-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ga8Gngv1prTL3vjrDguLmogUO/WECKjc7YjgkpWFzLnRi40si2Mvl3ZN1nCD1C6X hQ66OfAMlBdkqq7Z2HN5hw== 0000928598-01-500093.txt : 20010402 0000928598-01-500093.hdr.sgml : 20010402 ACCESSION NUMBER: 0000928598-01-500093 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DANIELSON HOLDING CORP CENTRAL INDEX KEY: 0000225648 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 956021257 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-06732 FILM NUMBER: 1587511 BUSINESS ADDRESS: STREET 1: 767 THIRD AVE 5TH FL CITY: NEW YORK STATE: NY ZIP: 10017 BUSINESS PHONE: 2128880347 MAIL ADDRESS: STREET 1: 767 THIRD AVE CITY: NEW YORK STATE: NY ZIP: 10017-2023 FORMER COMPANY: FORMER CONFORMED NAME: MISSION INSURANCE GROUP INC DATE OF NAME CHANGE: 19900826 FORMER COMPANY: FORMER CONFORMED NAME: MISSION EQUITIES CORP DATE OF NAME CHANGE: 19770921 10-K 1 dhc10k.txt FORM 10K 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, 2000 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 COMMISSION FILE NUMBER 1-6732 DANIELSON HOLDING CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) Delaware 95-6021257 (State of incorporation) (I.R.S. Employer Identification No.) 767 Third Avenue, New York, New York 10017-2023 (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 888-0347 SECURITIES REGISTERED PURSUANT TO SECTION 12 (B) OF THE ACT: NAME OF EACH EXCHANGE ON TITLE OF EACH CLASS WHICH REGISTERED ------------------- ---------------- Common Stock, $0.10 par value............... American Stock Exchange SECURITIES REGISTERED PURSUANT TO SECTION 12 (G) OF THE ACT: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] At March 21, 2001, the aggregate market value of the registrant's voting stock held by non-affiliates was $67,718,889. 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 21, 2001 ----- ----------------------------- Common Stock, $0.10 par value 19,505,954 shares The following documents have been incorporated by reference herein: 2000 Annual Report to Stockholders, as indicated herein (Parts I and II) PART I ITEM 1. BUSINESS. INTRODUCTION Danielson Holding Corporation ("DHC" or "Registrant") is a holding company incorporated in Delaware, having separate subsidiaries (collectively with DHC, the "Company") offering a variety of insurance products. It is DHC's intention to grow by developing business partnerships and making strategic acquisitions. As part of DHC's ongoing corporate strategy, DHC has continued to seek acquisition opportunities which will both complement its existing operations and enable DHC to earn an attractive return on investment. The largest subsidiary of DHC is its indirectly wholly-owned California insurance company, National American Insurance Company of California (together with its subsidiaries, "NAICC"). NAICC writes non-standard and preferred private passenger and commercial automobile, homeowners' and workers' compensation insurance in the western United States, primarily California. DHC had cash and investments at the holding company level of $21.0 million at December 31, 2000. Total liabilities of DHC at the same date were $346,000. The Company expects to report, as of the end of its 2000 tax year, aggregate consolidated net operating tax loss carryforwards ("NOLs") for Federal income tax purposes of approximately $899 million. These losses will expire over the course of the next 19 years unless utilized prior thereto. See Note 8 of the Notes to Consolidated Financial Statements. DESCRIPTION OF BUSINESSES Set forth below is a description of 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 and preferred private passenger and commercial automobile, homeowners' and workers' compensation insurance in the western states, primarily California. NAICC is a second 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, in Oregon and Washington in April, 1998 and in Arizona in 1999. NAICC writes its California business through two general agents that use over 700 sub-agents to obtain applications for policies. Oregon, Washington and Arizona business is written directly through appointed independent agents. Policyholder selection is governed by underwriting guidelines established by NAICC. NAICC began writing non-standard commercial automobile insurance in 1995 through independent agents. Non-standard risks are those segments of the driving public which generally are not considered "preferred" business, such as drivers with a record of prior accidents or driving violations, drivers involved in particular occupations or driving certain types of vehicles, or those who have been non-renewed or declined by another insurance company. Generally, non-standard premium rates are higher than standard premium rates and policy limits are lower than typical policy limits. NAICC's management believes that it is able to achieve underwriting success through refinement of various risk profiles, thereby dividing the non-standard market into more defined segments which can be adequately priced. -1- The majority of automobiles owned or used by businesses are insured under policies that provide other coverages for the business, such as commercial multi-peril insurance. Businesses which are unable to insure a specific driver and businesses having vehicles not qualifying for commercial multi-peril insurance are typical NAICC commercial automobile policyholders. Examples of these risks include drivers with more than one moving violation, one and two vehicle accounts, and specialty haulers, such as sand and gravel, farm vehicles and certain short-haul common carriers. The typical NAICC commercial automobile policy covers fleets of four or fewer vehicles. NAICC does not insure long-haul truckers, trucks hauling logs, gasoline or similar higher hazard operations. The current average annual premium of the policies in force is approximately $2,518. Net written premiums were $27.2 million, $29.7 million and $27.9 million in 2000, 1999 and 1998, respectively for all private passenger automobile programs. Net written premiums were $16.7 million, $21.9 million, and $26.3 million in 2000, 1999 and 1998, respectively, for the non-standard private passenger automobile program. Until January 1, 1999, NAICC ceded 25 percent of its California non-standard private passenger automobile business to a major reinsurance company under a quota share reinsurance agreement. Effective January 1, 1999, the ceding percentage was reduced to 10%. NAICC's Oregon and Washington non-standard automobile, California preferred automobile, and its commercial automobile businesses are reinsured 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 2000 was due to increased competition in the California marketplace. Part of the decrease in its California non-standard automobile business continues to be offset by the preferred automobile program in California. Net written premiums for preferred automobile were $10.5 million, $7.8 million and $1.6 million in 2000, 1999 and 1998, respectively. Net written premium growth for NAICC's non-standard private passenger automobile program outside of California was flat during 2000. Net written premiums for commercial automobile were $23.1 million, $12.6 million and $13.5 million in 2000, 1999 and 1998, respectively. The increase in 2000 is attributable to increased production as a result of increased marketing efforts. 