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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, 1998
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. [ ]
At March 24, 1999, the aggregate market value of the registrant's voting
stock held by non-affiliates was $45,247,170.
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 24, 1999
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Common Stock, $0.10 par value 15,576,276 shares
The following documents have been incorporated by reference herein:
1998 Annual Report to Stockholders, as indicated herein (Parts I and II)
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<PAGE>
PART I
Item 1. BUSINESS.
INTRODUCTION
Danielson Holding Corporation ("DHC" or "Registrant") is a holding
company incorporated in Delaware, having separate subsidiaries (collectively
with DHC, the "Company") offering a variety of insurance products. It is DHC's
intention to grow by developing business partnerships and making strategic
acquisitions. As part of DHC's ongoing corporate strategy, DHC has continued to
seek acquisition opportunities which will both complement its existing
operations and enable DHC to earn an attractive return on investment. The
largest subsidiary of DHC is its indirectly wholly-owned California insurance
company, National American Insurance Company of California (together with its
subsidiaries, "NAICC"). NAICC writes workers' compensation, non-standard private
passenger and commercial automobile insurance in the western United States,
primarily California.
DHC retained cash and investments at the holding company level of $6.8
million at December 31, 1998. Total liabilities of DHC at the same date were
$293,000.
The Company will report, as of the end of its 1998 tax year, aggregate
consolidated net operating tax loss carryforwards ("NOLs") for Federal income
tax purposes of approximately $1.3 billion. These losses will expire over the
course of the next 14 years unless utilized prior thereto. See Note 12 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 non-standard private passenger and commercial automobile and
workers' compensation 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.
GENERAL
NAICC began writing non-standard private passenger automobile insurance
in California in July, 1993 and in Oregon and Washington in April, 1998. NAICC
writes its California business through a general agent which uses over 700
sub-agents to obtain applications for policies. The Oregon/Washington business
is written directly through twenty-one appointed independent agents.
Policyholder selection is governed by underwriting guidelines established by
NAICC. NAICC began writing non-standard commercial automobile insurance in 1995
through independent agents. Non-standard risks are those segments of the driving
public which generally are not considered "preferred" business, such as drivers
with a record of prior accidents or driving violations, drivers involved in
particular occupations or driving certain types of vehicles, or those who have
been non-renewed or declined by another insurance company. Generally,
non-standard premium rates are higher than standard premium rates and policy
limits are lower than typical policy limits. NAICC's management believes that it
is able to achieve underwriting success through refinement of various risk
profiles, thereby dividing the non-standard market into more defined segments
which can be adequately priced.
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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. The typical NAICC
commercial automobile policy covers fleets of four or fewer vehicles. NAICC does
not insure long-haul truckers, trucks hauling logs, gasoline or similar higher
hazard operations. The current average annual premium of the policies in force
is approximately $2,650.
Net written premiums were $26.3 million, $29.8 million and $14.5
million in 1998, 1997 and 1996, respectively, for the non-standard private
passenger automobile program. Until January 1, 1997, NAICC ceded 50 percent of
its California 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. The ceding percentage
was further reduced to 10 percent effective January 1, 1999. NAICC's
Oregon/Washington non-standard automobile and California preferred automobile
business is written on an excess of loss basis, where the company retains the
first $250,000. The decrease in California non-standard private passenger
automobile premiums in 1998 were due to several new companies entering the
California marketplace and a 10 percent rate reduction taken mid-year. Part of
the decrease in its California non-standard automobile business was offset by
management's decision to expand its non-standard automobile business into Oregon
and Washington, and to begin offering a preferred automobile program in
California. Net written premiums for commercial automobile were $13.5 million in
1998, $8.8 million in 1997 and $4.8 million in 1996. NAICC has increased its
production efforts in commercial automobile by adding to the number of
commercial automobile agents in both 1997 and 1998 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. 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, $17.2 million, and $16.8 million, in 1998, 1997, and 1996,
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.
NAICC does not write any business through managing general agents. Its
California non-standard private passenger automobile program, representing 38.7%
of net written premiums, is produced through one general agent, and its
preferred private passenger automobile program is produced through another
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. 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
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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.
Private passenger automobile policy limits vary by state. In
California, non-standard 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. In Oregon and Washington,
non-standard policies provide minimum coverage of $25,000 per person, $50,000
per accident for liability and bodily injury and $10,000 per accident for
property damage, and can provide coverage to a maximum of $250,000 per person,
$500,000 per accident for liability and bodily injury and $25,000 per accident
for property damage. In general, preferred policies provide coverage to a
maximum of $250,000 per person, $500,000 per accident for liability and bodily
injury and $25,000 per accident for property damage. The maximum non-standard
commercial automobile policy limit provided by NAICC is $1 million bodily injury
and property damage combined single limit of liability for each occurrence.
During 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 in California 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 are placed with two major reinsurance companies
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 Ramon, 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. In April 1998, NAICC began
marketing non-standard private passenger automobile insurance directly through
21 independent agents in Oregon and Washington. NAICC also began a preferred
private passenger automobile program in California in February 1998 which is
marketed through a second 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, Idaho and Montana through more than 650 independent
agents. 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 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.
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CLAIMS
All automobile claims are handled by employees of NAICC at its home
office in Long Beach, California. Claims are reported by agents, insureds and
claimants directly to NAICC. Claims involving suspected fraud are referred to an
in-house special investigation unit ("SIU") which manages a detailed
investigation of these claims using outside investigative firms. When evidence
of fraudulent activity is identified, the SIU works with the various state
departments of insurance, the National Insurance Crime Bureau and local law
enforcement agencies in handling the claims.
Workers' compensation claims are received, reviewed, processed and paid
by NAICC employees located in claims service offices in Long Beach, California.
Most of NAICC's policyholders are not of sufficient size or type to make a more
specialized managed care approach to medical cost containment more cost
effective.
The California Automobile Assigned Risk Plan provides 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 1970 and which are currently in run-off. The principal exposure arises
from direct excess and primary policies of business in run-off, the obligations
of which were assumed by NAICC in 1985. These direct excess and primary claims
are relatively few in number and have policy limits of between $50,000 and
$1,000,000, with reinsurance generally above $50,000. NAICC also has
environmental claims primarily 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 (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 there is the
potential that NAICC's exposure could be materially in excess of amounts which
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are currently recorded. 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, 1998 and 1997, NAICC's net unpaid losses
and LAE relating to environmental claims were approximately $10.8 million and
$10.9 million, respectively.
Due to the factors discussed above and others, the process used in
estimating unpaid losses and loss adjustment expenses cannot provide an exact
result. Management believes that the provisions for unpaid losses and loss
adjustment expenses are adequate to cover the net cost of losses and loss
expenses incurred to date; however, such liability is necessarily based on
estimates and there can be no assurance that the ultimate liability will not
exceed, or even materially exceed, such estimates.
ANALYSIS OF LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of NAICC's unpaid losses
and LAE (in thousands):
Years Ended December 31,
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1998 1997 1996
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Net unpaid losses and LAE at January 1 $ 85,762 $ 97,105 $ 116,294
Net unpaid losses acquired with Valor
Insurance Company -- -- 403
--------- --------- ---------
85,762 97,105 116,697
Incurred related to:
Current year 39,131 37,142 26,979
Prior years -- 940 10,120
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Total incurred 39,131 38,082 37,099
Paid Related to:
Current year (16,169) (13,729) (10,559)
Prior years (31,258) (35,696) (46,132)
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Total paid (47,427) (49,425) (56,691)
--------- --------- ---------
Net unpaid losses and LAE at
December 31 77,466 85,762 97,105
Plus: reinsurance recoverables 18,187 20,185 23,546
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Gross unpaid losses and LAE at
December 31 $ 95,653 $ 105,947 $ 120,651
========= ========= =========
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The losses and LAE incurred in 1996 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 1995 1996 1997 1998
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <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 $116,294 $97,105 $85,762 $77,466
Net unpaid losses and
LAE re-estimated as of:
One year later 120,527 100,599 92,632 94,364 105,568 119,607 131,748 126,414 98,045 85,762
Two years later 124,167 100,143 87,504 99,875 111,063 123,039 141,602 126,796 97,683
Three years later 121,081 94,954 89,844 107,945 117,756 136,735 141,787 127,621
Four years later 116,384 96,948 95,576 116,018 138,877 140,076 144,491
Five years later 118,175 101,537 102,081 136,269 142,423 142,537
Six years later 122,784 107,344 119,107 139,493 144,457
Seven years later 128,589 122,985 121,161 141,467
Eight Years later 143,585 124,749 122,664
Nine Years later 145,093 125,801
Ten Years later 146,050
Cumulative (deficiency)
redundancy (30,192) (30,529) (30,794) (43,657) (39,632) (23,314) (15,866) (11,327) (578)
Cumulative net amounts
paid as of:
One year later 41,767 38,165 31,162 39,131 39,650 42,264 46,582 46,132 35,696
Two years later 72,735 56,876 53,424 63,483 68,025 71,702 80,515 74,543 54,815
Three years later 86,142 71,543 66,198 81,485 88,038 95,525 101,726 90,818
Four years later 96,352 78,991 75,963 94,238 106,431 110,163 114,424
Five years later 102,385 84,980 83,704 108,923 118,136 119,474
Six years later 107,661 90,458 95,199 118,397 125,218
Seven years later 112,555 100,559 102,886 124,569
Eight years later 121,724 107,630 107,726
Nine years later 128,313 111,735
Ten years later 132,185
</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,
--------------------------------------------------------------------------
1998 1997 1996 1995 1994 1993
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Gross unpaid losses and LAE at end of year: $ 95,653 $ 105,947 $ 120,651 $ 137,406 $ 146,330 $ 137,479
Gross unpaid losses and LAE re-estimated as of:
One year later 107,060 121,787 149,416 149,815 137,898
Two years later 121,335 150,106 161,731 141,737
Three years later 150,815 162,246 158,263
Four years later 165,111 162,697
Five years later 165,077
Gross cumulative deficiency: (1,113) (684) (13,409) (18,781) (27,598)
Gross cumulative amount paid as of:
One year later 36,542 47,835 54,901 53,798 53,634
Two years later 21,794 92,422 92,991 88,930
Three years later 110,498 122,095 116,605
Four years later 136,448 138,924
Five years later 148,928
</TABLE>
The cumulative deficiency as of December 31, 1995 on a net basis of
$11.3 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 $39.6 million and $43.7
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 through 1995
loss years.
Conditions and trends that have affected the development of these
liabilities in the past may not necessarily recur in the future. It would not be
appropriate to use this cumulative history in the projection of future
performance.
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 1998 were 15.1 percent of direct written premiums.
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As of December 31, 1998, 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, 1998, NAICC
had reinsurance recoverables on paid and unpaid claims of $6.1 million, $6.3
million, and $7.5 million from GRC, ARC, and Lloyd's respectively. Both GRC and
ARC had an A.M. Best rating of A+ or better. 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 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 1999, NAICC will not be permitted
to pay dividends without prior regulatory approval.
RISK-BASED CAPITAL
A model for determining the risk-based capital ("RBC") requirements for
property and casualty insurance companies was adopted in December 1993.
Insurance companies are required to report their RBC ratios based on their 1994
annual statements. NAICC has calculated its RBC requirement under the most
recent RBC model and it has sufficient capital in excess of any regulatory
action level. The 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
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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, 1998, the RBC of NAICC was 232% greater than the
Company Action Level. NAICC currently has no plans to take any action designed
to significantly affect its RBC level.
HOLDING COMPANY BUSINESS
DHC is a holding company incorporated under the General Corporation Law
of the State of Delaware. As of December 31, 1998, 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 $6.8 million in cash and investments.
FORMER TRUST BUSINESS
In March 1993, DHC acquired all of the common stock of Danielson Trust
Company ("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, 1998, the Company had a consolidated net operating
loss carryforward of approximately $1.3 billion for Federal income tax purposes.
This number is based upon Federal consolidated income tax losses for the periods
through December 31, 1997 and an estimate of the 1998 taxable results. Some or
all of the carryforward may be available to offset, for Federal income tax
purposes, the future taxable income, if any, of DHC and its wholly-owned
subsidiaries. The Internal Revenue Service ("IRS") 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
-11-
<PAGE>
statements. The amount of the deferred asset considered realizable could be
increased in the near term if estimates of future taxable income during the
carryforward period are increased.
