172,493) (154,592) Additional long-term borrowings 163,397 189,512 Reductions of long-term debt (138,738) (256,323) Repurchases of capital stock (4,466) (2,506) Cash dividends paid (16,708) (15,002) 41,622 (25,112) Net Increase (Decrease) in Cash and Short-term Investments 22,921 (626,083) Cash and short-term investments at beginning of period 167,950 837,429 Cash and short-term investments at end of period $190,871 $ 211,346 4 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. Accounting Policies Basis of Presentation The accompanying consolidated financial statements for American Financial Corporation ("AFC") and subsidiaries are unaudited, but management believes that all adjustments (consisting only of normal recurring accruals unless otherwise disclosed herein) necessary for fair presentation have been made. The results of operations for interim periods are not necessarily indicative of results to be expected for the year. The financial statements have been prepared in accordance with the instructions to Form 10-Q and therefore do not include all information and footnotes necessary to be in conformity with generally accepted accounting principles. Changes in ownership levels of subsidiaries and investees have resulted in certain differences in the financial statements and have affected comparability between years. Certain reclassifications have been made to prior years to conform to the current year's presentation. All significant intercompany balances and transactions have been eliminated. All acquisitions have been treated as purchases. The results of operations of companies since their formation or acquisition are included in the consolidated financial statements. AFC's ownership of subsidiaries and significant investees with publicly traded shares was as follows: June 30, December 31, 1994 1993 1992 American Annuity Group, Inc. ("AAG") 80% 80% 82% American Financial Enterprises, Inc. ("AFEI") 83% 83% 83% American Premier Underwriters, Inc. 40% 41%(a) 51% (formerly The Penn Central Corporation) Chiquita Brands International, Inc. 46% 46% 46% Citicasters Inc. (formerly Great American 30% 20% 40% Communications Company - "GACC") General Cable Corporation (b) 45% 45% Spelling Entertainment Group Inc. ("Spelling") - (c) 48% <FN> (a) In anticipation of a reduction of AFC's ownership of American Premier below 50%, AFC ceased accounting for it as a subsidiary and began accounting for it as an investee in April 1993. (b) Sold in June 1994. (c) Sold in March 1993. Investments AFC implemented Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," beginning December 31, 1993. This standard requires (i) debt securities be classified as "held to maturity" and reported at amortized cost if AFC has the positive intent and ability to hold them to maturity, (ii) debt and equity securities be classified as "trading" and reported at fair value, with unrealized gains and losses included in earnings, if they are bought and held principally for selling in the near term and (iii) debt and equity securities not classified as held to maturity or trading be classified as "available for sale" and reported at fair value, with unrealized gains and losses reported as a separate component of shareholders' equity. Only in certain limited circumstances, such as significant issuer credit deterioration or if required by insurance or other regulators, may a company change its intent to hold a certain security to maturity without calling into question its intent to hold other debt securities to maturity in the future. 5 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Premiums and discounts on collateralized mortgage obligations are amortized over their expected average lives using the interest method. Gains or losses on sales of securities are recognized at the time of disposition with the amount of gain or loss determined on the specific identification basis. When a decline in the value of a specific investment is considered to be other than temporary, a provision for impairment is charged to earnings and the carrying value of that investment is reduced. Investment in Investee Corporations Investments in securities of 20%- to 50%-owned companies are carried at cost, adjusted for AFC's proportionate share of their undistributed earnings or losses. Investments in less than 20%-owned companies are accounted for by the equity method when, in the opinion of management, AFC can exercise significant influence over operating and financial policies of the investee. Due to GACC's financial difficulties, AFC transferred all GACC securities and loans to the investee account and reduced the carrying value of that investment to estimated net realizable value ($35 million) at the end of 1992. AFC resumed equity accounting for its investment following GACC's reorganization at the end of 1993. Cost in Excess of Net Assets Acquired The excess of cost of subsidiaries and investees (purchased subsequent to October 1970) over AFC's equity in the underlying net assets ("goodwill") is being amortized over 40 years. The excess of AFC's equity in the net assets of other subsidiaries and investees over