2000 Annual Report
As of and for the years
ended December 31,
----------------------------------
(IN THOUSANDS, EXCEPT SHARE AND
PER SHARE AMOUNTS, STOCK PRICES AND EMPLOYEES) 2000 1999 1998
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
Earned premiums ........................ $ 67,034 $ 54,040 $ 55,411
Total revenues ......................... $ 86,237 $ 71,158 $ 64,744
Net income ............................. $ 1,030 $ 1,255 $ 2,301
Net cash provided by (used in) continuing
operating activities ................. $ 6,644 $ (6,478) $ (5,170)
Net income per diluted share
of Common Stock ...................... $ 0.05 $ 0.07 $ 0.14
Combined ratio ......................... 123.1% 125.2% 108.6%
================================================================================
BALANCE SHEET AND OTHER DATA
Total investments ...................... $ 154,130 $ 140,391 $ 134,859
Policyholder liabilities ............... $ 123,601 $ 111,987 $ 109,539
Stockholders' equity ................... $ 81,330 $ 76,226 $ 63,273
Book value per share of Common Stock ... $ 4.21 $ 4.13 $ 4.06
Common Stock price range
High ................................. $ 7 3/8 $ 7 1/2 $ 8 1/8
Low .................................. $ 3 7/8 $ 2 7/8 $ 3
Shares of Common Stock
outstanding at year end .............. 19,295,954 18,476,265 15,576,276
Employees of continuing
operations at year end ............... 156 138 155
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 ...................................... 9
Consolidated Balance Sheets ................................................ 10
Consolidated Statements of Stockholders' Equity ............................ 11
Consolidated Statements of Cash Flows ...................................... 12
Notes to Consolidated Financial Statements ................................. 13
Independent Auditors' Report ............................................... 25
Responsibility for Financial Reporting ..................................... 25
Quarterly Financial Data ................................................... 26
Stock Market Prices ........................................................ 26
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) 2000 1999 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
A. RESULTS OF OPERATIONS
Total revenues ............................... $ 86,237 $ 71,158 $ 64,744 $ 65,746 $ 48,704
Income (loss) from continuing operations
before extraordinary items ................. $ 1,030 $ 1,255 $ 2,301 $ 4,589 $ (6,240)(1,2)
Net loss from discontinued operations ........ -- -- -- -- $ (633)(3)
Loss on disposal of discontinued operations .. -- -- -- -- $ (1,246)(3)
Net income (loss) ............................ $ 1,030 $ 1,255 $ 2,301 $ 4,589 $ (8,119)(1,2,3)
Diluted earnings (loss) per share
of Common Stock:
Income (loss) from continuing operations
before extraordinary items ............... $ 0.05 $ 0.07 $ 0.14 $ 0.28 $ (0.41)(1,2)
Net loss from discontinued operations ...... -- -- -- -- $ (0.04)(3)
Loss on disposal of discontinued operations .. -- -- -- -- $ (0.08)(3)
Net income (loss) .......................... $ 0.05 $ 0.07 $ 0.14 $ 0.28 $ (0.53)(1,2,3)
B. BALANCE SHEET DATA
Invested assets .............................. $ 154,130 $ 140,391 $ 134,859 $ 142,823 $ 151,555
Total assets ................................. $ 210,829 $ 194,752 $ 180,895 $ 187,773 $ 196,419
Unpaid losses and loss adjustment expenses ... $ 100,030 $ 94,934 $ 95,653 $ 105,947 $ 120,651
Stockholders' equity ......................... $ 81,330 $ 76,226 $ 63,273 $ 63,920 $ 58,853
Shares of Common Stock outstanding ........... 19,295,954(4) 18,476,265(4) 15,576,276(4) 15,576,287(4) 15,360,238(4)
(1) Includes expenses incurred in connection with the terminated proposed
merger with Midland Financial Group, Inc. and non-recurring compensation
expenses for death benefits and severance pay.
(2) Includes $10 million increase in provision for pre-1980 accident year
losses and loss adjustment expenses relating to run-off businesses and $4
million reduction in policyholder dividend accrual.
(3) In 1996, DHC sold 100% of the common stock of Danielson Trust Company.
Accordingly, Danielson Trust's results are reported herein as discontinued
operations and are included in net income (loss).
(4) Does not give effect to currently exercisable options and, in 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 2000 consolidated Federal
income tax return will report a cumulative net operating loss carryforward
currently estimated at $899 million, which will expire in various amounts, if
not used, between 2001 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.
PROPERTY AND CASUALTY INSURANCE OPERATIONS
Net premiums earned were $67.0 million, $54.0 million and $55.4 million in
2000, 1999 and 1998, respectively. The change in net premiums earned were
directly related to the change in net written premiums. Net written premiums
were $73.1 million, $56.6 million and $58.9 million in 2000, 1999, and 1998,
respectively.
The overall increase in net written premiums in 2000 was attributable to
growth in our commercial automobile insurance business. Workers' compensation
net written premiums increased by $9.3 million during 2000 over the comparable
year to date period in 1999 due to increased production primarily outside
California, and decreased reinsurance coverage associated with the rescission of
a treaty effective in 1999. The commercial automobile net written premiums grew
from $12.7 million in 1999 to $23.1 million in 2000 due to increased production
primarily in California. New written premiums for personal automobile insurance
remained relatively flat during 2000.
Premiums and fees receivable, net of allowances, increased by $3.9 million
or 34%. The increase is attributable to the growth in installment premiums in
our commercial automobile programs. In 1998, the Company introduced automobile
programs that have installment features on policy terms in excess of six months.
During 2000 these programs experienced significant growth. Premiums from the
automobile program that generally offer policy terms less than six months and do
not utilize installment plans declined in 2000. The effect of these trends was
to increase the installment premium receivable by $4.0 million as well as the
related unearned premium on those installment premiums. The Company expects this
trend to continue into 2001.