The Company's net operating tax loss carryforwards will expire, if not
used, in the following approximate amounts in the following years (dollars in
thousands):
Year Ending Amount of Carryforwards
December 31, Expiring
----------- -----------------------
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 38,255
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 11
of the Notes to the Consolidated Financial Statements for a description of
certain restrictions on the transfer of Common Stock.
YEAR 2000 COMPLIANCE
The Company has undertaken a review of its systems for "year 2000"
compliance at both the holding company and subsidiary levels. DHC has completed
an assessment of its hardware and software systems and has contacted the third
party vendors that it believes are critical to its operations. DHC has developed
a budget for bringing its systems into compliance and does not anticipate that
it will be required to make material expenditures. Although DHC expects that it
will be year 2000 compliant prior to the end of 1999 and has received assurances
from its third party vendors that they will be year 2000 compliant, DHC is
currently developing a contingency plan in the event that those assumptions are
incorrect.
NAICC is highly dependent on electronic data processing and information
systems in its operations. NAICC believes that its hardware and operating system
software are year 2000 compliant. NAICC also 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 has completed and tested the modifications to its
insurance applications and believes that they are year 2000 compliant. All
non-insurance applications (e.g. e-mail software, accounting software, and
report archiving software) are expected to be upgraded and year 2000 compliant
by the second quarter of 1999.
-12-
<PAGE>
NAICC has identified the third parties material to its operations and
is continuing to monitor and, in the case of certain material third parties, has
been able to test its interface to the external systems of its third-party
business associates and believes that they are year 2000 compliant.
NAICC believes that it does not currently issue any insurance policies
with coverages under which claims for year 2000 related losses or damages could
be successfully asserted. Management does not believe that material risk exists
that such claims will be made on previous policies.
NAICC is utilizing internal and external resources to meet its
deadlines for year 2000 modifications. The costs of year 2000 related efforts
were $200,000 for the year ended December 31, 1998. Remediation costs are
expected to total $150,000 during 1999. Due to the complexities of estimating
the cost of modifying all applications to become year 2000 compliant and the
difficulties in assessing third-party vendor's ability to become year 2000
compliant, estimates are subject to and are likely to change
The management of NAICC believes that its electronic data processing
and information systems will be year 2000 compliant. However, should any
material system fail to correctly process information due to the century change,
operations could be interrupted and this could have a material adverse effect on
NAICC's results of operations.
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, year
2000 compliance, 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, 1998, the number of employees of DHC and its
consolidated subsidiaries was approximately as follows:
NAICC 143
DHC (holding company only) 12
---
Total 155
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
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<PAGE>
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 14 of the Notes to Consolidated Financial Statements.
Item 3. LEGAL PROCEEDINGS.
NAICC is a party to various legal proceedings which are considered
routine and incidental to its insurance business and are not material to the
financial condition and operation of such business. DHC is not a party to any
legal proceeding which is considered material to the financial condition and
operation of its business. See Note 15 of the Notes to Consolidated Financial
Statements.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
-14-
<PAGE>
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
"Stock Market Prices" on page 26 of DHC's 1998 Annual Report to
Stockholders (included as an exhibit hereto) is incorporated herein by
reference.
Item 6. SELECTED FINANCIAL DATA.
"Selected Consolidated Financial Data" on page 2 of DHC's 1998 Annual
Report to Stockholders (included as an exhibit hereto) is incorporated
herein by reference.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
"Management's Discussion and Analysis of Financial Condition and
Results of Operations" on pages 3 through 8 of DHC's 1998 Annual Report
to Stockholders (included as an exhibit hereto) is incorporated herein
by reference.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
"Market Risk" on pages 5 through 7 of DHC's 1998 Annual Report to
Stockholders (included as an exhibit hereto) is incorporated herein by
reference.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Consolidated Financial Statements of DHC and its subsidiaries,
together with the Notes thereto, and "Quarterly Financial Data,"
included on pages 9 through 12, 13 through 24, and 26, respectively, of
DHC's 1998 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, other than William W.
Palmer, who was appointed by the other Directors on September 15, 1998 following
the Annual Meeting of Stockholders, were elected to their present terms of
office by the stockholders at the Annual Meeting of Stockholders of DHC held on
September 15, 1998. 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.
DIRECTOR
DIRECTOR AGE PRINCIPAL OCCUPATION SINCE
- -------- --- -------------------- -----
Martin J. Whitman 74 Chairman of the Board 1990
and Chief Executive Officer of DHC
David M. Barse 36 President and Chief 1996
Operating Officer of DHC
Eugene M. Isenberg 69 Chairman of the Board and 1990
Chief Executive Officer of
Nabors Industries, Inc.
Joseph F. Porrino 54 Counsellor to the President of the 1990
New School for Social Research
Frank B. Ryan 62 Professor of Mathematics at 1990
Rice University
Wallace O. Sellers 69 Vice Chairman and Director of 1995
Enhance Financial Services
Group, Inc.
Anthony G. Petrello 44 President and Chief Operating 1996
Officer of Nabors Industries, Inc.
Stanley J. Garstka 55 Deputy Dean and Professor in the 1996
Practice of Management at Yale
University School of Management
Timothy C. Collins 42 Chief Executive Officer and Senior 1996
Managing Director of Ripplewood
Holdings LLC
William W. Palmer 37 Chief of Staff and General 1998
Counsel to the Commissioner
for the California Department
of Insurance
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<PAGE>
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. ("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, from
January 1991 to May 1998, the President) of Third Avenue Trust and its
predecessor, Third Avenue Value Fund, Inc. (together with its predecessor,
"Third Avenue Trust"), an open-end management investment company registered
under the Investment Company Act of 1940 and containing four investment series
of which he is a trustee, and EQSF Advisers, Inc. ("EQSF"), Third Avenue Trust's
investment adviser (of which he was President until February 1998). 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
helped to found during the first quarter of 1987 and which ceased operations in
December, 1996. Since March 1991, Mr. Whitman has served as a Director of Nabors
Industries, Inc. ("Nabors"), a publicly-traded oil and gas drilling company
listed on the American Stock Exchange ("AMEX"). Since August, 1997, Mr. Whitman
has served as a director of Tejon Ranch Co., an agricultural and land management
company listed on the New York Stock Exchange ("NYSE"). From March 1993 through
February 1996, Mr. Whitman served as a director of Herman's Sporting Goods,
Inc., a retail sporting goods chain, which filed a voluntary petition under
Chapter 11 of the United States Bankruptcy Code on April 26, 1996. Mr. Whitman
also serves as a Director of the Company's 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's second book, VALUE INVESTING: A BALANCED APPROACH, is expected to
be in bookstores on April 16, 1999. 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. From April
1995 until May 1998 and February 1998, respectively, he was an Executive Vice
President and Chief Operating Officer of Third Avenue Trust and EQSF, at which
times he assumed the position of President. 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. 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.
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<PAGE>
Dr. Ryan, since August 1990, has been a Professor of Mathematics at
Rice University (currently on leave). 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. Until 1998, Dr. Ryan
served as a Director of America West Airlines, Inc., a publicly-traded company
listed on the NYSE, and now continues as an advisory director. From August 1990
to February 1995, Dr. 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. 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>
Mr. Palmer has been the Chief of Staff and General Counsel to the
Commissioner for the California Department of Insurance (the "Commissioner")
since March 1998. Mr. Palmer is also the Chief Executive Officer of the
California Conservation and Liquidation Office, where he oversees the management
of 69 insurance companies with combined assets exceeding $1.6 billion that have
been conserved or liquidated by the Commissioner. From January 1, 1995 to March
1998, Mr. Palmer was Chief Counsel to the Department of Insurance. Prior to
January 1, 1995, Mr. Palmer was in private practice as an attorney with Farmer &
Murphy. Mr. Palmer received a Bachelor of Arts degree in History and Political
Science from the University of California, Los Angeles in 1985 and a Juris
Doctor from the University of the Pacific, McGeorge School of Law in 1989.
EXECUTIVE OFFICERS.
The executive officers of DHC are as follows:
NAME AGE PRINCIPAL POSITION WITH REGISTRANT
- ---- --- ----------------------------------
Martin J. Whitman 74 Chairman of the Board, Chief
Executive Officer and a Director
David M. Barse 36 President, Chief Operating Officer
and a Director
Michael T. Carney 45 Chief Financial Officer and Treasurer
Ian M. Kirschner 43 General Counsel and Secretary
For additional information about Messrs. Whitman and Barse, see
"Directors" above.
Mr. Carney was the Chief Financial Officer ("CFO") of DHC from August
1990 until March 1996 and has been the CFO of the Company and a director of
NAICC since August 1996. Since 1990, Mr. Carney has served as Treasurer and CFO
of Third Avenue Trust and EQSF and, since 1989, as CFO of MJW&Co., 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, Inc.
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
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<PAGE>
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, except for one Form 3 with respect to Mr. Palmer (not involving any
transaction), 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, 1998.
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 1998 by the Chief
Executive Officer. No other executive officers of DHC had cash compensation for
such year in excess of $100,000. Only those columns which call for information
applicable to DHC or the individual named for the periods indicated have been
included in such table.
<TABLE>
<CAPTION>
Long Term
Compensation
Awards
Annual Compensation Securities
----------------------- Underlying All Other
Name and Principal Position Year Salary a ($) Bonus ($) Options (#) Compensation ($)
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Martin J. Whitman 1998 $ 200,000 -0- -0- -0-
----------------------------------------------------------------------
Chairman of the Board &
Chief Executive Officer 1997 $ 200,000 -0- -0- -0-
----------------------------------------------------------------------
1996 $ 200,000 -0- -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 1998, 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 1998. Only those
tabular columns which call for information applicable to DHC or the named
individual have been included in such table.
Number of Securities Value of Unexercised in-the-
Underlying Unexercised Money Options at
Options at Fiscal Year-End (#) Fiscal Year-End ($)
---------------------------------------------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- --------------------------------------------------------------------------------
Martin J. Whitman 210,000 -0- $118,125 -0-
- --------------------------------------------------------------------------------
- ------------
(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 OF DIRECTORS
During 1998, 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 1998, each of Mr. Porrino, Dr. Ryan, and Mr. Garstka received
$10,000 and each of Mr. Sellers, Mr. Isenberg, Mr. Petrello 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.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During 1998, 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 24, 1999 of (a) each Director, (b) each executive officer, and (c)
each person known by DHC to own beneficially more than five percent of the
outstanding shares of Common Stock. DHC believes that, except as otherwise
stated, the beneficial holders listed below have sole voting and investment
power regarding the shares reflected as being beneficially owned by them.
Amount and Nature of
Beneficial Ownership Percent of Class(1)
-------------------- -------------------
PRINCIPAL STOCKHOLDERS
Commissioner of Insurance 1,803,235 (2,3) 11.6
of the State of California
c/o William Palmer
Chief of Staff
Mission Insurance Companies' Trusts
3333 Wilshire Boulevard - 3rd Floor
Los Angeles, CA 90010
Martin J. Whitman 2,321,941 (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
RR 1, Box 31D
Millbrook, NY 12545
Whitman Heffernan & Rhein Workout
Fund, L.P.
c/o WHR Management Company, L.P.
RR 1, Box 31D
Millbrook, NY 12545 1,054,996 (2) 6.8
- ----------
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<PAGE>
Third Avenue Value Fund 803,669 (2) 5.2
767 Third Avenue
New York, NY 10017-2023
OFFICERS AND DIRECTORS
Martin J. Whitman 2,321,941 (2,4,5,6) 14.7
David M. Barse 74,999 (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 26,666 (11) *
Stanley J. Garstka 37,674 (11) *
Timothy C. Collins 26,666 (11) *
William W. Palmer 0 *
Michael Carney 64,999 (12) *
Ian M. Kirschner 8,999 (13) *
All Officers and Directors
as a Group (12 persons) 2,787,202 (14) 17.2
- ----------
* Percentage of shares beneficially owned does not exceed one percent of
the outstanding Common Stock.
