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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
COMMISSION FILE NUMBER 1-6732
Danielson Holding Corporation
(Exact name of registrant as specified in its charter)
Delaware 95-6021257
(State of incorporation) (I.R.S. Employer Identification No.)
767 Third Avenue, New York, New York 10017-2023
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 888-0347
Securities registered pursuant to Section 12 (b) of the Act:
Name of each exchange on
Title of each class which registered
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Common Stock, $0.10 par value .........American Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12 (G) OF THE ACT: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
- -
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
At March 17, 1998, the aggregate market value of the registrant's voting stock
held by non-affiliates was $102,127,519.
Indicate the number of shares outstanding of each of the registrant's classes
of common stock, as of the latest practicable date.
CLASS OUTSTANDING AT MARCH 17, 1998
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Common Stock, $0.10 par value 15,576,287 shares
The following documents have been incorporated by reference herein:
1997 Annual Report to Stockholders, as indicated herein (Parts I and II)
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PART I
ITEM 1. BUSINESS.
INTRODUCTION
Danielson Holding Corporation ("DHC" or "Registrant") is a holding
company incorporated in Delaware, having separate subsidiaries (collectively
with DHC, the "Company") offering a variety of insurance products. It is DHC's
intention to grow by developing business partnerships and making strategic
acquisitions. The largest subsidiary of DHC is its indirectly wholly-owned
California insurance company, National American Insurance Company of California
(together with its subsidiaries, "NAICC"). NAICC writes workers' compensation,
non-standard private passenger and commercial automobile insurance in the
western United States, primarily California.
Until December 31, 1996, DHC also owned a California trust company
subsidiary, Danielson Trust Company ("Danielson Trust"), which formerly was
known, prior to November 13, 1993, as HomeFed Trust. In February 1994,
Danielson Trust acquired the assets of the Western Trust Services division of
Grossmont Bank. On December 31, 1996, DHC consummated the sale of Danielson
Trust to North American Trust Company. See Note 5 of the Notes to Consolidated
Financial Statements.
As part of DHC's ongoing corporate strategy, DHC has continued to seek
acquisition opportunities which will both complement its existing operations and
enable DHC to earn an attractive return on investment. During 1996, DHC entered
into an agreement to acquire, by merger, Midland Financial Group, Inc.
("Midland"). As a result of the crash of TWA Flight 800, in which the
President of DHC, the President of NAICC and the President of Midland were
killed, the proposed merger with Midland was terminated by the mutual consent of
DHC and Midland. See Note 3 of the Notes to Consolidated Financial Statements.
On January 15, 1997, DHC entered into a letter of intent with The
Progressive Corporation ("Progressive") pursuant to which it was proposed that
DHC sell to Progressive 11 million newly issued shares of Common Stock of DHC
for consideration having a value of $6.60 per share. Progressive would then
have owned a 42% interest in DHC. On March 10, 1997, Progressive informed DHC
that, for "internal Progressive reasons", it was terminating its discussions
with DHC.
DHC retained cash and investments at the holding company level of $8.7
million at December 31, 1997. Total liabilities of DHC at the same date were
$400,000.
The Company will report, as of the end of its 1997 tax year, aggregate
consolidated net operating tax loss carryforwards ("NOLs") for Federal income
tax purposes of approximately $1.36 billion. These losses will start to expire
in 1998 unless utilized prior thereto. See Note 11 of the Notes to Consolidated
Financial Statements.
DESCRIPTION OF BUSINESSES
Set forth below is a description of the business operations of the
Company's insurance services business.
DHC's wholly-owned subsidiary, NAICC, is a California corporation engaged
in writing workers' compensation, non-standard private passenger and commercial
automobile insurance in the western states, primarily California. NAICC is a
third tier subsidiary of DHC. NAICC's immediate parent corporation is KCP
Holding Company ("KCP"). KCP is wholly-owned by Mission American Insurance
Company ("MAIC"), which in turn is wholly-owned by DHC.
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General
NAICC began writing non-standard private passenger automobile insurance
in California in July, 1993. NAICC writes this business through a general agent
which uses over 700 sub-agents to obtain applications for policies.
Policyholder selection is governed by underwriting guidelines established by
NAICC. NAICC began writing non-standard commercial automobile insurance in 1995
through independent agents. Non-standard risks are those segments of the
driving public which generally are not considered "preferred" business, such as
drivers with a record of prior accidents or driving violations, drivers involved
in particular occupations or driving certain types of vehicles, or those who
have been non-renewed or declined by another insurance company. Generally, non-
standard premium rates are higher than standard premium rates and policy limits
are lower than typical policy limits. NAICC's management believes that it is
able to achieve underwriting success through refinement of various risk
profiles, thereby dividing the non-standard market into more defined segments
which can be adequately priced.
The majority of automobiles owned or used by businesses are insured under
policies that provide other coverages for the business, such as commercial
multi-peril insurance. Standard insurers, however, often will not cover certain
commercial automobiles because of the claims experience and/or the type of the
business, or the use or the driver of the automobile. Businesses which are
unable to insure a specific driver and businesses having vehicles not qualifying
for commercial multi-peril insurance are typical NAICC commercial automobile
policyholders. Examples of these risks include drivers with more than one
moving violation, one and two vehicle accounts, and specialty haulers, such as
sand and gravel, farm vehicles and certain short-haul common carriers. NAICC's
policies in force typically cover fleets of four or fewer automobiles. NAICC
does not insure long-haul truckers, trucks hauling logs, gasoline or similar
higher hazard operations. The current average annual premium of the policies in
force is approximately $2,200.
Net written premiums were $29.8 million, $14.5 million and $15 million in
1997, 1996 and 1995, respectively, for the non-standard private passenger
automobile program. Until January 1, 1997, NAICC ceded 50 percent of its
private passenger automobile business to a major reinsurance company under a
quota share reinsurance agreement, at which time the agreement was amended to
reduce the ceding percentage to 25 percent. Net written premiums for commercial
automobile were $8.8 million in 1997, $4.8 million in 1996 and $2.1 million in
1995. The increase in private passenger automobile premiums all came from the
California market and was due, in part, to legislation in California requiring
motorists to provide proof of insurance at the time of vehicle registration.
NAICC has increased its production efforts in commercial automobile by adding to
the number of commercial automobile agents in 1997 and increasing the marketing
efforts in each of NAICC's branch offices.
NAICC writes workers' compensation insurance in California and four other
western states. Workers' compensation insurance policies provide coverage for
statutory benefits which employers are required to pay to employees who are
injured in the course of employment including, among other things, temporary or
permanent disability benefits, death benefits, medical and hospital expenses and
expenses for vocational rehabilitation. Policies are issued having a term of no
more than one year. While a substantial portion of NAICC's premium volume had
historically come from California workers' compensation insurance, NAICC's
premium volume in workers' compensation has declined significantly in California
since 1995 when a new "open rating" law replaced the old workers' compensation
"minimum rate" law and fierce price competition immediately followed. Net
written premiums for workers' compensation were $17.2 million, $16.8 million,
and $38.2 million, in 1997, 1996, and 1995, respectively. In response to
developments affecting the market for workers' compensation insurance in
California, NAICC has pursued a strategy of re-deploying its capital either in
other specialty lines of insurance such as non-standard automobile insurance or
in the workers' compensation line in geographic markets believed by NAICC to
have greater potential for profitability than California. In furtherance of its
strategy to write workers' compensation insurance in markets other than
California, in June 1996, NAICC acquired Valor Insurance Company, Incorporated
("Valor"), a Montana-domiciled specialty insurance company that writes workers'
compensation insurance policies.
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NAICC does not write any business through managing general agents. Its
non-standard private passenger automobile, representing 53% of net written
premiums, is produced through one general agent.
UNDERWRITING
Insurers admitted in California are required to obtain approval from the
California Department of Insurance of rates and/or forms prior to being used as
part of an insurance contract in California. Many of the states in which NAICC
does business have similar requirements. Rates and policy forms are developed
and periodically revised by NAICC and filed with the regulators in each of the
relevant states, depending upon each state's requirements. NAICC relies upon
its own and industry experience in establishing rates.
NAICC's private passenger automobile policies provide maximum coverage of
up to $15,000 per person, $30,000 per accident for liability for bodily injury
and $10,000 per accident for liability for property damage. NAICC also writes
physical damage coverages for up to $33,000 per vehicle. The maximum non-
standard commercial automobile policy limit provided by NAICC is $1 million
bodily injury and property damage combined single limit of liability for each
occurrence. During 1995, 1996 and 1997, NAICC retained the first $150,000 bodily
injury and property damage combined single limit of liability for each
occurrence, with losses in excess of $150,000, per occurrence, being ceded to
its reinsurers. NAICC increased its retention to $250,000 effective January 1,
1998.
Workers' compensation rates, rating plans, policyholder dividend plans
and policy forms are developed and filed by NAICC's underwriting personnel with
the appropriate regulatory agency in each state in which NAICC operates. NAICC
relies principally upon rates promulgated by either the Workers' Compensation
Insurance Rating Bureau or the National Council on Compensation Insurance, the
statistical agent for other western states in which NAICC markets insurance.
NAICC maintains a disciplined approach to risk selection and pricing. In
accordance with this policy, NAICC selects each prospective policyholder based
on the characteristics of such risk and establishes premiums based on loss
experience and risk exposure. NAICC's pricing policy is not driven by market
share considerations.
NAICC retains the first $500,000 of each workers' compensation loss and
has purchased reinsurance for up to $49.5 million in excess of its retention,
the first $9.5 million of which is placed with a major reinsurance company and
the remaining $40 million of which is provided by 16 other companies.
MARKETING
NAICC maintains five new business production offices located in Portland,
Oregon, Phoenix, Arizona and San Francisco, Fresno, and Long Beach, California.
The marketing and underwriting employees at these offices solicit and underwrite
only new applications produced by independent agents. NAICC believes that its
local presence allows it to better serve policyholders and independent agents.
All other functions of policyholder service, renewal underwriting, policy
issuance, premium collection and record retention are performed centrally at
NAICC's home office in Long Beach, California.
NAICC currently markets its non-standard private passenger automobile
insurance in California through one general agent. Beginning in 1998, NAICC
will market non-standard private passenger automobile insurance directly through
independent agents in Oregon and Washington. NAICC has also begun a preferred
private passenger automobile program in California in 1998 which will be
marketed through another general agent. NAICC markets non-standard commercial
automobile insurance through approximately 600 independent agents located in
Arizona, California, Idaho, Nevada, Oregon, Utah and Washington.
NAICC writes workers' compensation insurance primarily in the states of
California, Oregon, Arizona and Idaho through approximately 650 independent
property and casualty insurance agents and brokers. The agency contracts
provide authority to bind coverage within detailed underwriting guidelines set
by NAICC. Valor markets workers' compensation insurance to Montana employers.
All business is produced and serviced through its home office in Billings,
Montana. NAICC targets employers having operations that are classified
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as low to moderate hazard and that generally have payrolls under $1 million.
Typically, annual premium for employers in this payroll category are less than
$25,000. Valor writes workers' compensation for employers of a wide range of
hazard classifications, from banks to construction businesses, and targets the
larger employers in the state of Montana.
CLAIMS
All automobile claims are handled by employees of NAICC at its home
office in Long Beach, California. Claims are reported by agents, insureds and
claimants directly to NAICC. Claims involving suspected fraud are referred to an
in-house special investigation unit ("SIU") adjuster who manages a detailed
investigation of these claims using outside investigative firms. When evidence
of fraudulent activity is identified, the SIU adjuster works with the various
state departments of insurance, the National Insurance Crime Bureau and local
law enforcement agencies in handling the claims.
Workers' compensation claims are received, reviewed, processed and paid
by NAICC employees located in claims service offices in Portland, Oregon and
Long Beach, California. Most of NAICC's policyholders are not of sufficient
size or type to make a more specialized managed care approach to medical cost
containment more cost effective.
The California Automobile Assigned Risk Plan provides state mandated
minimum levels of automobile liability coverage to drivers whose driving
records, or other relevant characteristics, make it difficult for them to obtain
insurance in the voluntary market. NAICC does not expect to receive a material
number of assignments arising from its non-standard private passenger automobile
business and does not believe that the assignments will have a material adverse
effect upon the profitability of this line of business.
Losses and Loss Adjustment Expenses
NAICC's unpaid losses and loss adjustment expenses ("LAE") represent the
estimated indemnity cost and loss adjustment expenses necessary to cover the
ultimate net cost of investigating and settling claims. Such estimates are
based upon estimates for reported losses, historical company experience of
losses reported by reinsured companies for insurance assumed, and actuarial
estimates based upon historical company and industry experience for development
of reported and unreported claims (incurred but not reported). Any changes in
estimates of ultimate liability are reflected in current operating results.
Inflation is assumed, along with other factors, in estimating future claim costs
and related liabilities. NAICC does not discount any of its loss reserves.
The ultimate cost of claims is difficult to predict for several reasons.
Claims may not be reported until many years after they are incurred. Changes in
the rate of inflation and the legal environment have created forecasting
complications. Court decisions may dramatically increase liability in the time
between the dates on which a claim is reported and its resolution. Punitive
damages awards have grown in frequency and magnitude. The courts have imposed
increasing obligations on insurance companies to defend policyholders. As a
result, the frequency and severity of claims have grown rapidly and
unpredictably.
NAICC has claims for environmental clean-up against policies issued prior
to 1980 and which are currently in run-off. The principal exposure arises from
direct excess and primary policies of business in run-off, the obligations of
which were assumed by NAICC in 1985. These direct excess and primary claims are
relatively few in number and have policy limits of between $50,000 and
$1,000,000, with reinsurance generally above $50,000. NAICC also has
environmental claims arising associated with participations in excess of loss
reinsurance contracts assumed by NAICC. These reinsurance contracts have
relatively low limits, generally less than $25,000, and estimates of unpaid
losses are based on information provided by the primary insurance company.
The unpaid losses and LAE related to environmental clean-up is
established based upon facts currently known and the current state of the law
and coverage litigation. Liabilities are estimated for known claims
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(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
bulk 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
exposure exists in excess of amounts which are currently recorded which could be
material. However, management does not expect that liabilities associated with
these types of claims will result in a material adverse effect on future
liquidity or financial position. Liabilities such as these are based upon
estimates and there can be no assurance that the ultimate liability will not
exceed, or even materially exceed, such estimates.
NAICC is involved in litigation related to certain environmental claims
which have some significant uncertainties. Such uncertainties include
difficulties in predicting the outcome of judicial decisions as case law evolves
regarding liability exposure, insurance coverage and interpretation of policy
language with respect to environmental claims. While the outcome of such
litigation cannot be determined at this time, such litigation, net of
liabilities established therefor and giving effect to reinsurance, is not
expected to have a material adverse effect on the future liquidity or financial
position of NAICC. As of December 31, 1997 and 1996, NAICC's net unpaid losses
and LAE relating to environmental claims were approximately $10.9 million and
$13.4 million, respectively.
Due to the factors discussed above and others, the process used in
estimating unpaid losses and loss adjustment expenses cannot provide an exact
result. Management believes that the provisions for unpaid losses and loss
adjustment expenses are adequate to cover the net cost of losses and loss
expenses incurred to date; however, such liability is necessarily based on
estimates and there can be no assurance that the ultimate liability will not
exceed, or even materially exceed, such estimates.
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ANALYSIS OF LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of NAICC's unpaid losses
and LAE (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
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1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net unpaid losses and LAE at January 1 $ 97,105 $116,294 $128,625
Net unpaid losses acquired with Valor
Insurance Company - 403 -
-------- -------- --------
97,105 116,697 128,625
Incurred related to:
Current year 37,142 26,979 45,592
Prior years 940 10,120 3,123
-------- -------- --------
Total incurred 38,082 37,099 48,715
-------- -------- --------
Paid Related to:
Current year (13,729) (10,559) (14,464)
Prior years (35,696) (46,132) (46,582)
-------- -------- --------
Total paid (49,425) (56,691) (61,046)
-------- -------- --------
Net unpaid losses and LAE at
December 31 $ 85,762 $ 97,105 $116,294
Plus: reinsurance recoverables 20,185 23,546 21,112
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Gross unpaid losses and LAE at
December 31 $105,947 $120,651 $137,406
======== ======== ========
</TABLE>
The losses and LAE incurred related to prior years is attributable to claims
from businesses which are in run-off. In 1996, management of NAICC strengthened
the unpaid losses and allocated loss adjustment expenses ("ALAE") of pre-1980
businesses assumed by NAICC in 1985 and which are in run-off. NAICC increased
these run-off claim liabilities by $10 million. The pre-1980 run-off
liabilities include claims relating to environmental clean-up for policies
issued prior to 1970. NAICC increased its bulk unpaid liabilities related to
these claims, principally the unpaid ALAE, as it had become evident that the
legal costs associated with these claims would be significantly greater than
previously anticipated.
The following table indicates the manner in which unpaid losses and LAE at the
end of a particular year change as time passes. The first line reflects the
liability as originally reported, net of reinsurance, at the end of the stated
year. Each calendar year-end liability includes the estimated liability for
that accident year and all prior accident years comprising that liability. The
second section shows the original recorded net liability as of the end of
successive years adjusted to reflect facts and circumstance which are later
discovered. The next line, cumulative (deficiency) or redundancy, compares the
adjusted net liability amount to the net liability amount as originally
established and reflects whether the net liability as originally recorded was
adequate to cover the estimated cost of claims or redundant. The third section
reflects the cumulative amounts related to that liability that were paid, net of
reinsurance, as of the end of successive years.