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 $22.3 million, $13.1 million and $17.2 million, in 2000, 1999, and 1998, respectively. In response to developments affecting the market for workers' compensation insurance in California, NAICC has pursued a strategy of aggressively seeking business 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. During 2000 Valor increased its direct written premiums $3.3 million from $6.6 million to $9.9 million. NAICC does not write any business through managing general agents. Its California non-standard private passenger automobile program, representing 12.2% of net written premiums, is produced through one general agent, and its preferred private passenger automobile program in California, representing 14.4% of net written premiums, is produced through another general agent. Beginning in 2001, NAICC discontinued its California preferred private passenger automobile program. -2- 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 by NAICC and filed with the regulators in each of the relevant states, depending upon each state's requirements. NAICC relies upon its own, as well as industry experience, in establishing rates. Private passenger automobile policy limits vary by state. In California, non-standard policies provide maximum coverage up to $15,000 per person, $30,000 per accident for liability and bodily injury and $10,000 per accident for property damage. In Arizona, Oregon and Washington, non-standard policies provide minimum coverage of $25,000 per person, $50,000 per accident for liability and bodily injury and $10,000 per accident for property damage, and can provide coverage to a maximum of $250,000 per person, $500,000 per accident for liability and bodily injury and $25,000 per accident for property damage. In general, preferred policies provide coverage to a maximum of $250,000 per person, $500,000 per accident for liability and bodily injury and $25,000 per accident for property damage. The maximum non-standard commercial automobile policy limit provided by NAICC is $1 million bodily injury and property damage combined single limit of liability for each occurrence. NAICC retains the first $250,000 bodily injury and property damage combined single limit of liability for each occurrence, with losses in excess of $250,000, per occurrence, being ceded to its reinsurers. Workers' compensation rates, rating plans, policyholder dividend plans and policy forms are developed and filed 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 $200,000 of each workers' compensation loss and has purchased reinsurance for up to $49.8 million in excess of its retention, the first $9.5 million of which are placed with three major reinsurance companies, with the remaining $40.3 million being provided by 16 other companies. In April 2000, NAICC entered into a workers' compensation excess of loss reinsuarnce agreement with SCOR Re Insurance Company that provides coverage down to $200,000. In January 1999, NAICC entered into a workers' compensation reinsurance agreement with Reliance Insurance Company (the "Reliance Agreement") with a term of two years. The Reliance Agreement provided excess of loss coverage down to $10,000 and a 20% quota share below the excess retention resulting in a maximum net loss to NAICC of $18,000 per claim. In the fourth quarter of 1999, NAICC executed an agreement to rescind the Reliance Agreement. The terms of the rescission include the return of amounts paid by NAICC during the nine month period the Reliance Agreement was active plus a settlement fee to terminate the Reliance Agreement. NAICC recognized a gain of $8,317,000 in the fourth quarter of 1999 as a result of this rescission. MARKETING NAICC maintains five new business production offices located in Portland, Oregon, Phoenix, Arizona and Concord, 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. NAICC writes non-standard private passenger automobile insurance directly through 128 independent agents in Arizona, Idaho, Nevada, Oregon and Washington. NAICC also began a preferred private passenger automobile -3- program in California in February 1998 which is marketed through a second general agent. NAICC markets its non-standard commercial automobile insurance through approximately 900 independent agents located in Arizona, California, Idaho, Nevada, Oregon, Utah and Washington. NAICC writes workers' compensation business primarily in the states of California, Oregon, Arizona, Idaho and Montana through more than 800 independent agents. The agency contracts provide authority to bind coverage within specific 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. CLAIMS All automobile claims are handled by employees of NAICC at its home office in Long Beach, California. Claims are reported by agents, insureds and claimants directly to NAICC. Claims involving suspected fraud are referred to an in-house special investigation unit ("SIU") which manages a detailed investigation of these claims using outside investigative firms. When evidence of fraudulent activity is identified, the SIU works with the various state departments of insurance, the National Insurance Crime Bureau and local law enforcement agencies in handling the claims. Workers' compensation claims are received, reviewed and processed by NAICC employees located in claims service offices in Long Beach, California. Most of NAICC's policyholders are not of sufficient size or type to make a more specialized managed care approach to medical cost containment more cost effective. The California Automobile Assigned Risk Plan provides for state mandated minimum levels of automobile liability coverage