(1) Share percentage ownership is rounded to nearest tenth of one percent
and reflects the effect of dilution as a result of outstanding options
to the extent such options are, or within 60 days will become,
exercisable. As of March 24, 1999 (the date as of which this table was
prepared), there were exercisable options outstanding to purchase
1,333,379 shares of Common Stock. Shares underlying any option which
was exercisable on March 24, 1999 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.
-22-
<PAGE>
(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.
(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 73,558 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 41,666
shares of Common Stock at an exercise price of $5.6875 per share and
33,333 shares of Common Stock at an exercise price of $7.0625 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 8,334 shares of Common Stock at an exercise price of
$5.6875 per share, 16,667 shares of Common Stock at an exercise price
of $7.0625 per share or 50,000 shares of Common Stock at an exercise
price of $3.65625 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 26,666 shares of Common Stock at an exercise price of
$5.50 per share. Does not include shares underlying options to purchase
an aggregate of 13,334 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 41,666
shares of Common Stock at an exercise price of $5.6875 per share and
23,333 shares of Common Stock at an exercise price of $7.0625 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 8,334 shares of Common Stock at an exercise price of
$5.6875 per share, 11,667 shares of Common Stock at an exercise price
of $7.0625 per share or 35,000 shares of Common Stock at an
-23-
<PAGE>
exercise price of $3.65625 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 4,166 shares of Common Stock at an exercise price of
$5.6875 per share and 3,333 shares of Common Stock at an exercise price
of $7.0625 per share. Does not include shares underlying options to
purchase an aggregate of 834 shares of Common Stock at an exercise
price of $5.6875 per share, 1,667 shares of Common Stock at an exercise
price of $7.0625 per share or 10,000 shares of Common Stock at an
exercise price of $3.65625 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.
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.
-24-
<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.
-25-
<PAGE>
ANNUAL REPORT TO SECURITY-HOLDERS:
13.1 1998 Annual Report of Danielson Holding Corporation. (To be
included herewith at page 38.)
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, 1998 for which this Report is
filed, DHC filed no reports on Form 8-K.
-26-
<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 26, 1999
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 26, 1999 By /s/ MARTIN J. WHITMAN
----------------------------------------------
Martin J. Whitman
Chairman of the Board and Chief
Executive Officer and a Director
Date: March 26, 1999 By /s/ DAVID M. BARSE
----------------------------------------------
David M. Barse
President and Chief Operating Officer
and a Director
Date: March 26, 1999 By /s/ MICHAEL T. CARNEY
----------------------------------------------
Michael T. Carney
Chief Financial Officer
Date: March 26, 1999 By /s/ JOSEPH F. PORRINO
----------------------------------------------
Joseph F. Porrno
Director
Date: March 26, 1999 By /s/ FRANK B. RYAN
----------------------------------------------
Frank B. Ryan
Director
Date: March 26, 1999 By /s/ EUGENE M. ISENBERG
----------------------------------------------
Eugene M. Isenberg
Director
-27-
<PAGE>
Date: March 26, 1999 By /s/ WALLACE O. SELLERS
----------------------------------------------
Wallace O. Sellers
Director
Date: March 26, 1999 By /s/ ANTHONY G. PETRELLO
----------------------------------------------
Anthony G. Petrello
Director
Date: March 26, 1999 By /s/ STANLEY J. GARSTKA
----------------------------------------------
Stanley J. Garstka
Director
Date: March 26, 1999 By /s/ TIMOTHY C. COLLINS
----------------------------------------------
Timothy C. Collins
Director
Date: March 26, 1999 By /s/ WILLIAM W. PALMER
----------------------------------------------
William W. Palmer
Director
-28-
<PAGE>
<TABLE>
<CAPTION>
DANIELSON HOLDING CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Page Number
-----------
<S> <C>
Independent Auditors' Report................................................................... F-2
Danielson Holding Corporation and Consolidated Subsidiaries:
Statements of Operations - For the years ended December 31, 1998, 1997 and 1996............... *
Balance Sheets - December 31, 1998 and 1997................................................... *
Statements of Stockholders' Equity - For the years ended December 31, 1998, 1997 and 1996 *
Statements of Cash Flows - For the years ended December 31, 1998, 1997 and 1996............... *
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 1998 Annual Report to Stockholders.
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Danielson Holding Corporation:
Under date of March 5, 1999, we reported on the consolidated balance
sheets of Danielson Holding Corporation and subsidiaries as of December 31, 1998
and 1997, 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, 1998, as contained in the 1998 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 1998. In connection
with our audits of the aforementioned consolidated financial statements, we also
audited the related consolidated financial statement schedules as listed in the
accompanying index. These financial statement schedules are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statement schedules based on our audits.
In our opinion, such financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
----------------------------------------
KPMG LLP
New York, New York
March 5, 1999
F-2
<PAGE>
SCHEDULE I
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN
RELATED PARTIES
(In thousands)
DECEMBER 31, 1998
-------------------------------------------
Cost or Fair Amount Reflected on
Amortized Cost Value Balance Sheet
-------------- ----- -------------------
Fixed maturities classified as
available-for-sale:
U.S. Government/Agency $ 35,583 $ 36,404 $ 36,404
Mortgage-backed 47,352 47,821 47,821
Corporate 29,196 30,458 30,458
-------- -------- --------
Total fixed maturities 112,131 114,683 114,683
-------- -------- --------
Equity securities:
Common stocks 20,129 16,889 16,889
-------- -------- --------
Total equity securities 20,129 16,889 16,889
-------- -------- --------
Short term investments 3,287 3,287 3,287
-------- -------- --------
Total investments $135,547 $134,859 $134,859
======== ======== ========
S-1
<PAGE>
SCHEDULE II
DANIELSON HOLDING CORPORATION
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
(Parent Company Only)
STATEMENTS OF OPERATIONS
(In thousands)
FOR THE YEARS ENDED DECEMBER 31,
1998 1997 1996
------- ------- -------
REVENUES:
Net investment income $ 429 $ 538 $ 534
Net realized investment gains (losses) -- 2 (1)
------- ------- -------
TOTAL REVENUES 429 540 533
------- ------- -------
EXPENSES:
Employee compensation and benefits 1,177 1,170 1,201
Professional fees 427 426 288
Expenses in connection with terminated
proposed acquisition -- -- 1,849
Nonrecurring compensation -- -- 820
Other general and administrative fees 611 615 684
------- ------- -------
TOTAL EXPENSES 2,215 2,211 4,842
------- ------- -------
Loss before provision for
income taxes (1,786) (1,671) (4,309)
Income tax provision 25 26 3
------- ------- -------
Loss before equity in net income of
subsidiaries (1,811) (1,697) (4,312)
Equity in net income (loss) of subsidiaries 4,112 6,286 (3,807)
------- ------- -------
NET INCOME (LOSS) $ 2,301 $ 4,589 $(8,119)
======= ======= =======
S-2
<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,
---------------------------
1998 1997
--------- --------
<S> <C> <C>
ASSETS:
Cash $ 45 $ 47
Fixed maturities:
Available-for-sale at fair value
(Cost: $6,684 and $8,618 ) 6,713 8,617
Short term investments, at cost which approximates
fair value 40 62
--------- --------
TOTAL CASH AND INVESTMENTS 6,798 8,726
Investment in subsidiaries 56,500 55,366
Accrued investment income 60 62
Other assets 208 166
--------- --------
TOTAL ASSETS $ 63,566 $ 64,320
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Other liabilities $ 293 $ 400
--------- --------
TOTAL LIABILITIES 293 400
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 ; outstanding 15,576,276
shares and 15,576,287 shares) 1,559 1,559
Additional paid-in capital 46,673 46,673
Accumulated other comprehensive income (loss) (688) 2,260
Retained earnings 15,795 13,494
Treasury stock (Cost of 10,718 shares and 10,707 shares) (66) (66)
--------- --------
TOTAL STOCKHOLDERS' EQUITY 63,273 63,920
--------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 63,566 $ 64,320
========= ========
</TABLE>
S-3
<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,
--------------------------------
1998 1997 1996
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net income (loss) $ 2,301 $ 4,589 $ (8,119)
Adjustments to reconcile net income (loss) to
net cash used in operating activities:
Net realized investment (gains) losses -- (2) 1
Change in accrued investment income 2 69 45
Depreciation and amortization (252) (57) (60)
Equity in net (income) loss of subsidiaries (4,112) (6,286) 3,807
Increase (decrease) in accrued expenses (132) (411) 502
Other, net (13) 56 9
-------- -------- --------
Net cash used in operating activities (2,206) (2,042) (3,815)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments purchased:
Fixed income maturities available-for-sale (11,215) (8,001) (10,584)
Proceeds from sales:
Fixed income maturities available-for-sale 3,412 951 5,542
Investments, matured or called
Fixed income maturities available-for-sale 10,037 5,562 8,585
Purchases of property and equipment (52) -- --
Net proceeds from sale of Danielson Trust Company 2,968
Net cash provided by (used in)
investing activities -- -- --
-------- -------- --------
2,182 (1,488) 6,511
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of options
to purchase Common Stock -- 671 --
Retirement of stock options -- (107) --
Change in receivable from subsidiary -- -- 353
Additional capital contributed to subsidiaries -- -- (458)
-------- -------- --------
Net cash provided by
(used in) financing activities -- 564 (105)
-------- -------- --------
Net increase (decrease) in cash and
short term investments (24) (2,966) 2,591
Cash and short term investments at
beginning of year 109 3,075 484
-------- -------- --------
CASH AND SHORT TERM INVESTMENTS AT
END OF YEAR $ 85 $ 109 $ 3,075
======== ======== ========
</TABLE>
S-4
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE IV
DANIELSON HOLDING CORPORATION
REINSURANCE
(in thousands)
PERECENTAGE
CEDED EARNED ASSUMED EARNED OF AMOUNT
GROSS EARNED TO OTHER FROM OTHER NET EARNED ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
---------- ---------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1998:
Property and liability
insurance premiums $ 65,861 $ 10,450 $ -- $ 55,411 --
========== ========== ========== ========== ========
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 --
========== ========== ========== ========== ========
</TABLE>
S-5
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE V
DANIELSON HOLDING CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
ADDITIONS
------------------------------------
BALANCE AT CHARGED TO COSTS CHARGED TO BALANCE AT
BEGINNING OF PERIOD AND EXPENSES OTHER ACCOUNTS DEDUCTIONS END OF PERIOD
------------------- ------------ -------------- ---------- -------------
Allowance for premiums
and fees receivable
For the year ended December 31,
<S> <C> <C> <C> <C> <C> <C>
1996 $ 153 $ 66 $ 43 $ 32 $ 230
=========== =========== =========== ======= ======
1997 $ 230 $ 53 $ 20 $ 124 $ 179
=========== =========== =========== ======= ======
1998 $ 179 $ 29 $ -- $ 72 $ 136
=========== =========== =========== ======= ======
Allowance for uncollectable
reinsurance on paid losses
For the year ended December 31,
1996 $ 388 $ -- $ -- $ 72 $ 316
=========== =========== =========== ======= ======
1997 $ 316 $ 65 $ -- $ 7 $ 374
=========== =========== =========== ======= ======
1998 $ 374 $ -- $ -- $ -- $ 374
=========== =========== =========== ======= ======
Allowance for uncollectable
reinsurance on unpaid losses
For the year ended December 31,
1996 $ 425 $ -- $ -- $ -- $ 425
=========== =========== =========== ======= ======
1997 $ 425 $ 74 $ -- $ -- $ 499
=========== =========== =========== ======= ======
1998 $ 499 $ 60 $ -- $ -- $ 559
=========== =========== =========== ======= ======
</TABLE>
S-6
<PAGE>
<TABLE>
<CAPTION>
SCHEDULES III AND VI
DANIELSON HOLDING CORPORATION
SUPPLEMENTAL INFORMATION
CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS
(in thousands)
OTHER
AFFILIATION DEFERRED RESERVES FOR UNPAID DISCOUNT FROM POLICY CLAIMS
WITH ACQUISITION CLAIMS AND CLAIM RESERVES FOR UNEARNED AND BENEFITS NET EARNED INVESTMENT
REGISTRANT COSTS ADJUSTMENT EXPENSES UNPAID CLAIMS PREMIUMS PAYABLE PREMIUMS INCOME
---------- ----- ------------------- ------------- -------- ------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
Consolidated
Property-Casualty
Entities:
AS OF AND FOR THE YEAR
ENDED 12/31/98 $ 2,381 $ 95,653 $ -- $ 13,705 -- $ 55,411 $ 7,745
======== ============ ========== ========= ========= ========= =========
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
======== ============ ========== ========= ========= ========= =========
====================================================================================================================================
</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 12/31/98 $ 39,131 $ -- $ 9,899 $ 3,401 $ 47,427 $ 58,880
========= ========= ========= ========= ========== =========
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
========= ========= ========= ========= ========== =========
</TABLE>
S-7
DANIELSON HOLDING CORPORATION
------------------------------------
1998 ANNUAL REPORT
<PAGE>
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) 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
RESULTS OF OPERATIONS