its cost of acquiring these companies ("negative goodwill") has been allocated to AFC's basis in these companies' fixed assets, goodwill and other long-term assets and is amortized on a 10- to 40-year basis. Insurance Claims and Reserves Insurance claims and reserves include unpaid losses and loss adjustment expenses in addition to unearned insurance premiums. As discussed under "Reinsurance" below, amounts have not been reduced for reinsurance recoverable. The net liabilities stated for unpaid claims and for expenses of investigation and adjustment of unpaid claims are based upon (a) the accumulation of case estimates for losses reported prior to the close of the accounting period on the direct business written; (b) estimates received from ceding reinsurers and insurance pools and associations; (c) estimates of unreported losses based on past experience and (d) estimates based on experience of expenses for investigating and adjusting claims. These liabilities are subject to the impact of changes in claim amounts and frequency and other factors. In spite of the variability inherent in such estimates, management believes that the liabilities for unpaid losses and loss adjustment expenses are adequate. Changes in estimates of the liabilities for losses and loss adjustment expenses are reflected in the Statement of Earnings in the period in which determined. Unearned insurance premiums represent that portion of premiums written which is applicable to the unexpired terms of policies in force, generally computed by the application of daily pro rata fractions. On reinsurance assumed from other insurance companies or written through various underwriting organizations, unearned premiums are based on reports received from such companies and organizations. 6 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Policy acquisition costs (principally commissions, premium taxes and other underwriting expenses) related to the production of new business are deferred and included in "Prepaid expenses, deferred charges and other assets". For the property and casualty companies, the deferral of acquisition costs is limited based upon their recoverability without any consideration for anticipated investment income. Deferred policy acquisition costs ("DPAC") are charged against income ratably over the term of the related policies. For the annuity company, DPAC is amortized, with interest, in relation to the present value of expected gross profits on the policies. Reinsurance In the normal course of business, AFC's insurance subsidiaries cede reinsurance to other companies to diversify risk and limit maximum loss arising from large claims. To the extent that any reinsuring companies are unable to meet obligations under the agreements covering reinsurance ceded, AFC's insurance subsidiaries would remain liable. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsurance policies. AFC insurance subsidiaries report as assets (a) the estimated reinsurance recoverable on unpaid losses, including an estimate for losses incurred but not reported, and (b) amounts paid to reinsurers applicable to the unexpired terms of policies in force. AFC insurance subsidiaries also assume reinsurance from other companies. Income on reinsurance assumed is recognized based on reports received from ceding reinsurers. Annuity Policyholders' Funds Accumulated Annuity premium deposits and benefit payments are generally recorded as increases or decreases in "annuity policyholders' funds accumulated" rather than as revenue and expense. Increases in this liability for interest credited are charged to expense and decreases for surrender charges are credited to other income. Statement of Cash Flows For cash flow purposes, "investing activities" are defined as making and collecting loans and acquiring and disposing of debt or equity instruments and property and equipment. "Financing activities" include obtaining resources from owners and providing them with a return on their investments, borrowing money and repaying amounts borrowed. Annuity receipts, benefits and withdrawals are also reflected as financing activities. All other activities are considered "operating". Short-term investments having original maturities of three months or less when purchased are considered to be cash equivalents for purposes of the financial statements. Income Taxes AFC files consolidated federal income tax returns which include all 80%-owned U.S. subsidiaries. Deferred income taxes are calculated using the liability method. Under this method, deferred income tax assets and liabilities are determined based on differences between financial reporting and tax bases and are measured using enacted tax rates. Deferred tax assets are recognized if it is more likely than not that a benefit will be realized. 