to drivers whose driving records, or other relevant characteristics, make it difficult for them to obtain insurance coverage in the voluntary market. NAICC does not expect to receive a material number of assignments arising from this program and does not believe that the assignments will have a material adverse effect on its profitability. LOSSES AND LOSS ADJUSTMENT EXPENSES NAICC's unpaid losses and loss adjustment expenses ("LAE") represent the estimated indemnity cost and loss adjustment expenses necessary to cover the ultimate net cost of investigating and settling claims. Such estimates are based upon estimates for reported losses, historical company experience of losses reported by reinsured companies for insurance assumed, and actuarial estimates based upon historical company and industry experience for development of reported and unreported claims (incurred but not reported). Any changes in estimates of ultimate liability are reflected in current operating results. Inflation is assumed, along with other factors, in estimating future claim costs and related liabilities. NAICC does not discount any of its loss reserves. The ultimate cost of claims is difficult to predict for several reasons. Claims may not be reported until many years after they are incurred. Changes in the rate of inflation and the legal environment have created forecasting complications. Court decisions may dramatically increase liability in the time between the dates on which a claim is reported and its resolution. Punitive damages awards have grown in frequency and magnitude. The courts have imposed increasing obligations on insurance companies to defend policyholders. As a result, the frequency and severity of claims have grown rapidly and unpredictably. NAICC has claims for environmental clean-up against policies issued prior to 1970 and which are currently in run-off. The principal exposure arises from direct excess and primary policies of business in run-off, the obligations of which were assumed by NAICC in 1985. These direct excess and primary claims are relatively few in number and have policy limits of between $50,000 and $1,000,000, with reinsurance generally above -4- $50,000. NAICC also has environmental claims arising associated with participations in excess of loss reinsurance contracts assumed by NAICC. These reinsurance contracts have relatively low limits, generally less than $25,000, and estimates of unpaid losses are based on information provided by the primary insurance company. The unpaid loss and LAE related to environmental cleanup is established considering facts currently known and the current state of the law and coverage litigation. Liabilities are estimated for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific contract of insurance or reinsurance and management can reasonably estimate its liability. Estimates for unknown claims and development of reported claims are included in NAICC's loss and LAE. The liability for development of reported claims is based on estimates of the range of potential losses for reported claims in the aggregate. Estimates of liabilities are reviewed and updated continually and there is the potential that NAICC's exposure could be materially in excess of amounts that are currently recorded. Management does not expect that liabilities associated with these types of claims will result in a material adverse effect on future liquidity or financial position. However, liabilities such as these are based upon estimates and there can be no assurance that the ultimate liability will not exceed, or even materially exceed, such estimates. As of December 31, 2000 and 1999, NAICC's net unpaid losses and LAE relating to environmental claims were approximately $7.6 million and $8.3 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. -5- 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, --------------------------------------------------------- 2000 1999 1998 ---- ---- ---- Net unpaid losses and LAE at January 1 $79,306 $ 77,466 $ 85,762 Incurred related to: Current year 55,269 43,301 39,131 Prior years 5,254 2,491 -- ---------- ----------- ----------- Total incurred 60,523 45,792 39,131 ---------- ----------- ----------- Paid Related to: Current year (26,147) (16,527) (16,169) Prior years (34,293) (27,425) (31,258) ---------- ----------- ----------- Total paid (60,440) (43,952) (47,427) ---------- ----------- ----------- Net unpaid losses and LAE at December 31 79,389 79,306 77,466 Plus: reinsurance recoverables on unpaid losses 20,641 15,628 18,187 ---------- ----------- ----------- Gross unpaid losses and LAE at December 31 $ 100,030 $ 94,934 $ 95,653 ========== =========== ===========
The losses and LAE incurred during 2000 related to prior years is attributable to development on the commercial automobile lines and certain lines in run-off. The losses and LAE incurred during 1999 related to prior years is primarily attributable to development in the California workers' compensation line. NAICC increased its bulk unpaid liabilities related to these policies, as it has become evident that the loss costs associated with these claims would be greater than previously anticipated. The following table indicates the manner in which unpaid losses and LAE at the end of a particular year change as time passes. The first line reflects the liability as originally reported, net of reinsurance, at the end of the stated year. Each calendar year-end liability includes the estimated liability for that accident year and all prior accident years comprising that liability. The second section shows the original recorded net liability as of the end of successive years adjusted to reflect facts and circumstances that are later discovered. The next line, cumulative (deficiency) or redundancy, compares the adjusted net liability amount to the net liability amount as originally established and reflects whether the net liability as originally recorded was adequate to cover the estimated cost of claims or redundant. The third section reflects the cumulative amounts related to that liability that were paid, net of reinsurance, as of the end of successive years. -6-