Earned premiums............................................................... $ 55,411 $ 53,069 $ 36,625
Total revenues................................................................ $ 64,744 $ 65,746 $ 48,704
Income (loss) from continuing operations...................................... $ 2,301 $ 4,589 $ (6,240)
Net income (loss)............................................................. $ 2,301 $ 4,589 $ (8,119)
Net cash used in continuing operating activities.............................. $ (5,170) $ (11,583) $(26,949)
Income (loss) from continuing operations per diluted share of
Common Stock................................................................ $ 0.14 $ 0.28 $ (0.41)
Net income (loss) per diluted share of Common Stock........................... $ 0.14 $ 0.28 $ (0.53)
Combined ratio................................................................ 108.6% 111.0% 136.7%
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET AND OTHER DATA
Total investments............................................................. $134,859 $142,823 $151,555
Policyholder liabilities...................................................... $109,539 $116,607 $129,352
Stockholders' equity.......................................................... $ 63,273 $ 63,920 $ 58,853
Book value per share of Common Stock.......................................... $ 4.06 $ 4.10 $ 3.83
Common Stock price range
High........................................................................ $ 8 1/8 $ 14 $ 8 3/8
Low......................................................................... $ 3 $ 4 7/8 $ 4 3/4
Shares of Common Stock outstanding at year end................................ 15,576,276 15,576,287 15,360,238
Employees of continuing operations at year end................................ 155 159 152
</TABLE>
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
FINANCIAL TABLE OF CONTENTS
-----------------------------------------
Selected Consolidated Financial Data...............................2
Management's Discussion and Analysis of
Financial Condition and Results of Operations..................3
Consolidated Statements of Operations..............................9
Consolidated Balance Sheets.......................................10
Consolidated Statements of Stockholders' Equity...................11
Consolidated Statements of Cash Flows.............................12
Notes to Consolidated Financial Statements........................13
Independent Auditors' Report......................................25
Responsibility for Financial Reporting............................25
Quarterly Financial Data..........................................26
Stock Market Prices...............................................26
1
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<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) 1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
A. RESULTS OF OPERATIONS
Total revenues...................................... $ 64,744 $ 65,746 $ 48,704 $ 75,458 $105,545
Income (loss) from continuing operations
before extraordinary items........................ $ 2,301 $ 4,589 $ (6,240)/1,2/ $ 4,349 $ 3,769
Net loss from discontinued operations............... -- -- $ (633)/3/ $ (2,033)/3/ $ (624)/3/
Loss on disposal of discontinued operations......... -- -- $ (1,246)/3/ -- --
Net income (loss)................................... $ 2,301 $ 4,589 $ (8,119)/1,2,3/ $ 2,316 /3/ $ 3,895/3,4/
Diluted earnings (loss) per share of Common Stock:
Income (loss) from continuing operations
before extraordinary items........................ $ 0.14 $ 0.28 $ (0.41)/1,2/ $ 0.27 $ 0.24
Net loss from discontinued operations............. -- -- $ (0.04)/3/ $ (0.13)/3/ $ (0.04)/3/
Loss on disposal of discontinued operations....... -- -- $ (0.08)/3/ -- --
Net income (loss)................................. $ 0.14 $ 0.28 $ (0.53)/1,2,3/ $ 0.14 /3/ $ 0.25/3,4/
B. BALANCE SHEET DATA
Invested assets..................................... $134,859 $142,823 $151,555 $180,263 $179,141
Total assets........................................ $180,895 $187,773 $196,419 $226,896 $239,410
Unpaid losses and loss adjustment expenses.......... $ 95,653 $105,947 $120,651 $137,406 $146,330
Stockholders' equity................................ $ 63,273 $ 63,920 $ 58,853 $ 69,821 $ 62,318
Shares of Common Stock outstanding.................. 15,576,276/5/ 15,576,287/5/ 15,360,238/5/ 15,360,255/5/ 15,360,270/5/
</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 Does not give effect to currently exercisable options to purchase shares of
Common Stock.
2
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 regular Federal income tax due to its net
operating loss carryforwards and the recognition of losses from several trusts
that assumed various liabilities of certain present and former subsidiaries of
DHC. It is expected that the Company's 1998 consolidated Federal income tax
return will report a cumulative net operating loss carryforward currently
estimated at approximately $1.3 billion, which will expire in various amounts,
if not used, between 1999 and 2012. See Note 12 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 $55.4 million, $53.1 million and $36.6 million in
1998, 1997 and 1996, respectively. The increases in net premiums earned were
directly related to the change in net written premiums. Net written premiums
were $58.9 million, $55.8 million, and $36.1 million in 1998, 1997 and 1996,
respectively. The increase in 1998 was primarily attributable to the premium
growth in NAICC's automobile programs, which was mainly due to the increased
number of commercial automobile agent appointments made during 1997 and 1998 and
increased marketing efforts in each of NAICC's branch offices. Net written
premiums for workers' compensation in 1998 remained comparable to those for
1997.
Net investment income was $7.7 million, $9.3 million, and $10.1 million in
1998, 1997 and 1996, respectively. Net investment income has declined as average
fixed income invested assets continued to decline in 1998 due in part to the
purchase of $20 million of equity securities. As of December 31, 1998 and 1997,
the average yield on NAICC's portfolio was 6.7 percent and 6.9 percent,
respectively. The estimated average maturity of the portfolio was 4.12 years at
December 31, 1998.
Cash used in operations was $3 million, $9.6 million, and $23.1 million, in
1998, 1997, and 1996, 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 was due from reinsurers at the end of 1998.
In February 1999, NAICC collected approximately $4 million as partial settlement
on the Hughes-Fullerton Claim from certain participants. See Note 6 of the Notes
to Consolidated Financial Statements. Overall cash and invested assets, stated
at market, were $128.9 million at December 31, 1998 as compared to $134.8
million at December 31, 1997.
Net losses and loss adjustment expenses (LAE) were $39.1 million, $38.1
million, and $37.1 million in 1998, 1997 and 1996, respectively. The resulting
loss and LAE ratios were 70.6 percent, 71.8 percent and 101.3 percent in 1998,
1997 and 1996, respectively. The decrease in the loss and LAE ratio in 1998 and
1997 was due to a continued shift of business to automobile lines which have
lower loss and LAE ratios than does workers' compensation. The high percentage
of 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
3
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
--------------------------------------
(CONTINUED)
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, 1998 and
December 31, 1997 were approximately $10.8 million and $10.9 million
respectively.
Policy acquisition costs were $13.3 million in 1998 and 1997, and $9.9 million
in 1996. As a percentage of net premiums earned, policy acquisition expenses
were 24.0 percent, 25.1 percent and 27.1 percent in 1998, 1997 and 1996,
respectively. Policy acquisition costs include expenses directly related to
premium volume (i.e., commissions, premium taxes and state assessments and other
underwriting expenses). The decline in the policy acquisition expense ratio in
1998 and 1997 was due primarily to the overall growth in premium volume while
other underwriting expenses remained relatively constant.
General and administrative expenses were $7.3 million, $7.0 million and $6.6
million in 1998, 1997 and 1996, respectively. General and administrative
expenses have increased in 1998, in line with the overall premium growth. The
increase in 1997 is attributable to the inclusion of twelve months of expenses
for Valor Insurance Company, NAICC's subsidiary acquired in June, 1996.
Policyholder dividends were reduced in 1996 by $4 million as compared to
provisions of $471,000 and $467,000 in 1998 and 1997, 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 108.6 percent, 111.0 percent and 136.7
percent in 1998, 1997 and 1996, respectively. The high combined ratio in 1996
was due to the provision for additional losses and ALAE associated with NAICC's
run-off business.
The insurance operations had income from operations of $4.1 million in 1998 as
compared to income from operations of $6.3 million in 1997 and a loss from
operations of $1.9 million in 1996. 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 $252,000, $2.2
million and $500,000 in 1998, 1997 and 1996, respectively.
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 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, 1998, 1997 and 1996, cash used in parent-only
operating activities was $2.2 million, $2.0 million and $3.8 million,
respectively. Cash used in operations is pri-
4
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
marily 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
additional cash used in 1996 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, $392,000 was paid in 1997 and $200,000 was paid in 1998. The
remaining balance will be paid in 1999. 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
As of December 31, 1998, cash and investments of DHC were approximately $6.8
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.
DHC's sources of funds are its investments as well as dividends received from
its subsidiaries. Various state insurance requirements restrict the amounts that
may be transferred to DHC in the form of dividends from its insurance
subsidiaries without prior regulatory approval. To the extent that NAICC's
unassigned surplus remains negative in 1999, 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 and Montana insurance laws and regulations. The Company's investment
portfolio is composed primarily of fixed maturities and is weighted heavily
toward investment grade short and medium term securities. 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, 1998, by investment grade (dollars in thousands):
Cost Fair Value
- --------------------------------------------------------------
Investment by investment grade:
Fixed maturities
U.S. Government/Agency.............. $ 35,583 $ 36,404
Mortgage-backed..................... 47,352 47,821
Corporates (AAA to A)............... 27,190 28,436
Corporates (BBB).................... 2,006 2,022
---------------------
Total fixed maturities............ 112,131 114,683
Equity securities..................... 20,129 16,889
---------------------
Total............................. $132,260 $131,572
=====================
During 1998, NAICC purchased $20 million in equity securities. The following
table sets forth a summary NAICC's equity securities portfolio at December 31,
1998 (dollars in thousands):
Cost Fair Value
- ---------------------------------------------------------------
Equity securities by type:
U.S. domestic securities............ $ 9,636 $ 7,400
Foreign securities.................. 10,493 9,489
--------------------
Total equity securities........... $20,129 $16,889
====================
MARKET RISK
The Company's objectives in managing its investment portfolio are to maximize
investment income and investment returns while minimizing overall credit risk.
Investment strategies are developed based on many factors including underwriting
results, overall tax position, regulatory requirements, and fluctuations in
interest rates. Investment decisions are made by management and approved by the
Board of Directors. Market risk represents the potential for loss due to adverse
changes in the fair value of securities. The market risks related to the
Company's fixed maturity portfolio are primarily interest rate risk and
prepayment risk. The market risks related to the Company's equity portfolio are
foreign currency risk and equity price risk.
RISKS RELATED TO FIXED MATURITIES
Interest rate risk is the price sensitivity of fixed maturities to changes in
interest rates. Management views these potential changes in price within the
overall context of asset and liability matching. Management estimates the payout
patterns of the Company's liabilities, primarily loss reserves, to determine
their duration. Management sets duration targets for the Company's fixed income
portfolio after consideration of the duration of its
5
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
--------------------------------------
(CONTINUED)
liabilities, which management believes mitigates the overall interest rate risk.
Fixed maturities of the Company include Mortgage-Backed Securities (MBS)
representing 41.7 percent and 41.8 percent of total fixed maturities at December
31, 1998 and December 31, 1997, respectively. All MBS held by the Company are
issued by the Federal National Mortgage Association (FNMA) or the Federal Home
Loan Mortgage Corporation (FHLMC), which are both rated Aaa by Moody's Investors
Services. Both FNMA and FHLMC are corporations that were created by Acts of
Congress. FNMA and FHLMC guarantee the principal balance of their securities.
FNMA guarantees timely payment of principal and interest.
One of the risks associated with MBS is the timing of principal payments on
the mortgages underlying the securities. The principal an investor receives
depends upon amortization schedules and the termination pattern (resulting from
prepayments or defaults) of the individual mortgages included in the underlying
pool of mortgages. The principal is guaranteed but the yield and cash flow can
vary depending on the timing of the repayment of the principal balance.