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<TABLE>
<CAPTION>
Analysis of Net Losses and Loss Adjustment Expense ("LAE") Development (dollars in thousands):
Years Ended December 31,
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1988 1989 1990 1991 1992 1993 1994
---------- --------- --------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Net unpaid losses and LAE at end of year $115,858 $ 95,272 $ 91,870 $ 97,810 $104,825 $119,223 $128,625
Net unpaid losses and LAE re-estimated as of:
One year later 120,527 100,599 92,632 94,364 105,568 119,607 131,748
Two years later 124,167 100,143 87,504 99,875 111,063 123,039 141,602
Three years later 121,081 94,954 89,844 107,945 117,756 136,735 141,787
Four years later 116,384 96,948 95,576 116,018 138,877 140,076
Five years later 118,175 101,537 102,081 136,269 142,423
Six years later 122,784 107,344 119,107 139,493
Seven years later 128,589 122,985 121,161
Eight Years later 143,585 124,749
Nine Years later 145,093
Cumulative (deficiency) redundancy (29,235) (29,477) (29,291) (41,683) (37,598) (20,853) (13,162)
Cumulative net amounts paid as of:
One year later 41,767 38,165 31,162 39,131 39,650 42,264 46,582
Two years later 72,735 56,876 53,424 63,483 68,025 71,702 80,515
Three years later 86,142 71,543 66,198 81,485 88,038 95,525 101,726
Four years later 96,352 78,991 75,963 94,238 106,431 110,163
Five years later 102,385 84,980 83,704 108,923 118,136
Six years later 107,661 90,458 95,199 118,397
Seven years later 112,555 100,559 102,886
Eight years later 121,724 107,630
Nine years later 128,313
<CAPTION>
Years Ended December 31,
---------------------------------
1995 1996 1997
---------- --------- --------
<S> <C> <C> <C>
Net unpaid losses and LAE at end of year $116,294 $97,105 $85,762
Net unpaid losses and LAE re-estimated as of:
One year later 126,414 98,045
Two years later 126,796
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight Years later
Nine Years later
Cumulative (deficiency) redundancy (10,502) (940)
Cumulative net amounts paid as of:
One year later 46,132 35,696
Two years later 74,543
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
</TABLE>
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The following table reflects the same information as the preceding table gross
of reinsurance (dollars in thousands):
<TABLE>
<CAPTION>
Years ended December 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Gross unpaid losses and LAE at end of year: $105,947 $120,651 $137,406 $146,330 $137,479
Gross unpaid losses and LAE re-estimated as of:
One year later 121,787 149,416 149,815 137,898
Two years later 150,106 161,731 141,737
Three years later 162,246 158,263
Four years later 162,697
Gross cumulative deficiency: (1,136) (12,700) (15,916) (25,218)
Gross cumulative amount paid as of:
One year later 47,835 54,901 53,798 53,634
Two years later 92,422 92,991 88,930
Three years later 122,095 116,605
Four years later 138,924
</TABLE>
The cumulative deficiency as of December 31, 1995 on a net basis of $10.5
million is due to the strengthening of the unpaid losses and ALAE of pre-1980
businesses assumed by NAICC in 1985 and which are in run-off. NAICC increased
these run-off claim liabilities in 1996 by $10 million. The pre-1980 run-off
liabilities include claims relating to environmental clean-up for policies
issued prior to 1970.
The cumulative deficiency on a net basis of $37.6 million and $41.7 million
as of December 31, 1992 and 1991, respectively, is also attributable to adverse
development of workers' compensation loss experience in the 1990 and 1991 loss
years. The California workers' compensation industry, including NAICC,
experienced adverse development of those loss years. The adverse development
was the result of a significant increase in frequency in workers' compensation
claims that was brought on by a downturn in the California economy, an increase
in unemployment and a dramatic increase in stress and post-termination claims.
The adverse development in 1990 and 1991 was significantly offset by favorable
workers' compensation loss experience and development in the 1992, 1993 and 1994
loss years.
Conditions and trends that have affected the development of these liabilities
in the past may not necessarily recur in the future. It would not be
appropriate to use this cumulative history in the projection of future
performance.
The table above would ordinarily present a ten year development of unpaid
losses and LAE, however, the loss and LAE data of NAICC relating to periods
prior to 1988 are not comparable to such data for periods subsequent to 1988.
In 1988, NAICC assumed the unpaid policyholder liabilities of MAIC for accident
years 1985, 1986 and 1987. The data subsequent to 1987 necessary to update the
unpaid losses and LAE of NAICC as of December 31, 1987 and prior includes loss
and LAE data relating to MAIC which is not reflected in the December 31, 1987
unpaid losses and LAE of NAICC and such data cannot be segregated because of the
assumption of those 1985, 1986 and 1987 accident year liabilities in 1988. The
1988 assumption of the policyholder liabilities of MAIC was the last of a series
of significant events and transactions which resulted in, among other things,
the acquisition by DHC of a majority ownership interest in NAICC, a change in
the management of NAICC and a material change in the business and operations of
NAICC. As a result of these material changes affecting NAICC, the table above,
reflecting information commencing in 1988, provides the most meaningful and
relevant historical analysis possible of unpaid losses and LAE of NAICC.
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Although NAICC continues to receive claims related to 1988 and earlier, the
liability recorded represents the best estimate by NAICC's management of the
liability for currently foreseeable claims. As stated above, the losses and
loss adjustment expenses reflected in the tables above are reduced both for
amounts ceded to other insurers and for other recoveries.
CEDED REINSURANCE AND REINSURANCE WITH AFFILIATES
In its normal course of business in accordance with industry practice, NAICC
reinsures a portion of its exposure with other insurance companies so as to
effectively limit its maximum loss arising out of any one occurrence. Contracts
of reinsurance do not legally discharge the original insurer from its primary
liability. Estimated reinsurance receivables arising from these contracts of
reinsurance are, in accordance with generally accepted accounting principles,
reported separately as assets. Premiums for reinsurance ceded by NAICC in 1997
were 16.4 percent of written premiums.
As of December 31, 1997, General Reinsurance Corporation (GRC), American
Reinsurance Company (ARC), and Lloyd's of London (Lloyd's) 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, 1997, NAICC
had reinsurance recoverables on paid and unpaid claims of $6.3 million , $7.4
million, and $9.3 million from GRC, ARC, and Lloyd's respectively. GRC and ARC
had an A.M. Best rating of A++ and A+, respectively. The paid and unpaid
recoverable amounts ceded to Lloyd's relate to business in run-off and assumed
by NAICC. NAICC believes that Equitas has authority to respond on behalf of all
of the syndicates underlying the reinsurance contracts with Lloyd's. See Note 6
of the Notes to Consolidated Financial Statements for further information on
reinsurance.
NAICC and two of its subsidiaries participate in an inter-company pooling and
reinsurance agreement under which Danielson Insurance Company ("DICO") and
Danielson National Insurance Company ("DNIC") cede 100% of their net liability,
defined to include premiums, losses and allocated loss adjustment expenses, to
NAICC to be combined with the net liability for policies of NAICC in formation
of a "Pool". NAICC simultaneously cedes to DICO and DNIC 10% of the net
liability of the Pool. DNIC commenced participation in July, 1993 and DICO
commenced participation in January, 1994. Additionally, both DICO and DNIC
reimburse NAICC for executive services, professional services, and
administrative expenses based on designated percentages of net premiums written
for each line of business.
REGULATION
Insurance companies are subject to insurance laws and regulations established
by the states in which they transact business. The agencies established
pursuant to these state laws have broad administrative and supervisory powers
relating to the granting and revocation of licenses to transact 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,
capital and surplus requirements and the maximum concentrations of certain
classes of investments. Most states also have enacted legislation regulating
insurance holding company systems, including acquisitions, extraordinary
dividends, the terms of affiliate transactions and other related matters. The
Company and its insurance subsidiaries have registered as holding company
systems pursuant to such legislation in California and routinely report to other
jurisdictions. The National Association of Insurance Commissioners has formed
committees and appointed advisory groups to study and formulate regulatory
proposals on such diverse issues as the use of surplus debentures, accounting
for reinsurance transactions and the adoption of risk-based capital
requirements. It is not possible to predict the impact of future state and
federal regulation on the operations of the Company or its insurance
subsidiaries.
NAICC is an insurance company domiciled in the State of California and is
regulated by the California Department of Insurance for the benefit of
policyholders. The California Insurance Code does not permit the
-10-
<PAGE>
payment of shareholder dividends that exceed the greater of net income or 10% of
statutory surplus and such dividends can only be paid out of accumulated earned
surplus without prior approval from the Insurance Commissioner. To the extent
that NAICC's unassigned surplus remains negative in 1998, NAICC will not be
permitted to pay dividends without prior regulatory approval.
CAPITAL ADEQUACY AND RISK-BASED CAPITAL
Several measures of capital adequacy are common in the property-casualty
industry. The two most often used are (a) premiums-to-surplus (which measures
pressure on capital from inadequate pricing), and (b) reserves-to-surplus (which
measures pressure on capital from inadequate loss and loss adjustment expense
reserves). A commonly accepted maximum premiums-to-surplus ratio is 3 to 1;
commonly accepted reserves-to-surplus ratios range from 3-5 to 1.
The following table shows the consolidated premiums-to-surplus and reserves-to-
surplus ratios of NAICC (on a statutory basis):
Years Ended December 31,
------------------------
1997 1996 1995
------- ------- ------
Ratio of:
Premiums-to-surplus 1.2:1 .9:1 1.2:1
Reserves-to-surplus 1.9:1 2.1:1 2.6:1
Given the foregoing relatively conservative financial security ratios,
NAICC's management believes that existing capital is adequate to support higher
than industry average premium growth for the foreseeable future.
A model for determining the risk-based capital ("RBC) requirements for
property and casualty insurance companies was adopted in December 1993.
Insurance companies are required to report their RBC ratios based on their 1994
annual statements. NAICC has calculated its RBC requirement under the most
recent RBC model and it has sufficient capital in excess of any regulatory
action level. The Company believes that RBC is the most appropriate indicator
of potential regulatory oversight.
The RBC model sets forth four levels of increasing regulatory
intervention: (1) Company Action Level (200% of an insurer's Authorized Control
Level) at which the insurer must submit to the regulator a plan for increasing
such insurer's capital; (2) Regulatory Action Level (150% of an insurer's
Authorized Control Level), at which the insurer must submit a plan for
increasing its capital to the regulator and the regulator may issue corrective
orders; (3) Authorized Control Level (a multi-step calculation based upon
information derived from an insurer's most recent filed statutory annual
statement), at which the regulator may take action to rehabilitate or liquidate
the insurer; and (4) Mandatory Control Level (70% of an insurer's Authorized
Control Level), at which the regulator must rehabilitate or liquidate the
insurer.
At December 31, 1997, the RBC of NAICC was 264% greater than the
Company Action Level. NAICC currently has no plans to take any action designed
to affect its RBC level.
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<PAGE>
HOLDING COMPANY BUSINESS
DHC is a holding company incorporated under the General Corporation Law of
the State of Delaware. As of December 31, 1997, DHC had the following material
assets and no material liabilities:
(i) ownership of its MAIC subsidiary, an insurance holding company that
owns, directly or indirectly, all of the stock of NAICC, DNIC, DICO,
Valor, and two licensed insurance subsidiaries which are expected to
commence writing insurance lines in the future; and
(ii) approximately $8.7 million in cash and investments.
FORMER TRUST BUSINESS
In March 1993, DHC acquired all of the common stock of Danielson Trust
(which was known as HomeFed Trust until November 13, 1993), a trust company
chartered by the California State Banking Department to provide trust and
fiduciary services and located in San Diego, California. In February 1994,
Danielson Trust acquired the assets of the Western Trust Services division of
Grossmont Bank. On January 31, 1996, following approval of the California State
Banking Department, Danielson Trust sold substantially all of the fiduciary
accounts administered by its Santa Barbara branch to The Bank of Montecito. In
connection with the sale, in January 1996, Danielson Trust recognized a gain of
$32,874.
Danielson Trust's business consisted of providing trust and investment
services to individuals, not-for-profit corporations and retirement service
clients, including its affiliates. In addition, since 1994 Danielson Trust
provided custodial services for certificates of deposit to affiliated and
unaffiliated broker-dealers, as well as other custodial services to an
affiliated mutual fund.
On December 31, 1996, DHC consummated the sale of Danielson Trust to North
American Trust Company for $3 million in cash and recognized a loss of $1.2
million on disposal.
TAX LOSS CARRYFORWARD
As of December 31, 1997, the Company had a consolidated net operating loss
carryforward of approximately $1.36 billion for Federal income tax purposes.
This number is based upon Federal consolidated income tax losses for the periods
through December 31, 1996 and an estimate of the 1997 taxable loss. Some or all
of the carryforward may be available to offset, for Federal income tax purposes,
the future taxable income, if any, of DHC and its wholly-owned subsidiaries.
The Internal Revenue Service ("IRS") may attempt to challenge the amount of this
net operating loss in the event of a future tax audit. Management believes,
based in part upon the views of its tax advisors, that its net operating loss
calculations are reasonable and that it is reasonable to conclude that the
Company's net operating losses would be available for use by the Company. These
tax loss attributes are currently fully reserved, for valuation purposes, on the
Company's financial statements. The amount of the deferred asset considered
realizable could be increased in the near term if estimates of future taxable
income during the carryforward period are increased.
The Company's net operating tax loss carryforwards will expire, if not
used, in the following approximate amounts in the following years (dollars in
thousands):
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<PAGE>
Year Ending Amount of Carryforwards
December 31, Expiring
------------ -----------------------
1998 $ 33,328
1999 203,868
2000 253,098
2001 155,806
2002 142,982
2003 60,849
2004 69,947
2005 106,225
2006 92,355
2007 89,790
2008 31,688
2009 39,689
2010 23,600
2011 19,755
2012 38,799
The Company's ability to utilize its net operating tax loss
carryforwards would be substantially reduced if DHC were to undergo an
"ownership change" within the meaning of Section 382(g)(1) of the Internal
Revenue Code. In an effort to reduce the risk of an ownership change, DHC has
imposed restrictions on the ability of holders of five percent or more of common
stock of DHC, par value $0.10 per share ("Common Stock") to transfer the Common
Stock owned by them and to acquire additional Common Stock, as well as the
ability of others to become five percent stockholders as a result of transfers
of Common Stock. Notwithstanding such transfer restrictions, there could be
circumstances under which an issuance by DHC of a significant number of new
shares of Common Stock or other new class of equity security having certain
characteristics (for example, the right to vote or to convert into Common Stock)
might result in an ownership change under the Internal Revenue Code. See Note
10 of the Notes to the Consolidated Financial Statements for a description of
certain restrictions on the transfer of Common Stock.
DHC'S BUSINESS PLAN AND DEVELOPMENT
DHC's business plan is to grow by developing business partnerships and
making strategic acquisitions that are expected to contribute higher than
average returns for our stockholders. On February 26, 1996, DHC entered into a
merger agreement pursuant to which DHC would have acquired all of the
outstanding stock of Midland in a merger transaction. As described earlier, the
proposed merger was terminated in July, 1996 due to the loss of several key
executives in the crash of TWA Flight 800.
On January 15, 1997, DHC entered into a letter of intent with
Progressive pursuant to which it was proposed that DHC sell to Progressive 11
million newly issued shares of Common Stock of DHC for consideration having a
value of $6.60 per share. Progressive would then have owned a 42% interest in
DHC. On March 10, 1997, Progressive informed DHC that, for "internal
Progressive reasons", it was terminating its discussions with DHC.
YEAR 2000 COMPLIANCE
The Company has reviewed its information systems hardware and software
operations and applications in relation to "year 2000". The Company believes
that its hardware and operating system software are year 2000 compliant. NAICC
believes that it has identified substantially all of the application software
programs which require modification in order to become year 2000 compliant and
has a formal plan to correct and test the programs affected by the conversion of
a two-digit year to a four-digit year. NAICC expects the early phases of the
project to be completed during the middle of 1998. The final phases of the
project are
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<PAGE>
scheduled to be completed by December 31, 1998. The review of systems also
included the identification of vendors that may have a significant impact on the
Company's operations and their expected completion of any conversions.
The Company believes that its information systems operations and those
of its significant vendors are or will become year 2000 compliant such that
there should not be any material adverse impact on the Company's financial
condition or results of operations. However, ensuring that all of the Company's
software is in fact year 2000 compliant is a difficult and time consuming task.
Problems may arise in updating the software that are currently unforeseen by
management. In addition, the Company is not in a position to ensure that all of
its significant vendors in fact become year 2000 compliant and is relying on
information received from those vendors as to their year 2000 compliance. The
Company currently estimates the costs to be incurred prior to December 31, 1999
are approximately $200,000 to complete all programming changes, related testing,
and implementation. There can be no assurance, however, that those costs will
not be significantly higher or that an unforeseen failure by the Company or any
of its vendors to become year 2000 compliant will not have a material adverse
effect on the Company's business.
STATEMENT CONCERNING FORWARD-LOOKING INFORMATION
This Item 1 to the Report on Form 10-K, together with Items 2, 3, 7,
and 8, contain forward-looking statements, including statements concerning
plans, capital adequacy, adequacy of reserves, utilization of tax losses, goals,
future events or performance and underlying assumptions and other statements
which are other than statements of historical facts. Such forward-looking
statements may be identified, without limitation, by the use of the words
"believes", "anticipates", "expects", "intends", "plans" and other similar
expressions. All such statements represent only current estimates or
expectations as to future results and are subject to risks and uncertainties
which could cause actual results to materially differ from current estimates or
expectations. See "RISK FACTORS THAT MAY AFFECT FUTURE RESULTS" in Item 7 for
further information concerning certain of those risks and uncertainties.
EMPLOYEES
As of December 31, 1997, the number of employees of DHC and its
consolidated subsidiaries was approximately as follows:
NAICC 146
DHC (holding company only) 13
---
Total 159
None of these employees is covered by any collective bargaining agreement. DHC
believes that the staffing levels are adequate to conduct future operations.
ITEM 2. PROPERTIES.
DHC leases a minimal amount of space for use as administrative and
executive offices. DHC's lease has a term of approximately five years which is
scheduled to expire in 2003. DHC believes that the space available to it is
adequate for DHC's current and foreseeable needs.
NAICC's headquarters are located in a leased office facility in Rancho
Dominguez, California, pursuant to a long term lease which is scheduled to
expire in 1999. In addition, NAICC has entered into short term leases in
connection with its operations in various locations on the west coast of the
United States. NAICC believes that the foregoing leased facilities are adequate
for NAICC's current and anticipated future needs.
See Note 13 of the Notes to Consolidated Financial Statements.
-14-
<PAGE>
Item 3. LEGAL PROCEEDINGS.
NAICC is a party to various legal proceedings which are considered
routine and incidental to its insurance business and are not material to the
financial condition and operation of such business. DHC is not a party to any
legal proceeding which is considered material to the financial condition and
operation of its business. See Note 14 of the Notes to Consolidated Financial
Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
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<PAGE>
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
"Stock Market Prices" on page 32 of DHC's 1997 Annual Report to
Stockholders (included as an exhibit hereto) is incorporated herein by
reference.
ITEM 6. SELECTED FINANCIAL DATA.