The increase in the allowance for premiums and fees receivable during 2000
of $726,000 was attributable to the change in the mix of premiums receivable in
2000 versus 1999. In 2000 the Company experienced significant growth in its
automobile programs that have premium installment features as noted above. In
conjunction with the increase in installment premiums the Company experienced an
increase in collection efforts relating to such premiums, especially
non-standard policies. As a result, the Company increased both its allowance for
premiums and the amount of write-offs against such allowance. The Company
expects this trend to continue in 2001.
Net investment income was $7.7 million, $7.3 million and $7.7 million in
2000, 1999, and 1998, respectively. Net investment income has increased as
fixed-income invested assets increased by $9.1 million. The increase in invested
assets is attributable to increased premium volume and the receipt of the
Reliance settlement. As of December 31, 2000 and 1999, the average yield on
NAICC's portfolio was 6.6 percent and 6.6 percent, respectively. The estimated
average maturity of the portfolio at December 31, 2000 was 3.25 years compared
to 3.77 years at December 31, 1999.
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 $60.5 million, $45.8
million, and $39.1 million in 2000, 1999, and 1998, respectively. The resulting
net loss and LAE ratios were 90.3 percent, 84.7 percent and 70.6 percent in
2000, 1999 and 1998, respectively. The increase in the loss and LAE ratio during
2000 was attributable to higher than expected losses in our commercial and
private passenger automobile programs and additional development in our run-off
lines. The increase in the loss and LAE ratio in 1999 over 1998 was due to
higher than expected losses in the California workers' compensation line and
developments on certain businesses in run-off.
Policy acquisition costs were $16.4 million, $13.9 million, and $13.3
million in 2000, 1999, and 1998. As a percentage of net premiums earned, policy
acquisition expenses were 24.5 percent, 25.7 percent, and 24.0 percent in 2000,
1999, and 1998, 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 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. The increase in the policy
acquisition expense ratio in 1999 over 1998 was due in part to an increase in
our preferred private passenger automobile line of business. That line of
business has higher commission costs than our non-standard private passenger
automobile line of business.
General and administrative expenses were $5.5 million, $5.8 million, and
$7.3 million in 2000, 1999, and 1998, respectively. General and administrative
expenses decreased in 2000 due to cost saving measures implemented by the
Company at the end of 1999. The decrease in 1999 was in line with the overall
premium activity for that year.
Policyholder dividends incurred were $(144,817), $2.2 million, and $471,000
in 2000, 1999, and 1998, respectively. The negative policyholder dividend in
2000 was 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 increase in the
policyholder dividends during 1999 was 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 123.1 percent, 125.2 percent, and 108.6
in 2000, 1999, and 1998, respectively. The decrease in the combined ratio in
2000 was due to premium growth and reduced costs associated with producing such
premiums. The increase in the combined ratio in 1999 was due to higher than
expected loss costs, and policyholder dividends.
The insurance operations had income from operations of $1.7 million, $3.0
million, and $4.1 million in 2000, 1999, and 1998, respectively. 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. The decrease in 1999
was attributable to the decrease in premium volume, along with an increase in
loss and loss adjustment expenses, which was offset in part by the gain on a
treaty rescission of $8.3 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
provided by insurance operations was $8.1 million in 2000 while cash used in
insurance operations was $4.6 million and $3.0 million in 1999 and 1998,
respectively. 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. The Company believes that its liquidity needs will continue to
be met through the same sources in the future.
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.
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, 2000, 1999, and 1998, cash used in parent-only
operating activities was $1.5 million, $1.9 million, and $2.2 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."
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2000, cash and investments of DHC were
4
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
approximately $21.0 million. As previously described, the primary use of
funds was the payment of general and administrative expenses in the normal
course of business. 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'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. NAICC does not
invest in high yield non-investment grade 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, 2000, by investment grade (dollars in thousands):
Cost Fair Value
- --------------------------------------------------------------------------------
Investment by investment grade:
Fixed maturities
U.S. Government/Agency ............................ $ 34,167 $ 34,682
Mortgage-backed ................................... 37,592 37,640
Asset-backed ...................................... 1,967 1,974
Corporates (AAA to A) ............................. 38,948 39,075
Corporates (BBB to B) ............................. 10,993 9,842
------------------------
Total fixed maturities .......................... 123,667 123,213
Equity securities ................................... 25,064 24,454
------------------------
Total ........................................... $148,731 $147,667
========================
The following table sets forth a summary of the Company's equity securities
portfolio at December 31, 2000 (dollars in thousands):
Cost Fair Value
- --------------------------------------------------------------------------------
Equity securities by type:
U.S. domestic securities .......................... $14,726 $14,302
Foreign securities ................................ 10,338 10,152
------------------------
Total equity securities ......................... $25,064 $24,454
========================
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.
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 30.5 percent and 35.1 percent of total fixed maturities at December
31, 2000 and December 31, 1999, 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 mort-
5
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------
(CONTINUED)
gages. 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):
2000 1999
---------------------------------------------
AMORTIZED PERCENT Amortized Percent
COST OF TOTAL Cost of Total
- --------------------------------------------------------------------------------
Non-PAC/TAC ..................... $19,774 53% $19,317 48%
PAC/TAC ......................... 17,818 47% 20,872 52%
---------------------------------------------
$37,592 100% $40,189 100%
=============================================
The following table provides information about the Company's fixed maturity
investments at December 31, 2000 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.
There-
(IN THOUSANDS) 2001 2002 2003 2004 2005 after Total
- -----------------------------------------------------------------------------------------------------------------------------------
U.S. Government/Agency $10,506 $ 6,395 $ 2,155 $3,528 $2,700 $ 8,883 $34,167
Average interest rate 6.64% 7.53% 6.76% 5.62% 7.37% 8.35%
Mortgage-backed 4,777 4,649 3,940 2,772 3,331 18,123 37,592
Average interest rate 7.21% 7.35% 7.44% 7.52% 7.50% 6.90%
Asset-backed 1,967 1,967
Average interest rate 5.81%
Corporates (AAA to A) 1,490 3,825 10,900 11,725 7,025 3,983 38,948
Average interest rate 8.08% 7.31% 6.29% 6.07% 6.51% 6.54%
Corporates (BBB to B) 1,000 9,993 10,993
Average interest rate 9.50% 8.77%
-------------------------------------------------------------------------------------------
Total $19,740 $14,869 $16,995 $18,025 $13,056 $40,982 $123,667
===========================================================================================
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, 2000.