Securities that have an amortized cost greater than par, which are backed by
mortgages that repay faster (or slower) than expected, will incur a decrease (or
increase) in yield. Those securities that have an amortized cost lower than par
that repay faster (or slower) than expected will generate an increase (or
decrease) in yield. The degree to which a security is susceptible to changes in
yield is influenced by the difference between its amortized cost and par, the
relative sensitivity to repayment of the underlying mortgages backing the
securities in a changing interest rate environment, and the repayment priority
of the securities in the overall securitization structure. The Company attempts
to limit repayment risk by purchasing MBS whose costs are below or do not
significantly exceed par, and by primarily purchasing structured securities with
repayment protection to provide a more certain cash flow to the investor. There
are various types of bonds that may comprise a MBS and they can have differing
interest rates and maturities, as well as priorities to the cash flows of the
underlying mortgages or assets. MBS with sinking fund schedules are known as
Planned Amortization Classes (PAC) and Targeted Amortization Classes (TAC). The
structures of PACs and TACs attempt to increase the certainty of the timing of
prepayment and thereby minimize the prepayment and interest rate risk.
MBS, as well as callable bonds, have a greater sensitivity to market value
declines in a rising interest rate environment than to market value increases in
a declining interest rate environment. This is primarily due to the ability and
the incentive of the payor to prepay the principal or the issuer to call the
bond in a declining interest rate scenario.
NAICC's MBS by type of instrument are as follows
(in thousands):
1998 1997
----------------------------------------
AMORTIZED PERCENT Amortized Percent
COST OF TOTAL Cost of Total
- --------------------------------------------------------------
Non-PAC/TAC......... $21,474 45% $18,627 32%
PAC/TAC............. 25,878 55% 39,745 68%
---------------------------------------
$47,352 100% $58,372 100%
=======================================
The following table provides information about the Company's fixed maturity
investments at December 31, 1998 that are sensitive to changes in interest
rates. The table presents expected cash flows of principal amounts and related
weighted average interest rate by expected maturity dates. The expected maturity
date for other than mortgage-backed securities is the earlier of call date or
maturity date, and for mortgage-backed securities is based on expected payment
patterns. Actual cash flows could differ, and potentially materially differ from
expected amounts considering the weighting of the Company's portfolio towards
mortgage-backed securities.
<TABLE>
<CAPTION>
There-
(IN THOUSANDS) 1999 2000 2001 2002 2003 after Total
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
U.S. Government/Agency $17,587 $2,708 $5,670 $1,945 $900 $6,772 $35,582
Average interest rate 6.06% 6.19% 7.14% 10.30% 9.25% 8.35%
Mortgage-backed 558 3,272 5,049 2,548 4,034 31,892 47,353
Average interest rate 6.98% 6.93% 7.21% 6.79% 6.86% 6.90%
Corporates (AAA to A) 100 2,290 3,659 5,100 16,041 27,190
Average interest rate 5.25% 8.85% 6.91% 6.23% 6.54%
Corporates (BBB) 2,006 2,006
Average interest rate 10.13%
----------------------------------------------------------------------------------------
Total $20,151 $6,080 $13,009 $8,152 $10,034 $54,705 $112,131
========================================================================================
</TABLE>
6
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
Management believes that the interest and prepayment risks generally inherent in
the Company's fixed maturity portfolio are not significant at December 31, 1998.
RISKS RELATED TO EQUITY SECURITIES
The increase in the equity portfolio during 1998 was done to diversify NAICC's
investments. After consideration of NAICC's relatively conservative ratios
measuring its capital adequacy noted above, management believed additional
diversification was warranted.
Since the portfolio includes both domestic and foreign securities, the
portfolio is subject to foreign currency risk. Foreign currency risk is the
sensitivity to exchange rate fluctuations of the market value and investment
income related to foreign denominated financial instruments. At December 31,
1998, NAICC held approximately $10.3 million of yen denominated equity
securities. See Note 10 of the Notes to Consolidated Financial Statements. In
order to mitigate the risk of significant adverse currency exchange rate
fluctuations, NAICC purchased a foreign currency option that hedges the foreign
currency risk beyond a strike price of 142.8 yen to the dollar. As of December
31, 1998, the yen to dollar exchange rate was approximately 113.5. Management
believed that this hedge instrument was prudent to mitigate volatility in
foreign exchange rates.
Equity price risk is the potential loss arising from changes in the value of
equity securities. Typically, equity securities have more year-to-year price
volatility than medium term investment grade fixed maturity instruments.
The foreign currency and equity price risks inherent in the equity portfolio
are subject to several factors beyond the control of management. Although
management has employed what it believes to be appropriate instruments to
mitigate those risks, there can be no assurance that the future price
fluctuations would not be material.
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 74 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 write its premium volume profitably. As
part of Proposition 103, the California Department of Insurance issued new
regulations for private passenger automobile rates requiring that the three
mandatory rating factors of (1) driving safety record, (2) number of miles
driven annually, and (3) years of driving experience have the first, second and
third greatest weights, respectively. Geographic location and other
characteristics may still be used as optional rating factors; however, the
combined weight of all such optional rating factors may not be greater than the
third mandatory rating factor of years of driving experience. Previously,
insurers could use geographic location as the primary rating factor. NAICC has
made the appropriate modifications to its rating plans in order to comply with
the latest regulations.
The California workers' compensation market, where NAICC had historically
written a significant amount of its premium, continues to be very price
competitive. Workers' compensation premium volume has continued to decline as
competitors continue to price policies at rates well below a level necessary to
achieve an underwriting profit.
AUTHORITATIVE ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities"("FAS 133"). FAS 133 is effective for fiscal years
beginning after June 15, 1999 and establishes standards for the reporting for
derivative instruments. It requires changes in the fair value of a derivative
instrument and the changes in fair value of the assets or liabilities hedged by
that instrument to be included in income. To the extent that the hedge
transaction is effective, income is equally offset by both investments.
Currently the changes in fair value of derivative instruments and hedged items
are reported in net unrealized gain (loss) on securities. The Company has not
adopted FAS 133. However, the effect of adoption on the consolidated financial
statements at December 31, 1998 would not be material.
During 1998, the Company adopted the following new standards: FAS Statement
130, "Reporting Comprehensive Income" ("FAS 130"); FAS Statement 131,
"Disclosures about Segments of an Enterprise and Related Information" ("FAS
131"); and FAS Statement 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits" ("FAS 132").
FAS 130 establishes standards for the reporting and presentation of
comprehensive income and its components in a full set of financial statements.
Comprehensive income encompasses all changes in stockholders' equity (except
those arising from transactions with stockholders) and includes net income, net
unrealized capital gains or losses on available-for-sale securities and foreign
currency translation adjustments. Comprehensive income is disclosed in the
Consolidated Statement of Stockholders' Equity. FAS
7
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
-------------------------------------------------------------
(CONTINUED)
131 redefines how reportable segments are determined and requires disclosure of
certain financial and descriptive information about a company's reportable
segments. The Company views its operations as one segment consisting of Property
and Casualty operations. FAS 132 alters disclosure requirements regarding
pensions and other postretirement benefits in the financial statements of
employers who sponsor such benefit plans. The revised disclosure requirements
are designed to provide additional information to assist readers in evaluating
future costs related to such plans. The required pension disclosures are
included in Note 13 of the Notes to Consolidated Financial Statements. As each
of these new standards only requires additional disclosure information in the
consolidated financial statements, they do not affect the Company's consolidated
financial position or results of operations.
YEAR 2000 COMPLIANCE
The Company has undertaken a review of its systems for year 2000 compliance at
both the holding company and subsidiary levels. DHC has completed an assessment
of its hardware and software systems and has contacted the third party vendors
that it believes are critical to its operations. DHC has developed a budget for
bringing its systems into compliance and does not anticipate that it will be
required to make material expenditures. Although DHC expects that it will be
year 2000 compliant prior to the end of 1999 and has received assurances from
its third party vendors that they will be year 2000 compliant, DHC is currently
developing a contingency plan in the event that those assumptions are incorrect.
NAICC is highly dependent on electronic data processing and information
systems in its operations. NAICC believes that its hardware and operating system
software are year 2000 compliant. All non-insurance applications (e.g., e-mail
software, accounting software, and report archiving software) are expected to be
upgraded and year 2000 compliant by the second quarter of 1999.
NAICC has identified the third parties material to its operations and is
continuing to monitor and, in the case of certain material third parties, has
been able to test its interface to the external systems of its third-party
business associates and believes that they are year 2000 compliant.
NAICC believes that it does not currently issue any insurance policies with
coverage under which claims for year 2000 related losses or damages could be
successfully asserted. Management does not believe that material risk exists
that such claims will be made on previous policies.
NAICC is utilizing internal and external resources to meet its deadlines for
year 2000 modifications. The costs of year 2000 related efforts were $200,000
for the year ended December 31, 1998. Remediation costs are expected to total
$150,000 during 1999. Due to the complexities of estimating the cost of
modifying all applications to become year 2000 compliant and the difficulties in
assessing third-party vendor's ability to become year 2000 compliant, estimates
are subject to and are likely to change.
The management of NAICC believes that its electronic data processing and
information systems will be year 2000 compliant. However, should any material
system fail to correctly process information due to the century change,
operations could be interrupted and this could have a material adverse effect on
NAICC's results of operations.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
As noted above, the foregoing discussion and the Notes to Consolidated
Financial Statements may include forward-looking statements that involve risks
and uncertainties. In addition to other factors and matters discussed elsewhere
herein, some of the important factors that, in the view of the Company, could
cause actual results to differ materially from those discussed in the
forward-looking statements include the following:
1. The insurance products sold by the Company are subject to intense competition
from many competitors, many of whom have substantially greater resources than
the Company. There can be no assurance that the Company will be able to
successfully compete in these markets and generate sufficient premium volume at
attractive prices to be profitable.
2. In order to implement its business plan, the Company has been seeking to
enter into strategic partnerships and/or make acquisitions of businesses that
would enable the Company to earn an attractive return on investment.
Restrictions on the Company's ability to issue additional equity in order to
finance any such transactions exist which could significantly affect the
Company's ability to finance any such transaction. The Company may have limited
other resources with which to implement its strategy and there can be no
assurance that any transaction will be successfully consummated.
3. The insurance industry is highly regulated and it is not possible to predict
the impact of future state and federal regulation on the operations of the
Company.
4. Unpaid losses and loss adjustment expenses ("LAE") are based on estimates of
reported losses, historical Company experience of losses reported by reinsured
companies for insurance assumed from such insurers, and estimates based on
historical Company and industry experience for unreported claims. Such liability
is, by necessity, based upon estimates which may change in the near term, and
there can be no assurance that the ultimate liability will not exceed, or even
materially exceed, such estimates.