"Selected Consolidated Financial Data" on page 6 of DHC's 1997 Annual
Report to Stockholders (included as an exhibit hereto) is incorporated
herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
"Management's Discussion and Analysis of Financial Condition and
Results of Operations" on pages 7 through 12 of DHC's 1997 Annual
Report to Stockholders (included as an exhibit hereto) is incorporated
herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Consolidated Financial Statements of DHC and its subsidiaries,
together with the Notes thereto, and "Quarterly Financial Data,"
included on pages 13 through 16, 17 through 30, and 32, respectively,
of DHC's 1997 Annual Report to Stockholders (included as an exhibit
hereto), are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
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<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
DIRECTORS.
The Directors of DHC are listed on the following pages with brief
statements of their principal occupations and other information. A listing of
the Directors' and officers' beneficial ownership of Common Stock appears on
subsequent pages under the heading "Item 12. Security Ownership of Certain
Beneficial Owners and Management." All of the Directors were elected to their
present terms of office by the stockholders at the Annual Meeting of
Stockholders of DHC held on May 21, 1997. The term of office of each Director
continues until the election of Directors to be held at the next Annual Meeting
of Stockholders or until his successor has been elected. There is no family
relationship between any Director and any other Director or executive officer of
DHC. The information set forth below concerning the Directors has been
furnished by such Directors to DHC.
<TABLE>
<CAPTION>
DIRECTOR
DIRECTOR AGE PRINCIPAL OCCUPATION SINCE
- -------- --- -------------------- -----
<S> <C> <C> <C>
Martin J. Whitman 73 Chairman of the Board and Chief Executive Officer of 1990
DHC
David M. Barse 35 President and Chief Operating Officer of DHC 1996
Eugene M. Isenberg 68 Chairman of the Board and Chief Executive Officer of 1990
Nabors Industries, Inc.
Joseph F. Porrino 53 Executive Vice President of the New School for Social 1990
Research
Frank B. Ryan 61 Professor of Mathematics at Rice University 1990
Wallace O. Sellers 68 Vice Chairman and Director of Enhance Financial 1995
Services Group, Inc.
Anthony G. Petrello 43 President and Chief Operating Officer of Nabors 1996
Industries, Inc.
Stanley J. Garstka 54 Deputy Dean and Professor in the Practice of 1996
Management at Yale University School of Management
Timothy C. Collins 41 Chief Executive Officer and Senior Managing Director 1996
of Ripplewood Holdings LLC
</TABLE>
Mr. Whitman is the Chairman of the Board, Chief Executive Officer and a
Director of DHC. Since 1974, Mr. Whitman has been the President and
controlling stockholder of M.J. Whitman & Co., Inc. (now known as Martin J.
Whitman & Co., Inc.) ("MJW&Co") which, until August 1991, was a registered
broker-dealer. From August 1994 to December 1994, Mr. Whitman served as the
Managing Director of M.J. Whitman, L.P.
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<PAGE>
("MJWLP"), then a registered broker-dealer which succeeded to the broker-dealer
business of MJW&Co. Since January 1995, Mr. Whitman has served as the Chairman
and Chief Executive Officer (and, until June 1995, as President) of M. J.
Whitman, Inc. ("MJW"), which succeeded at that time to MJWLP's broker-dealer
business. Also since January 1995, Mr. Whitman has served as the Chairman and
Chief Executive Officer of M.J. Whitman Holding Corp. ("MJWHC"), the parent of
MJW and other affiliates. Since March 1990, Mr. Whitman has been the Chairman of
the Board, Chief Executive Officer and a Trustee (and, since January 1991, the
President) of Third Avenue Trust and its predecessor, Third Avenue Value Fund,
Inc. (together with its predecessor, "Third Avenue Trust"), an open-end
management investment company registered under the Investment Company Act of
1940 and containing three investment series of which he is a trustee, and EQSF
Advisers, Inc. ("EQSF"), Third Avenue Trust's investment adviser. Until April
1994, Mr. Whitman also served as the Chairman of the Board, Chief Executive
Officer and a Director of Equity Strategies Fund, Inc., previously a registered
investment company. Mr. Whitman is a Managing Director of Whitman Heffernan
Rhein & Co., Inc. ("WHR"), an investment and financial advisory firm which he
founded with James P. Heffernan and C. Kirk Rhein, Jr. during the first quarter
of 1987 and which ceased operations in December, 1996. Since March 1991, Mr.
Whitman has served as a Director of Nabors Industries, Inc., a publicly-traded
company. From March 1993 through February 1996, Mr. Whitman served as a director
of Herman's Sporting Goods, Inc., a retail sporting goods chain, which filed a
voluntary petition under Chapter 11 of the United States Bankruptcy Code on
April 26, 1996. Mr. Whitman also serves as a Director of the Company's
subsidiaries, including National American Insurance Company of California
("NAICC") and KCP Holding Company ("KCP"). Mr. Whitman co-authored the book The
---
Aggressive Conservative Investor. Mr. Whitman is a Distinguished Faculty Fellow
- --------------------------------
in Finance at the Yale University School of Management ("Yale School of
Management"). Mr. Whitman graduated from Syracuse University magna cum laude in
1949 with a Bachelor of Science degree and received his Masters degree in
Economics from the New School for Social Research in 1956. Mr. Whitman is a
Chartered Financial Analyst.
Mr. Barse has been the President, Chief Operating Officer and a Director
of DHC since July 1996 and a director of NAICC since August 1996. Since June
1995, Mr. Barse has been the President of each of MJW and MJWHC. Since April
1995, he has been an Executive Vice President and Chief Operating Officer of
Third Avenue Trust and EQSF. Mr. Barse joined the predecessors of MJW and MJWHC
in December 1991 as General Counsel. Mr. Barse was previously an attorney with
the law firm of Robinson Silverman Pearce Aronsohn & Berman LLP. Mr. Barse
received a Bachelor of Arts in Political Science from George Washington
University in 1984 and a Juris Doctor from Brooklyn Law School in 1987.
Mr. Isenberg, since 1987, has been Chairman and Chief Executive Officer
of Nabors Industries, Inc. ("Nabors"), a publicly-traded oil and gas drilling
company listed on the American Stock Exchange ("AMEX"). Beginning in 1996, Mr.
Isenberg commenced his term as a Governor of the AMEX. From 1969 to 1982, Mr.
Isenberg was Chairman of the Board and principal stockholder of Genimar Inc., a
steel trading and building products manufacturing company. From 1955 to 1968,
Mr. Isenberg was employed in various management capacities with the Exxon Corp.
Mr. Isenberg graduated from the University of Massachusetts in 1950 with a
Bachelor of Arts degree in Economics and from Princeton University in 1952 with
a Masters degree in Economics.
Mr. Porrino has been the Counselor to the President of the New School for
Social Research (the "New School") since February, 1998 and was the Executive
Vice President of the New School from September 1991 to February, 1998. Prior
to that time, Mr. Porrino was a partner in the New York law firm of Putney,
Twombly, Hall & Hirson, concentrating his practice in the area of labor law.
Mr. Porrino received a Bachelor of Arts degree from Bowdoin College in 1966, and
was awarded a Juris Doctor degree from Fordham University School of Law in 1970.
Dr. Ryan, since August 1990, has been a Professor of Mathematics at Rice
University. Since November, 1996, Dr. Ryan has served as a Director of Siena
Holdings, Inc., a real estate and health management company, the capital stock
of which is traded over-the-counter. Since March 1996, Dr. Ryan has served as a
Director of Texas Micro Inc., a computer systems company, the capital stock of
which is traded on NASDAQ. Since March 1995, Dr. Ryan has served as a Director
of America West Airlines, Inc., a publicly-traded company listed on the New York
Stock Exchange ("NYSE"). From August 1990 to February 1995, Dr.
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<PAGE>
Ryan also served as Vice President-External Affairs at Rice University. For two
years ending August 1990, Dr. Ryan was the President and Chief Executive Officer
of Contex Electronics Inc., a subsidiary of Buffton Corporation, the capital
stock of which is publicly traded on the AMEX. Prior to that, and beginning in
1977, Dr. Ryan was a Lecturer in Mathematics at Yale University, where he was
also the Associate Vice President in charge of institutional planning. Dr. Ryan
obtained a Bachelor of Arts degree in Physics in 1958 from Rice University, a
Masters degree in Mathematics from Rice in 1961, and a Doctorate in Mathematics
from Rice in 1965.
Mr. Sellers is Vice-Chairman and a Director of Enhance Financial Group,
Inc. ("Enhance Group"), a financial services corporation the capital stock of
which is publicly traded on the NYSE. Until December 31, 1994, Mr. Sellers was
the President and Chief Executive Officer of Enhance Group, from its inception
in 1986, as well as its principal subsidiaries, Enhance Reinsurance Company and
Asset Guaranty Insurance Company, from their inceptions in 1986 and 1988,
respectively. From 1987 to 1994, Mr. Sellers served as a Director, and from
1992 to 1993 as the Chairman, of the Association of Financial Guaranty Insurors
in New York. Mr. Sellers received a Bachelor of Arts degree from the University
of New Mexico in 1951 and a Masters degree in Economics from New York University
in 1956. Mr. Sellers attended the Advanced Management Program at Harvard
University in 1975 and is a Chartered Financial Analyst.
Mr. Petrello has been the President and Chief Operating Officer of Nabors
since 1992 and has been a director of Nabors and a member of the Executive
Committee of its board of directors since 1991. Since December, 1997, Mr.
Petrello has served as a Director of Cendant Corp., a consumer services
corporation the capital stock of which is traded on the NYSE. Mr. Petrello was
formerly a partner with the law firm Baker & McKenzie, which he had been with
since 1979. In 1986, Mr. Petrello was named Managing Partner of Baker &
McKenzie's New York Office and served in that capacity until 1991 when he
resigned as a partner in such law firm. Mr. Petrello continues as Of Counsel to
Baker & McKenzie.
Mr. Garstka has been Deputy Dean at the Yale School of Management since
November, 1995 and has been a Professor in the Practice of Management at the
Yale School of Management since 1988. Mr. Garstka was the Acting Dean of the
Yale School of Management from August 1994 to October 1995, and an Associate
Dean of the Yale School of Management from 1984 to 1994. Mr. Garstka has served
on the Board of Trustees of MBA Enterprises Corps, a non-profit organization,
since 1991 and on the Board of Trustees of The Foote School in New Haven,
Connecticut since 1995. From 1988 to 1990, Mr. Garstka served as a director of
Vyquest, Inc., a publicly-traded company listed on the AMEX. Mr. Garstka was a
Professor in the Practice of Accounting from 1983 to 1988, and an Associate
Professor of Organization and Management from 1978 to 1983, at the Yale School
of Management. Mr. Garstka has also authored numerous articles on accounting
and mathematics. Mr. Garstka received a Bachelor of Arts degree in Mathematics
from Wesleyan University in Middletown, Connecticut in 1966, a Masters degree in
Industrial Administration in 1968 from Carnegie Mellon University and a
Doctorate in Operations Research in 1970 from Carnegie Mellon University.
Mr. Collins has been the Chief Executive Officer and Senior Managing
Director of Ripplewood Holdings LLC, a private investment firm, since October
1995. From January 1990 to September 1995, Mr. Collins was the Senior Managing
Director of Onex Investment Corp., a private investment firm. Since April 1994,
Mr. Collins has been a director of Scotsman Industries, Inc., a publicly-traded
company listed on the NYSE. Mr. Collins is also a director of Dayton Superior
Corporation (NYSE) and is a trustee of DePauw University. Mr. Collins received
a Bachelor of Arts degree in Philosophy from DePauw University in 1978, and a
Masters in Private and Public Management from the Yale School of Management in
1982.
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<PAGE>
Executive Officers.
The executive officers of DHC are as follows:
NAME AGE PRINCIPAL POSITION WITH REGISTRANT
- ---- --- ----------------------------------
Martin J. Whitman 73 Chairman of the Board, Chief
Executive Officer and a Director
David M. Barse 35 President, Chief Operating Officer
and a Director
Michael T. Carney 44 Chief Financial Officer and Treasurer
Ian M. Kirschner 42 General Counsel and Secretary
For additional information about Messrs. Whitman and Barse, see
"Directors" above.
Mr. Carney was the Chief Financial Officer ("CFO") of the Company from
August 1990 until March 1996 and has been the CFO of the Company and a director
of NAICC since August 1996. Since 1990, Mr. Carney has served as Treasurer and
CFO of Third Avenue Trust and EQSF and, since 1989, as CFO of MJW&Co., and MJW
and MJWHC and their predecessors. From 1990 through April 1994, Mr. Carney also
served as CFO of Carl Marks Strategic Investments, L.P.; from 1989 through
December, 1996 Mr. Carney served as CFO of WHR; and from 1989 through April
1994, Mr. Carney served as Treasurer and CFO of Equity Strategies Fund. From
1988 to 1989, Mr. Carney was the Director of Accounting of Smith New Court, Carl
Marks, Inc., and, from 1986 to 1988, Mr. Carney served as the Controller of Carl
Marks & Co., Inc. Mr. Carney graduated from St. John's University in 1981 with
a Bachelor of Science degree in Accounting.
Mr. Kirschner has been the General Counsel and Secretary of DHC since
August 1996. Mr. Kirschner has also served as General Counsel and Secretary of
MJWHC and MJW since January 1996 and of Third Avenue Trust and EQSF since
January 1997. From February 1993 to June 1995, Mr. Kirschner was a Vice
President, the General Counsel and Secretary of 2 I Inc., a then NASDAQ Small-
Cap listed holding company. Mr. Kirschner has been practicing law since 1979,
and was Of Counsel to Morgan, Lewis & Bockius, from October, 1990 to October,
1992. Mr. Kirschner obtained a Bachelor of Arts degree from the State
University of New York at Binghamton in 1976 and a Juris Doctor from Boston
University School of Law in 1979.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934 requires DHC's
Directors and executive officers, and persons who own more than ten percent of a
registered class of the DHC's equity securities, to file with the Securities and
Exchange Commission and the American Stock Exchange initial reports of ownership
and reports of changes in ownership of Common Stock and other equity securities
of DHC. Officers, Directors and greater than ten-percent stockholders are
required by Federal securities regulations to furnish DHC with copies of all
Section 16(a) forms they file.
To DHC's knowledge, based solely upon review of the copies of such
reports furnished to DHC and written representations that no other reports were
required, all Section 16(a) filing requirements applicable to DHC's officers,
Directors and greater than ten percent beneficial owners were complied with for
the fiscal year ended December 31, 1997.
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<PAGE>
Item 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following Summary Compensation Table presents certain information
relating to compensation paid by DHC for services rendered in 1997 by the Chief
Executive Officer. No other executive officers of DHC had cash compensation for
such year in excess of $100,000. Only those columns which call for information
applicable to DHC or the individual named for the periods indicated have been
included in such table.
<TABLE>
<CAPTION>
LONG TERM
ANNUAL COMPENSATION COMPENSATION
------------------------------------------
AWARDS
--------------------
SECURITIES ALL OTHER
YEAR SALARY /A/ BONUS UNDERLYING OPTIONS COMPENSATION
NAME AND PRINCIPAL POSITION ($) ($) (#) ($)
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Martin J. Whitman 1997 $200,000 -0- -0-
------------------------------------------------
Chairman of the Board & Chief Executive 1996 $200,000 -0- -0-
Officer
------------------------------------------------
1995 $200,000 -0- -0-
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
The following table presents certain information relating to the value of
unexercised stock options as of the end of 1997, on an aggregated basis, owned
by the named executive officer of DHC as of the last day of the fiscal year.
Such officer did not exercise any of such options during 1997. Only those
tabular columns which call for information applicable to DHC or the named
individuals have been included in such table.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED IN-THE-MONEY
UNEXERCISED OPTIONS AT FISCAL OPTIONS
YEAR-END AT FISCAL YEAR-END
(#) ($)
----------------------------------------------------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Martin J. Whitman 210,000 -0- $892,500 -0-
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
COMPENSATION OF DIRECTORS
During 1997, each Director who was not an officer or employee of the
Company or its subsidiaries received compensation of $2,500 for each Board
meeting attended, whether in person or by telephone. For attendance at Board
meetings during 1997, each of Mr. Porrino, Mr. Sellers, Dr. Ryan, Mr. Isenberg,
Mr. Petrello and Mr. Garstka received $12,500 and Mr. Collins received $7,500,
plus, in each case, reimbursement of reasonable expenses. Directors who are
officers or employees of the Company or its subsidiaries receive no fees for
service on the Board. No attendance fee is paid to any Directors with respect to
any committee meetings.
- ----------------------
/a/ Amounts shown indicate cash compensation earned and received by executive
officers in the year shown. Executive officers also participate in DHC
group health insurance.
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<PAGE>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During 1997, none of the persons who served as members of the Compensation
Committee of DHC's Board of Directors also was, during that year or previously,
an officer or employee of DHC or any of its subsidiaries or had any other
relationship requiring disclosure herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth the beneficial ownership of Common Stock
as of March 17, 1998 of (a) each Director, (b) each executive officer, and (c)
each person known by DHC to own beneficially more than five percent of the
outstanding shares of Common Stock. DHC believes that, except as otherwise
stated, the beneficial holders listed below have sole voting and investment
power regarding the shares reflected as being beneficially owned by them.
<TABLE>
<CAPTION>
AMOUNT AND NATURE OF BENEFICIAL
OWNERSHIP PERCENT OF CLASS /1/
---------------------------------- ----------------------------------
<S> <C> <C>
PRINCIPAL STOCKHOLDERS
Commissioner of Insurance 1,803,235 /2,3/ 11.6
of the State of California
c/o Geoffrey A. Nicholls
Deputy Trustee
Mission Insurance Companies' Trusts
3333 Wilshire Boulevard - 3rd Floor
Los Angeles, CA 90010
Martin J. Whitman 2,321,414 /2,4,5,6/ 14.7
c/o Danielson Holding Corporation
767 Third Avenue
New York, NY 10017-2023
James P. Heffernan 1,372,980 /2,5,6/ 8.7
c/o WHR Management Company, L.P.
2 Park Place
Bronxville, NY 10708
Whitman Heffernan & Rhein Workout 1,054,996 /2/ 6.8
Fund, L.P.
c/o WHR Management Company, L.P.