RISKS RELATED TO EQUITY SECURITIES
The increase in the equity portfolio during 1998 was done to diversify
NAICC's investments. After consideration of NAICC's relatively conservative
capital position, management believed additional diversification was warranted.
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. 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,
2000, 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 year-to-year price
volatility than medium term investment grade fixed maturity instruments.
The foreign currency and equity price risks inherent in the equity
portfolio are subject to several factors beyond the control of management. At
December 31, 2000 the only foreign currency exposure was Japenese yen. To manage
foreign currency exposure on the Company's foreign equity holdings, the Company
reviews the available hedging products. In 1998 the Company entered into a yen
put option contract which expired in 1999. At December 31, 2000 there were no
hedging instuments in place. It is management's view that the cost of entering
into a subsequent hedging instrument would outweigh any potential benefit of
such instrument.
AUTHORITATIVE ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board 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 will adopt FAS 133 on
January 1, 2001. The adoption of FAS 133 is not expected to have a material
effect on the Company's results of operations or financial condition.
Effective January 1, 1999, the Company adopted AICPA Statement of Position
98-1, Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use (SOP 98-1). The statement establishes the standard in which certain
internal costs incurred to develop software used internally can be capitalized.
During 1999, the Company capitalized approximately $142,000 of internal costs,
mostly salary and benefits, related to software developed.
Effective January 1, 1999, the Company adopted AICPA Statement of Position
97-3, Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments. The statement establishes the standards for reporting assessments
charged to an enterprise. An enterprise is required to recognize a liability for
insurance related assessments when an assessment is probable and estimable. The
impact of adopting this statement was not material to the consolidated financial
statements.
In September 2000, the Financial Accounting Standards Board 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.
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 periods of rate adequacy
followed by increased competition and rate inadequacy. The general economic
conditions in California, where NAICC writes approximately 63 percent of its
current business, are currently competitive.
The competition, rate regulation and loss experience in the automobile
markets are currently such that NAICC is able to write its premium volume
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.
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 has increased slightly as
competitors have begun to raise rates during 2000. 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 and the
Company's future growth could continue to be limited by such activity.
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:
7
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------
(CONTINUED)
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.
8
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
---------------------------
For the years ended December 31,
--------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION) 2000 1999 1998
REVENUES:
- ---------------------------------------------------------------------------------------------------------------------------------
Gross premiums earned............................................................... $73,888 63,710 $65,861
Ceded premiums earned............................................................... (6,854) (9,670) (10,450)
--------------------------------------
Net premiums earned................................................................. 67,034 54,040 55,411
Net investment income............................................................... 9,326 7,777 8,174
Net realized investment gains (losses).............................................. 8,765 (152) 252
Gain on reinsurance treaty rescission............................................... -- 8,317 --
Other income........................................................................ 1,112 1,176 907
--------------------------------------
TOTAL REVENUES.................................................................... 86,237 71,158 64,744
LOSSES AND EXPENSES:
Gross losses and loss adjustment expenses........................................... 71,524 57,610 45,559
Ceded losses and loss adjustment expenses........................................... (11,001) (11,818) (6,428)
--------------------------------------
Net losses and loss adjustment expenses............................................. 60,523 45,792 39,131
Policyholder dividends.............................................................. (145) 2,217 471
Policy acquisition expenses......................................................... 16,436 13,864 13,300
General and administrative expenses................................................. 8,259 7,989 9,531
--------------------------------------
TOTAL LOSSES AND EXPENSES......................................................... 85,073 69,862 62,433
--------------------------------------
Income before provision for income tax................................................ 1,164 1,296 2,311
Income tax provision.................................................................. 134 41 10
======================================
NET INCOME ........................................................................... $ 1,030 $ 1,255 $ 2,301
======================================
EARNINGS PER SHARE OF COMMON STOCK:
Basic................................................................................. $ 0.06 $ 0.08 $ 0.15
Diluted............................................................................... $ 0.05 $ 0.07 $ 0.14
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
9
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
---------------------------
December 31,
-----------------------
(IN THOUSANDS, EXCEPT SHARE INFORMATION) 2000 1999
- --------------------------------------------------------------------------------------------------------------------------------
ASSETS:
Fixed maturities at fair value (Cost: $123,667 and $113,641)...................................... $123,213 110,841
Equity securities at fair value (Cost: $25,064 and $20,614)....................................... 24,454 21,316
Short term investments, at cost which approximates fair value..................................... 6,463 8,234
-----------------------
TOTAL INVESTMENTS............................................................................. 154,130 140,391
Cash.............................................................................................. 6,082 105
Accrued investment income......................................................................... 1,782 1,499
Premiums and fees receivable, net of allowances of $588 and $274.................................. 15,555 11,619
Reinsurance recoverable on paid losses, net of allowances of $623 and $402........................ 4,020 6,060
Reinsurance recoverable on unpaid losses, net of allowances of $101 and $246...................... 20,641 15,628
Prepaid reinsurance premiums...................................................................... 2,629 1,767
Property and equipment, net of accumulated depreciation of $8,748 and $8,225...................... 1,325 1,762
Deferred acquisition costs........................................................................ 3,665 2,522
Receivable on reinsurance treaty rescission....................................................... -- 11,459
Other assets...................................................................................... 1,000 1,940
-----------------------
TOTAL ASSETS.................................................................................. $210,829 $194,752
=======================
LIABILITIES AND STOCKHOLDERS' EQUITY:
Unpaid losses and loss adjustment expenses........................................................ $100,030 $ 94,934
Unearned premiums................................................................................. 23,207 16,239
Policyholder dividends............................................................................ 364 814
Reinsurance premiums payable...................................................................... 1,630 905
Funds withheld on ceded reinsurance............................................................... 1,666 1,708
Other liabilities................................................................................. 2,602 3,926
-----------------------
TOTAL LIABILITIES............................................................................. 129,499 118,526
Preferred Stock ($0.10 par value; authorized 10,000,000 shares;
none issued and outstanding).................................................................... -- --
Common Stock ($0.10 par value; authorized 100,000,000 shares;