Analysis of Net Losses and Loss Adjustment Expense ("LAE") Development (dollars in thousands): YEAR ENDED DECEMBER 31 ---------------------- 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- Net unpaid losses and LAE at end of year $91,870 $ 97,810 $104,825 $119,223 $128,625 $116,294 $97,105 $ 85,762 $ 77,466 $79,306 $79,389 Net unpaid losses and LAE re- estimated as of: One year later 92,632 94,364 105,658 119,607 131,748 126,414 98,045 85,762 79,957 84,560 Two years later 87,504 99,875 111,063 123,039 141,602 126,796 97,683 85,684 82,778 Three years later 89,844 107,945 117,756 136,735 141,787 127,621 98,545 87,613 Four years later 95,576 116,018 138,877 140,076 144,491 129,792 102,053 Five years later 102,081 136,269 142,423 142,537 146,827 133,985 Six years later 119,107 139,493 144,457 144,556 151,784 Seven years later 121,161 141,467 145,370 147,916 Eight Years later 122,664 142,031 148,052 Nine Years later 122,814 144,936 Ten Years later 125,500 Cumulative (deficiency) redundancy (33,630) (47,126) (43,227) (28,693) (23,159) (17,691) (4,948) (1,851) (5,312) (5,254) Cumulative net amounts paid as of: One year later 31,162 39,131 39,650 42,264 46,582 46,132 35,696 31,317 43,090 51,608 Two years later 53,424 63,483 68,025 71,702 80,515 74,543 54,815 43,855 62,577 Three years later 66,198 81,485 88,038 95,525 101,726 90,818 63,290 56,968 Four years later 75,963 94,238 106,431 110,163 114,424 97,900 74,306 Five years later 83,704 108,923 118,136 119,474 119,310 108,061 Six years later 95,199 118,397 125,218 122,296 128,117 Seven years later 102,886 124,569 126,362 129,378 Eight years later 107,726 125,256 132,482 Nine years later 108,277 130,963 Ten years later 112,800
-7- The following table reflects the same information as the preceding table gross of reinsurance (dollars in thousands):
Years ended December 31, 1993 1994 1995 1996 1997 1998 1999 2000 ---- ---- ---- ---- ---- ---- ---- ---- Gross unpaid losses and LAE at end of year: $ 137,479 $ 146,330 $ 137,406 $120,651 $ 105,947 $ 95,653 $ 94,934 $100,030 Gross unpaid losses and LAE re-estimated a as of: One year later 137,898 149,815 149,416 121,787 107,060 99,314 103,166 Two years later 141,737 161,731 150,106 121,335 106,543 100,893 Three years later 158,263 162,246 150,815 122,369 110,091 Four years later 162,697 165,111 153,509 126,736 Five years later 165,077 168,045 159,164 Six years later 167,702 174,811 Seven years later 172,768 Gross cumulative deficiency: (35,289) (28,481) (21,758) (6,085) (4,144) (5,240) (8,232) Gross cumulative amount paid as of: One year later 53,634 53,798 54,901 47,835 36,542 55,245 61,397 Two years later 88,930 92,991 92,422 21,794 56,948 99,185 Three years later 116,605 122,095 110,498 37,092 93,694 Four years later 138,924 136,448 124,153 71,414 Five years later 148,928 146,803 157,591 Six years later 157,196 178,827 Seven years later 187,373 Gross unpaid losses and LAE latest re-estimate 172,768 174,811 159,164 126,736 110,091 100,893 103,166 Reinsurance recoverable latest re-estimate 24,852 23,028 25,179 24,683 22,478 18,116 20,470 ------------------------------------------------------------------------- Net unpaid losses and LAE latest re-estimate 147,916 151,784 133,985 102,053 87,613 82,778 82,697 -------------------------------------------------------------------------
The cumulative deficiency as of December 31, 1999 and 1998 on a net basis of $5.3 million is due to the strengthening of the unpaid losses and ALAE ongoing lines of business including workers' compensation, preferred private passenger automobile, and commercial automobile of approximately $3.4 million. The increase for commercial automobile was attributable to adverse development. The increase in the loss and LAE for workers' compensation is attributable to higher than expected losses in California. The cumulative deficiency as of December 31, 1995 on a net basis of $17.7 million is due to the strengthening of the unpaid losses and ALAE of pre-1980 businesses assumed by NAICC in 1985 and which are in run-off. NAICC increased these run-off claim liabilities by $10 million in 1996. The pre-1980 run-off liabilities include claims relating to environmental clean-up for policies issued prior to 1970. The cumulative deficiency on a net basis of $43.2 million and $47.1 million as of December 31, 1992 and 1991, respectively, is also attributable to both adverse development of workers' compensation loss experience in the 1990 and 1991 loss years and development in certain lines in run-off. The California workers' compensation industry, including NAICC, experienced adverse development of those loss years. The adverse development was the result of a significant increase in frequency in workers' compensation claims that was brought on by a downturn in the California economy, an increase in unemployment and a dramatic increase in stress and post-termination claims. The adverse development in 1990 and 1991 was significantly offset by favorable workers' compensation loss experience and development in the 1992 through 1995 loss years. Conditions and trends that have affected the development of these liabilities in the past may not necessarily recur in the future. It would not be appropriate to use this cumulative history in the projection of future performance. -8- REINSURANCE 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 2000 were 9.5 percent of written premiums. As of December 31, 2000, General Reinsurance Corporation (GRC), and Mitsui Marine & Fire Insurance Company, Ltd. ("MMF"), were the only reinsurers that comprised more than 10 percent of NAICC's reinsurance recoverable on paid and unpaid claims. NAICC monitors all reinsurers, by reviewing A.M. Best reports and ratings, information obtained from reinsurance intermediaries and analyzing financial statements. At December 31, 2000, NAICC had reinsurance recoverables on paid and unpaid claims of $12.3 million and $2.3 million from GRC and MMF, respectively. Both GRC and MMF have an A.M. Best rating of A+ or better. The unsecured balance from MMF is approximately $1.2 million. The paid and unpaid recoverable amounts ceded to MMF relate to business in run-off and assumed by NAICC. See Note 2 of the Notes to Consolidated Financial Statements for further information on reinsurance. NAICC and two of its subsidiaries participate in an inter-company pooling and reinsurance agreement under which Danielson Insurance Company ("DICO") and Danielson National Insurance Company ("DNIC") cede 100% of their net liability, defined to include premiums, losses and allocated loss adjustment expenses, to NAICC to be combined with the net liability for policies of NAICC in formation of a "Pool". NAICC simultaneously cedes to DICO and DNIC 10% of the net liability of the Pool. DNIC commenced participation in July, 1993 and DICO commenced participation in January, 1994. Additionally, both