2 Park Place
Bronxville, NY 10708
Third Avenue Value Fund 803,669 /2/ 5.2
767 Third Avenue
New York, NY 10017-2023
</TABLE>
- ---------------------------
-22-
<PAGE>
<TABLE>
<CAPTION>
OFFICERS AND DIRECTORS
<S> <C> <C>
Martin J. Whitman 2,321,414 /2,4,5,6/ 14.7
David M. Barse 33,333 /7/ *
Joseph F. Porrino 56,667 /8/ *
Frank B. Ryan 48,667 /8/ *
Eugene M. Isenberg 69,924 /9/ *
Wallace O. Sellers 50,000 /10/ *
Anthony G. Petrello 13,333 /11/ *
Stanley J. Garstka 24,341 /11/ *
Timothy C. Collins 13,333 /11/ *
Michael Carney 33,333 /12/ *
Ian M. Kirschner 4,833 /13/ *
All Officers and Directors
as a Group (11 persons) 2,669,178 /14/ 16.6
</TABLE>
- ---------------------------------------------------------
* Percentage of shares beneficially owned does not exceed one percent of the
outstanding Common Stock.
/1/ Share percentage ownership is rounded to nearest tenth of one percent and
reflects the effect of dilution as a result of outstanding options to the extent
such options are, or within 60 days will become, exercisable. As of March 17,
1998 (the date as of which this table was prepared), there were exercisable
options outstanding to purchase 1,257,084 shares of Common Stock. Shares
underlying any option which was exercisable on March 17, 1998 or becomes
exercisable within the next 60 days are deemed outstanding only for purposes of
computing the share ownership and share ownership percentage of the holder of
such option.
/2/ In accordance with provisions of DHC's Certificate of Incorporation, all
certificates representing shares of Common Stock beneficially owned by holders
of five percent or more of Common Stock are owned of record by DHC, as escrow
agent, and are physically held by DHC in that capacity.
/3/ Beneficially owned by the Commissioner of Insurance of the State of
California in his capacity as trustee for the benefit of holders of certain
deficiency claims against certain trusts which assumed liabilities of certain
present and former insurance subsidiaries of DHC.
- --------------------------
-23-
<PAGE>
/4/ Includes 803,669 shares beneficially owned by Third Avenue Value Fund
("TAVF"), an investment company registered under the Investment Company Act of
1940; 104,481 shares beneficially owned by Martin J. Whitman & Co., Inc.
("MJW&Co"), a private investment company; and 73,031 shares beneficially owned
by Mr. Whitman's wife and three adult family members. Mr. Whitman controls the
investment adviser of TAVF, and may be deemed to own beneficially a five percent
equity interest in TAVF. Mr. Whitman is the principal stockholder in MJW&Co,
and may be deemed to own beneficially the shares owned by MJW&Co. Mr. Whitman
disclaims beneficial ownership of the shares of Common Stock owned by TAVF and
Mr. Whitman's family members.
/5/ Includes 1,054,996 shares of Common Stock beneficially owned by Whitman
Heffernan & Rhein Workout Fund, L.P. ("WHR Fund"), an investment limited
partnership. Each of Messrs. Whitman and Heffernan is a general partner of the
partnership that is the general partner of WHR Fund. Each disclaims beneficial
ownership of the shares owned by the WHR Fund.
/6/ Includes shares underlying currently exercisable options to purchase an
aggregate of 210,000 shares of Common Stock at an exercise price of $3.00 per
share.
/7/ Includes shares underlying options to purchase an aggregate of 33,333
shares of Common Stock at an exercise price of $5.6875 per share, which are
currently exercisable or become exercisable within the next 60 days. Does not
include shares underlying options to purchase an aggregate of 16,666 shares of
Common Stock at an exercise price of $5.6875 per share or 50,000 shares at an
exercise price of $7.0625 per share which are not currently exercisable nor
become exercisable within the next 60 days.
/8/ Includes shares underlying currently exercisable options to purchase an
aggregate of 46,667 shares of Common Stock at an exercise price of $3.63 per
share.
/9/ Includes 20,088 shares owned by Mentor Partnership, a partnership
controlled by Mr. Isenberg, and 28 shares owned by Mr. Isenberg's wife. Also
includes shares underlying currently exercisable options to purchase an
aggregate of 46,666 shares of Common Stock at an exercise price of $3.63 per
share.
/10/ Includes shares underlying currently exercisable options to purchase an
aggregate of 40,000 shares of Common Stock at an exercise price of $7.00 per
share.
/11/ Includes shares underlying currently exercisable options to purchase an
aggregate of 13,333 shares of Common Stock at an exercise price of $5.50 per
share. Does not include shares underlying options to purchase an aggregate of
26,667 shares of Common Stock at an exercise price of $5.50 per share which are
not currently exercisable nor become exercisable within the next 60 days.
/12/ Includes shares underlying options to purchase an aggregate of 33,333
shares of Common Stock at an exercise price of $5.6875 per share, which are
currently exercisable or become exercisable within the next 60 days. Does not
include shares underlying options to purchase an aggregate of 16,666 shares of
Common Stock at an exercise price of $5.6875 per share or 35,000 shares at an
exercise price of $7.0625 per share which are not currently exercisable nor
become exercisable within the next 60 days.
/13/ Includes shares underlying currently exercisable options to purchase an
aggregate of 3,333 shares of Common Stock at an exercise price of $5.6875 per
share. Does not include shares underlying options to purchase an aggregate of
1,667 shares of Common Stock at an exercise price of $5.6875 per share or 5,000
shares of Common Stock at an exercise price of $7.0625 per share which are not
currently exercisable nor become exercisable within the next 60 days.
/14/ In calculating the percentage of shares owned by officers and Directors as
a group, the shares of Common Stock underlying all options which are
beneficially owned by officers and Directors and which are currently exercisable
or become exercisable within the next 60 days are deemed outstanding.
-24-
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
DHC shares certain personnel and facilities with several affiliated and
unaffiliated companies (including M.J. Whitman, Inc., a broker-dealer of which
Mr. Whitman is the Chairman and Chief Executive Officer and Mr. Barse is the
President and Chief Operating Officer), and certain expenses are allocated among
the various entities. Personnel costs are allocated based upon actual time
spent on DHC's business or upon fixed percentages of compensation. Costs
relating to office space and equipment are allocated based upon fixed
percentages. Inter-company balances are reconciled and reimbursed on a monthly
basis.
-25-
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this Report:
(1) Financial Statements -- see Index to Consolidated Financial
Statements and Financial Statement Schedules appearing on Page F-1.
(2) Financial Statement Schedules -- see Index to Consolidated
Financial Statements and Financial Statement Schedules appearing on
Page F-1.
(3) Exhibits:
EXHIBIT NO./1/ NAME OF EXHIBIT
- ----------- ---------------
Organizational Documents:
------------------------
3.1 * Certificate of Incorporation of Registrant.
3.2 * Bylaws of Registrant.
Material Contracts--Miscellaneous:
---------------------------------
10.1 * Stock Sale Agreement dated October 10, 1996 between Danielson
Holding Corporation and North American Trust Company. (Filed
with Report on Form 8-K dated December 31, 1996, Exhibit 10.1.)
10.2 * Assignment and Assumption Agreement dated December 31, 1996 by
and between North American Trust Company, North American
Fiduciary Services, Inc. and Danielson Holding Corporation.
(Filed with Report on Form 8-K dated December 31, 1996, Exhibit
10.2.)
10.3 * Merger Agreement dated December 31, 1996 by and among North
American Trust Company, North American Fiduciary Services, Inc.,
Danielson Trust Company and Danielson Holding Corporation.
(Filed with Report on Form 8-K dated December 31, 1996, Exhibit
10.3.)
Material Contracts--Executive Compensation Plans and
----------------------------------------------------
Arrangements:
-------------
10.4 * 1990 Stock Option Plan. (Filed with Report on Form 8-K dated
September 4, 1990, Exhibit 10.8.)
10.5 * 1995 Stock and Incentive Plan. (Included as Exhibit A to Proxy
Statement filed on March 30, 1995.)
/1/ Exhibit numbers are referenced to Item 601 of Regulation S-K under the
Securities Exchange Act of 1934.
* Asterisk indicates an exhibit previously filed with the Securities and
Exchange Commission and incorporated herein by reference.
-26-
<PAGE>
Annual Report to Security-Holders:
---------------------------------
13.1 1997 Annual Report of Danielson Holding Corporation. (To be
included herewith at page 39.)
Subsidiaries:
------------
21 * Subsidiaries of Danielson Holding Corporation. (Filed with Report
on Form 10-K for the fiscal year ended December 31, 1996, Exhibit
21.)
(b) During the quarter ended December 31, 1997 for which this Report is
filed, DHC filed no reports on Form 8-K.
-27-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Danielson Holding Corporation has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
DANIELSON HOLDING CORPORATION
(Registrant)
By /s/ Martin J. Whitman
-----------------------------------------
Martin J. Whitman
Chairman and Chief Executive Officer
Date: March 27, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of Danielson Holding
Corporation and in the capacities and on the dates indicated.
Date: March 27, 1998 By /S/ MARTIN J. WHITMAN
--------------------------------------
Martin J. Whitman
Chairman of the Board and Chief
Executive Officer and a Director
Date: March 27, 1998 By /S/ DAVID M. BARSE
--------------------------------------
David M. Barse
President and Chief Operating
Officer and a Director
Date: March 27, 1998 By /S/ MICHAEL T. CARNEY
--------------------------------------
Michael T. Carney
Chief Financial Officer
Date: March 27, 1998 By /S/ JOSEPH F. PORRINO
--------------------------------------
Joseph F. Porrino
Director
Date: March 27, 1998 By /S/ FRANK B. RYAN
--------------------------------------
Frank B. Ryan
Director
Date: March 27, 1998 By /S/ EUGENE M. ISENBERG
--------------------------------------
Eugene M. Isenberg
Director
-28-
<PAGE>
Date: March 27, 1998 By /S/ WALLACE O. SELLERS
--------------------------------------
Wallace O. Sellers
Director
Date: March 27, 1998 By /S/ ANTHONY G. PETRELLO
--------------------------------------
Anthony G. Petrello
Director
Date: March 27, 1998 By /S/ STANLEY J. GARSTKA
--------------------------------------
Stanley J. Garstka
Director
Date: March 27, 1998 By /S/ TIMOTHY C. COLLINS
--------------------------------------
Timothy C. Collins
Director
-29-
<PAGE>
DANIELSON HOLDING CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
Page Number
-----------
<S> <C>
Independent Auditors' Report.................................................................. F-2
Danielson Holding Corporation and Consolidated Subsidiaries:
Statements of Operations - For the years ended December 31, 1997, 1996 and 1995.............. *
Balance Sheets - December 31, 1997 and 1996.................................................. *
Statements of Stockholders' Equity - For the years ended December 31, 1997, 1996 and 1995.... *
Statements of Cash Flows - For the years ended December 31, 1997, 1996 and 1995.............. *
Schedule I - Summary of Investments - Other than Investments in Related Parties.............. S-1
Schedule II - Condensed Financial Information of the Registrant.............................. S-2-4
Schedule IV - Reinsurance.................................................................... S-5
Schedule V - Valuation and Qualifying Accounts............................................... S-6
Schedule III - Supplemental Information Concerning Property-Casualty
and VI Insurance Operations.......................................................... S-7
</TABLE>
Schedules other than those listed above are omitted because either they are
not applicable or not required or the information required is included in the
Company's Consolidated Financial Statements.
- ---------------
* Incorporated by reference to DHC's 1997 Annual Report to Stockholders.
F-1
-30-
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Danielson Holding Corporation:
Under date of February 27, 1998, we reported on the consolidated balance
sheets of Danielson Holding Corporation and subsidiaries as of December 31, 1997
and 1996, 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, 1997, as contained in the 1997 annual report to stockholders.
These consolidated financial statements and our report thereon are incorporated
by reference in the annual report on Form 10-K for the year 1997. In connection
with our audits of the aforementioned consolidated financial statements, we also
audited the related consolidated financial statement schedules as listed in the
accompanying index. These financial statement schedules are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statement schedules based on our audits.
In our opinion, such financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.
/S/ KPMG PEAT MARWICK LLP
---------------------------
KPMG Peat Marwick LLP
New York, New York
February 27, 1998
F-2
-31-
<PAGE>
SCHEDULE I
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN
RELATED PARTIES
(In thousands)
December 31, 1997
---------------------------------------------
Cost or Fair Amount Reflected on
Amortized Cost Value Balance Sheet
-------------- -------- -------------------
Fixed maturities classified as
available-for-sale:
U.S. Government/Agency $ 48,635 $ 49,344 $ 49,344
Mortgage-backed 58,372 58,950 58,950
Corporate 32,082 32,605 32,605
-------- -------- --------
Total fixed maturities 139,089 140,899 140,899
-------- -------- --------
Equity securities:
Common stocks 363 813 813
-------- -------- --------
Total equity securities 363 813 813
-------- -------- --------
Short term investments 1,111 1,111 1,111
-------- -------- --------
Total investments $140,563 $142,823 $142,823
======== ======== ========
S-1
-32-
<PAGE>
SCHEDULE II
DANIELSON HOLDING CORPORATION
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
(Parent Company Only)
STATEMENTS OF OPERATIONS
(In thousands)
<TABLE>
<CAPTION>
For the years ended December 31,
-----------------------------------
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Revenues:
Net investment income $ 538 $ 534 $ 675
Net realized investment gains (losses) 2 (1) (2)
Other income -- -- 26
------- ------- -------
Total revenues 540 533 699
------- ------- -------
EXPENSES:
Employee compensation and benefits 1,170 1,201 1,442
Professional fees 426 288 221
Expenses in connection with terminated
proposed acquisition -- 1,849 --
Nonrecurring compensation -- 820 --
Other general and administrative fees 615 684 657
------- ------- -------
Total expenses 2,211 4,842 2,320
------- ------- -------
Loss before provision for
income taxes (1,671) (4,309) (1,621)
Income tax provision 26 3 36
------- ------- -------
Loss before equity in net income of
subsidiaries (1,697) (4,312) (1,657)
Equity in net income (loss) of subsidiaries 6,286 (3,807) 3,973
------- ------- -------
NET INCOME (LOSS) $4,589 $(8,119) $2,316
====== ======== ======
</TABLE>
S-2
-33-
<PAGE>
SCHEDULE II, continued
DANIELSON HOLDING CORPORATION
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
(Parent Company Only)
BALANCE SHEETS
(In thousands, except share and per share information)
<TABLE>
<CAPTION>
December 31,
----------------------------------
1997 1996
---- ----
<S> <C> <C>
Assets:
Cash $ 47 $ 75
Fixed maturities:
Available-for-sale at fair value
(Cost: $8,618 and $7,026 ) 8,617 7,025
Short term investments, at cost which approximates
fair value 62 3,000
------- -------
Total cash and investments 8,726 10,100
Investment in subsidiaries 55,366 49,167
Accrued investment income 62 131
Other assets 166 240
------- -------
TOTAL ASSETS $64,320 $59,638
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY:
Other liabilities $ 400 $ 785
------- -------
Total liabilities 400 785
------- -------
Preferred Stock ($0.10 par value; authorized 10,000,000
shares; none issued and outstanding) -- --
Common Stock ($0.10 par value; authorized 20,000,000
shares; issued 15,586,994 shares and 15,370,894 shares;
outstanding 15,576,287 shares and 15,360,238 shares) 1,559 1,537
Additional paid-in capital 46,673 46,131
Net unrealized gain on available-for-sale securities 2,260 2,346
Retained earnings 13,494 8,905
Treasury stock (Cost of 10,707 shares and 10,656 shares) (66) (66)
------- -------
TOTAL STOCKHOLDERS' EQUITY 63,920 58,853
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $64,320 $59,638
======= =======
</TABLE>
S-3
-34-
<PAGE>
SCHEDULE II, CONTINUED
DANIELSON HOLDING CORPORATION
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
(Parent Company Only)
STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
For the years ended December 31,
-----------------------------------
1997 1996 1995
---------- ----------- ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 4,589 $ (8,119) $ 2,316
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Net realized investment (gains) losses (2) 1 2
Change in accrued investment income 69 45 1
Depreciation and amortization (57) (60) 86
Equity in net (income) loss of subsidiaries (6,286) 3,807 (3,973)
Increase (decrease) in accrued expenses (411) 502 (47)
Other, net 56 9 (79)
------- -------- --------
Net cash used in operating activities (2,042) (3,815) (1,694)
------- -------- --------
Cash flows from investing activities:
Investments purchased:
Fixed income maturities available-for-sale (8,001) (10,584) (10,787)
Proceeds from sales:
Fixed income maturities available-for-sale 951 5,542 1,837
Investments, matured or called
Fixed income maturities available-for-sale 5,562 8,585 11,210
Net proceeds from sale of Danielson Trust Company -- 2,968 --
------- -------- --------
Net cash provided by (used in)
investing activities (1,488) 6,511 2,260
------- -------- --------
Cash flows from financing activities:
Proceeds from exercise of options
to purchase Common Stock 671 -- --
Retirement of stock options (107) -- (286)
Change in receivable from subsidiary -- 353 (12)
Additional capital contributed to subsidiaries -- (458) --
------- -------- --------
Net cash provided by
(used in) financing activities 564 (105) (298)
------- -------- --------
Net increase (decrease) in cash and
short term investments (2,966) 2,591 268
Cash and short term investments at
beginning of year 3,075 484 216
------- -------- --------
Cash and short term investments at
end of year $ 109 $ 3,075 $ 484
======= ======== ========
</TABLE>
S-4
-35-
<PAGE>
SCHEDULE IV
DANIELSON HOLDING CORPORATION
REINSURANCE
(in thousands)
<TABLE>
<CAPTION>
CEDED EARNED ASSUMED EARNED PERCENTAGE
GROSS EARNED TO OTHER FROM OTHER NET EARNED OF AMOUNT
AMOUNT COMPANIES COMPANIES AMOUNT ASSUMED TO NET
------ --------- --------- ------ --------------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1997:
Property and liability
insurance premiums $ 64,745 $ 11,676 $ -- $ 53,069 --
========== ========== ========== ========== ==========
Year Ended December 31, 1996:
Property and liability
insurance premiums $ 52,066 $ 15,441 $ -- $ 36,625 --
========== ========== ========== ========== ==========
Year Ended December 31, 1995:
Property and liability
insurance premiums $ 76,688 $ 16,140 $ -- $ 60,548 --
========== ========== ========== ========== ==========
</TABLE>
S-5
-36-
<PAGE>
SCHEDULE V
DANIELSON HOLDING CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
ADDITIONS
----------------------------------
BALANCE AT CHARGED TO COSTS CHARGED TO BALANCE AT
BEGINNING OF PERIOD AND EXPENSES OTHER ACCOUNTS DEDUCTIONS END OF PERIOD
------------------- ------------ -------------- ---------- -------------
<S> <C> <C> <C> <C> <C>
Allowance for premiums
and fees receivable $ 230 $ 53 $ 20 $ 124 $ 179
========== ========== ========== ========== ==========
Allowance for uncollectable
reinsurance on paid losses $ 316 $ 65 $ -- $ 7 $ 374
========== ========== ========== ========== ==========
Allowance for uncollectable
reinsurance on unpaid losses $ 425 $ 74 $ -- $ -- $ 499
========== ========== ========== ========== ==========
</TABLE>
S-6
-37-
<PAGE>
SCHEDULES III AND VI
DANIELSON HOLDING CORPORATION
SUPPLEMENTAL INFORMATION
CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS
(in thousands)
<TABLE>
<CAPTION>
RESERVES DISCOUNT
FOR UNPAID FROM
CLAIMS AND RESERVES OTHER
AFFILIATION DEFERRED CLAIM FOR POLICYCLAIMS
WITH ACQUISITION ADJUSTMENT UNPAID UNEARNED AND BENEFITS NET EARNED INVESTMENT
REGISTRANT COSTS EXPENSES CLAIMS PREMIUMS PAYABLE PREMIUMS INCOME
---------- ----- -------- ------ -------- ------- -------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Consolidated
Property-Casualty
Entities:
AS OF AND FOR
THE YEAR
ENDED 12/31/97 $ 1,550 $ 105,947 $ -- $ 10,249 -- $ 53,069 $ 9,272
============ ============= ========== ========= ============ ========== ===========
As of and for
the year
ended 12/31/96 $ 957 $ 120,651 $ -- $ 8,294 -- $ 36,625 $ 10,121
============ ============= ========== ========= ============ ========== ===========
As of and for
the year
ended 12/31/95 $ 1,045 $ 137,406 $ -- $ 8,563 -- $ 60,548 $ 12,351
============ ============= ========== ========= ============ ========== ===========
</TABLE>
<TABLE>
<CAPTION>
CLAIMS AND CLAIM
AFFILIATION ADJUSTMENT EXPENSES AMORTIZATION OTHER PAID CLAIMS
WITH INCURRED RELATED TO OF DEFERRED OPERATING AND CLAIM NET WRITTEN
REGISTRANT CURRENT YEAR PRIOR YEARS ACQUISITION COSTS EXPENSES ADJUSTMENT EXPENSES PREMIUMS
------------ ------------ ----------- ----------------- -------- ------------------- --------
<S> <C> <C> <C> <C> <C> <C>
Consolidated
Property-Casualty
Entities:
AS OF AND FOR
THE YEAR
ENDED 12/31/97 $ 37,142 $ 940 $ 10,063 $ 3,278 $ 49,425 $ 55,760
============ ============= ========== ========= ============ ==========
As of and for
the year
ended 12/31/96 $ 26,979 $ 10,120 $ 6,239 $ 3,668 $ 56,691 $ 36,136
============ ============= ========== ========= ============ ==========
As of and for
the year
ended 12/31/95 $ 45,592 $ 3,123 $ 9,089 $ 4,302 $ 61,046 $ 55,295
============ ============= ========== ========= ============ ==========
</TABLE>
S-7
-38-
<PAGE>
EXHIBIT 13
DANIELSON HOLDING CORPORATION
1997
ANNUAL REPORT
<PAGE>
MISSION STATEMENT
DANIELSON HOLDING CORPORATION
IS A DEBT-FREE HOLDING COMPANY
WHOSE SUBSIDIARIES ARE INVOLVED IN FINANCIAL SERVICES.