issued 19,306,694 shares and 18,486,994 shares; outstanding 19,295,954 shares
and 18,476,265 shares)....................................................................... 1,931 1,849
Additional paid-in capital........................................................................ 62,449 59,491
Accumulated other comprehensive income (loss)..................................................... (1,064) (2,098)
Retained earnings................................................................................. 18,080 17,050
Treasury stock (Cost of 10,740 shares and 10,729 shares).......................................... (66) (66)
-----------------------
TOTAL STOCKHOLDERS' EQUITY.................................................................... 81,330 76,226
-----------------------
Commitments and contingencies
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................................................... $210,829 $194,752
=======================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
10
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
---------------------------
For the years ended December 31,
-----------------------------------------------------------------
(IN THOUSANDS, EXCEPT SHARE AMOUNTS) 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK
Balance, beginning of year.................................. $ 1,849 $ 1,559 $ 1,559
Issuance of Common Stock.................................... 82 290 --
--------- --------- ---------
Balance, end of year........................................ 1,931 1,849 1,559
--------- --------- ---------
ADDITIONAL PAID-IN CAPITAL
Balance, beginning of year.................................. 59,491 46,673 46,673
Issuance of Common Stock.................................... 2,958 12,818 --
--------- --------- ---------
Balance, end of year........................................ 62,449 59,491 46,673
--------- --------- ---------
RETAINED EARNINGS
Balance, beginning of year.................................. 17,050 15,795 13,494
Net income ................................................. 1,030 1,030 1,255 $1,255 2,301 $2,301
--------- ------ --------- ------ -------- ------
Balance, end of year........................................ 18,080 17,050 15,795
--------- --------- ---------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Balance, beginning of year.................................. (2,098) (688) 2,260
Net unrealized gain (loss) on available-for-sale securities
($1,034, $(1,410), and $(2,948)pre-tax, in 2000, 1999, and
1998 respectively)(1)..................................... 1,034 (1,410) (2,948)
------ ------ -------
Other comprehensive income (loss)........................... 1,034 1,034 (1,410) (1,410) (2,948) (2,948)
--------- ------ --------- ------ -------- ------
Total comprehensive income (loss)........................... $2,064 $ (155) $ (647)
====== ======= ======
Balance, end of year........................................ (1,064) (2,098) (688)
--------- --------- ---------
TREASURY STOCK
Balance, beginning and end of year.......................... (66) (66) (66)
--------- --------- ---------
Total stockholders' equity.............................. $81,330 $76,226 $63,273
========= ========= =========
- ---------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK, SHARES
Balance, beginning of year.................................. 18,486,994 15,586,994 15,586,994
Issuance of Common Stock.................................... 819,700 2,900,000 --
Exercise of options to purchase Common Stock................ -- -- --
---------- ---------- ----------
Balance, end of year........................................ 19,306,694 18,486,994 15,586,994
========== ========== ==========
TREASURY STOCK, SHARES
Balance, beginning of year.................................. 10,729 10,718 10,707
Purchased during year....................................... 11 11 11
--------- --------- ---------
Balance, end of year........................................ 10,740 10,729 10,718
========== ========== ==========
- ----------
(1) Disclosure of reclassification amount
2000 1999 1998
------- ------- -------
Unrealized holding losses
Arising during the period $(7,731) $(1,258) $(3,200)
Less: reclassification adjustment
for net (gains) losses included
in net income (8,765) 152 (252)
------- ------- -------
Net unrealized losses on securities $ 1,034 $(1,410) $(2,948)
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
11
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31,
---------------------------------------
(IN THOUSANDS) 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Income from continuing operations................................................... $ 1,030 $ 1,255 $ 2,301
Adjustments to reconcile income from continuing operations to
net cash used in operating activities:
Net realized investment (gains) losses.......................................... (8,765) 152 (252)
Depreciation and amortization................................................... 384 654 855
Change in accrued investment income............................................. (283) (72) 579
Change in premiums and fees receivable.......................................... (3,936) (1,647) (4,534)
Change in reinsurance recoverables.............................................. 2,040 1,654 809
Change in reinsurance recoverable on unpaid losses ............................. (5,013) 2,559 1,998
Change in prepaid reinsurance premiums.......................................... (862) (99) 13
Change in deferred acquisition costs............................................ (1,143) (141) (831)
Change in unpaid losses and loss adjustment expenses............................ 5,096 (719) (10,294)
Change in unearned premiums..................................................... 6,968 2,534 3,456
Change in policyholder dividends payable........................................ (450) 633 (230)
Change in reinsurance payables and funds withheld............................... 683 (972) 1,087
Change in receivable on reinsurance treaty rescission........................... 11,459 (11,459) --
Other, net...................................................................... (564) (810) (127)
---------------------------------------
Net cash provided by (used in) operating activities........................... 6,644 (6,478) (5,170)
---------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales:
Fixed income maturities available-for-sale........................................ 16,656 741 3,412
Equity securities................................................................. 26,735 -- 240
Investments, matured or called:
Fixed income maturities available-for-sale........................................ 21,829 29,995 52,338
Investments purchased:
Fixed income maturities available-for-sale........................................ (48,077) (32,255) (28,408)
Equity securities................................................................. (22,462) (560) (19,952)
Purchases of property and equipment................................................. (159) (370) (127)
Proceeds from sale of property and equipment........................................ -- -- 6
---------------------------------------
Net cash (used in) provided by investing activities........................... (5,478) (2,449) 7,509
---------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of Common Stock.............................................. 3,040 13,109 --
---------------------------------------
Net cash provided by financing activities..................................... 3,040 13,109 --
---------------------------------------
Net increase in cash and short term investments....................................... 4,206 4,182 2,339
Cash and short term investments at beginning of year.................................. 8,339 4,157 1,818
---------------------------------------
Cash and short term investments at end of year........................................ $ 12,545 8,339 4,157
=======================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
12
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 2000, 1999, AND 1998
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 Mission American Insurance Company ("MAIC"). MAIC owns 100 percent of
the voting stock of KCP Holding Company ("KCP"). KCP 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 63 percent of its insurance in
California and 12 percent of its business in Montana. For the years ended
December 31, 2000 and 1999, personal lines direct written premiums, representing
28 percent and 36 percent, respectively, of total direct written premiums, were
produced through two general agents of NAICC. For the year ended December 31,
1998, private passenger automobile direct written premiums, representing 44
percent of total direct written premiums, were produced through one general
agent 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. Certian
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 which
are classified as "trading" are bought and held principally for sale 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 $1.2
million and $640,000 at December 31, 2000 and 1999, 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
increase in earned but unbilled premiums reflects the growth in workers'
compensation premium during 2000.