7 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Benefit Plans AFC's Employee Stock Ownership Retirement Plan ("ESORP") is a noncontributory, trusteed plan which invests in securities of AFC and affiliates for the benefit of the employees of AFC and certain of its subsidiaries. The ESORP covers all employees of participating companies who are qualified as to age and length of service. Contributions are discretionary by the directors of participating companies and are charged against earnings in the year for which they are declared. Under AFC's Book Value Incentive Plan, units may be granted at initial values between 80% and 120% of "book value" to key employees. Units may be exercised at any time, to the extent vested. Payments are made to the holder 50% in cash and the remainder in installments over a ten-year period with an assumed interest factor of 12% per annum. "Book value" is determined in accordance with generally accepted accounting principles except that all equity securities (including investees and subsidiaries with publicly traded shares) are reflected at market value. The value of the units is the excess of the current book value of a share of AFC Common Stock, as defined, over the initial value of the units at the date of grant. This value is being accrued over the vesting period (five years). AFC and many of its subsidiaries provide health care and life insurance benefits to eligible retirees. The projected future cost of providing these benefits is expensed over the period the employees qualify for such benefits. Effective January 1, 1994, AFC implemented SFAS No. 112, "Employers' Accounting for Postemployment Benefits" which covers benefits provided to former or inactive employees (primarily those on disability) who were not deemed retired under other company plans. This standard requires companies to accrue the projected future cost of providing postemployment benefits instead of recognizing an expense for these benefits when paid. The implementation of SFAS No. 112 did not have a material effect on AFC's financial position or results of operations. Debt Discount Debt discount and expenses are amortized over the lives of respective borrowings, generally on the interest method. Unamortized balances are charged off in the event of early retirement of the related debt. B. Sales of Investees In June 1994, AFC sold its investment in General Cable common stock to an unaffiliated company for $27.6 million in cash. AFC realized a $1.7 million pretax gain on the sale (excluding its share of American Premier's loss on its sale of General Cable notes). In March 1993, AFC sold its common stock investment in Spelling to Blockbuster Entertainment Corporation in exchange for 7.6 million shares of Blockbuster common stock and warrants to purchase an additional two million Blockbuster shares at $25 per share. AFC realized a $52 million pretax gain on the sale. 8 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED C. Segments of Operations Through subsidiaries, AFC is engaged in several financial businesses, including property and casualty insurance, annuities and portfolio investing. AFC also owns significant portions of the voting equity securities of certain companies (investee corporations - see Note D). The following table (in thousands) shows AFC's revenues by significant business segment. Intersegment transactions are not significant. Six months ended June 30, Revenues (a) 1994 1993 Property and casualty insurance: Underwriting $ 651,863 $ 847,876 Investment and other income 158,938 245,292 810,801 1,093,168 Annuities (b) 186,590 204,259 Other 22,038 231,044 1,019,429 1,528,471 Equity in net earnings of investee corporations 12,222 53,246 $1,031,651 $1,581,717 <FN> (a) See Note A for a discussion of certain sales of subsidiaries and investees affecting the comparability of revenues in the table above. (b) Represents primarily investment income and realized gains. D. Investee Corporations Investment in investee corporations represents AFC's ownership of securities of certain companies. All of the companies named in the following table are subject to the rules and regulations of the SEC. Market value of the investments was approximately $825 million and $940 million at June 30, 1994 and December 31, 1993, respectively. AFC's investment (and common stock ownership percentage) in these investees was as follows (dollars in thousands): Investment (Ownership %) June 30, December 31, 1994 1993 American Premier (a) $524,982 (40%) $559,116 (41%) Chiquita 292,878 (46%) 277,854 (46%) Citicasters (a) 61,264 (30%) 36,892 (20%) General Cable (b) 25,938 (45%) $879,124 $899,800 <FN> (a) In March 1994, American Premier changed its name from The Penn Central Corporation to reflect its identity as a property and casualty insurance company. In May 1994, Citicasters changed its name from Great American Communications Company to reflect its identity as a pure broadcaster focused on metropolitan markets. (b) Sold in June 1994. On June 30, 1994, AFEI, whose assets consist primarily of investments in American Premier and AAG, purchased 1.2 million shares of Citicasters common stock for $23.9 million in cash. 9 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Summarized financial information for AFC's major investees follows (in millions): Six months ended June 30, American Premier 1994 1993 Revenues $828 $797 Income (Loss) from Continuing Operations (39) 106 Discontinued Operations (2) 3 Net Income (Loss) (41) 109 In connection with the acquisition of General Cable in June 1994 by an unaffiliated company, American Premier sold long-term notes receivable from General Cable to that company and recorded a $76 million pretax loss. Six months ended June 30, Chiquita 1994 1993 Net Sales $1,322 $1,413 Operating Income 151 112 Income before Extraordinary Item 67 35 Extraordinary Item (23) - Net Income 44 35 E. Long-Term Debt Long-term debt consisted of the following (in thousands): June 30, December 31, 1994 1993 American Financial Corporation (Parent Company): Non-subordinated $ 488,524 $ 564,075 Subordinated 4,275 7,799 492,799 571,874 Subsidiaries: Non-subordinated 476,449 357,132 Senior Subordinated 110,368 125,000 586,817 482,132 $1,079,616 $1,054,006 In April 1994, AFC completed an offer to issue 9-3/4% Debentures due April 20, 2004 in exchange for its publicly traded debentures. In the exchange offer, AFC issued approximately $203.8 million of the 9-3/4% Debentures. A cash premium of $6.5 million on the debentures exchanged is included in Extraordinary Items in the Statement of Earnings. AFC also redeemed at par all 13-1/2% Debentures not tendered in the exchange for approximately $63.2 million in cash. 10 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED At June 30, 1994, sinking fund and other scheduled principal payments on debt for the balance of 1994 and the subsequent five years were as follows (in thousands): Parent Company Subsidiaries Total 1994 $ 3,231 $ 1,654 $ 4,885 1995 261 61,746 62,007 1996 261 1,499 1,760 1997 5,430 37,902 43,332 1998 261 174,565 174,826 1999 225,827 24,646 250,473 AFC may, at its option, apply debentures otherwise purchased in excess of scheduled payments to satisfy any sinking fund requirement. The scheduled principal payments shown above assume that debentures purchased are applied to the earliest scheduled retirements. F. Capital Subject to Mandatory Redemption Capital subject to mandatory redemption includes AFC's Mandatory Redeemable Preferred Stock and capital subject to a put option. Mandatory Redeemable Preferred Stock The outstanding shares of Mandatory Redeemable Preferred Stock are nonvoting, cumulative and consisted of the following: June 30, December 31, 1994 1993 Series E - $10.50 par value per share; annual dividends per share $1. 504,711 504,711 Series I - $28.00 liquidation value per share; annual dividends per share $2.66. - 150,212 In February 1994, AFC redeemed the outstanding shares of Series I Preferred Stock. Approximately 45% of the Series E Preferred Stock is scheduled to be retired in December 1994; the balance is to be retired in December 1995. Capital Subject to Put Option Under an agreement entered into in 1983, certain members of the Lindner family (the "Group") who, in the aggregate, owned 1,848,235 shares of AFC Common Stock, were granted options to purchase an additional 1,225,000 shares. The options, which expire two years after the death of Robert D. Lindner, are exercisable at $6.65 per share plus $.40 per share per year from April 1983. Holders have the right to "put" to AFC any shares of AFC Common Stock or options at any time at a price equal to AFC's book value per share, adjusted to reflect all equity securities (including investees and subsidiaries with publicly traded shares) at market prices. The purchase price is to be paid one-third in cash and the balance in a five-year installment note bearing interest at a rate equal to the five- year U.S. Treasury note rate plus 3%. AFC has the right to "call" any AFC shares owned by the Group after Robert D. Lindner's death at the same price as described under the "put" (but not less than $6.65 per share plus 10% compounded annually from April 1983). Further, AFC has a right of first refusal on shares owned by members of the Group. 11 AMERICAN FINANCIAL CORPORATION 10-Q NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED At June 30, 1994, the Group owned 1,533,767 shares of AFC Common Stock and options to purchase an additional 762,500 shares. The aggregate purchase price for all shares covered by the put is included in "capital subject to mandatory redemption" and amounted to $30 million and $40 million at June 30, 1994 and December 31, 1993, respectively. Changes in the aggregate purchase price are charged or credited directly to retained earnings without affecting earnings. G. Other Preferred Stock Other Preferred Stock is nonvoting, cumulative and consisted of the following: June 30, December 31, 1994 1993 Series F - $20.00 liquidation value per share; annual dividends per share $1.80; 10% may be retired annually at AFC's option between 1994 and 1996. 13,744,754 13,753,254 Series G - $10.50 liquidation value per share; annual dividends per share $1.05; may be retired at AFC's option. 