Danielson Holding Corporation's business plan is to grow by developing
business partnerships and making strategic acquisitions that are expected to
contribute higher than average returns for our stockholders. Management seeks
transactions that will contribute to the growth of its existing businesses, as
well as transactions that represent new ventures for the Company.
<PAGE>
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
As of and for the years ended December 31
(In thousands, except share and per share amounts, ---------------------------------------------------
stock prices and employees) 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------
RESULTS OF OPERATIONS
===========================================================================================================
<S> <C> <C> <C>
Earned premiums .................................... $ 53,069 $ 36,625 $ 60,548
Total revenues ..................................... $ 65,746 $ 48,704 $ 75,458
Income (loss) from continuing operations ........... $ 4,589 $ (6,240) $ 4,349
Net income (loss) .................................. $ 4,589 $ (8,119) $ 2,316
Net cash used in continuing operating activities ... $ (11,583) $ (26,949) $ (3,663)
Income (loss) from continuing operations per diluted
share of Common Stock ............................ $ 0.28 $ (0.41) $ 0.27
Net income (loss) per diluted share of Common Stock $ 0.28 $ (0.53) $ 0.14
Combined ratio ..................................... 111.0% 136.7% 113.4%
===========================================================================================================
<CAPTION>
BALANCE SHEET AND
OTHER DATA
===========================================================================================================
<S> <C> <C> <C>
Total investments .................................. $ 142,823 $ 151,555 $ 180,263
Policyholder liabilities ........................... $ 116,607 $ 129,352 $ 150,633
Stockholders' equity ............................... $ 63,920 $ 58,853 $ 69,821
Book value per share of Common Stock ............... $ 4.10 $ 3.83 $ 4.55
Common Stock price range
High ............................................. $ 14 $ 8 3/8 $ 8
Low .............................................. $ 4 7/8 $ 4 3/4 $ 6 5/8
Shares of Common Stock outstanding at year end ..... 15,576,287 15,360,238 15,360,255
Employees of continuing operations at year end ..... 159 152 168
</TABLE>
1 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
TO OUR SHAREHOLDERS:
1997 was a disappointment because we did not achieve our goal of
consummating an acceptable transaction by year end. However, significant
improvements were achieved in the operations of our principal subsidiary,
National American Insurance Company of California ("NAICC").
ACQUISITION DEVELOPMENTS
We remain disciplined and continue to seek out opportunities that not only
support our fundamental strategy but also create long-term value for our
shareholders. Our review of potential transaction opportunities increased
dramatically after the termination of discussions with The Progressive
Corporation. On the insurance front, we refused to engage in the bidding up of
non-standard auto insurance companies although we examined a number of such
opportunities. In each instance, after careful due diligence, we concluded that
it would not be prudent to compete with the pricing.
Faced with the prospect of not locating a suitable and fairly priced
insurance company opportunity, we turned our attention in other directions.
Notwithstanding our inability to execute our original plan with Danielson Trust
Company, we are staunch believers in the money management business; an industry
characterized by the ability to create strong cash flows provided that there is
persistency in the amount of funds under management. Each week there is an
announcement about a transaction in the money management industry and DHC is
reviewing them all. Companies with persistent asset growth and strong management
teams remain extremely attractive. DHC has initiated efforts to seek out those
money management firms that have the qualities we find attractive for long-term
success.
We will continue to pursue transaction opportunities with businesses we
believe in and in which we can find value for DHC and we believe we have the
requisite expertise to effectively identify such quality companies. We have also
undertaken considerable efforts in examining other transactions in the financial
services arena. Among those we have reviewed are banking and trust institutions,
mortgage servicers and real estate companies. We remain dedicated to
consummating a transaction that is in the best interests of our stockholders at
the earliest practicable time.
We remain
disciplined
and continue
to seek out
opportunities
that not only
support our
fundamental
strategy but
also create
long-term
value for our
shareholders.
2 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NAICC
In addition to reviewing such opportunities, we continue to refine and
shore up our subsidiaries' operations.
In 1997, NAICC increased production in its automobile product lines to
offset the decline in its workers' compensation written premiums from 1995 and
1996. Direct written premiums for the year increased 30.3% to $66.7 million from
$51.2 million in 1996. Workers' compensation premiums finished the year at $17.5
million, versus $17.4 million in 1996. Non-standard personal automobile and
commercial automobile premiums increased 46.0% over 1996 to $49.2 million.
The increase in written premiums in 1997 was the result of management's
decision to place more emphasis on the personal and commercial automobile
business and less on the still very competitive California workers' compensation
market. In 1995, the first year of open rating in California, NAICC wrote $32.6
million in California workers' compensation premiums; this fell to $9.4 million
in 1996 and $7.8 million in 1997. NAICC planned from the outset of open rating
to maintain its underwriting and pricing discipline and, as a result, fully
expected not to be a factor in the California workers' compensation market for
the first few years of open rating. NAICC and its subsidiary, Valor Insurance,
also produced workers' compensation business in Arizona, Idaho, Oregon and
Montana. Direct written premiums in these states were $9.7 million, an increase
of $1.7 million over the $8.0 million in 1996. This increase was due primarily
to having Valor's premiums included for the first full year and to increased
premiums in Arizona and Oregon.
Direct written premiums for the non-standard private passenger automobile
business were $39.3 million, a 39.4% increase over 1996. This significant
increase was due in part to the passage of legislation in California which
requires motorists to have proof of insurance at the time of vehicle
registration, and to the increased marketing efforts of NAICC's general agent.
NAICC's profitable growth and continued success in the California non-standard
private passenger automobile business is also attributable to its claims service
and diligent anti-fraud efforts. We do not expect to see the same growth in this
line of business for
Direct
written
premiums
for the year
increased
30.3% to
$66.7 million
from
$51.2 million
in 1996.
3 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
TO OUR SHAREHOLDERS:
1998 due to the intensified competition in the California non-standard
automobile marketplace. As a result, management has made the decision to expand
its non-standard private passenger automobile business into Oregon and
Washington in the first quarter of 1998.
Finally, the direct written premiums from our commercial automobile
insurance business increased from $5.5 million in 1996 to $9.9 million in 1997.
The increase was due to the rise in the number of commercial automobile agent
appointments made in 1997 and the additional marketing efforts in each of our
branches. Also, having the commercial automobile program in place for at least a
year in all states in which we now do business, including Arizona, California,
Idaho, Nevada, Oregon and Washington, has enhanced our recognition in the
commercial automobile market. We expect a significant part of our growth over
the next couple of years to come from our commercial automobile program.
Thank you for your continued support and patience in 1997. Despite the
significant improvements in our operations, we are not pleased that as of this
writing we do not have a definitive transaction to present to our shareholders.
DHC will work hard in 1998 to build long-term shareholder value.
Sincerely,
/s/ Martin J. Whitman /s/ David M. Barse
Martin J. Whitman David M. Barse
Chairman of the Board & President & Chief Operating Officer
Chief Executive Officer
March 27, 1998
We expect a
significant
part of our
growth over
the next
couple of
years to
come from
our
commercial
automobile
program.
4 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
FINANCIAL TABLE OF CONTENTS
Selected Consolidated Financial Data........................................ 6
Management's Discussion and Analysis of
Financial Condition and Results of Operations............................. 7
Consolidated Statements of Operations....................................... 13
Consolidated Balance Sheets................................................. 14
Consolidated Statements of Stockholders' Equity............................. 15
Consolidated Statements of Cash Flows....................................... 16
Notes to Consolidated Financial Statements.................................. 17
Independent Auditors' Report................................................ 31
Responsibility for Financial Reporting...................................... 31
Quarterly Financial Data.................................................... 32
Stock Market Prices......................................................... 32
5 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
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.
<TABLE>
<CAPTION>
Years ended December 31,
-------------------------------------------------------------------------------------
(In thousands, except share
and per share amounts) 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
A. RESULTS OF OPERATIONS
<S> <C> <C> <C> <C> <C>
Total revenues................................ $ 65,746 $ 48,704 $ 75,458 $105,545 $100,013
Income (loss) from continuing operations
before extraordinary items.................. $ 4,589 $ (6,240)(1),(2) $ 4,349 $ 3,769 $ 2,816
Net loss from discontinued operations......... -- $ (633)(3) $ (2,033)(3) $ (624)(3) $ (70)(3)
Loss on disposal of discontinued operations... -- $ (1,246)(3) -- -- --
Net income (loss)............................. $ 4,589 $ (8,119)(1),(2),(3) $ 2,316(3) $ 3,895(3),(4) $ 3,234(3),(5)
Diluted earnings per share of Common Stock:
Income (loss) from continuing operations
before extraordinary items................ $ 0.28 $ (0.41)(1),(2) $ 0.27 $ 0.24 $ 0.18
Net loss from discontinued operations....... -- $ (0.04)(3) $ (0.13)(3) $ (0.04)(3) $ (0.01)(3)
Loss on disposal of discontinued operations. -- $ (0.08)(3) -- -- --
Net income (loss)........................... $ 0.28 $ (0.53)(1),(2),(3) $ 0.14(3) $ 0.25(3),(4) $ 0.20(3),(5)
B. BALANCE SHEET DATA
Invested assets............................... $142,823 $151,555 $180,263 $179,141 $174,125
Total assets.................................. $187,773 $196,419 $226,896 $239,410 $233,809
Unpaid losses and loss adjustment expenses.... $105,947 $120,651 $137,406 $146,330 $137,479
Stockholders' equity.......................... $ 63,920 $ 58,853 $ 69,821 $ 62,318 $ 58,838
Shares of Common Stock outstanding............ 15,576,287(6) 15,360,238(6) 15,360,255(6) 15,360,270(6) 15,110,251(6)
</TABLE>
(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) Includes extraordinary gain from distribution from an unaffiliated trust.
(5) Includes extraordinary gains from a former subsidiary, as well as a former
trust administered by the California Insurance Commissioner as trustee.
(6) Does not give effect to currently exercisable options to purchase shares
of Common Stock.
6 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
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 Federal income tax due to 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 1997
consolidated Federal income tax return will report a cumulative net operating
loss carryforward currently estimated at approximately $1.4 billion, which will
expire in various amounts, if not used, between 1998 and 2012. See Note 11 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 primarily in property and casualty
insurance.
Property and Casualty Insurance Operations
Net premiums earned were $53.1 million, $36.6 million and $60.5 million in
1997, 1996 and 1995, respectively. The increase and decrease in net premiums
earned are directly related to the change in net written premiums. Net written
premiums were $55.8 million, $36.1 million, and $55.3 million in 1997, 1996 and
1995, respectively. The increase in 1997 is attributable to the premium growth
in NAICC's automobile lines. Net written premiums in 1997 in non-standard
private passenger and non-standard commercial automobile lines increased by
$15.3 million and $4.0 million, respectively. The increase in private passenger
automobile premiums occurred in California and was due, in part, to legislation
enacted in California requiring motorists to provide proof of insurance at the
time of vehicle registration. The relatively modest increase in commercial
automobile premiums was due to the increased number of commercial automobile
agent appointments made during 1997 and the increased marketing efforts in each
of NAICC's branch offices. Net written premiums for workers' compensation in
1997 remained comparable to those for 1996 as additional written premiums
outside of California offset continued declines in California. The decline in
net earned premiums from 1995 to 1996 is primarily due to the significant
reduction of written premiums in the California workers' compensation line of
insurance.
Net investment income was $9.3 million, $10.1 million, and $12.4 million in
1997, 1996 and 1995, respectively. Net investment income has declined as average
invested assets declined in each of 1997 and 1996. As of December 31, 1997 and
1996, the average yield on NAICC's portfolio was 6.3 percent and 7.2 percent,
respectively. The estimated average maturity of the portfolio is 4.9 years.
Cash used in operations was $9.6 million, $23.1 million, and $2 million, in
1997, 1996, and 1995, respectively. The cash used in operations in all three
years is primarily due to the decline in workers' compensation written premiums
while claims from the workers' compensation line, which are generally paid out
over several years, continue to be paid and settled. Also adversely affecting
cash flow in 1997 was an environmental claim which NAICC settled and paid for
$5.9 million, of which $5.3 million is due from reinsurers. See Note 6 of the
Notes to Consolidated Financial Statements. Overall cash and invested
7 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
assets, stated at market, were $134.8 million at December 31, 1997 as compared
to $142.6 million at December 31, 1996.
Net losses and loss adjustment expenses (LAE) were $38.1 million, $37.1
million, and $48.7 million in 1997, 1996 and 1995, respectively. The resulting
loss and LAE ratios were 71.8 percent, 101.3 percent and 80.5 percent in 1997,
1996 and 1995, respectively. The decrease in the loss and LAE ratio in 1997 over
1996 (exclusive of the charge in 1996 to strengthen unpaid losses in run-off)
was due to a continued shift of business to automobile lines which have lower
loss and LAE ratios than does workers' compensation. The increase in the loss
and LAE ratio in 1996 was due primarily to a decision by management of NAICC to
strengthen the unpaid losses and allocated loss adjustment expenses (ALAE) of
pre-1980 businesses assumed by NAICC in 1985 and which are in run-off. NAICC
increased these run-off claim liabilities by $10 million in 1996. The pre-1980
run-off liabilities include claims relating to environmental clean-up for
policies issued prior to 1970. NAICC increased its bulk unpaid liabilities
related to these claims, principally the unpaid ALAE, as it had become evident
that the legal costs associated with these claims would be significantly greater
than previously anticipated. The loss and LAE ratio, exclusive of the additional
losses and ALAE associated with NAICC's run-off businesses, was 74 percent in
1996. Net unpaid losses and LAE relating to environmental claims at December 31,
1997 are approximately $10.9 million.
Policy acquisition costs were $13.3 million, $9.9 million and $13.4
million in 1997, 1996 and 1995, respectively. As a percentage of net premiums
earned, policy acquisition expenses were 25.1 percent, 27.1 percent and 22.1
percent in 1997, 1996 and 1995, 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 1997 was due
primarily to the overall growth in premium volume while fixed underwriting
expenses remained relatively constant. The increase in the policy acquisition
expense ratio in 1996 was due in part to the shift of premium toward the
automobile lines of business, which generally have a higher commission rate, and
in part to workers' compensation premiums declining more than the fixed
underwriting expenses of policy acquisition costs.
General and administrative expenses were $7.0 million, $6.6 million and
$6.4 million in 1997, 1996 and 1995, respectively. General and administrative
expenses would have decreased in 1997, without the inclusion of twelve months of
expenses for Valor Insurance Company, Incorporated, NAICC's subsidiary acquired
in June, 1996. The decreases in general and administrative expenses in 1997 and
1996 are attributable to staff reductions made in response to the decrease in
workers' compensation written premiums.
Policyholder dividends were reduced in 1996 by $4 million as compared to
provisions of $467,000 and $137,000 in 1997 and 1995, respectively. The decrease
in the policyholder dividend liability in 1996 was due to the decline in
workers' compensation premium in California as well as a reduction in the rates
at which premiums were written in 1995. As the California workers' compensation
premium volume declined, the board of directors of NAICC deferred the
declaration and payment of California policyholder dividends in the hope that
NAICC could increase its volume profitably in the near term. In December, 1996,
the board of directors of NAICC passed a resolution that it would not pay any
further policyholder dividends on California workers' compensation policies
written prior to January 1, 1995. This decision was based on the significant
decline in premium volume as a result of open rating in California. Management
made the decision to allow the workers' compensation premium volume to decline
in California rather than compete at rates which management believes are
significantly below a level necessary to achieve a profit.