DICO and DNIC reimburse NAICC for executive services, professional services, and administrative expenses based on designated percentages of net premiums written for each line of business. REGULATION Insurance companies are subject to insurance laws and regulations established by the states in which they transact business. The agencies established pursuant to these state laws have broad administrative and supervisory powers relating to the granting and revocation of licenses to transact 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 an extraordinary shareholder dividend without prior approval from the Insurance Commissioner. Dividends are considered extraordinary if they exceed the greater of net income or 10% of statutory surplus as of the prior December 31. To the extent that NAICC has available unassigned surplus, as defined for dividend purposes, NAICC will be able to pay dividends totalling $3.6 million during 2001 without prior regulatory approval. -9- RISK-BASED CAPITAL A model for determining the risk-based capital ("RBC) requirements for property and casualty insurance companies was adopted in December 1993. Insurance companies are required to report their RBC ratios based on their 1994 annual statements. NAICC has calculated its RBC requirement under the most recent RBC model and it has sufficient capital in excess of any regulatory action level. The RBC model sets forth four levels of increasing regulatory intervention: (1) Company Action Level (200% of an insurer's Authorized Control Level) at which the insurer must submit to the regulator a plan for increasing such insurer's capital; (2) Regulatory Action Level (150% of an insurer's Authorized Control Level), at which the insurer must submit a plan for increasing its capital to the regulator and the regulator may issue corrective orders; (3) Authorized Control Level (a multi-step calculation based upon information derived from an insurer's most recent filed statutory annual statement), at which the regulator may take action to rehabilitate or liquidate the insurer; and (4) Mandatory Control Level (70% of an insurer's Authorized Control Level), at which the regulator must rehabilitate or liquidate the insurer. At December 31, 2000, the RBC of NAICC was 239% 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, 2000, 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 other insurance subsidiaries which may commence writing insurance lines in the future; and (ii) approximately $21.0 million in cash and investments. TAX LOSS CARRYFORWARD At the close of 2000, the Company had a consolidated net operating loss carryforward of approximately $899 million for Federal income tax purposes. This estimate is based upon Federal consolidated income tax losses for the periods through December 31, 1999 and an estimate of the 2000 taxable results. Some or all of the carryforward may be available to offset, for Federal income tax purposes, the future taxable income, if any, of DHC and its wholly-owned subsidiaries. The Internal Revenue Service ("IRS") has not audited any of the Company's tax returns for any of the years during the carryforward period including those returns for the years in which the losses giving rise to the net operating loss carryforward were reported. The net operating loss carryforward is currently fully reserved, for valuation purposes, on the Company's financial statements. The amount of the deferred asset considered realizable could be increased in the near term if estimates of future taxable income during the carryforward period are increased. -10- 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 ------------ -------- 2001 153,397 2002 139,613 2003 60,849 2004 69,947 2005 106,225 2006 92,355 2007 89,790 2008 31,688 2009 39,689 2010 23,600 2011 19,755 2012 38,255 2019 33,636 The Company's ability to utilize its net operating tax loss carryforwards would be substantially reduced if DHC were to undergo an "ownership change" within the meaning of Section 382(g)(1) of the Internal Revenue Code. We will be treated as having had an "ownership change" if there is more than 50% increase in stock ownership during a 3 year "testing period" by "5% stockholders." For this purpose, stock ownership is measured by value, and does not include so-called "straight preferred" stock. In an effort to reduce the risk of an ownership change, DHC has imposed restrictions on the ability of holders of five percent or more of the common stock of DHC, par value $0.10 per share ("Common Stock"), to transfer the Common Stock owned by them and to acquire additional Common Stock, as well as the ability of others to become five percent stockholders as a result of transfers of Common Stock. The transfer restrictions were implemented in 1990, and we expect that they will remain in-force as long as the NOL is available to us. Notwithstanding such transfer restrictions, there could be circumstances under which an issuance by DHC of a significant number of new shares of Common Stock or other new class of equity security having certain characteristics (for example, the right to vote or to convert into Common Stock) might result in an ownership change under the Internal Revenue Code. STATEMENT CONCERNING FORWARD-LOOKING INFORMATION This Item 1 to the Report on Form 10-K, together with Items 2, 3, 7, and 8, contain forward-looking statements, including statements concerning plans, capital adequacy, adequacy of reserves, utilization of tax losses, goals, future events or performance and underlying assumptions and other statements which are other than statements of historical facts. Such forward-looking statements may be identified, without limitation, by the use of the words "believes", "anticipates", "expects", "intends", "plans" and other similar expressions. All such statements represent only current estimates or expectations as to future results and are subject to risks and uncertainties which could cause actual results to materially differ from current estimates or expectations. See "RISK FACTORS THAT MAY AFFECT FUTURE RESULTS" in Item 7 for further information concerning certain of those risks and uncertainties. EMPLOYEES As of December 31, 2000, the number of employees of DHC and its consolidated subsidiaries was approximately as follows: NAICC 144 DHC (holding company only) 12 --- Total 156 -11- None of these employees is covered by any collective bargaining agreement. DHC believes that the staffing levels are adequate to conduct future operations. ITEM 2. PROPERTIES. DHC