364,158 364,158 In the second quarter of 1994, AFC purchased 8,500 shares of Series F Preferred Stock from a subsidiary's profit sharing plan for $159,000. H. Common Stock At June 30, 1994, Carl H. Lindner and certain members of the Lindner family owned all of the outstanding Common Stock of AFC. I. Extraordinary Items Extraordinary items consisted of the following (in thousands): Premium paid on AFC debentures exchanged $ 6,454 Loss on subsidiary's prepayment of debt (net of minority interest of $142) 947 Share of loss on investee's prepayment of debt 9,036 $16,437 J. Cash Flows - Fixed Maturity Investments "Investing activities" related to fixed maturity investments in AFC's 1994 Statement of Cash Flows consisted of the following (in thousands): Held to Available Maturity For Sale Total Purchases $645,767 $335,033 $980,800 Maturities and paydowns 107,100 131,661 238,761 Sales 7,781 496,363 504,144 K. Pending Legal Proceedings Counsel has advised AFC that there is little likelihood of any substantial liability being incurred from any litigation pending against AFC and subsidiaries. L. Proposed Sale of Personal Lines Business In June 1994, American Premier announced the termination of discussions regarding the previously announced proposal from AFC to purchase GAI's personal lines business. American Premier said that negotiations were terminated because the parties did not reach agreement on the various terms and conditions of the sale. 12 AMERICAN FINANCIAL CORPORATION 10-Q ITEM 2 Management's Discussion and Analysis of Financial Condition and Results of Operations GENERAL AFC is organized as a holding company with almost all of its operations being conducted by subsidiaries and investees. The parent corporation, however, has continuing expenditures for administrative expenses and corporate services and, most importantly, for the payment of principal and interest on borrowings and redemptions of and dividends on AFC Preferred Stock. Therefore, certain analyses are best done on a parent only basis while others are best done on a total enterprise basis. In addition, since many of its businesses are financial in nature, AFC does not prepare its consolidated financial statements using a current-noncurrent format. Consequently, certain traditional ratios and financial analysis tests are not meaningful. LIQUIDITY AND CAPITAL RESOURCES Ratios The ratio of AFC's (parent only) long-term debt to equity (excluding Capital Subject to Mandatory Redemption) was 1.08 at June 30, 1994, compared to 1.06 at December 31, 1993. Adding AFC's Capital Subject to Mandatory Redemption to its debt changes these ratios to 1.16 and 1.16; whereas, adding it to equity changes the ratios to 1.01 and .98 at those same dates. AFC's ratio of earnings to fixed charges on a total enterprise basis was 2.00 for the first six months of 1994 compared to 2.62 for the entire year of 1993; ratios of earnings to fixed charges and preferred dividends were 1.66 and 2.26 for the same periods. Sources of Funds A wholly-owned subsidiary, Great American Holding Corporation ("GAHC"), has a revolving credit agreement with several banks under which it can borrow up to $300 million. The credit line converts to a four-year term loan in December 1996 with scheduled principal payments to begin in March 1997. Borrowings under the credit line are made by GAHC and are advanced to AFC. The line is guaranteed by AFC and secured by 50% of the stock of Great American Insurance Company ("GAI"). GAHC had no outstanding borrowings under the agreement at December 31, 1993 and $115 million outstanding at June 30, 1994. Investments Significant portions of equity and, to a lesser extent, fixed income investments are concentrated in a relatively limited number of major positions. This approach allows management to more closely monitor these companies and the industries in which they operate. Some of the investments, because of their size, may not be as readily marketable as the typical small investment position. Alternatively, a large equity position may be attractive to persons seeking to control or influence the policies of a company. While management believes this investment philosophy will produce higher overall returns, such concentrations subject the portfolio to greater risk in the event one of the companies invested in becomes financially distressed. Approximately 95% of the bonds and redeemable preferred stocks held by AFC were rated "investment grade" (credit rating of AAA to BBB) at June 30, 1994. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated and non-investment grade. 13 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued The cost basis of investments other than investees was determined after deducting cumulative provisions for impairment aggregating $49 million at June 30, 1994 and $47 million at December 31, 1993. RESULTS OF OPERATIONS General Due to a decrease in ownership percentage, AFC ceased accounting for American Premier as a subsidiary and began accounting for it as an investee on April 1, 1993. As a result, current year income statement components are not comparable to prior years and are not necessarily indicative of future years. Pretax earnings in the first six months of 1994 were $61 million less than in the comparable 1993 period, primarily due to (i) a $52 million pretax gain on the sale of an investee in 1993, (ii) a $28 million loss in 1994 representing AFC's share of American Premier's loss on the sale of General Cable notes