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
13
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 2000, 1999, AND 1998
(CONTINUED)
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, 2000 and 1999, 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 2000, 1999 and 1998 was
$12.2 million, $10.1 million and $9.9 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
2.7 percent, 6.1 percent and 8.8 percent of workers' compensation direct written
premiums for the years ended December 31, 2000, 1999 and 1998, 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, 2000.
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.
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, 16,793,873, and 16,006,708 for
the years ended December 31, 2000, 1999 and 1998, respectively. Basic earnings
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 18,482,980, 16,356,821, and
15,576,281, for the years ended December 31, 2000, 1999, and 1998, 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, 2000. 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
14
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
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. RECLASSIFICATIONS
Certain reclassifications have been made to prior years' amounts to conform
to the current year's presentation.
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. For
risks other than worker's compensation NAICC cedes reinsurance on an excess of
loss basis for risks in excess of $250,000. In 1998, NAICC ceded 25 percent of
its private passenger automobile business on a quota share basis. Effective
January 1, 1999, the quota share agreement was amended to reduce the cessation
rate 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,
------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Direct ........................... $ 80,856 $ 66,375 $ 69,318
Ceded ............................ (7,715) (9,770) (10,438)
------------------------------------------
Net premium ...................... $ 73,141 $ 56,605 $ 58,880
==========================================
In 1997, NAICC paid $5.9 million in losses and loss adjustment expenses
relating to an environmental claim filed by Hughes Aircraft (the
"Hughes-Fullerton Claim"). The Hughes-Fullerton Claim 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 three of those years. The Hughes-Fullerton Claim liability is reinsured
under various contracts involving numerous reinsurance companies under which
NAICC ceded $5.3 million. In 1999 NAICC collected approximately $5.3 million as
settlement on the Hughes-Fullerton Claim from almost all participants.
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, NAICC collected approximately $2.7 million
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. 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, 2000, 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, 2000, NAICC had reinsurance recoverables
on paid and unpaid claims of $12.3 million and $2.3 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.
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.
15
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 2000, 1999, AND 1998
(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,
--------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Net unpaid losses and
LAE at January 1 .................... $ 79,306 $ 77,466 $ 85,762
Incurred related to:
Current year ........................ 55,269 43,301 39,131
Prior years ......................... 5,254 2,491 --
--------------------------------------
Total incurred ........................ 60,523 45,792 39,131
--------------------------------------
Paid related to:
Current year ........................ (26,147) (16,527) (16,169)
Prior years ......................... (34,293) (27,425) (31,258)
--------------------------------------
Total paid ............................ (60,440) (43,952) (47,427)
--------------------------------------
Net unpaid losses and
LAE at December 31 .................. 79,389 79,306 77,466
Plus: reinsurance
recoverables ........................ 20,641 15,628 18,187
--------------------------------------
Gross unpaid losses and
LAE at December 31 .................. $100,030 $ 94,934 $ 95,653
======================================
The losses and LAE incurred during 2000 related to prior years is
attributable to development 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 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, 2000 and
1999, NAICC's net unpaid losses and LAE relating to environmental claims were
approximately $7.6 million and $8.3 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
"Insurance Department"). Prescribed statutory accounting practices include a
variety of publications of the National Association of Insurance Commissioners
(the "Associ-
16
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
ation"), 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,
2000 and 1999, DHC's operating insurance subsidiaries had statutory capital and
surplus of $50.4 million and $52.5 million, respectively. The combined statutory
net income for DHC's operating insurance subsidiaries, as reported to the
regulatory authorities for the years ended December 31, 2000, 1999 and 1998,
was $0.6 million, $2.5 million and $3.5 million, respectively. The California
Department of Insurance 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 Montana Department
of Insurance has completed its examination of the statuatory 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") shall
be 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 codificaion is expected to be the foundation of a state's
statutory accounting practice, it may be subject to modification by practices
presented 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 adoption of the
codification does not have a material effect on the statutory capital of its
insurance subsidiaries.
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. The overall limit of dividends that can be
paid during 2001 is aproximately $3.6 million as long as there is sufficient
accumulated surplus to pay such.
5) INVESTMENTS
The cost or amortized cost, unrealized gains, unrealized losses and fair
value of the Company's investments at December 31, 2000 and 1999, categorized by
type of security, were as follows (dollars in thousands):
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
======== ====== ====== ========
December 31, 1999
--------------------------------------------
Cost or
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
- --------------------------------------------------------------------------------
Fixed maturities:
U.S. Government/
Agency ......................... $ 25,755 $ 100 $ 655 $ 25,200
Mortgage-backed ................ 40,189 67 1,336 38,920
Asset-backed ................... 9,512 -- 8 9,504
Corporate ...................... 38,185 48 1,016 37,217
-------- ------ ------ --------
Total fixed
maturities ............... 113,641 215 3,015 110,841
-------- ------ ------ --------
Equity securities ................ 20,614 1,847 1,145 21,316
-------- ------ ------ --------
Total available-for-sale ......... $134,255 $2,062 $4,160 $132,157
======== ====== ====== ========
Fixed maturities of the Company include mortgage-backed securities ("MBS")
representing 30.5 percent and 35.1 percent of the Company's total fixed
maturities at December 31, 2000 and 1999, respectively. All MBS held by the
Company are issued by the Federal National Mortgage Association ("Fannie
17
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 2000, 1999 AND 1998
(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 maturities, by amortized cost and fair
value, at December 31, 2000, 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 ................................. $ 19,740 $ 19,778
Over one year to five years ...................... 74,757 75,601
Over five years to ten years ..................... 26,561 25,365
More than ten years .............................. 2,609 2,469
------------------------
Total fixed maturities ......................... $123,667 $123,213
========================
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,
--------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Fixed maturities $ 2,346 $(5,352) $ 742
Equity securities (1,312) 3,942 (3,690)
--------------------------------
$ 1,034 (1,410) $(2,948)
================================
Net realized investment gains (losses) in 2000, 1999, and 1998 were as
follows (dollars in thousands):
For the years ended
December 31,
---------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Fixed maturities ................................ $ 43 $ 3 $ 198
Equity securities ............................... 8,722 (155) 54
---------------------------
Net realized investment gains (losses) ......... $8,765 $(152) $252
===========================
Gross realized gains relating to fixed maturities were $60,000, $3,000 and
$213,000 for the years ended December 31, 2000, 1999 and 1998, respectively.