Combined underwriting ratios were 111.0 percent, 136.7 percent and 113.4
percent in 1997, 1996 and 1995, respectively. The increase in the combined ratio
in 1996 was due to the provision for additional losses and ALAE associated with
NAICC's run-off businesses.
The insurance operations had income from operations of $6.3 million in
1997 as compared to a loss from operations of $1.9 million in 1996 and income of
$6.0 million in 1995. The net loss in 1996 was due to the provision for losses
and ALAE in the run-off businesses of $10 million. Net income or loss, as the
case may be, includes realized gains of $2.2 million, $500,000 and $209,000 in
1997, 1996 and 1995, respectively.
8 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
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 two most common measures of capital adequacy for insurance companies
are premium-to-surplus ratios (which measure current operating risk) and
reserves-to-surplus ratios (which measure financial risk related to possible
changes in the level of loss and loss adjustment expense reserves). A commonly
accepted net written premium-to-surplus ratio is 3 to 1, although this varies
with different lines of business. NAICC's 1997 premium-to-surplus ratio of 1.2
to 1 remains under leveraged by current industry standards. The maximum industry
standard of losses and loss adjustment expense reserves-to-surplus ratio is 5 to
1, compared with NAICC's ratio of 1.9 to 1. Given these relatively conservative
financial security ratios, management is confident that existing capital is
adequate to support higher than industry average premium growth for the
foreseeable future.
The National Association of Insurance Commissioners (the "Association"),
in response to growing concerns about the financial health of insurance
companies, adopted the "Solvency Policing Agenda for 1990" which outlined
several areas for strengthening state regulation in order to head off federal
regulation. One of these areas was the development of a model for the insurance
industry for determining risk-based capital (RBC) requirements. The RBC model
has proved to be a very complex and far reaching element of the Association's
agenda as well as controversial. The controversies arise from the application of
a standard RBC model to all property and casualty companies, whose underwriting
risks are widely diverse.
The RBC model for property and casualty insurance companies was adopted in
December 1993 and companies are 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, 1997, 1996 and 1995, cash used in parent-only
operating activities was $2.0 million, $3.8 million and $1.7 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. The 1996 increase in cash used
(and subsequent decrease in 1997) was primarily attributable to the payment of
expenses related to the terminated proposed merger with Midland Financial Group,
Inc. See Note 3 of the Notes to Consolidated Financial Statements. Such payments
made during the year ended December 31, 1996 amounted to $1.8 million. The
Company also incurred $1.3 million of non-recurring compensation in 1996 of
which $820,000 was related to the parent. Of the parent-only expense, $111,000
was paid in 1996 and $392,000 was paid in 1997. The remaining balance will be
paid over the next two years. See Note 4 of the Notes to Consolidated Financial
Statements. 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
For the year ended December 31, 1997, cash and investments of DHC were
approximately $8.7 million. As previously described, the primary use of funds
was the payment of general and administrative expenses in the normal course of
business. The funds were also used for the payment of 1996 non-recurring
compensation. In 1997, DHC received cash in the amount of $671,000 from the
exercise of stock options and used cash in the amount of approximately $107,000
for the buyback of stock options.
9 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
DHC's sources of funds are its investments as well as dividends received
from its subsidiaries. Various state insurance law requirements restrict the
amounts that may be transferred to DHC in the form of dividends from its
insurance subsidiaries without prior regulatory approval. To the extent that
NAICC's unassigned surplus remains negative in 1998, NAICC will not be permitted
to pay dividends without prior regulatory approval. See Note 8 of the Notes to
Consolidated Financial Statements.
Current fixed maturity holdings of DHC are in U.S. Treasury obligations
and asset-backed securities. For information regarding the Company's operating
subsidiaries' liquidity and capital resources, see "RESULTS OF NAICC'S
OPERATIONS, Liquidity and Capital Resources."
THE COMPANY'S INVESTMENTS
The amount and type of certain of the Company's investments are regulated
by California 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. The Company does not invest
in high yield non-investment grade securities. See Notes 1(B) and 9 of the Notes
to Consolidated Financial Statements.
The following table sets forth a summary of the Company's investment
portfolio at December 31, 1997, by investment grade (dollars in thousands):
Cost Fair Value
- --------------------------------------------------------------------------------
Investment by investment grade:
Fixed maturities
U.S. Government/Agency ..................... $ 48,635 $ 49,344
Mortgage-backed ............................ 58,372 58,950
Corporates (AAA to A) ...................... 28,546 29,020
Corporates (BBB) ........................... 3,536 3,585
-------------------------
Total fixed maturities ................... 139,089 140,899
Equity securities ............................ 363 813
-------------------------
Total .................................... $139,452 $141,712
=========================
Fixed maturities of the Company include Mortgage-Backed Securities (MBS)
representing 41.8 percent and 37.6 percent of total fixed maturities at December
31, 1997 and December 31, 1996, respectively. All MBS held by the Company are
issued by the Federal National Mortgage Association (FNMA) or the Federal Home
Loan Mortgage Corporation (FHLMC), which are both rated Aaa by Moody's Investors
Services. Both FNMA and FHLMC are corporations that were created by Acts of
Congress. FNMA and FHLMC guarantee the principal balance of their securities.
FNMA guarantees timely payment of principal and interest.
One of the risks associated with MBS is the timing of principal payments
on the mortgages underlying the securities. The principal an investor receives
depends upon amortization schedules and the termination pattern (resulting from
prepayments or defaults) of the individual mortgages included in the underlying
pool of mortgages. The principal is guaranteed but the yield and cash flow can
vary depending on the timing of the repayment of the principal balance.
Securities that have an amortized cost greater than par, which are backed by
mortgages that repay faster (or slower) than expected, will incur a decrease (or
increase) in yield. Those securities that have an amortized cost lower than par
that repay faster (or slower) than expected will generate an increase (or
decrease) in yield. The degree to which a security is susceptible to changes in
yield is influenced by the difference between its amortized cost and par, the
relative sensitivity to repayment of the underlying mortgages backing the
securities in a changing interest rate environment, and the repayment priority
of the securities in the overall securitization structure. NAICC 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.
10 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NAICC's MBS by type of instrument are as follows (in thousands):
1997 1996
------------------------------------------------------
Amortized Percent Amortized Percent
Cost of Total Cost of Total
- --------------------------------------------------------------------------------
Non-PAC/TAC ........ $18,627 32% $18,649 34%
PAC/TAC ............ 39,745 68% 36,042 66%
------------------------------------------------------
$58,372 100% $54,691 100%
======================================================
Management of NAICC believes that the interest and prepayment risks
generally inherent in MBS are not significant in the portfolio at December 31,
1997.
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 80 percent of its
current business, are currently favorable.
The competition, rate regulation and loss experience in the automobile
markets are currently such that NAICC is able to increase its premium volume
profitably. Legislation in California requiring motorists to provide proof of
insurance at the time of vehicle registration has contributed to a growth in
non-standard private passenger premiums. 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 continued to decline as
competitors continue to price policies at rates well below a level necessary to
achieve an underwriting profit.
AUTHORITATIVE ACCOUNTING PRONOUNCEMENTS
At December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). In accordance
with the provisions of SFAS 128, all prior years' earnings per share data have
been restated and both basic earnings per share and diluted earnings per share
have been presented on the face of the income statement. See Note 1(J) of the
Notes to Consolidated Financial Statements.
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS 130"). SFAS 130 establishes standards for the reporting and
display of comprehensive income and its components in a full set of
general-purpose financial statements. SFAS 130 is effective for fiscal years
beginning after December 15, 1997. This Statement relates to presentation of
information and will have no impact on the results of operations or financial
condition of the Company.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131"). SFAS 131 establishes standards for the reporting of information
about operating segments in annual financial statements and requires the
reporting of select information about operating segments in interim financial
reports. SFAS 131 is effective for
11 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
financial statements for periods beginning after December 15, 1997. This
Statement relates to presentation of information and will have no impact on the
results of operations or financial condition of the Company.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
As noted above, the foregoing discussion and the Notes to Consolidated
Financial Statements may include forward-looking statements that involve risks
and uncertainties. In addition to other factors and matters discussed elsewhere
herein, some of the important factors that, in the view of the Company, could
cause actual results to differ materially from those discussed in the
forward-looking statements include the following:
1. The insurance products sold by the Company are subject to intense
competition from many competitors, many of whom have substantially greater
resources than the Company. There can be no assurance that the Company will be
able to successfully compete in these markets and generate sufficient premium
volume at attractive prices to be profitable.
2. In order to implement its business plan, the Company has been seeking
to enter into strategic partnerships and/or make acquisitions of businesses that
would enable the Company to earn an attractive return on investment.
Restrictions on the Company's ability to issue additional equity in order to
finance any such transactions exist which could significantly affect the
Company's ability to finance any such transaction. The Company may have limited
other resources with which to implement its strategy and there can be no
assurance that any transaction will be successfully consummated.
3. The insurance industry is highly regulated and it is not possible to
predict the impact of future state and federal regulation on the operations of
the Company.
12 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the years ended December 31,
----------------------------------------
(In thousands, except per share information) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Gross premiums earned ............................................................ $ 64,745 $ 52,066 $ 76,688
Ceded premiums earned ............................................................ (11,676) (15,441) (16,140)
----------------------------------------
Net premiums earned .............................................................. 53,069 36,625 60,548
Net investment income ............................................................ 9,810 10,655 13,026
Net realized investment gains .................................................... 2,174 499 207
Other income ..................................................................... 693 925 1,677
----------------------------------------
Total revenues ................................................................. 65,746 48,704 75,458
----------------------------------------
Losses and expenses:
Gross losses and loss adjustment expenses ........................................ 49,350 53,697 63,543
Ceded losses and loss adjustment expenses ........................................ (11,268) (16,598) (14,828)
----------------------------------------
Net losses and loss adjustment expenses .......................................... 38,082 37,099 48,715
Policyholder dividends ........................................................... 467 (4,000) 137
Policy acquisition expenses ...................................................... 13,341 9,907 13,391
Expenses in connection with terminated proposed acquisition ...................... -- 1,849 --
Nonrecurring compensation ........................................................ -- 1,272 --
General and administrative expenses .............................................. 9,220 8,799 8,746
----------------------------------------
Total losses and expenses ...................................................... 61,110 54,926 70,989
----------------------------------------
Income (loss) from continuing operations before provision for income tax ........... 4,636 (6,222) 4,469
Income tax provision ............................................................... 47 18 120
----------------------------------------
Income (loss) from continuing operations ........................................... 4,589 (6,240) 4,349
Discontinued operations:
Net loss from operations ......................................................... -- (633) (2,033)
Loss on disposal ................................................................. -- (1,246) --
----------------------------------------
Net income (loss) .................................................................. $ 4,589 $ (8,119) $ 2,316
========================================
Basic Earnings (loss) per share of Common Stock:
Income (loss) from continuing operations ........................................... $ 0.30 $ (0.41) $ 0.28
Discontinued operations:
Loss from operations ............................................................. -- (0.04) (0.13)
Loss on disposal ................................................................. -- (0.08) --
----------------------------------------
Net income (loss) .................................................................. $ 0.30 $ (0.53) $ 0.15
========================================
Diluted Earnings (loss) per share of Common Stock:
Income (loss) from continuing operations ........................................... $ 0.28 $ (0.41) $ 0.27
Discontinued operations:
Loss from operations ............................................................. -- (0.04) (0.13)
Loss on disposal ................................................................. -- (0.08) --
----------------------------------------
Net income (loss) .................................................................. $ 0.28 $ (0.53) $ 0.14
========================================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
13 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-------------------------
(In thousands, except share and per share information) 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Fixed maturities at fair value (Cost: $139,089 and $143,424)......................................... $140,899 $143,330
Equity securities at fair value (Cost: $363 and $257)................................................ 813 2,697
Short term investments, at cost which approximates fair value........................................ 1,111 5,528
-------------------------
Total investments................................................................................ 142,823 151,555
Cash................................................................................................. 707 1,155
Accrued investment income............................................................................ 2,006 2,397
Premiums and fees receivable, net of allowances of $179 and $230..................................... 5,438 5,597
Reinsurance recoverable on paid losses, net of allowances of $374 and $316........................... 8,523 3,071
Reinsurance recoverable on unpaid losses, net of allowances of $499 and $425......................... 20,185 23,546
Prepaid reinsurance premiums......................................................................... 1,681 2,417
Property and equipment, net of accumulated depreciation of $7,690 and $7,102......................... 2,499 2,968
Deferred acquisition costs........................................................................... 1,550 957
Other assets......................................................................................... 2,361 2,756
-------------------------
Total assets..................................................................................... $187,773 $196,419
=========================
LIABILITIES AND STOCKHOLDERS' EQUITY:
Unpaid losses and loss adjustment expenses........................................................... $105,947 $120,651
Unearned premiums.................................................................................... 10,249 8,294
Policyholder dividends............................................................................... 411 407
Reinsurance premiums payable......................................................................... 1,244 1,765
Funds withheld on ceded reinsurance.................................................................. 1,254 1,479
Other liabilities.................................................................................... 4,748 4,970
-------------------------
Total liabilities................................................................................ 123,853 137,566
Preferred Stock ($0.10 par value; authorized 10,000,000 shares;
none issued and outstanding)....................................................................... -- --
Common Stock ($0.10 par value; authorized 20,000,000 shares;
issued 15,586,994 shares and 15,370,894 shares;
outstanding 15,576,287 shares and 15,360,238 shares)............................................... 1,559 1,537
Additional paid-in capital........................................................................... 46,673 46,131
Net unrealized gain on securities.................................................................... 2,260 2,346
Retained earnings.................................................................................... 13,494 8,905
Treasury stock (Cost of 10,707 shares and 10,656 shares)............................................. (66) (66)
-------------------------
Total stockholders' equity....................................................................... 63,920 58,853
-------------------------
Commitments and contingencies
Total liabilities and stockholders' equity....................................................... $187,773 $196,419
=========================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
14 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
For the years ended December 31,
----------------------------------------------
(In thousands, except share amounts) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Common stock
Balance, beginning of year....................................................... $ 1,537 $ 1,537 $ 1,537
Exercise of options to purchase Common Stock..................................... 22 -- --
-----------------------------------------------
Balance, end of year............................................................. 1,559 1,537 1,537
-----------------------------------------------
Additional paid-in capital
Balance, beginning of year....................................................... 46,131 46,131 46,417
Exercise of options to purchase Common Stock..................................... 649 -- --
Retirement of stock options...................................................... (107) -- (286)
-----------------------------------------------
Balance, end of year............................................................. 46,673 46,131 46,131
-----------------------------------------------
Net unrealized gain (loss) on available-for-sale securities
Balance, beginning of year....................................................... 2,346 5,195 (278)
Net unrealized gain on the date of reclassification
of available-for-sale securities............................................... -- -- 2,880
Net increase (decrease).......................................................... (86) (2,849) 2,593
-----------------------------------------------
Balance, end of year............................................................. 2,260 2,346 5,195
-----------------------------------------------
Retained earnings
Balance, beginning of year....................................................... 8,905 17,024 14,708
Net income (loss)................................................................ 4,589 (8,119) 2,316
-----------------------------------------------
Balance, end of year............................................................. 13,494 8,905 17,024
-----------------------------------------------
Treasury stock
Balance, beginning and end of year............................................... (66) (66) (66)
-----------------------------------------------
Total stockholders' equity................................................... $63,920 $58,853 $69,821
===============================================
- ------------------------------------------------------------------------------------------------------------------------------------
Common stock, shares
Balance, beginning of year....................................................... 15,370,894 15,370,894 15,370,894
Exercise of options to purchase Common Stock..................................... 216,100 -- --
-----------------------------------------------
Balance, end of year............................................................. 15,586,994 15,370,894 15,370,894
===============================================
Treasury stock, shares
Balance, beginning of year....................................................... 10,656 10,639 10,624
Purchased during year............................................................ 51 17 15
-----------------------------------------------
Balance, end of year............................................................. 10,707 10,656 10,639
===============================================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
15 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the years ended December 31,
----------------------------------------
(In thousands) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Income (loss) from continuing operations.............................................. $ 4,589 $ (6,240) $ 4,349
Adjustments to reconcile income (loss) from continuing operations to
net cash used in operating activities:
Net realized investment gains..................................................... (2,174) (499) (207)
Depreciation and amortization..................................................... 905 920 1,360
Change in accrued investment income............................................... 391 412 175
Change in premiums and fees receivable............................................ 159 3,504 8,010
Change in reinsurance recoverables................................................ (5,452) (1,065) 4,280
Change in reinsurance recoverable on unpaid losses ............................... 3,361 (1,155) (3,407)
Change in prepaid reinsurance premiums............................................ 736 80 487
Change in deferred acquisition costs.............................................. (593) 97 1,159
Change in unpaid losses and loss adjustment expenses.............................. (14,704) (18,886) (8,924)
Change in unearned premiums....................................................... 1,955 (569) (5,765)
Change in policyholder dividends payable.......................................... 4 (4,257) (1,616)
Change in reinsurance payables and funds withheld................................. (746) (382) (248)
Other, net........................................................................ (14) 1,091 (3,316)
----------------------------------------
Net cash used in operating activities........................................... (11,583) (26,949) (3,663)
----------------------------------------
Cash flows from investing activities:
Proceeds from sales:
Fixed income maturities available-for-sale.......................................... 951 12,668 7,464
Equity securities................................................................... 2,159 351 --
Other investments................................................................... -- -- 433
Investments, matured or called:
Fixed income maturities held-to-maturity............................................ -- -- 4,890
Fixed income maturities available-for-sale.......................................... 23,002 29,821 23,157
Investments purchased:
Fixed income maturities available-for-sale.......................................... (19,664) (19,463) (25,881)
Equity securities................................................................... (129) -- --
Other investments................................................................... -- -- (105)
Acquisition of Valor Insurance Company (net of cash
and short-term investments of $1,461)............................................... -- (1,450) --
Net proceeds from sale of Danielson Trust Company..................................... -- 2,968 --
Purchases of property and equipment................................................... (165) (32) (338)
Proceeds from sale of property and equipment.......................................... -- 86 --
----------------------------------------
Net cash provided by investing activities....................................... 6,154 24,949 9,620
----------------------------------------
Cash flows from financing activities:
Retirement of stock options........................................................... (107) -- (286)
Proceeds from exercise of options to purchase
Common Stock........................................................................ 671 -- --
----------------------------------------
Net cash provided by (used in) financing activities............................. 564 -- (286)
----------------------------------------
Net cash provided by (used in) continuing operations.................................... (4,865) (2,000) 5,671
Net cash used in discontinued operations................................................ -- (120) --
----------------------------------------
Net increase (decrease) in cash and short term investments.............................. (4,865) (2,120) 5,671
Cash and short term investments at beginning of year.................................... 6,683 8,803 3,132
----------------------------------------
Cash and short term investments at end of year.......................................... $ 1,818 $ 6,683 $ 8,803
========================================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
16 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996, and 1995
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"). See also Note 2 "ACQUISITION OF VALOR INSURANCE COMPANY." In March
1993, DHC acquired 100 percent of the common stock of Danielson Trust Company
("Danielson Trust"). On December 31, 1996, DHC sold 100 percent of the common
stock of Danielson Trust. See also Note 5 "DISCONTINUED OPERATIONS."