8
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
------------------------------
<TABLE>
<CAPTION>
For the years ended December 31,
----------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION) 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
REVENUES:
Gross premiums earned............................................................... $65,861 $64,745 $ 52,066
Ceded premiums earned............................................................... (10,450) (11,676) (15,441)
----------------------------------------
Net premiums earned................................................................. 55,411 53,069 36,625
Net investment income............................................................... 8,174 9,810 10,655
Net realized investment gains....................................................... 252 2,174 499
Other income........................................................................ 907 693 925
----------------------------------------
TOTAL REVENUES.................................................................... 64,744 65,746 48,704
----------------------------------------
LOSSES AND EXPENSES:
Gross losses and loss adjustment expenses........................................... 45,559 49,350 53,697
Ceded losses and loss adjustment expenses........................................... (6,428) (11,268) (16,598)
----------------------------------------
Net losses and loss adjustment expenses............................................. 39,131 38,082 37,099
Policyholder dividends.............................................................. 471 467 (4,000)
Policy acquisition expenses......................................................... 13,300 13,341 9,907
Expenses in connection with terminated proposed acquisition......................... -- -- 1,849
Nonrecurring compensation........................................................... -- -- 1,272
General and administrative expenses................................................. 9,508 9,220 8,799
----------------------------------------
TOTAL LOSSES AND EXPENSES......................................................... 62,410 61,110 54,926
----------------------------------------
Income (loss) from continuing operations before provision for income tax ............. 2,334 4,636 (6,222)
Income tax provision.................................................................. 33 47 18
----------------------------------------
Income (loss) from continuing operations ............................................. 2,301 4,589 (6,240)
Discontinued operations:
Net loss from operations............................................................ -- -- (633)
Loss on disposal.................................................................... -- -- (1,246)
----------------------------------------
NET INCOME (LOSS)..................................................................... $ 2,301 $ 4,589 $ (8,119)
========================================
BASIC EARNINGS (LOSS) PER SHARE OF COMMON STOCK:
Income (loss) from continuing operations.............................................. $ 0.15 $ 0.30 $ (0.41)
Discontinued operations:
Loss from operations................................................................ -- -- (0.04)
Loss on disposal.................................................................... -- -- (0.08)
----------------------------------------
NET INCOME (LOSS) .................................................................... $ 0.15 $ 0.30 $ (0.53)
========================================
DILUTED EARNINGS (LOSS) PER SHARE OF COMMON STOCK:
Income (loss) from continuing operations.............................................. $ 0.14 $ 0.28 $ (0.41)
Discontinued operations:
Loss from operations................................................................ -- -- (0.04)
Loss on disposal.................................................................... -- -- (0.08)
----------------------------------------
NET INCOME (LOSS) .................................................................... $ 0.14 $ 0.28 $ (0.53)
========================================
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
9
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
CONSOLIDATED BALANCE SHEETS
-----------------------
<TABLE>
<CAPTION>
December 31,
--------------------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION) 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Fixed maturities at fair value (Cost: $112,131 and $139,089)...................................... $114,683 $140,899
Equity securities at fair value (Cost: $20,129 and $363).......................................... 16,889 813
Short term investments, at cost which approximates fair value..................................... 3,287 1,111
--------------------------
TOTAL INVESTMENTS............................................................................. 134,859 142,823
Cash.............................................................................................. 870 707
Accrued investment income......................................................................... 1,427 2,006
Premiums and fees receivable, net of allowances of $136 and $179.................................. 9,972 5,438
Reinsurance recoverable on paid losses, net of allowances of $374 and $374........................ 7,714 8,523
Reinsurance recoverable on unpaid losses, net of allowances of $559 and $499...................... 18,187 20,185
Prepaid reinsurance premiums...................................................................... 1,668 1,681
Property and equipment, net of accumulated depreciation of $8,322 and $7,690...................... 1,930 2,499
Deferred acquisition costs........................................................................ 2,381 1,550
Other assets...................................................................................... 1,887 2,361
--------------------------
TOTAL ASSETS.................................................................................. $180,895 $187,773
==========================
LIABILITIES AND STOCKHOLDERS' EQUITY:
Unpaid losses and loss adjustment expenses........................................................ $ 95,653 $105,947
Unearned premiums................................................................................. 13,705 10,249
Policyholder dividends............................................................................ 181 411
Reinsurance premiums payable...................................................................... 2,143 1,244
Funds withheld on ceded reinsurance............................................................... 1,442 1,254
Other liabilities................................................................................. 4,498 4,748
--------------------------
TOTAL LIABILITIES............................................................................. 117,622 123,853
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; outstanding 15,576,276 shares and 15,576,287 shares).................. 1,559 1,559
Additional paid-in capital........................................................................ 46,673 46,673
Accumulated other comprehensive income (loss)..................................................... (688) 2,260
Retained earnings................................................................................. 15,795 13,494
Treasury stock (Cost of 10,718 shares and 10,707 shares).......................................... (66) (66)
--------------------------
TOTAL STOCKHOLDERS' EQUITY.................................................................... 63,273 63,920
--------------------------
Commitments and contingencies
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................................................... $180,895 $187,773
==========================
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
10
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
------------------------------------
<TABLE>
<CAPTION>
For the years ended December 31,
----------------------------------------------------------
(IN THOUSANDS, EXCEPT SHARE AMOUNTS) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
COMMON STOCK
Balance, beginning of year.................................. $ 1,559 $ 1,537 $ 1,537
Exercise of options to purchase Common Stock................ -- 22 --
--------- --------- ---------
Balance, end of year........................................ 1,559 1,559 1,537
--------- --------- ---------
ADDITIONAL PAID-IN CAPITAL
Balance, beginning of year.................................. 46,673 46,131 46,131
Exercise of options to purchase Common Stock................ -- 649 --
Retirement of stock options................................. -- (107) --
--------- --------- ---------
Balance, end of year........................................ 46,673 46,673 46,131
--------- --------- ---------
RETAINED EARNINGS
Balance, beginning of year.................................. 13,494 8,905 17,024
Net income (loss)........................................... 2,301 $2,301 4,589 $4,589 (8,119) $(8,119)
--------- ------ --------- ------ -------- ------
Balance, end of year........................................ 15,795 13,494 8,905
--------- --------- ---------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Balance, beginning of year.................................. 2,260 2,346 5,195
Net unrealized gain (loss) on available-for-sale securities
($(2,948), $(86), and $(2,849) pre-tax, in 1998, 1997, and
1996 respectively)(1)..................................... (2,948) (86) (2,849)
------ ------ -------
Other comprehensive income.................................. (2,948) (2,948) (86) (86) (2,849) (2,849)
--------- ------ --------- ------ -------- ------
Total comprehensive income.................................. $ (647) $4,503 $(10,968)
====== ====== ========
Balance, end of year........................................ (688) 2,260 2,346
--------- --------- ---------
TREASURY STOCK
Balance, beginning and end of year.......................... (66) (66) (66)
--------- --------- ---------
Total stockholders' equity.............................. $63,273 $63,920 $58,853
========= ========= =========
- -----------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK, SHARES
Balance, beginning of year.................................. 15,586,994 15,370,894 15,370,894
Exercise of options to purchase Common Stock................ -- 216,100 --
--------- --------- ---------
Balance, end of year........................................ 15,586,994 15,586,994 15,370,894
========== ========== ==========
TREASURY STOCK, SHARES
Balance, beginning of year.................................. 10,707 10,656 10,639
Purchased during year....................................... 11 51 17
--------- --------- ---------
Balance, end of year........................................ 10,718 10,707 10,656
========= ========= =========
</TABLE>
- ------------------------------
(1) Disclosure of reclassification amount
1998 1997 1996
------ ------ ------
Unrealized holding losses
Arising during the period $(3,200) $(2,260) $(3,348)
Less: reclassification adjustment
for net gains included in net income 252 2,174 499
------- ------- -------
Net unrealized losses on securities $(2,948) $ (86) $(2,849)
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
11
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
----------------------------------
<TABLE>
<CAPTION>
For the years ended December 31,
--------------------------------------
(IN THOUSANDS) 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Income (loss) from continuing operations............................................ $ 2,301 $ 4,589 $ (6,240)
Adjustments to reconcile income (loss) from continuing operations to
net cash used in operating activities:
Net realized investment gains................................................... (252) (2,174) (499)
Depreciation and amortization................................................... 855 905 920
Change in accrued investment income............................................. 579 391 412
Change in premiums and fees receivable.......................................... (4,534) 159 3,504
Change in reinsurance recoverables.............................................. 809 (5,452) (1,065)
Change in reinsurance recoverable on unpaid losses ............................. 1,998 3,361 (1,155)
Change in prepaid reinsurance premiums.......................................... 13 736 80
Change in deferred acquisition costs............................................ (831) (593) 97
Change in unpaid losses and loss adjustment expenses............................ (10,294) (14,704) (18,886)
Change in unearned premiums..................................................... 3,456 1,955 (569)
Change in policyholder dividends payable........................................ (230) 4 (4,257)
Change in reinsurance payables and funds withheld............................... 1,087 (746) (382)
Other, net...................................................................... (127) (14) 1,091
--------------------------------------
Net cash used in operating activities......................................... (5,170) (11,583) (26,949)
--------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales:
Fixed income maturities available-for-sale........................................ 3,412 951 12,668
Equity securities................................................................. 240 2,159 351
Investments, matured or called:
Fixed income maturities available-for-sale........................................ 52,338 23,002 29,821
Investments purchased:
Fixed income maturities available-for-sale........................................ (28,408) (19,664) (19,463)
Equity securities................................................................. (19,952) (129) --
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................................................. (127) (165) (32)
Proceeds from sale of property and equipment........................................ 6 -- 86
--------------------------------------
Net cash provided by investing activities..................................... 7,509 6,154 24,949
--------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of stock options......................................................... -- (107) --
Proceeds from exercise of options to purchase
Common Stock...................................................................... -- 671 --
--------------------------------------
Net cash provided by financing activities..................................... -- 564 --
--------------------------------------
Net cash provided by (used in) continuing operations.................................. 2,339 (4,865) (2,000)
Net cash used in discontinued operations.............................................. -- -- (120)
--------------------------------------
Net increase (decrease) in cash and short term investments............................ 2,339 (4,865) (2,120)
Cash and short term investments at beginning of year.................................. 1,818 6,683 8,803
--------------------------------------
Cash and short term investments at end of year........................................ $ 4,157 $ 1,818 $ 6,683
======================================
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
12
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 1998, 1997, AND 1996
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 commercial
non-standard automobile insurance in the western United States, primarily
California. NAICC writes approximately 74 percent of its insurance in
California. For the years ended December 31, 1998, 1997 and 1996, private
passenger automobile direct written premiums, representing 44 percent, 59
percent and 55 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 accumulated other comprehensive income (loss) in stockholders'
equity until realized. No deferred tax liability has been provided for
unrealized appreciation due to the anticipated availability of the Company's net
operating tax loss carryforwards, and other various deferred tax assets.
A decline in the market value of any security below cost which is deemed to be
other than temporary is charged to earnings, resulting in the establishment of a
new cost basis for such security.
Premiums and discounts of fixed maturities are amortized or accreted based on
the effective interest method. Dividend and interest income are recognized when
earned. The cost of securities sold is determined using the specific
identification method.
Equity securities are stated at fair value, and any increase or decrease from
cost is reported as accumulated other comprehensive income (loss) in
stockholders' equity as unrealized gain or loss.
Short term investments are stated at cost which approximates fair value.
Investments having an original maturity of three months or less from the time of
purchase have been classified as "short term investments."
C. REVENUE RECOGNITION
Earned premium income is recognized ratably over the contract period of an
insurance policy. A liability is established for unearned insurance premiums
representing the portion of premiums received that is applicable to the
unexpired terms of policies in force. Premiums earned include an estimate for
earned but unbilled premiums. Premiums earned but unbilled and included in
premiums receivable were $1.5 million and $1.2 million at December 31, 1998 and
1997, 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
13
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 1998, 1997, AND 1996
(CONTINUED)
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.
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, 1998 and 1997, 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 1998, 1997 and 1996 was $9.9 million,
$10.1 million and $6.2 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 8
percent, 10 percent and 6 percent of workers' compensation direct written
premiums for the years ended December 31, 1998, 1997 and 1996, 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, 1998.
H. PROPERTY AND EQUIPMENT
Property and equipment, which include data processing hardware and software
and leasehold improvements, are carried at historical cost less accumulated
depreciation. Depreciation of property and equipment is provided over the
estimated useful lives of the respective assets. Leasehold improvements are
amortized on a straight-line basis over the estimated useful lives of the assets
or over the term of the leases, whichever is shorter. The useful lives of all
property and equipment range from three to 12 years.
I. INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and the respective tax basis
thereof. Deferred tax assets and liabilities are measured using enacted tax
rates which are expected to apply to taxable income in the years in which those
temporary differences are anticipated to be recovered or settled, and are
limited, through a valuation allowance, to the amount realizable. See Note 12
"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. 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 16,006,708 and 16,194,180 for the years ended December
31, 1998 and 1997, 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 15,576,281, 15,481,041, and 15,360,250 for the
years ended December 31, 1998, 1997 and 1996, 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, 1998. The fair
value of all
14
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
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 ("SFAS") No. 123, "Accounting for Stock-Based Compensation" had been
applied. See Note 13 "Employee Benefit and Stock Option Plans."
N. RECLASSIFICATIONS
Certain reclassifications have been made to prior years' amounts to conform to
the current year's presentation.