leases a minimal amount of space for use as administrative and executive offices. DHC's lease has a term of approximately five years which is scheduled to expire in 2003. DHC believes that the space available to it is adequate for DHC's current and foreseeable needs. NAICC's headquarters are located in a leased office facility in Rancho Dominguez, California, pursuant to a five-year lease which is scheduled to expire in 2004. In addition, NAICC has entered into short term leases in connection with its operations in various locations on the west coast of the United States. NAICC believes that the foregoing leased facilities are adequate for NAICC's current and anticipated future needs. See Note 10 of the Notes to Consolidated Financial Statements. ITEM 3. LEGAL PROCEEDINGS. NAICC is a party to various legal proceedings which are considered routine and incidental to its insurance business and are not material to the financial condition and operation of such business. Danielson Reinsurance Corporation ("Danielson Re"), an indirect wholly owned subsidiary of DHC (the "Registrant"), is the grantor of the Mission Reinsurance Corporation Trust (the "Trust"). The Trust was one of several created in connection with the insolvency and reorganization of Mission Insurance Group, Inc. and its subsidiaries from which the Company emerged. In connection with the liquidation of the Trust by the Missouri Department of Insurance (the "Insurance Department"), a surplus existed from which the Insurance Department sought to pay interest to the claimants of the Trust. DHC challenged the Insurance Department's plan to pay interest in the Circuit Court of Jackson County, Missouri, which is overseeing the liquidation of the Trust, arguing that any surplus belonged to Danielson Re as the grantor of the Trust. The Circuit Court upheld the plan and DHC appealed that decision. On June 22, 1999, the Missouri Court of Appeals reversed the decision of the Circuit Court and remanded the matter to the Circuit Court, ruling that no interest can be paid to claimants of insolvent insurance companies under the Missouri Insurance Code. As a result of that decision, Danielson Re would have been entitled to any surplus remaining in the Trust after payment of all claims and expenses of the Trust, which was believed to approximate $14 million. The Insurance Department appealed the decision of the Court of Appeals to the Missouri Supreme Court, which reversed the decision of the Court of Appeals. As a result, the Insurance Department is permitted to pay interest on claims, and it is anticipated that there will be no surplus remaining in the Trust after payment of the interest. See Note 11 of the Notes to Consolidated Financial Statements. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. -12- PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. "Stock Market Prices" on page 26 of DHC's 2000 Annual Report to Stockholders (included as an exhibit hereto) is incorporated herein by reference. On December 29, 2000, the Company sold, for aggregate cash consideration of $3,073,875, 819,700 newly issued shares of Common Stock. The sale was a private placement to 22 accredited investors made pursuant to Regulation D under the Securities Act of 1933. Brokerage commissions of $33,900 were paid to M.J. Whitman, Inc., an affiliate of DHC, in connection with the placement of certain of those shares by M.J. Whitman, Inc. ITEM 6. SELECTED FINANCIAL DATA. "Selected Consolidated Financial Data" on page 2 of DHC's 2000 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 2000 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 2000 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 2000 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. -13- PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. DIRECTORS. The Directors of DHC are listed on the following pages with brief statements of their principal occupations and other information. A listing of the Directors' and officers' beneficial ownership of Common Stock appears on subsequent pages under the heading "Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT." All of the Directors were elected to their present terms of office by the stockholders at the Annual Meeting of Stockholders of DHC held on June 15, 2000. The term of office of each Director continues until the election of Directors to be held at the next Annual Meeting of Stockholders or until his successor has been elected. There is no family relationship between any Director and any other Director or executive officer of DHC. DHC, Martin J. Whitman and SZ Investments, LLC ("SZ") have entered into an agreement pursuant to which, as long as SZ continues to directly or indirectly own at least 1,000,000 shares of Common Stock, (i) SZ will have the right to continue to nominate two members of DHC's Board of Directors (which nominees were Samuel Zell and William Pate) and (ii) Mr. Whitman has agreed to vote and use his best efforts to cause to be voted the shares of Common Stock owned or controlled by him in favor of SZ's designees. In addition, SZ has agreed that, so long as Mr. Whitman directly or indirectly owns 500,000 shares of Common Stock and Mr. Whitman continues to be affiliated with Third Avenue Funds in the same or substantially similar manner as his current affiliation (so long as such entities continue to exist), SZ will vote the shares owned by it for the election of Mr. Whitman and one other designee of Mr. Whitman (which nominee was David Barse). The information set forth below concerning the Directors has been furnished by such Directors to DHC.
DIRECTOR DIRECTOR AGE PRINCIPAL OCCUPATION SINCE - -------- --- -------------------- ----- Martin J. Whitman 76 Chief Executive Officer of the Company 1990 David M. Barse 38 President and Chief Operating Officer of the 1996 Company Samuel Zell 59 Chairman of Equity Group Investments, L.L.C. 1999 Eugene M. Isenberg 71 Chairman of the Board and Chief Executive 1990 Officer of Nabors Industries, Inc. Joseph F. Porrino 56 Counselor to the President of New School 1990 University; Senior Consultant, Powers Global Strategies, LLC Frank B. Ryan 64 Professor of Mathematics at Rice University 1990 Wallace O. Sellers 71 Vice Chairman and Director of Enhance Financial 1995 Services Group, Inc. -14- Stanley J. Garstka 57 Deputy Dean and Professor in the Practice of 1996 Management at Yale University School of Management William Pate 37 Director of Mergers and Acquisitions of Equity 1999 Group Investments, L.L.C.