and (iii) a $15 million reduction in interest expense (excluding the effects of deconsolidating American Premier in April 1993). Property and Casualty Insurance Underwriting profitability is measured by the combined ratio which is a sum of the ratio of underwriting expenses to premiums written and the ratio of losses and loss adjustment expenses to premiums earned. When the combined ratio is under 100%, underwriting results are generally considered profitable; when the ratio is over 100%, underwriting results are generally considered unprofitable. The combined ratio does not reflect investment income, other income or federal income taxes. The combined underwriting ratio (statutory basis, after policyholders' dividends) of GAI and its property and casualty insurance subsidiaries was 103.4% for the first six months of 1994 compared to 104.1% for the same period in 1993 and 103.9% for the entire year of 1993. Property and casualty insurance premiums were $196 million less than in the first six months of 1993, reflecting the deconsolidation of American Premier beginning in the second quarter of 1993. Insurance premiums for the remainder of AFC's insurance group increased $58 million (10%) and insurance expenses increased $48 million (8%). The increase in premiums was due to an increase in sales of specialized niche products and auto insurance and a decrease in the percentage of business ceded to reinsurers. Investment Income Excluding American Premier, investment income increased $7 million (2%) from 1993 due to an increase in investments held. Realized Gains Realized capital gains have been an important part of AFC's return on its investments in marketable securities. Individual securities are sold creating gains and losses from time to time as investment strategies change or as market opportunities appear to present optimal conditions. Investee Corporations Equity in net earnings of investee corporations (companies in which AFC owns a significant portion of the voting stock) represents AFC's proportionate share of the investees' earnings and losses. AFC's equity in net earnings (losses) of investee corporations in the first six months of 1994 includes its share ($28.4 million) of American Premier's loss on the sale of General Cable notes. 14 AMERICAN FINANCIAL CORPORATION 10-Q Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Gains on Sales of Investee Corporations The gains on sales of investee corporations represent pretax gains on the sales of General Cable common stock in 1994 and Spelling Entertainment Group common stock in 1993. Sales of Other Products and Services Sales of other products and services in 1993 represent American Premier's revenues from systems and software engineering services and the manufacture and supply of industrial products and services. Benefits to Annuity Policyholders Benefits to annuity policyholders increased 2% over those of the comparable period in 1993. The average crediting rate on funds held has decreased from 6.2% at December 31, 1992 to 5.3% at December 31, 1993 and June 30, 1994. The rate at which interest is credited on annuity policyholders' funds is subject to change based on management's judgment of market conditions. Interest on Borrowed Money The decrease in interest expense is due primarily to the deconsolidation of American Premier, repayments of borrowings by AFC and certain subsidiaries and the AFC debt exchange in 1994. Interest expense included in AFC's Statement of Earnings was comprised of (in millions): Six months ended June 30, 1994 1993 AFC Parent $30.4 $35.2 Great American Holding Company 10.6 12.4 Great American Insurance 6.0 8.2 American Premier - 17.2 American Annuity 11.5 9.9 American Financial Enterprises .3 7.2 Other Companies .1 .8 $58.9 $90.9 Other Operating and General Expenses Included in operating and general expenses in the first six months of 1994 and 1993 are charges of $3.1 million and $26.2 million, respectively, for minority interest. Also included is a credit of $3.9 million in 1994 for units outstanding under AFC's Book Value Incentive Plan and a charge of $8 million in 1993 for the estimated costs of moving AAG's annuity operations from Los Angeles to Cincinnati. Income Taxes The 1993 provision for income tax includes a $15 million first quarter benefit due to American Premier's revision of estimated future taxable income likely to be generated during the company's tax loss carryforward period. New Accounting Standards Effective January 1, 1994, AFC implemented SFAS 112, "Employers' Accounting for Postemployment Benefits"; the implementation of this standard did not have a material adverse effect on AFC. 15 AMERICAN FINANCIAL CORPORATION 10-Q PART II OTHER INFORMATION Items required in Part II of this form have been omitted since they are either inapplicable or not required. Signature Pursuant to the requirements of the Securities Exchange Act of 1934, American Financial Corporation has duly caused this Report to be signed on its behalf by the undersigned duly authorized. American Financial Corporation August 11, 1994 BY:/s/ FRED J. RUNK Fred J. Runk Vice President and Treasurer 16