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 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, 1998, 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 year ended
December 31,
------------------
1996
- ------------------------------------------------------------------
Revenues................................ $3,493
General and administrative expenses..... 4,126
---------------------
Net loss................................ $ (633)
=====================
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
15
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 1998, 1997, AND 1996
(CONTINUED)
deemed uncollectable. NAICC evaluates the financial condition of its reinsurers
and monitors concentrations of credit risk arising from similar geographic
regions, activities, or economic characteristics of the reinsurers to minimize
its exposure to significant losses from reinsurer insolvencies.
NAICC 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 prior to January 1, 1998 and $250,000 thereafter. In 1996, 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. It was further reduced to 10 percent
effective January 1, 1999. 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,
--------------------------------
1998 1997 1996
- --------------------------------------------------------------
Direct...................... $ 69,318 $ 66,700 $ 51,201
Ceded....................... (10,438) (10,940) (15,065)
-------------------------------
Net premium................. $ 58,880 $ 55,760 $ 36,136
===============================
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 arbitration and litigation proceedings pending at December 31, 1998.
The dispute related to this submission centers on the allocation of occurrences
and coverages. In February 1999, NAICC collected approximately $4 million as
partial settlement on the Hughes-Fullerton Claim from certain participants.
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, 1998, 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, 1998, NAICC
had reinsurance recoverables on paid and unpaid claims of $6.1 million, $6.3
million and $7.5 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,
---------------------------------
1998 1997 1996
- ---------------------------------------------------------------
Net unpaid losses and
LAE at January 1........ $ 85,762 $97,105 $116,294
Net unpaid losses acquired
with Valor.............. -- -- 403
---------------------------------
85,762 97,105 116,697
---------------------------------
Incurred related to:
Current year............ 39,131 37,142 26,979
Prior years............. -- 940 10,120
---------------------------------
Total incurred............ 39,131 38,082 37,099
---------------------------------
Paid related to:
Current year............ (16,169) (13,729) (10,559)
Prior years............. (31,258) (35,696) (46,132)
---------------------------------
Total paid................ (47,427) (49,425) (56,691)
---------------------------------
Net unpaid losses and
LAE at December 31...... 77,466 85,762 97,105
Plus: reinsurance
recoverables............ 18,187 20,185 23,546
---------------------------------
Gross unpaid losses and
LAE at December 31...... $ 95,653 $105,947 $120,651
=================================
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 has 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 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
rein-
16
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
surance 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 as well as
currently established case estimates and industry development factors for
reported claims. Estimates of liabilities are reviewed and updated continually
and there is the potential that NAICC's exposure could be materially in excess
of amounts which are currently recorded. 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, 1998 and 1997, NAICC's net unpaid losses and LAE relating to
environmental claims were approximately $10.8 million and $10.9 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, 1998 and 1997, DHC's operating insurance subsidiaries reported
statutory capital and surplus of $44.4 million and $45.1 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, 1998, 1997 and 1996, was $3.5 million, $5.9 million and ($5.6)
million, respectively. The Montana Department of Insurance has concluded its
examination of the statutory basis financial statements of Valor as of December
31, 1995. No adjustments were made to the Statutory Basis Financial Statements
of Valor.
In December 1993, the Association adopted a model for determining the
risk-based capital ("RBC") requirements for property and casualty insurance
companies. Under the RBC model, property and casualty insurance companies are
required to report their RBC ratios based on their latest statutory annual
statements as filed with the regulatory authorities. NAICC has calculated its
RBC requirement under the Association's model, and has capital in excess of any
regulatory action or reporting level.
Insurance companies are subject to insurance laws and regulations established
by the states in which they transact business. The agencies established pursuant
to these state laws have broad administrative and supervisory powers relating to
the granting and revocation of licenses to transact insurance business,
regulation of trade practices, establishment of guaranty associations, licensing
of agents, approval of policy forms, premium rate filing requirements, reserve
requirements, the form and content of required regulatory financial statements,
periodic examinations of insurers' records, capital and surplus requirements and
the maximum concentrations of certain classes of investments. Most states also
have enacted legislation regulating insurance holding company systems, including
with respect to acquisitions, extraordinary dividends, the terms of affiliate
transactions and other related matters. DHC and its insurance subsidiaries have
registered as a holding company system pursuant to such legislation in
California and routinely report to other jurisdictions. The Association has
formed committees and appointed advisory groups to study and formulate
regulatory proposals on such diverse issues as the use of surplus debentures,
accounting for reinsurance transactions and the adoption of RBC requirements. It
is not possible to predict the impact of future state and federal
17
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 1998, 1997, AND 1996
(CONTINUED)
regulation on the operations of the Company. The Association has adopted a
comprehensive set of accounting principles for qualifications as an Other
Comprehensive Basis of Accounting to become effective in 2001. The principles
adopted by the Association are subject to ratification by regulatory authorities
or legislatures in each state. The company does not believe that application of
these proposed comprehensive accounting principles will have a material impact
on the financial condition 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 1999, NAICC will not be permitted to pay dividends without
prior regulatory approval.
9) INVESTMENTS
The cost or amortized cost, unrealized gains, unrealized losses and fair value
at December 31, 1998 and 1997, categorized by type of security, were as follows
(dollars in thousands):
DECEMBER 31, 1998
-------------------------------------
COST OR
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
- ------------------------------------------------------------------
Fixed maturities:
U.S. Government/
Agency............... $ 35,583 $ 853 $ 32 $ 36,404
Mortgage-backed...... 47,352 526 57 47,821
Corporate............ 29,196 1,271 9 30,458
------------------------------------------
Total fixed
maturities..... 112,131 2,650 98 114,683
------------------------------------------
Equity securities...... 20,129 334 3,574 16,889
------------------------------------------
Total available-for-sale $132,260 $2,984 $3,672 $131,572
==========================================
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
============================================
Fixed maturities of the Company include mortgage-backed securities ("MBS")
representing 41.7 percent and 41.8 percent of the Company's total fixed
maturities at December 31, 1998 and 1997, 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, 1998, are shown below. Expected maturities may differ from
contractual maturities due to borrowers having the right to call or prepay their
obligations with or without call or prepayment penalties. Expected maturities of
mortgage-backed securities are estimated based upon the remaining principal
balance, the projected cash flows and the anticipated prepayment rates of each
security (dollars in thousands):
Amortized Fair
Maturity Cost Value
- --------------------------------------------------------------
Available-for-sale:
One year or less.................... $ 20,151 $ 20,387
Over one year to five years......... 62,831 64,782
Over five years to ten years........ 29,149 29,514
More than ten years................. -- --
--------------------
Total fixed maturities............ $112,131 $114,683
====================
The following reflects the change in net unrealized gain (loss) on
available-for-sale securities included as a separate component of accumulated
other comprehensive income (loss) in stockholders' equity (dollars in
thousands):
For the years ended
December 31,
---------------------------
1998 1997 1996
- --------------------------------------------------------------
Fixed maturities................ $ 742 $1,904 $(4,916)
Equity securities............... (3,690) (1,990) 2,067
---------------------------
$(2,948) $ (86) $(2,849)
==========================
18
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
Net realized investment gains in 1998, 1997 and 1996 were as follows (dollars
in thousands):
For the years ended
December 31,
-------------------
1998 1997 1996
- --------------------------------------------------------------
Fixed maturities....................... $198 $ 38 $148
Equity securities...................... 54 2,136 351
-------------------
Net realized investment gains........ $252 $2,174 $499
-------------------
Gross realized gains relating to fixed maturities were $213,000, $75,000 and
$171,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
Gross realized losses relating to fixed maturities were $15,000, $37,000 and
$23,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
Gross realized gains relating to equity securities were $54,000, $2,136,000 and
$351,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
There were no gross realized losses relating to equity securities for the years
ended December 31, 1998, 1997 and 1996.
Net investment income for the past three years was as follows (dollars in
thousands):
For the years ended
December 31,
---------------------------
1998 1997 1996
- --------------------------------------------------------------
Fixed maturities............... $8,032 $9,682 $10,852
Short term investments......... 279 253 243
Other, net..................... 2 1 8
---------------------------
Total investment income...... 8,313 9,936 11,103
Less: Investment expense....... 139 126 448
---------------------------
Net investment income........ $8,174 $9,810 $10,655
===========================
There were no investments with a carrying value greater than ten percent of
stockholders' equity as of December 31, 1998, 1997 or 1996.
In compliance with state insurance laws and regulations, securities with a
fair value of approximately $51 million, $65 million and $85 million at December
31, 1998, 1997 and 1996, respectively, were on deposit with various states or
governmental regulatory authorities. In addition, at December 31, 1998, 1997 and
1996, respectively, investments with a fair value of $6.9 million, $5.6 million
and $4.3 million were held in trust or as collateral under the terms of certain
reinsurance treaties and letters of credit.
10) FOREIGN CURRENCY TRANSLATION AND FOREIGN
INVESTMENTS
During 1998, NAICC invested approximately $10.3 million in Japanese Yen based
equity securities. During the second quarter, NAICC purchased a foreign currency
option at a cost of $155,000 to sell Japanese Yen at a fixed price on a given
date in 1999. The foreign currency option is considered a derivative instrument.
Foreign currency translation gain for the year ended December 31, 1998 was
$855,050, net of a loss on the foreign currency option for the same period of
$150,000.
Assets and liabilities relating to investments in foreign corporations are
translated into U.S. dollars using current exchange rates; revenues and
expenses, if any, are translated into U.S. dollars using the average exchange
rate for the month when incurred. Translation gains and losses, net of
applicable taxes, are excluded from income and reported as accumulated other
comprehensive income (loss) in stockholders' equity.
11) 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, 1998, there were 15,586,994 shares of Common
Stock issued of which 15,576,276 were outstanding; the remaining 10,718 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 13 "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 12 "INCOME TAXES."
12) 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.
As of December 31, 1998, the Company has a consolidated net operating loss
carryforward of approximately $1.3 billion for Federal income tax purposes. This
number is based upon Federal consolidated income tax losses for the periods
through December 31, 1997 and an estimate of the 1998 taxable results. The net
operating loss carryforward will expire in various amounts, if not used, between
1999 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
19
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 1998, 1997, AND 1996
(CONTINUED)
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 11 "STOCKHOLDERS' EQUITY" for a description of
certain restrictions on the transfer of Common Stock.
The Company's net operating tax loss carryforwards will expire, if not used,
in the following amounts in the following years (dollars in thousands):
Year Ending Amount of Carryforward
December 31, Expiring
- --------------------------------------------------------
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...................... 38,255
----------
$1,327,907
==========
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,
--------------------
1998 1997 1996
- --------------------------------------------------------------
Federal income tax...................... $-- $-- $--
State and local......................... 33 47 18
--------------------
$33 $47 $18
====================
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 1998, 1997 and 1996, as compared to the provision for income
taxes (dollars in thousands):
For the years ended
December 31,
--------------------------
1998 1997 1996
- --------------------------------------------------------------
Computed "expected"
tax expense.................. $ 794 $ 1,576 $(2,115)
Change in valuation allowance . (12,573) 10,945 3,754
Decrease (increase) in NOL's
from the trusts.............. 11,672 (12,504) (1,755)
State and local tax expense.... 33 47 18
Other, net..................... 107 (17) 116
----------------------------
Total income tax expense....... $ 33 $ 47 $ 18
============================
The tax effects of temporary differences that give rise to the deferred tax
assets and liabilities at December 31, 1998 and 1997, respectively, are
presented as follows (dollars in thousands):
For the years ended
December 31,
-----------------------
1998 1997
- -----------------------------------------------------------
Deferred tax assets
Loss reserve discounting..... $ 5,104 $ 5,861
Unearned premiums............ 818 583
Net operating loss
carryforwards.............. 451,488 463,005
Allowance for doubtful
accounts................... 363 357
Policyholder dividends....... 61 140
Non-recurring compensation... 35 162
Unrealized loss on available-
for-sale securities........ 234 --
Capital loss carryforwards... 2,199 2,682
Other........................ 232 206
AMT credit carryforward...... 408 --
-----------------------
Total gross deferred tax asset 460,942 472,996
Less: Valuation allowance.... (460,006) (471,580)
-----------------------
Total deferred tax asset..... $ 936 $ 1,416
-----------------------
Deferred tax liabilities
Deferred acquisition costs... 810 527
Unrealized gains on available-
for-sale securities........ -- 768
Difference in tax basis
of bonds................... 126 121
-----------------------
Total deferred tax liability. 936 1,416
-----------------------
Net deferred tax asset....... $ -- $ --
=======================
13) 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
20
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
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 similar terms as those granted on that date under the 1990
Plan. During 1994, Junkyard Partners transferred 257,910 of its 630,000 options
to one of its limited partners. On December 29, 1994, DHC issued 257,910
restricted shares of Common Stock upon the exercise of such transferred options.