Mr. Whitman is the Chief Executive Officer and a Director of the Company. Since 1974, Mr. Whitman has been the President and controlling stockholder of M.J. Whitman & Co., Inc. (now known as Martin J. Whitman & Co., Inc.) ("MJW&Co") which, until August 1991, was a registered broker-dealer. 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, until June 1995, as President and until July 1999 as Chief Executive Officer) 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, until July 1999 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 (the "40 Act") and containing three investment series of which he is a trustee. Since July 1999, Mr. Whitman has been the Chairman of the Board, Chief Executive Officer and a Trustee of Third Avenue Variable Series Trust ("Variable Trust"), an open-end management investment company registered under the 40 Act and containing one investment series. Since March 1990, Mr. Whitman has been Chairman of the Board and Chief Executive Officer (and, until February 1998, the President) of EQSF Advisers, Inc. ("EQSF"), the investment adviser of Third Avenue Trust and Variable Trust. Until April 1994, Mr. Whitman also served as the Chairman of the Board, 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"). Since May 2000, Mr. Whitman has served as a director for Stewart Information Serives, a publicly traded title insurance company traded on the NYSE. From March 1993 through February 1996, Mr. Whitman served as a director of Herman's Sporting Goods, Inc., a retail sporting goods chain, which filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code on April 26, 1996. Mr. Whitman also serves as a Director of the Company's subsidiaries, including National American Insurance Company of California ("NAICC"). Mr. Whitman co-authored the book THE AGGRESSIVE CONSERVATIVE INVESTOR and is the author of VALUE INVESTING: A BALANCED APPROACH. 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 the Company since July 1996 and a director of NAICC since August 1996. Since June 1995, Mr. Barse has been the President (and, since July 1999, Chief Executive Officer) 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. Since July 1999, Mr. Barse has been the President and Chief Operating Officer of Variable Trust. 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. -15- Mr. Zell is the Chairman of the Board of the Company. Mr. Zell is Chairman of Equity Group Investments, L.L.C. ("EGI"), an investment company since 1999 and had been Chairman of the Board of Equity Group Investments, Inc. for more than five years. Mr. Zell is also Chairman of the Board of American Classic Voyages Co., a provider of overnight cruises in the United States; Anixter International Inc., a distributor of electrical and cable products; Capital Trust, Inc., a specialized finance company; Chart House Enterprises, Inc., an owner and operator of restaurants, and Manufactured Home Communities, an equity real estate investment trust ("REIT") primarily focused on manufactured home communities. Mr. Zell is Chairman of the Board of Trustees of Equity Office Properties Trust, an equity REIT primarily focused on office buildings and Equity Residential Properties Trust, an equity REIT primarily focused on multifamily residential properties. 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. In 1998, Mr. Eisenberg became a Director of the National Association of Securities Dealers, Inc. and NASDAQ. 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 New School University (the "New School") since February, 1998 and was the Executive Vice President of the New School from September 1991 to February, 1998. Mr. Porrino is also Senior Consultant to Powers Global Strategies, LLC, a government relations and strategic planning firm. Prior to that time, Mr. Porrino was a partner in the New York law firm of Putney, Twombly, Hall & Hirson, concentrating his practice in the area of labor law. Mr. Porrino received a Bachelor of Arts degree from Bowdoin College in 1966, and was awarded a Juris Doctor degree from Fordham University School of Law in 1970. Dr. Ryan is retired from his prior position as a Professor of Mathematics at Rice University. Since November, 1996, Dr. Ryan has served as a Director of Siena Holdings, Inc., a real estate and health management company, the capital stock of which is traded over-the-counter. From March 1996 through July 1999, Dr. Ryan served as a Director of Texas Micro Inc., a computer systems company that was merged with Radysis Corporation, 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. 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. 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 -16- 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. Pate has served as a director of Mergers and Acquisitions for EGI or its predecessor since February 1994. Mr. Pate serves on the Board of Directors of Davel Communications, Inc. Prior to February 1994, Mr. Pate was an associate at Credit Suisse First Boston. Mr. LeVine is currently a Special Deputy Commissioner of the California Department of Insurance and is the Chief Executive Officer of the California Conservation and Liquidation Office, which oversees the management of 53 insurance companies with combined assets exceeding $1.0 billion. Mr. LeVine has been Senior Staff Counsel with the California Department of Insurance since 1989. Prior to 1989, Mr. LeVine was in private practice as an attorney. Mr. LeVine received a Bachelor of Arts degree from the University of California, Berkeley with honors in 1975 and a Juris Doctor from the University of California, Los Angeles in 1982. EXECUTIVE OFFICERS. The executive officers of DHC are as follows: NAME AGE PRINCIPAL POSITION WITH REGISTRANT - ---- --- ---------------------------------- Martin J. Whitman 76 Chief Executive Officer and a Director David M. Barse 38 President, Chief Operating Officer and a Director Michael T. Carney 47 Chief Financial Officer and Treasurer W. James Hall 36 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. Since July 1999, Mr. Carney has served as Treasurer and CFO of Variable Trust. From 1990 through April 1994, Mr. Carney also served as CFO of Carl Marks Strategic Investments, L.P.; from 1989 through December, 1996 Mr. Carney served as CFO of WHR; and from 1989 through April 1994, Mr. Carney served as Treasurer and CFO of Equity Strategies Fund. From 1988 to 1989, Mr. Carney was the Director of Accounting of Smith New Court, Carl Marks, Inc., and, from 1986 to 1988, Mr. Carney served as the Controller of Carl Marks & Co., Inc. Mr. Carney graduated from St. John's University in 1981 with a Bachelor of Science degree in Accounting. Mr. Hall has been the General Counsel and Secretary of DHC since December 2000. Mr. Hall has also served as General Counsel and Secretary of MJWHC and MJW since June 2000, of Third Avenue Trust and EQSF since September 2000 and of Variable Trust since September 2000. Prior to June of 2000, Mr. Hall was an associate at Paul, Weiss, Rifkind, Wharton & Garrison LLP from February 2000. Mr. Hall served as and Associate at Morgan, Lewis Bockius LLP from November 1996 to January 2000 and an associate for Gibson, Dunn and Crutcher LLP March 1992 though June 1996. Mr. Hall served as a Captain in the U.S. Army Reserve from 1986 through 1992. Mr. Hall graduated from the University of Pennsylvania School of Law in 1991 and the Massachusetts Institute of Technology in 1986 with Bachelor of Science degrees in Biology and Aeronautical/Astronautical Engineering. -17- SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934 requires DHC's Directors and executive officers, and persons who own more than ten percent of a registered class of the DHC's equity securities, to file with the Securities and Exchange Commission and the American Stock Exchange initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of DHC. Officers, Directors and greater than ten-percent stockholders are required by Federal securities regulations to furnish DHC with copies of all Section 16(a) forms they file. To DHC's knowledge, based solely upon review of the copies of such reports furnished to DHC and written representations that no other reports were required, except for one Form 4 with respect to each of Mr. Pate, Mr. Barse, Mr. Carney and Mr. Hall, each of which was filed within two days of the required filing date, and one Form 4 with respect to SZ Investments, LLC not involving a 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, 2000. 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 2000 by the Chief Executive Officer and each other executive officer of DHC who had cash compensation for such year in excess of $100,000. Only those columns which call for information applicable to DHC or the individual named for the periods indicated have been included in such table.