Gross realized losses relating to fixed maturities were $17,000 and $15,000 for
the years ended December 31, 2000 and 1998, respectively. Gross realized gains
relating to equity securities were $8,734,000 and $54,000 for the years ended
December 31, 2000 and 1998, respectively. Gross realized losses relating to
equity securities were $12,000 and $155,000 for the years ended December 31,
2000 and 1999, respectively.
Net investment income for the past three years was as follows (dollars in
thousands):
For the years ended
December 31,
--------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Fixed maturities ........................... $8,621 $7,454 $8,032
Short term investments ..................... 717 363 279
Other, net ................................. 119 61 2
--------------------------------
Total investment income .................. 9,457 7,878 8,313
Less: Investment expense ................... 131 101 139
--------------------------------
Net investment income .................... $9,326 $7,777 $8,174
================================
There were no investments with a carrying value greater than ten percent of
stockholders' equity as of December 31, 2000, 1999, or 1998.
In compliance with state insurance laws and regulations, securities with a
fair value of approximately $44 million, $41 million and $51 million at December
31, 2000, 1999, and 1998, respectively, were on deposit with various states or
governmental regulatory authorities. In addition, at December 31, 2000, 1999,
and 1998, respectively, investments with a fair value of $6.5 million, $6.6
million and $6.9 million were held in trust or as collateral under the terms of
certain reinsurance treaties and letters of credit.
18
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
as of December 31, 2000 and 1999 was $1.1 million and $2 million, respectively.
Foreign currency translation gain as of December 31, 1998 was $855,050, net of
an unrealized loss on the foreign currency option for 1998 of $150,000.
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 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.
As of December 31, 2000, there were 19,306,694 shares of Common Stock
issued of which 19,295,954 were outstanding; the remaining 10,740 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 2000, the Company had a consolidated net operating loss
carryforward of approximately $899 million for Federal income tax purposes. This
estimate is based upon Federal consolidated income tax losses for the periods
through December 31, 1999 and an estimate of 2000 taxable results. The net
operating loss carryforward will expire in various amounts, if not used, between
2001 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 exceeds its
deferred 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
-------------------------------------------------------------
2001......................153,397
2002......................139,613
2003...................... 60,849
2004...................... 69,947
2005......................106,225
2006...................... 92,355
19
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 2000, 1999, AND 1998
(CONTINUED)
2007......................89,790
2008......................31,688
2009......................39,689
2010......................23,600
2011......................19,755
2012......................38,255
2019......................33,636
----------
$898,799
==========
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,
-------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Federal income tax ........................... $ -- $ -- $ --
State and other .............................. 134 41 10
-------------------------------
$134 $ 41 $ 10
===============================
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 2000, 1999 and 1998, as compared to the provision for income
taxes (dollars in thousands):
For the years ended
December 31,
-----------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
Computed "expected"
tax expense...................... $ 396 $ 462 $ 794
Change in valuation allowance ..... (89,394) (56,837) (12,573)
Decrease (increase) in losses
from the trusts.................. 30,303 (13,289) 7,125
Expiring NOL....................... 60,209 69,315 4,944
State and other tax expense........ 134 41 10
Other, net......................... (1,514) 349 (290)
-----------------------------------------
Total income tax expense........... $ 134 $ 41 $ 10
=========================================
The tax effects of temporary differences that give rise to the deferred tax
assets and liabilities at December 31, 2000 and 1999, respectively, are
presented as follows (dollars in thousands):
For the years ended
December 31,
------------------------
2000 1999
- -------------------------------------------------------------------------------
Deferred tax assets
Loss reserve discounting ......................... $ 5,347 $ 5,032
Unearned premiums ................................ 1,605 984
Net operating loss
carryforwards .................................. 305,592 395,800
Allowance for doubtful
accounts ....................................... 200 93
Policyholder dividends ........................... 124 277
Unrealized loss on available-
for-sale securities ............................ 72 713
Capital loss carryforwards ....................... -- 1,463
Other ............................................ 169 164
AMT credit carryforward .......................... 1,986 375
------------------------
Total gross deferred tax asset ................... 315,095 404,901
Less: Valuation allowance ........................ (313,616) (403,649)
------------------------
Total deferred tax asset ......................... $ 1,479 $ 1,252
------------------------
Deferred tax liabilities
Deferred acquisition costs ....................... 1,246 857
Difference in tax basis
of bonds ....................................... 166 127
Difference in tax basis of
property and equipment ......................... 67 268
------------------------
Total deferred tax liability ..................... 1,479 1,252
------------------------
Net deferred tax asset ........................... $ -- $ --
========================
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.
Options under and outside the 1990 Plan would have been granted for, in the
aggregate, the purchase of up to 2,030,000 shares of Common Stock.
On March 13, 1991, options to purchase an aggregate of 630,000 shares were
granted with an exercise price of $3.00 per share, the arithmetic average of the
closing prices of the Common Stock on the American Stock Exchange for the 30
days prior to the date of grant. An additional 630,000 options were granted
outside the 1990 Plan as of that date to Junkyard Partners, L.P. ("Junkyard
Partners"), upon similar terms as those granted on that date under the 1990
Plan. During 1994, Junkyard Partners transferred 257,910 of its 630,000 options
to one of its limited partners. On December 29, 1994, DHC issued 257,910
restricted shares of Common Stock upon the exercise of such transferred options.