In connection therewith, DHC received a total exercise price of $773,730.
Effective May 19, 1995, DHC purchased 69,453 of the remaining 372,090 options to
purchase Common Stock owned by Junkyard Partners. The options were exercisable
at the time of such purchase and otherwise would have expired on March 13, 2001.
The aggregate purchase price paid by DHC for the options was approximately
$286,500, which was equal to the difference between the closing price of Common
Stock on May 19, 1995 ($7.125 per share), the effective date of such purchase,
and the exercise price of such options ($3.00 per share), or $4.125 per share.
Effective November 12, 1997, DHC purchased 20,920 of the remaining 302,637
options to purchase Common Stock owned by Junkyard Partners. The options were
exercisable at the time of such purchase and otherwise would have expired on
March 13, 2001. The aggregate purchase price paid by DHC for the options was
$107,215, which was equal to the difference between the closing price of Common
Stock on November 12, 1997 ($8.125 per share), the effective date of such
purchase, and the exercise price of such options ($3.00 per share), or $5.125
per share.
On September 16, 1991, DHC granted, outside the 1990 Plan, options to purchase
an aggregate of 140,000 shares of Common Stock with an exercise price of $3.63,
the arithmetic average of the closing prices of the Common Stock on the American
Stock Exchange for the thirty days prior to the date of grant. On this date, the
Compensation Committee of the Board of Directors of DHC resolved that it
intended to refrain from granting any additional options under the 1990 Plan.
On June 13, 1997, options to purchase 210,000 shares of Common Stock granted
under the 1990 Plan were exercised at their exercise price of $3.00. As a
result, DHC received $630,000.
As of December 31, 1998, 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).
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
21
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------
DECEMBER 31, 1998, 1997 AND 1996
(CONTINUED)
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. 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 155,000
shares of Common Stock were granted under the 1995 Plan. The exercise price for
such options is $7.0625 (the mean of the high and low prices of the Common Stock
on the American Stock Exchange on the date of the grant).
On December 2, 1998, options to purchase an aggregate amount of 167,500 shares
of Common Stock were granted under the 1995 Plan. The exercise price for such
options is $3.65625 (the mean of the high and low prices of the Common Stock on
the American Stock Exchange on the date of the grant).
As of December 31, 1998, 491,662 options granted under the 1995 Plan were
exercisable. Options granted under the 1995 Plan generally become exercisable
over three years and expire ten years after the date of grant.
The Company applies APB Opinion 25 and Related Interpretations in accounting
for the Stock Option Plans. Accordingly, no compensation cost has been
recognized. Had compensation cost been determined based on the fair value at the
grant date of the options consistent with the method of SFAS Statement 123, the
net income (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):
1998 1997 1996
- --------------------------------------------------------------
Net income (loss)
As reported...................... $2,301 $4,589 $(8,119)
Pro forma........................ 1,827 4,303 (8,621)
Diluted earnings (loss) per share
As reported...................... $ 0.14 $ 0.28 $ (0.53)
Pro forma........................ 0.11 0.27 (0.56)
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) 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, was paid in full during 1997. All shares
have been released from collateral and allocated to employees. All of the shares
of Common Stock held by the ESOP are deemed to be outstanding for earnings per
share computations. KCP has elected to include the value of the Common Stock
allocated annually to participants under the ESOP in the calculation of its
matching contribution to the KCP and Subsidiaries Salary Deferred Plan and Trust
("401(k) Plan"). The participating employers contributed 50 percent of the first
six percent of employee-contributed compensation to the 401(k) Plan. The shares
of Common Stock owned by the ESOP as of December 31, 1998 and 1997,
respectively, were as follows:
1998 1997
- --------------------------------------------------------------
Allocated shares......................... 99,682 99,682
Unreleased shares........................ -- --
-------------------
99,682 99,682
===================
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.
22
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
The following table sets forth the Pension Plan's funded status at December
31, 1998 and 1997, valued at January 1, 1999 and 1998, respectively (dollars in
thousands):
1998 1997
- -------------------------------------------------------------
Actuarial present value of benefit obligations:
Accumulated benefits obligation,
including vested benefits of $1,261
for 1998 and $1,381 for 1997............ $1,613 $1,739
================
Projected benefit obligation.............. $1,801 $1,942
Plan assets at fair value................. 1,490 1,641
----------------
Projected benefit obligation in excess
of plan assets.......................... (311) (301)
Unrecognized net loss..................... 66 97
Unrecognized prior service cost........... 58 66
Adjustment required to recognize
minimum liability....................... -- --
-----------------
(Accrued) prepaid pension cost.......... $ (187) $ (138)
================
Net pension costs for the years ended December 31, 1998, 1997 and 1996 include
the following components:
For the years ended
December 31,
---------------------
1998 1997 1996
- -------------------------------------------------------------
Service cost......................... $207 $230 $ 237
Interest cost........................ 133 131 128
Expected (return) loss on plan assets (128) (102) (106)
Net amortization and deferral........ 8 8 23
--------------------
Net pension cost................... $220 $267 $ 282
====================
The Pension Plan's assets consist of U.S. Government obligations, registered
equity mutual funds and insured certificates of deposit. The average discount
rate used in determining the actuarial present value of the projected benefit
obligation was 7.0 percent, 7.75 percent and 7.5 percent for 1998, 1997 and
1996, respectively. The projected long-term rate of return on assets was 7.5
percent for 1998 and 7.25 percent for 1997 and 7 percent for 1996. The average
rate of compensation increase used in determining the actuarial present value of
the projected benefit obligation was 4.5 percent for 1998 and 1997.
The following tables provide a reconciliation of the changes in the Pension
Plan's benefit obligation and the fair value of plan assets as of December 31,
1998 and 1997 (dollars in thousands):
1998 1997
- -------------------------------------------------------------
Reconciliation of Benefit Obligation
Benefit Obligation, beginning of year.. $1,942 $1,921
Service Cost........................... 207 230
Interest Cost.......................... 133 131
Actuarial (gain) loss.................. (63) 13
Benefits paid.......................... (418) (353)
----------------
Benefit Obligation, end of year..... $1,801 $1,942
================
Reconciliation of Plan Assets
Plan Assets, beginning of year......... $1,641 $1,517
Actual return on plan assets........... 96 124
Employer contributions................. 171 353
Benefits paid.......................... (418) (353)
----------------
Plan Assets, end of year............ $1,490 $1,641
================
The prior service costs are amortized on a straight-line basis over the
average remaining service period of active participants. Gains and losses in
excess of 10 percent of the greater of the benefit obligation and the fair value
of related plan assets are amortized over the average remaining service period
of active participants. NAICC recognized $246,838, $229,635 and $252,229 in
accrued pension benefit for the years ended December 31, 1998, 1997 and 1996,
respectively.
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. KCP and subsidiaries contributed 50 percent of the first six percent of
employee-contributed compensation; Danielson Trust contributed 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 1998, 1997 and 1996, the employers' matching
obligation to the 401(k) Plan was satisfied through ESOP shares, cash and
forfeitures totaling $156,000, $186,000 and $242,000, respectively, in value.
23
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
---------------------------
DECEMBER 31, 1998, 1997, AND 1996
(CONTINUED)
14) 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 $1.5 million for the year ended
December 31, 1998 and $1.1 million for each of the the years ended December 31,
1997 and 1996. At December 31, 1998, future net minimum operating lease rental
payment commitments were as follows (dollars in thousands):
Years Ending Minimum Operating Lease
December 31, Rental Payments
- --------------------------------------------------------------
1999............................... $1,610
2000............................... 1,092
2001............................... 835
2002............................... 737
2003 and thereafter................ 180
------
Total commitments.................. $4,454
======
15) 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.
24
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, 1998 and 1997, 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, 1998.
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, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998, in conformity with generally accepted
accounting principles.
/S/ KPMG LLP
New York, New York
March 5, 1999
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 LLP. The independent auditors, whose appointment by
the Board of Directors was ratified by the Company's stockholders, express their
opinion on the fairness of presentation, in all material respects, of the
Company's Consolidated Financial Statements based on procedures which they
consider to be sufficient to form their opinion.
The Audit Committee of the Board of Directors meets periodically with
representatives of KPMG LLP and the Company's financial management to review
accounting, internal control, auditing and financial reporting matters.
25
DANIELSON HOLDING CORPORATION AND SUBSIDIARIES
<PAGE>
QUARTERLY FINANCIAL DATA
-------------------------------
(UNAUDITED)
The following table presents unaudited quarterly financial data for the years
ended December 31, 1998 and 1997. 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>
1998:
TOTAL REVENUES................................ $16,569 $15,837 $16,176 $16,162
NET INCOME.................................... 807 307 597 590
NET INCOME PER DILUTED SHARE.................. .05 .02 .04 .03
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
</TABLE>
STOCK MARKET PRICES
---------------------------------------
Danielson Holding Corporation Common Stock is listed and traded on the
American Stock Exchange (symbol: DHC). On March 18, 1999, there were
approximately 1,357 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.
<TABLE>
<CAPTION>
1998 1997
------------------------------------------------------------------
HIGH LOW CLOSE High Low Close
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
First Quarter............................................ 8 1/8 7 3/16 7 1/2 14 4 7/8 6 7/8
Second Quarter........................................... 8 7 7 3/8 8 1/2 6 3/8 7 7/8
Third Quarter............................................ 7 1/2 3 5/8 4 3/8 9 8 9
Fourth Quarter........................................... 4 3/8 3 3 9/16 9 5/8 6 3/4 7 1/4
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
26
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.
William W. Palmer
Chief of Staff and General Counsel
to the Commissioner for the California Department of Insurance
Anthony G. Petrello
President and Chief Operating Officer, Nabors Industries, Inc.
Joseph F. Porrino
Counsellor to the President,
New School for Social Research
Frank B. Ryan
Professor of Mathematics, Rice University
Wallace O. Sellers
Vice Chairman and 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: Jennifer DeLeon
Investor Relations
212/888-0347
Stock Transfer Agent and Registrar
American Stock Transfer and Trust Company
40 Wall Street
New York, NY 10005
718/921-8261
Independent Certified
Public Accountants
KPMG LLP
757 Third Avenue
New York, NY 10017
<PAGE>
DANIELSON HOLDING CORPORATION
767 Third Avenue--Fifth Floor
New York, New York 10017-2023
212/888-0347
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 114,683
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 16,889
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 134,859
<CASH> 870
<RECOVER-REINSURE> 25,901<F1>
<DEFERRED-ACQUISITION> 2,381
<TOTAL-ASSETS> 180,895
<POLICY-LOSSES> 95,653
<UNEARNED-PREMIUMS> 13,705
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 181
<NOTES-PAYABLE> 0
0
0
<COMMON> 1,559
<OTHER-SE> 61,714<F2>
<TOTAL-LIABILITY-AND-EQUITY> 180,895
55,411
<INVESTMENT-INCOME> 8,174
<INVESTMENT-GAINS> 252
<OTHER-INCOME> 907
<BENEFITS> 39,131
<UNDERWRITING-AMORTIZATION> 9,899
<UNDERWRITING-OTHER> 12,909
<INCOME-PRETAX> 2,334
<INCOME-TAX> 33
<INCOME-CONTINUING> 2,301
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,301
<EPS-PRIMARY> 0.15<F3>
<EPS-DILUTED> 0.14<F4>
<RESERVE-OPEN> 85,762
<PROVISION-CURRENT> 39,131
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 16,169
<PAYMENTS-PRIOR> 31,258
<RESERVE-CLOSE> 77,466
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1> Includes reinsurance recoverables on unpaid losses of 18,187 and reinsurance
recoverables on paid losses of 7,714.
<F2> Includes treasury stock of 66.
<F3> Represents earning per share--basic.
<F4> Represents earning per share--diluted.
</FN>
</TABLE>