The operations of DHC's primary insurance subsidiary, NAICC, are in
property and casualty insurance. NAICC writes workers' compensation and
non-standard automobile insurance in the western United States, primarily
California. NAICC writes approximately 80 percent of its insurance in
California. For the years ended December 31, 1997, 1996 and 1995, private
passenger automobile direct written premiums, representing 59 percent, 55
percent and 41 percent, respectively, 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
generally accepted accounting principles. All material transactions among
consolidated companies have been eliminated.
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 stockholders' equity until realized. Transfers of securities
between categories are recorded at fair value at the date of transfer. Net
unrealized gains or losses associated with transfers of fixed maturities
classified as held-to-maturity to fixed maturities classified as
available-for-sale are recorded as a separate component of stockholders' equity.
The net unrealized gains or losses on fixed maturities included in the separate
component of stockholders' equity for fixed maturities transferred from the
classification of available-for-sale to held-to-maturity are amortized into
earnings over the remaining life of the security as an adjustment to yield in a
manner consistent with the amortization or accretion of premium or discount on
the associated security. The Company does not hold any fixed maturities that are
classified as trading. In December 1995, the Company reclassified its entire
held-to-maturity portfolio to available-for-sale under a one-time provision
permitted by the Financial Accounting Standards Board. 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.
17 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996, and 1995
(continued)
Premiums and discounts of fixed maturities that are classified as
held-to-maturity securities 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 reflected 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 premiums. Premiums earned but unbilled and included in
premiums receivable were $1.2 million and $480,000 at December 31, 1997 and
1996, respectively.
D. Unpaid Losses and Loss Adjustment Expenses
Unpaid losses and loss adjustment expenses ("LAE") are based on estimates
of reported losses, historical Company experience of losses reported by
reinsured companies for insurance assumed from such insurers, and estimates
based on historical Company and industry experience for unreported claims.
Management believes that the provisions for unpaid losses and LAE are adequate
to cover the cost of losses and LAE incurred to date. However, such liability
is, by necessity, based upon estimates, which may change in the near term, and
there can be no assurance that the ultimate liability will not exceed, or even
materially exceed, such estimates. See Note 7 "Unpaid Losses and Loss Adjustment
Expenses."
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 and
reported as assets. 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, 1997 and 1996, the Company had
no reinsurance contracts which were accounted for as deposits. See Note 6
"REINSURANCE."
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 1997, 1996 and 1995 was
$10.1 million, $6.2 million and $9.1 million, respectively.
G. Policyholder Dividends
Policyholder dividends represent management's estimate of amounts to be
paid on participating policies which share in positive underwriting results,
based on the type of policy plan. Participating policies represent approximately
10 percent, 6 percent and 34 percent of workers' compensation direct written
premiums for the years ended December 31, 1997, 1996 and 1995, 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, 1997.
18 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
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 bases
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 realizable. See Note 11
"INCOME TAXES."
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. At December 31, 1997 the Company adopted Statement of Financial Accounting
Standards No. 128, "Earnings Per Share". In accordance with the provisions of
this Statement, all prior years' earnings per share data have been restated and
both basic earnings per share and diluted earnings per share have been presented
on the face of the income statement. 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, whether or
not currently exercisable. Such average shares were 16,194,180 and 15,988,879
for the years ended December 31, 1997 and 1995, respectively. Loss per share and
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 15,481,041,
15,360,250, and 15,360,263 for the years ended December 31, 1997, 1996 and 1995,
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, 1997. The fair
value of all other financial instruments approximates their respective carrying
value. See Note 9 "INVESTMENTS."
L. Use of Estimates
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements and 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 No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") had
been applied. See Note 12 "EMPLOYEE BENEFIT AND STOCK OPTION PLANS."
2) ACQUISITION OF VALOR INSURANCE COMPANY
On June 24, 1996, NAICC completed the acquisition of 100% of the
outstanding common stock of Valor Insurance Company, Incorporated ("Valor") for
$2.9 million in cash. Valor is a property and casualty insurance company
domiciled in the state of Montana and writes workers' compensation insurance in
Montana. The acquisition of Valor has been accounted for as a purchase. The
purchase price was allocated to the identifiable
19 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996, and 1995
(continued)
net assets of Valor based upon the estimated relative fair values thereof. In
connection with the acquisition, NAICC acquired net assets with a fair value of
approximately $1.1 million, resulting in $1.8 million of cost in excess of net
assets acquired. This amount, which is included in other assets at December 31,
1997, is being amortized over 10 years.
3) EXPENSES IN CONNECTION WITH TERMINATED PROPOSED ACQUISITION
On February 26, 1996, DHC signed an Agreement and Plan of Merger (the
"Merger") with Midland Financial Group, Inc. ("Midland") which provided for,
among other things, Midland to be merged into a subsidiary of DHC. On April 24,
1996, DHC and Midland filed a joint proxy statement with the Securities and
Exchange Commission with respect to the Merger and DHC filed registration
statements with respect to securities proposed to be issued in connection with
the Merger. As a result of the deaths of key executives of the Company and
Midland in the crash of TWA Flight 800, DHC and Midland signed a Termination
Agreement for the Merger on July 24, 1996. DHC deregistered the shares related
to the proposed Merger. The amounts expensed are amounts paid that relate
directly to the proposed Merger and include (without limitation) regulatory
filing fees, legal expenses, accounting expenses, printing costs, fairness
opinion expenses and investment banking fees.
4) NONRECURRING COMPENSATION
In recognition of the deaths of C. Kirk Rhein, Jr. and William Story, the
Company has contracted to pay death benefits, monthly, over a period of three
years, commencing August 1, 1996. Such amounts were expensed in August 1996
based on their estimated present value. DHC also contracted to pay severance
benefits over the course of one year, commencing August 1, 1996, in connection
with the resignation of certain former employees. Such amounts were expensed in
full in August 1996.
5) DISCONTINUED OPERATIONS
On December 31, 1996, DHC sold 100% of the common stock of Danielson Trust
to North American Trust Company for $3 million in cash. The sale resulted in a
loss of $1.2 million.
Trust and Fiduciary Services constituted a separate segment of the Company
and as a result, the net loss and loss on disposal of Danielson Trust are
reported herein as discontinued operations. Summarized operating results of
Danielson Trust are as follows (dollars in thousands):
For the years ended
December 31,
------------------------
1996 1995
- --------------------------------------------------------------------------------
Revenues ..................................... $ 3,493 $ 4,623
General and administrative
expenses ................................... 4,126 6,656
------------------------
Net Loss ..................................... $ (633) $(2,033)
========================
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of" ("SFAS 121") in 1995. Under SFAS 121,
long-lived assets, certain identifiable intangibles and goodwill related to such
assets to be held and used by an entity are required to be reviewed for
impairment whenever events or changes in circumstance indicate that the carrying
amount of such assets may not be recoverable. As a result of the 1995 net
operating losses of Danielson Trust, the Company was required to assess the
recoverability and amortization of goodwill associated with Danielson Trust.
Based upon this assessment, the Company reduced the carrying amount of the
remaining goodwill by $709,000, to $2.7 million. The writedown is included in
the net loss from discontinued operations.
6) 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.
20 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NAICC cedes reinsurance on an excess of loss basis for workers'
compensation risks in excess of $500,000 and generally for all other risks in
excess of $150,000. In 1996 and 1995, NAICC also ceded 50 percent of its private
passenger automobile business on a quota share basis. Effective January 1, 1997,
the quota share agreement was amended to reduce the cessation rate to 25
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,
---------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
Direct ................... $ 66,700 $ 51,201 $ 70,949
Ceded .................... (10,940) (15,065) (15,654)
---------------------------------------------
Net premium .............. $ 55,760 $ 36,136 $ 55,295
=============================================
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, all of which has been disputed by the reinsurers.
NAICC has initiated arbitration and litigation proceedings. The dispute related
to this submission centers on the allocation of occurrences and coverages.
Although the outcome of the pending arbitration cannot be predicted, NAICC
believes that the ultimate disposition of these proceedings will not have an
adverse impact on the financial condition of the Company.
As of December 31, 1997, General Reinsurance Corporation ("GRC"), American
Reinsurance Company ("ARC") and Lloyd's of London ("Lloyd's") 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, 1997, NAICC
had reinsurance recoverables on paid and unpaid claims of $6.3 million, $7.4
million and $9.3 million from GRC, ARC and Lloyd's, respectively. Both GRC and
ARC had an A.M. Best rating of A+ or better.
7) 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,
---------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
Net unpaid losses and
LAE at January 1 ................ $ 97,105 $ 116,294 $ 128,625
Net unpaid losses acquired
with Valor ...................... -- 403 --
---------------------------------------
97,105 116,697 128,625
---------------------------------------
Incurred related to:
Current year .................... 37,142 26,979 45,592
Prior years ..................... 940 10,120 3,123
---------------------------------------
Total incurred .................... 38,082 37,099 48,715
---------------------------------------
Paid related to:
Current year .................... (13,729) (10,559) (14,464)
Prior years ..................... (35,696) (46,132) (46,582)
---------------------------------------
Total paid ........................ (49,425) (56,691) (61,046)
---------------------------------------
Net unpaid losses and
LAE at December 31 .............. 85,762 97,105 116,294
Plus: reinsurance
recoverables .................... 20,185 23,546 21,112
---------------------------------------
Gross unpaid losses and
LAE at December 31 .............. $ 105,947 $ 120,651 $ 137,406
=======================================
The losses and LAE incurred related to prior years is attributable to
claims from businesses which are in run-off. In 1996, NAICC strengthened the
unpaid losses and allocated loss adjustment expenses ("ALAE") of pre-1980
businesses assumed by NAICC in 1985 and which are in run-off. NAICC increased
these run-off claim liabilities by $10 million. The pre-1980 run-off liabilities
include claims relating to environmental clean-up for policies issued prior to
1970. NAICC increased its bulk unpaid liabilities related to these claims,
principally the unpaid ALAE, as it had become evident that the legal costs
associated with these claims would be significantly greater than previously
anticipated. 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
21 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996, and 1995
(continued)
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 bulk 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 exposure exists in excess
of amounts which are currently recorded which could be material. However,
management does not expect that liabilities associated with these types of
claims will result in a material adverse effect on future liquidity or financial
position. Liabilities such as these are based upon estimates and there can be no
assurance that the ultimate liability will not exceed, or even materially
exceed, such estimates.
NAICC is involved in litigation related to certain environmental claims
which have some significant uncertainties. Such uncertainties include
difficulties in predicting the outcome of judicial decisions as case law evolves
regarding liability exposure, insurance coverage and interpretation of policy
language with respect to environmental claims. While the outcome of such
litigation cannot be determined at this time, such litigation, net of
liabilities established therefor and giving effect to reinsurance, is not
expected to have a material adverse effect on the future liquidity or financial
position of NAICC. As of December 31, 1997 and 1996, NAICC's net unpaid losses
and LAE relating to environmental claims were approximately $10.9 million and
$13.4 million, respectively.
8) REGULATION, DIVIDEND RESTRICTIONS AND STATUTORY SURPLUS
DHC's insurance subsidiaries are regulated by various states and prepare
their financial statements in accordance with statutory accounting principles.
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 "Association"), as well as state laws, regulations and general
administrative rules. Permitted statutory accounting practices encompass all
accounting practices not so prescribed. The Company has not applied any
permitted accounting practices in its statutory financial statements. As of
December 31, 1997 and 1996, DHC's operating insurance subsidiaries reported
statutory capital and surplus of $45.0 million and $41.4 million, respectively.
The combined statutory net income (loss) for DHC's operating insurance
subsidiaries, as reported to the regulatory authorities for the years ended
December 31, 1997, 1996 and 1995, was $5.9 million, ($5.6) million and $4.8
million, respectively. The Insurance Department has examined the statutory basis
financial statements of NAICC through December 31, 1995. No adjustments were
made to the statutory basis financial statements of NAICC or its subsidiaries.
The Montana Department of Insurance is currently conducting an examination of
the statutory basis financial statements of Valor as of December 31, 1995.
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
22 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
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.
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. To the extent that NAICC's unassigned
surplus remains negative in 1998, NAICC will not be permitted to pay dividends
without prior regulatory approval.
9) INVESTMENTS
The amortized cost, unrealized gains, unrealized losses and fair value at
December 31, 1997 and 1996, categorized by type of security, were as follows
(dollars in thousands):
December 31, 1997
-----------------------------------------------
Cost or
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
- --------------------------------------------------------------------------------
Fixed maturities:
U.S. Government/
Agency ................. $ 48,635 $ 715 $ 6 $ 49,344
Mortgage-backed .......... 58,372 740 162 58,950
Corporate ................ 32,082 593 70 32,605
-----------------------------------------------
Total fixed
maturities ......... 139,089 2,048 238 140,899
-----------------------------------------------
Equity securities .......... 363 450 -- 813
-----------------------------------------------
Total available-
for-sale ................. $139,452 $ 2,498 $ 238 $141,712
===============================================
December 31, 1996
-----------------------------------------------
Cost or
Amortized Unrealized Unrealized Fair
Cost Gain Loss Value
- --------------------------------------------------------------------------------
Fixed maturities:
U.S. Government/
Agency ................. $ 50,381 $ 686 $ 64 $ 51,003
Mortgage-backed .......... 54,691 384 1,198 53,877
Corporate ................ 38,352 444 346 38,450
-----------------------------------------------
Total fixed
maturities ......... 143,424 1,514 1,608 143,330
Equity securities .......... 257 2,440 -- 2,697
-----------------------------------------------
Total available-
for-sale ................. $143,681 $ 3,954 $ 1,608 $146,027
===============================================
Fixed maturities of the Company include mortgage-backed securities ("MBS")
representing 41.8 percent and 37.6 percent of the Company's total fixed
maturities at December 31, 1997 and 1996, respectively. All MBS held by the
Company are issued by the Federal National Mortgage Association ("Fannie 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, 1997, 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
23 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996, and 1995
(continued)
the anticipated prepayment rates of each security (dollars in thousands):
Amortized Fair
Maturity Cost Value
- --------------------------------------------------------------------------------
Available-for-sale:
One year or less ........................... $ 20,324 $ 20,358
Over one year to five years ................ 67,672 68,981
Over five years to ten years ............... 49,670 50,038
More than ten years ........................ 1,423 1,522
-------------------------
Total fixed maturities ................... $139,089 $140,899
=========================
In November 1995, the Financial Accounting Standards Board Emerging Issues
Task Force issued a Special Report, "A Guide to Implementation of Statement 115
on Accounting for Certain Investments in Debt and Equity Securities" (the
"Special Report") permitting companies to effect a one-time reclassification of
all securities held at that time. At December 1, 1995, the Company reclassified
all held-to-maturity securities to the available-for-sale security category. The
amortized cost of the fixed maturities that were transferred was $139.9 million.
Upon the adoption of the Special Report, unrealized gains of $2.9 million were
reported as a component of stockholders' equity with no effect on the Company's
earnings. The purpose of the Company's reclassification was to provide it with
increased flexibility both to respond to changes in market conditions which
could affect asset and liability matching and cash flow and to effect changes in
investment policy guidelines in response to changes in business conditions.
Pursuant to the Special Report, the reclassifications from the held-to-maturity
category in connection with the one-time reassessment do not affect the
Company's intent to hold other debt securities to maturity in the future.
The following reflects the change in net unrealized gain (loss) on
available-for-sale securities included as a separate component of stockholders'
equity (dollars in thousands):
For the years ended
December 31,
-----------------------------
1997 1996 1995
- ---------------------------------------------------------------
Fixed maturities................ $1,904 $(4,916) $5,392
Equity securities............... (1,990) 2,067 81
-----------------------------
$ (86) $(2,849) $5,473
=============================
Net realized investment gains in 1997, 1996 and 1995 were as follows (dollars
in thousands):
For the years ended
December 31,
------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
Fixed maturities .................. $ 38 $ 148 $ 129
Equity securities ................. 2,136 351 --
Other investments ................. -- -- 78
------------------------------------
Net realized gain ............... $2,174 $ 499 $ 207
====================================
Gross realized gains relating to fixed maturities were $75,000, $171,000
and $213,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
Gross realized losses relating to fixed maturities were $37,000, $23,000 and
$84,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
Gross realized gains relating to equity securities were $2,136,000 and $351,000
for the years ended December 31, 1997 and 1996, respectively. There were no
gross realized losses relating to equity securities in either year. There were
neither gross realized gains nor gross realized losses relating to equity
securities for the year ended December 31, 1995. Gross realized gains relating
to other investments were $78,000 for the year ended December 31, 1995 and there
were no gross realized losses relating to other investments in that year. There
were neither gross realized gains nor gross realized losses relating to other
investments for the years ended December 31, 1997 and 1996.
Net investment income for the past three years was as follows (dollars in
thousands):
For the years ended
December 31,
-----------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
Fixed maturities ..................... $ 9,682 $10,852 $12,320
Short term investments ............... 253 243 206
Other, net ........................... 1 8 899
-----------------------------------
Total investment income ............ 9,936 11,103 13,425
-----------------------------------
Less: Investment expense ............. 126 448 399
-----------------------------------
Net investment income .............. $ 9,810 $10,655 $13,026
===================================
24 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
Other investment income in 1995 includes interest of $840,000 received in
December 1995 relating to a previously disputed reinsurance recoverable.
During 1997, all of the securities held by the Company were income
producing.