In connection therewith, DHC received a total exercise price of $773,730.
Effective May 19, 1995, DHC purchased 69,453 of the remaining 372,090 options
20
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
to purchase Common Stock owned by Junkyard Partners. The options were
exercisable at the time of such purchase and otherwise would have expired on
March 13, 2001. The aggregate purchase price paid by DHC for the options was
approximately $286,500, which was equal to the difference between the closing
price of Common Stock on May 19, 1995 ($7.125 per share), the effective date of
such purchase, and the exercise price of such options ($3.00 per share), or
$4.125 per share. Effective November 12, 1997, DHC purchased 20,920 of the
remaining 302,637 options to purchase Common Stock owned by Junkyard Partners.
The options were exercisable at the time of such purchase and otherwise would
have expired on March 13, 2001. The aggregate purchase price paid by DHC for the
options was $107,215, which was equal to the difference between the closing
price of Common Stock on November 12, 1997 ($8.125 per share), the effective
date of such purchase, and the exercise price of such options ($3.00 per share),
or $5.125 per share.
On September 16, 1991, DHC granted, outside the 1990 Plan, options to
purchase an aggregate of 140,000 shares of Common Stock with an exercise price
of $3.63, the arithmetic average of the closing prices of the Common Stock on
the American Stock Exchange for the thirty days prior to the date of grant. On
this date, 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.
On June 13, 1997, options to purchase 210,000 shares of Common Stock
granted under the 1990 Plan were exercised at their exercise price of $3.00. As
a result, DHC received $630,000.
As of December 31, 2000, 841,717 options granted under and outside the 1990
Plan were exercisable and unexercised. All such options expire ten years after
the date of grant. The Board of Directors has voted to seek shareholder approval
for an extension of 140,000 of these options held by three current directors for
a term of an additional ten years.
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. No incentive stock options
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 aggregate
number of shares of Common Stock which may be issued under the 1995 Plan, or as
to which stock appreciation rights or other awards may be granted, may not
exceed 1,700,000.
On April 25, 1995, options to purchase 40,000 shares were granted under the
1995 Plan. The exercise price for such options is $7.00 per share (the mean of
the high and low prices of the Common Stock on the American Stock Exchange on
the date of grant).
On January 15, 1996, options to purchase an aggregate of 158,900 shares of
Common Stock were granted under the 1995 Plan. The exercise price for such
options is $6.6875 per share (the mean of the high and low prices of the Common
Stock on the American Stock Exchange on the date of grant). In 1997, 22,800 of
such options expired. In 1999, 10,000 of such options expired.
On September 17, 1996, options to purchase an aggregate of 120,000 shares
of Common Stock were granted under the 1995 Plan. The exercise price for such
options is $5.50 per share (the mean of the high and low prices of the Common
Stock on the American Stock Exchange on the date of grant). On September 19,
1996, options to purchase an aggregate of 125,000 shares of Common Stock were
granted under the 1995 Plan. The exercise price for such options is $5.6875 per
share (the mean of the high and low prices of the Common Stock on the American
Stock Exchange on the date of grant). In 1997, 1,500 of such options expired. In
2000, 5,000 of such options expired.
On December 17, 1996, options to purchase an aggregate of 35,000 shares of
Common Stock were granted under the 1995 Plan. The exercise price for all of
such options is $4.9375 per share (the mean of the high and low prices of the
Common Stock on the American Stock Exchange on the date of grant). In 1999,
10,000 of such options expired.
On March 31, 1997, options to purchase 6,100 shares of Common Stock were
exercised at their exercise price of $6.6875. As a result, DHC received $40,794.
On July 1, 1997, options to purchase an aggregate amount of 10,000 shares
of Common Stock were granted under the 1995 Plan. The exercise price for such
options is $8.0625 (the mean of the high and low prices of the Common Stock on
the American Stock Exchange on the date of the grant). In 1999, all of such
options expired.
On December 15, 1997, options to purchase an aggregate amount of 155,000
shares of Common Stock were granted under the 1995 Plan. The exercise price for
such options is $7.0625 (the mean of the high and low prices of the Common Stock
on the American Stock Exchange on the date of the grant). In 1999, 7,500 of such
options expired. In 2000, 5,000 of such options expired.
On December 2, 1998, options to purchase an aggregate amount of 167,500
shares of Common Stock were granted under the 1995 Plan. The exercise price for
such options is $3.65625 (the mean of the high and low prices of the Common
21
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 2000, 1999, AND 1998
(CONTINUED)
Stock on the American Stock Exchange on the date of the grant). In 1999, 5,000
of such options expired. In 2000, 10,000 of such options expired.
On December 8, 1999, options to purchase an aggregate amount of 142,500
shares of Common Stock were granted under the 1995 Plan. The exercise price for
such options is $5.3125 (the mean of the high and low prices of the Common Stock
on the American Stock Exchange on the date of the grant). In 2000, 10,000 of
such options expired.
On December 12, 2000, options to purchase an aggregate amount of 192,500
shares of Common Stock were granted under the 1995 plan. The exercise price for
such options is $4.00 (the mean of the high and low prices of the Common Stock
on the American Stock Exchange on the date of the grant). The Board of Directors
has voted to seek shareholder approval and ratification of an amendment to the
plan that will allow an additional grant of options to purchase 40,000 shares of
Common Stock for each qualified outside Director. If that amendment is approved
by shareholders and these grants are ratified, an additional 200,000 options
shall be deemed issued as of December 12, 2000 at an exercise price of $4.00. At
present, these options are not exercisable.
As of December 31, 1999, 731,000 options granted under the 1995 Plan were
exercisable. Options granted under the 1995 Plan generally become exercisable
over three years and expire ten years after the date of grant.