There were no investments with a carrying value greater than ten percent
of stockholders' equity as of December 31, 1997, 1996 or 1995.
In compliance with state insurance laws and regulations, securities with a
fair value of approximately $65 million, $85 million and $119 million at
December 31, 1997, 1996 and 1995, respectively, were on deposit with various
states or governmental regulatory authorities. In addition, at December 31,
1997, 1996 and 1995, respectively, investments with a fair value of $5.6
million, $4.3 million and $4.7 million were held in trust or as collateral under
the terms of certain reinsurance treaties and letters of credit.
10) STOCKHOLDERS' EQUITY
DHC is authorized to issue 20,000,000 shares of common stock, par value
$0.10 per share ("Common Stock"), and 10,000,000 shares of preferred stock, par
value $0.10 per share. As of December 31, 1997, there were 15,586,994 shares of
Common Stock issued of which 15,576,287 were outstanding; the remaining 10,707
shares of Common Stock issued but not outstanding are held as treasury stock.
There are no shares of preferred stock which were issued or outstanding. For
additional information about the Company's Stock Option Plans, see Note 12
"EMPLOYEE BENEFITS AND STOCK OPTION PLANS." 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. See Note 11 "INCOME
TAXES."
11) INCOME TAXES
DHC files a Federal consolidated income tax return with its subsidiaries
and certain trusts that assumed various liabilities of certain present and
former subsidiaries of DHC.
The Company has a consolidated net operating loss carryforward for Federal
income tax purposes of approximately $1.4 billion as of December 31, 1997. This
number is based upon Federal consolidated income tax losses for the periods
through December 31, 1996 and an estimate of the 1997 taxable loss. The net
operating loss carryforward will expire in various amounts, if not used, between
1998 and 2012. The Internal Revenue Service ("IRS") may attempt to challenge the
amount of this net operating loss in the event of a future tax audit. Management
believes, based in part upon the views of its tax advisors, that its net
operating loss calculations are reasonable and that it is reasonable to conclude
that the Company's net operating losses would be available for use by the
Company. These tax loss attributes are currently fully reserved, for valuation
purposes, on the Company's financial statements. The amount of the deferred tax
asset considered realizable could be increased in the near term if estimates of
future taxable income during the carryforward period are increased. See Note 10
"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
December 31, Carryforward Expiring
- ---------------------------------------------------------------
1998........................................ $ 33,328
1999........................................ 203,868
2000........................................ 253,098
2001........................................ 155,806
2002........................................ 142,982
2003........................................ 60,849
2004........................................ 69,947
2005........................................ 106,225
2006........................................ 92,355
2007........................................ 89,790
2008........................................ 31,688
2009........................................ 39,689
2010........................................ 23,600
2011........................................ 19,755
2012........................................ 38,799
----------
$1,361,779
==========
25 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996, and 1995
(continued)
The Company has made provisions for certain state and local 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,
--------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
Federal income tax ................... $ -- $ -- $ --
State and local ...................... 47 18 120
--------------------------------
$ 47 $ 18 $120
================================
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 1997, 1996 and 1995, as compared to the provision for income
taxes (dollars in thousands):
For the years ended
December 31,
-------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
Computed "expected"
tax expense ........................ $ 1,576 $ (2,115) $ 1,519
Change in valuation allowance ........ 10,945 3,754 1,819
Increase in net operating
losses from the trusts ............. (12,504) (1,755) (3,291)
State and local tax expense .......... 47 18 120
Other, net ........................... (17) 116 (47)
-------------------------------------
Total income tax expense ............. $ 47 $ 18 $ 120
=====================================
The tax effects of temporary differences that give rise to the deferred
tax assets and liabilities at December 31, 1997 and 1996, respectively, are
presented as follows (dollars in thousands):
December 31, December 31,
1997 1996
- --------------------------------------------------------------------------------
Deferred tax assets
Loss reserve discounting ................... $ 5,861 $ 7,124
Unearned premiums .......................... 583 400
Net operating loss
carryforwards ............................ 463,005 454,508
Allowance for doubtful
accounts ................................. 357 330
Policyholder dividends ..................... 140 138
Non-recurring compensation ................. 162 354
Capital loss carryforwards ................. 2,682 893
Other ...................................... 206 96
--------------------------
Total gross deferred tax asset ............. 472,996 463,843
Less: Valuation allowance .................. (471,580) (462,720)
--------------------------
Total deferred tax asset ................... $ 1,416 $ 1,123
--------------------------
Deferred acquisition costs ................. 527 325
Unrealized gains on available-
for-sale securities ...................... 768 798
--------------------------
Difference in tax basis
of bonds ................................. 121 --
--------------------------
Total deferred tax liability ............... 1,416 1,123
--------------------------
Net deferred tax asset ..................... $ -- $ --
==========================
26 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
12) 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 may be granted to existing officers or employees of DHC.
Options under and outside the 1990 Plan may be 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 the same 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 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 per share, 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 per
share. As a result, DHC received $630,000.
As of December 31, 1997, 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.
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).
27 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996, and 1995
(continued)
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.
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.
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).
On March 31, 1997, options to purchase 6,100 shares of Common Stock were
exercised at their exercise price of $6.6875 per share. 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).
On December 15, 1997, options to purchase an aggregate amount of 152,500
shares of Common Stock were granted under the 1995 Plan. The exercise price for
such options is $7.0625 per share (the mean of the high and low prices of the
Common Stock on the American Stock Exchange on the date of the grant).
As of December 31, 1997, 242,332 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 123, the net
income (loss) and earnings (loss) per share would have been reduced to
(increased to) the pro forma amounts indicated below (dollars in thousands
except per share amounts):
<TABLE>
<CAPTION>
1997 1996 1995
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income (loss)
As reported ................................. $ 4,589 $ (8,119) $ 2,316
Pro forma ................................... 4,303 (8,621) 2,275
Diluted earnings (loss) per share
As reported ................................. $ 0.28 $ (0.53) $ 0.14
Pro forma ................................... 0.27 (0.56) 0.14
</TABLE>
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 (loss) for 1997, 1996 and 1995 may not be
representative of the effects on net income (loss) 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, has been 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
28 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
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,
1997 and 1996, respectively, were as follows:
1997 1996
- --------------------------------------------------------------------------------
Allocated shares ......................... 99,682 101,299
Unreleased shares ........................ -- 20,528
-------------------------
99,682 121,827
=========================
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, 1997 and 1996, valued at January 1, 1998 and 1997, respectively
(dollars in thousands):
1997 1996
- --------------------------------------------------------------------------------
Actuarial present value of benefit obligations:
Accumulated benefits obligation,
including vested benefits of $1,381
for 1997 and $1,608 for 1996 ..................... $ 1,739 $ 1,921
=====================
Projected benefit obligation ......................... $ 1,942 $ 1,921
Plan assets at fair value ............................ 1,641 1,517
---------------------
Projected benefit obligation in excess
of plan assets ................................... (301) (404)
Unrecognized net (gain) loss ......................... 97 (68)
Unrecognized prior service cost ...................... 66 74
Adjustment required to recognize
minimum liability .................................. -- (6)
---------------------
(Accrued) prepaid pension cost ..................... $ (138) $ (404)
=====================
Net pension costs for the years ended December 31, 1997, 1996 and 1995 include
the following components:
For the years ended
December 31,
------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
Service cost ............................... $ 230 $ 237 $ 243
Interest cost .............................. 131 128 156
Actual (return) loss on plan assets ........ (91) (106) (201)
Net amortization and deferral .............. (3) 23 131
------------------------------
Net pension cost ......................... $ 267 $ 282 $ 329
==============================
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 7.75 percent, 7.5 percent and 7.25 percent for 1997, 1996
and 1995, respectively. The projected long-term rate of return on assets was
7.25 percent for 1997 and 7 percent for each of 1996 and 1995. The average rate
of compensation increase used in determining the actuarial present value of the
projected benefit obligation was 4.5 percent for 1997 and 1996.
KCP maintains the 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
12 percent of their eligible compensation to a maximum dollar amount allowed by
the IRS. As noted above, prior to July 1, 1995, the participating employers
contributed 50 percent of the first six percent of employee-contributed
compensation; however, effective July 1, 1995, Danielson Trust reduced its
maximum contribution to 50 percent of the first four percent of Danielson Trust
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 1997, 1996 and
1995, the employers' matching obligation to the 401(k) Plan was satisfied
through ESOP shares, cash and forfeitures totaling $186,000, $242,000 and
$211,000, respectively, in value.
29 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996, and 1995
(continued)
13) 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 $1.1 million for each of the
the years ended December 31, 1997 and 1996 and $1.2 million for the year ended
1995.
At December 31, 1997, future net minimum operating lease rental payment
commitments were as follows (dollars in thousands):
Year Ending Minimum Operating Lease
December 31, Rental Payments
- --------------------------------------------------------------
1998........................................ $1,447
1999........................................ 1,264
2000........................................ 743
2001........................................ 720
2002 and thereafter......................... 900
------
Total commitments........................... $5,074
======
14) 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.
30 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
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, 1997 and 1996, 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, 1997.
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 generally accepted auditing
standards. 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, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997, in conformity with generally accepted
accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
February 27, 1998
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 generally accepted accounting principles. 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 Peat Marwick 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 Peat Marwick LLP and the Company's financial management
to review accounting, internal control, auditing and financial reporting
matters.
31 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
QUARTERLY FINANCIAL DATA
(unaudited)
The following table presents unaudited quarterly financial data for the years
ended December 31, 1997 and 1996. 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.
<TABLE>
<CAPTION>
First Second Third Fourth
(In thousands, except per share amounts) Quarter Quarter Quarter Quarter
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997:
Total revenues.................................................. $15,698 $15,330 $17,357 $17,361
Net income...................................................... 2,437 523 561 1,068
Net income per diluted share.................................... .15 .03 .03 .07
1996:
Total revenues from continuing operations....................... $12,064 $12,244 $11,451 $12,945
Income (loss) from continuing operations........................ 638 (1,497)(1) (178)(1),(2) (5,203)(3)
Net loss from discontinued operations........................... (81)(4) (163)(4) (389)(4) --
Net income (loss) on disposal of Danielson Trust................ -- -- (1,271) 25
Income (loss) per diluted share from continuing operations...... .04 (.10)(1) (.01)(1),(2) (.34)(3)
Net loss per diluted share from discontinued operations......... -- (.01)(4) (.03)(4) --
Net loss per diluted share on disposal of Danielson Trust....... -- -- (.08) --
</TABLE>
(1) Includes expenses incurred in connection with the terminated proposed
merger with Midland Financial Group, Inc.
(2) Includes non-recurring compensation expenses of death benefits and
severance pay.
(3) Includes $10 million increase in provision for pre-1980 accident year
losses and LAE relating to run-off businesses and $4 million reduction in
policyholder dividend accrual.
(4) In 1996, DHC sold 100% of the common stock of Danielson Trust.
Accordingly, Danielson Trust's results are reported herein as discontinued
operations and are included in net income (loss).
STOCK MARKET PRICES
Danielson Holding Corporation Common Stock is listed and traded on the
American Stock Exchange (symbol: DHC). On March 16, 1998, there were
approximately 1,592 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.
1997 1996
- ------------------------------------------------------------------------------
High Low Close High Low Close
----------------------- ---------------------------
First Quarter.... 14 4 7/8 6 7/8 8 3/8 6 5/8 7 5/8
Second Quarter... 8 1/2 6 3/8 7 7/8 8 1/4 6 1/4 6 11/16
Third Quarter.... 9 8 9 7 5 1/4 5 1/2
Fourth Quarter... 9 5/8 6 3/4 7 1/4 5 5/8 4 3/4 5
- ------------------------------------------------------------------------------
32 o DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
CORPORATE OFFICERS
Martin J. Whitman
Chairman of the Board and
Chief Executive Officer
David M. Barse
President and
Chief Operating Officer
Michael T. Carney
Chief Financial Officer and Treasurer
Ian M. Kirschner
General Counsel and Secretary
BOARD OF DIRECTORS
David M. Barse
President and
Chief Operating Officer,
Danielson Holding Corporation
Timothy C. Collins
Chief Executive Officer and
Senior Managing Director, Ripplewood Holdings, LLC
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.
Anthony G. Petrello
President and Chief Operating Officer, Nabors Industries, Inc.
Joseph F. Porrino
Executive Vice President,
New School for Social Research
Frank B. Ryan
Professor of Mathematics,
Rice University
Wallace O. Sellers
Director, Enhance Financial Services
Group, Inc.
Martin J. Whitman
Chairman of the Board and
Chief Executive Officer,
Danielson Holding Corporation
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: Bridget Smith
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 Peat Marwick LLP
757 Third Avenue
New York, NY 10017
<PAGE>
Danielson Holding Corporation
767 Third Avenue--Fifth Floor
New York, New York 10017-2023
212/888-0347
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
DANIELSON HOLDING CORPORATION FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997, AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 140,899
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 813
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 142,823
<CASH> 707
<RECOVER-REINSURE> 28,708<F1>
<DEFERRED-ACQUISITION> 1,550
<TOTAL-ASSETS> 187,773
<POLICY-LOSSES> 105,947
<UNEARNED-PREMIUMS> 10,249
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 411
<NOTES-PAYABLE> 0
0
0
<COMMON> 1,559
<OTHER-SE> 62,361<F2>
<TOTAL-LIABILITY-AND-EQUITY> 187,773
53,069
<INVESTMENT-INCOME> 9,810
<INVESTMENT-GAINS> 2,174
<OTHER-INCOME> 693
<BENEFITS> 38,082
<UNDERWRITING-AMORTIZATION> 10,063
<UNDERWRITING-OTHER> 12,498
<INCOME-PRETAX> 4,636
<INCOME-TAX> 47
<INCOME-CONTINUING> 4,589
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,589
<EPS-PRIMARY> 0.30<F3>
<EPS-DILUTED> 0.28<F4>
<RESERVE-OPEN> 97,105
<PROVISION-CURRENT> 37,142
<PROVISION-PRIOR> 940
<PAYMENTS-CURRENT> 13,729
<PAYMENTS-PRIOR> 35,696
<RESERVE-CLOSE> 85,762
<CUMULATIVE-DEFICIENCY> (940)
<FN>
<F1>Includes reinsurance recoverables on unpaid losses of 20,185 and
reinsurance recoverables on paid losses of 8,523.
<F2>Includes treasury stock of 66.
<F3>Represents earnings per share-basic.
<F4>Represents earnings per share-diluted.
</FN>
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
DANIELSON HOLDING CORPORATION FOR THE FISCAL YEAR ENDED DECEMBER 13, 1996, AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<DEBT-HELD-FOR-SALE> 143,330
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 2,697
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 151,555
<CASH> 1,155
<RECOVER-REINSURE> 26,617<F1>
<DEFERRED-ACQUISITION> 957
<TOTAL-ASSETS> 196,419
<POLICY-LOSSES> 120,651
<UNEARNED-PREMIUMS> 8,294
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 407
<NOTES-PAYABLE> 0
0
0
<COMMON> 1,537
<OTHER-SE> 57,316<F2>
<TOTAL-LIABILITY-AND-EQUITY> 196,419
36,625
<INVESTMENT-INCOME> 10,655
<INVESTMENT-GAINS> 499
<OTHER-INCOME> 925
<BENEFITS> 37,099
<UNDERWRITING-AMORTIZATION> 6,239
<UNDERWRITING-OTHER> 15,588<F3>
<INCOME-PRETAX> (6,222)
<INCOME-TAX> 18
<INCOME-CONTINUING> (6,240)
<DISCONTINUED> (1,879)<F4>
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,119)
<EPS-PRIMARY> (0.53)<F5>
<EPS-DILUTED> (0.53)<F6>
<RESERVE-OPEN> 116,294
<PROVISION-CURRENT> 26,979
<PROVISION-PRIOR> 10,120
<PAYMENTS-CURRENT> 10,559
<PAYMENTS-PRIOR> 46,132
<RESERVE-CLOSE> 97,105<F7>
<CUMULATIVE-DEFICIENCY> (10,119)
<FN>
<F1>Included in this caption are reinsurance recoverables on unpaid losses of
23,546 and reinsurance recoverables on paid losses of 3,071.
<F2>Included in Stockholders' Equity-Other is treasury stock of 66.
<F3>Included in this caption are expenses in connection with terminated proposed
acquisition of 1,849 and non Recurring compensation of 1,272.
<F4>Loss from discontinued operations is comprised of loss from operations of
633 and loss on dispose of the segment of 1,246.
<F5>Represents earnings per share-basic.
<F6>Represents earnings per share-diluted.
<F7>Includes reserves of 403 of Valor Insurance Co. which was acquired on
June 24, 1996.
</FN>
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
*DANIELSON HOLDING CORPORATION FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> DEC-31-1995
<DEBT-HELD-FOR-SALE> 172,595
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 629
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 181,794
<CASH> 605
<RECOVER-REINSURE> 22,940<F1>
<DEFERRED-ACQUISITION> 1,045
<TOTAL-ASSETS> 227,924
<POLICY-LOSSES> 137,406
<UNEARNED-PREMIUMS> 8,563
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 4,664
<NOTES-PAYABLE> 0
<COMMON> 1,537
0
0
<OTHER-SE> 68,284<F2>
<TOTAL-LIABILITY-AND-EQUITY> 227,924
60,548
<INVESTMENT-INCOME> 13,161
<INVESTMENT-GAINS> 208
<OTHER-INCOME> 6,164<F3>
<BENEFITS> 48,715
<UNDERWRITING-AMORTIZATION> 9,089
<UNDERWRITING-OTHER> 19,704
<INCOME-PRETAX> 4,469
<INCOME-TAX> 120
<INCOME-CONTINUING> 4,349
<DISCONTINUED> (2,033)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,316
<EPS-PRIMARY> 0.15<F4>
<EPS-DILUTED> 0.14<F5>
<RESERVE-OPEN> 128,625
<PROVISION-CURRENT> 45,592
<PROVISION-PRIOR> 3,123
<PAYMENTS-CURRENT> 14,464
<PAYMENTS-PRIOR> 46,582
<RESERVE-CLOSE> 116,294
<CUMULATIVE-DEFICIENCY> 3,123
<FN>
<F1>Included in this caption are reinsurance recoverables on unpaid losses of
21,112 and reinsurance recoverables on paid losses of 1,828.
<F2>Included in Stockholders' Equity-Other is treasury stock of 66.
<F3>Included in the caption other income is trust fee income of 4,475.
<F4>Represents earnings per share-basic.
<F5>Represents earnings per share-diluted.
</FN>
</TABLE>