The Company applies APB Opinion 25 and Related Interpretations in
accounting for the Stock Option Plans. Accordingly, no compensation cost has
been recognized. Had compensation cost been determined based on the fair value
at the grant date of the 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):
2000 1999 1998
- --------------------------------------------------------------------------------
Net income
As reported ........................ $ 1,030 $1,255 $2,301
Pro forma .......................... $ 733 987 1,827
Diluted earnings per share
As reported ........................ $ 0.05 $ 0.07 $ 0.14
Pro forma .......................... $ 0.04 0.06 0.11
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 maintains 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 KCP and Subsidiaries 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, 2000 and 1999 were 60,728
and 76,893, respectively.
KCP 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, 2000 and 1999, valued at January 1, 2001 and 2000, respectively (dollars in
thousands):
2000 1999
- -------------------------------------------------------------------------------
Actuarial present value of benefit obligations:
Accumulated benefits obligation,
including vested benefits of $1,482
for 2000 and $1,560 for 1999 ..................... $ 1,766 $ 1,749
========================
Projected benefit obligation ....................... $ 1,769 $ 1,793
Plan assets at fair value .......................... 1,235 1,399
------------------------
Projected benefit obligation in excess
of plan assets ................................... (534) (394)
Unrecognized net loss .............................. 201 76
Unrecognized prior service cost .................... 41 49
Adjustment required to recognize
minimum liability ................................ -- --
------------------------
(Accrued) prepaid pension cost ................... $ (292) $ (269)
========================
22
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
Net pension costs for the years ended December 31, 2000, 1999, and 1998
include the following components:
For the years ended
December 31,
------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
-------
Service cost ................................ $ 250 $ 243 $ 207
Interest cost ............................... 116 112 133
Expected (return) loss on plan assets ....... (25) (101) (128)
Net amortization and deferral ............... (65) 8 8
------------------------------
Net pension cost .......................... $ 276 $ 262 $ 220
==============================
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 7.25 percent for 2000 and 1999 and 7.0 percent for 1998 .
The projected long-term rate of return on assets was 7.5 percent for 2000, 1999
and 1998. The average rate of compensation increase used in determining the
actuarial present value of the projected benefit obligation was 4.5 percent for
2000, 1999 and 1998.
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,
2000 and 1999 (dollars in thousands):
2000 1999
- -------------------------------------------------------------------------------
Reconciliation of Benefit Obligation
Benefit Obligation, beginning of year ............ $ 1,793 $ 1,801
Service Cost ..................................... 250 243
Interest Cost .................................... 116 112
Actuarial (gain) loss ............................ 53 9
Benefits paid .................................... (443) (372)
------------------------
Benefit Obligation, end of year ............... $ 1,769 $ 1,793
========================
Reconciliation of Plan Assets
Plan Assets, beginning of year ................... $ 1,399 $ 1,490
Actual return on plan assets ..................... 25 101
Employer contributions ........................... 254 180
Benefits paid .................................... (443) (372)
------------------------
Plan Assets, end of year ...................... $ 1,235 $ 1,399
========================
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 $281,777, $134,745 and $246,838 in
accrued pension benefit for the years ended December 31, 2000, 1999 and 1998,
respectively.
KCP maintains a 401(k) Plan in which all employees of KCP 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. KCP and subsidiaries 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 1999, 1998 and
1997, the employers' matching obligation to the 401(k) Plan was satisfied
through ESOP shares, cash and forfeitures totaling $146,000, $129,000, and
$156,000, 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, 2000 and 1999 and $1.5 million for the year ended
December 31, 1998. At December 31, 2000, future net minimum operating lease
rental payment commitments were as follows (dollars in thousands):
Years Ending Minimum Operating Lease
December 31, Rental Payments
- --------------------------------------------------------------------------------
2001................................................. $1,396
2002................................................. 1,319
2003................................................. 654
2004................................................. 433
2005 and thereafter.................................. --
------
Total commitments.................................... $3,802
======
23
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 2000, 1999, AND 1998
(CONTINUED)
11) ALLOWANCES
The following table sets forth the activity related to the premiums and
fees receivable at December 31, 2000 and 1999:
2000 1999
--------------------------
Beginning Balance: $ 274,028 $ 135,853
Increase to Allowance Charges to Expenses 726,426 444,244
Increase to Allowance Charges to Other Accounts 24,868 --
Deductions (437,693) (306,069)
--------------------------
Ending Balance $ 587,629 $ 274,028
==========================
The increase in the allowance and related reductions to the allowance
during the year are 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 policies.
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 $1,309,748, $1,193,941 and
$1,168,226, for the years 2000, 1999 and 1998, 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 consideration
paid by DHC in connection with such transaction. Samuel Zell and Willaim 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.
24
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, 2000 and 1999, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 2000.
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
acccepted 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, 2000 and 1999, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2000, in conformity with accounting
principles generally acccepted in the United States of America.
/s/ KPMG LLP
New York, New York
March 7, 2001
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.
25
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
QUARTERLY FINANCIAL DATA
---------------------------
(UNAUDITED)
The following table presents unaudited quarterly financial data for the
years ended December 31, 2000 and 1999. 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
- --------------------------------------------------------------------------------
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)
1999:
Total revenues ....................... $14,585 $14,312 $15,415 $26,846
Net income ........................... 101 266 466 422
Net income per diluted share ......... .01 .01 .03 .02
STOCK MARKET PRICES
---------------------------
Danielson Holding Corporation Common Stock is listed and traded on the
American Stock Exchange (symbol: DHC). On March 21, 2001, there were
approximately 1,361 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.
2000 1999
------------------------------------------------------
HIGH LOW CLOSE High Low Close
------------------------------------------------------
First Quarter.......... 7 3/8 4 3/4 6 3/8 4 5/8 2 7/8 2 7/8
Second Quarter......... 6 1/4 4 5/8 4 7/8 5 3/4 2 7/8 5 3/8
Third Quarter.......... 5 3 7/8 4 2/16 7 1/2 5 1/4 5 5/8
Fourth Quarter......... 4 9/16 3 9/16 4 9/16 6 1/8 4 5/8 5 3/4
------------------------------------------------------
26
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
Harry LeVine
State of California
Department of Insurance
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: Lisa Morris
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