LONG TERM ANNUAL COMPENSATION COMPENSATION -------------------------- ------------ AWARDS ------------ SECURITIES UNDERLYING ALL OTHER YEAR SALARY (a) BONUS OPTIONS COMPENSATION NAME AND PRINCIPAL POSITION ($) ($) (#) ($) - ---------------------------------------------------------------------------------------------------------------- Martin J. Whitman 2000 $ 200,000 -0- -0- -0- CHAIRMAN OF THE BOARD & CHIEF EXECUTIVE OFFICER 1999 $ 200,000 -0- -0- -0- 1998 $ 200,000 -0- -0- -0- - ---------------------------------------------------------------------------------------------------------------- David M. Barse 2000 $ 75,000 $150,000 50,000 -0- PRESIDENT AND CHIEF OPERATING OFFICER 1999 $ 75,000 $ 80,000 50,000 -0- 1998 $ 75,000 -0- 50,000 -0- - ---------------------------------------------------------------------------------------------------------------- Michael Carney 2000 $ 75,000 $ 50,000 25,000 -0- TREASURER AND CHIEF FINANCIAL OFFICER 1999 $ 75,000 $ 40,000 25,000 -0- 1998 $ 75,000 -0- 35,000 -0- - ----------------------------------------------------------------------------------------------------------------
OPTION/SAR GRANTS IN LAST FISCAL YEAR The following table presents certain information relating to the grants of stock options made during 2000 to the named executive officers of DHC. The options were granted under DHC's 1995 Stock and Incentive Plan. Pursuant to rules of the Securities and Exchange Commission, the table also shows the value of - -------- 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. -18- the options granted at the end of the option term if the stock price were to appreciate annually by 5% and 10%, respectively. There is no assurance that the stock price will appreciate at the rates shown in the table. Only those tabular columns which call for information applicable to DHC or the named individuals have been included in such table.
- ---------------------------------------------------------------------------------------------------- POTENTIAL REALIZABLE VALUE AT ASSUMED ANNUAL RATES OF STOCK PRICE APPRECIATION FOR INDIVIDUAL GRANTS OPTION TERM - ---------------------------------------------------------------------------------------------------- NUMBER OF PERCENT OF SECURITIES TOTAL UNDERLYING OPTIONS/SARS OPTIONS/ GRANTED TO SARS EMPLOYEES IN EXERCISE OR EXPIRATION GRANTED FISCAL YEAR BASE PRICE DATE NAME (#)(1) ($/Sh) 5%($) 10%($) - ---------------------------------------------------------------------------------------------------- Martin J. Whitman -0- - - - - - - ----------------------------------------------------------------------------------------------------- David M. Barse 50,000 26.0 4.00 12/12/10 125,779 318,748 - ----------------------------------------------------------------------------------------------------- Michael Carney 25,000 13.0 4.00 12/12/10 62,889 159,374 - ----------------------------------------------------------------------------------------------------
(1) One-half of these options become exercisable on June 12, 2001 and one- third of the balance of the options become exercisable on each of the first three anniversaries of the date of grant. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES The following table presents certain information relating to the value of unexercised stock options as of the end of 2000, on an aggregated basis, owned by the named executive officers of DHC as of the last day of the fiscal year. Such officers did not exercise any of such options during 2000. Only those tabular columns which call for information applicable to DHC or the named individuals have been included in such table.
- ---------------------------------------------------------------------------------------------- NUMBER OF SECURITIES VALUE OF UNEXERCISED IN-THE- UNDERLYING UNEXERCISED MONEY OPTIONS OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END (#) ($) - ---------------------------------------------------------------------------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---------------------------------------------------------------------------------------------- Martin J. Whitman 210,000 -0- $ 328,125 -0- - ---------------------------------------------------------------------------------------------- David M. Barse 183,333 66,667 $ 45,313 $ 28,125 - ---------------------------------------------------------------------------------------------- Michael Carney 136,667 33,333 $ 31,719 $ 14,063 - ----------------------------------------------------------------------------------------------
COMPENSATION OF DIRECTORS During 2000, 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 2000, each Director received $5,000, plus, in each case, reimbursement of -19- 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. AGREEMENTS WITH EXECUTIVE OFFICERS Effective April 14, 1999, the Company entered into written two-year employment agreements with David Barse, President, and Michael Carney, Chief Financial Officer. The agreements provide for the payment of base salary to each of Mr. Barse and Mr. Carney of not less than $75,000. If either executive officer's employment is terminated by the Company without cause (as defined), the Company is required to pay to him an amount equal to the balance of his base salary for the remainder of the term of the agreement plus, if he received a bonus with respect to the prior fiscal year, an amount equal to that bonus (or pro-rated portion thereof). COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION During 2000, 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 21, 2001 of (a) each Director, (b) each executive officer, and (c) each person known by DHC to own beneficially more than five percent of the outstanding shares of Common Stock. DHC believes that, except as otherwise stated, the beneficial holders listed below have sole voting and investment power regarding the shares reflected as being beneficially owned by them.
AMOUNT AND NATURE OF BENEFICIAL OWNERSHIP PERCENT OF CLASS (1) -------------------- -------------------- PRINCIPAL STOCKHOLDERS SZ Investments, LLC 3,900,437 (2)(3) 18.2 2 N. Riverside Plaza Chicago, IL 60606 Commissioner of Insurance 1,803,235 (2)(4) 9.2 of the State of California c/o Harry LeVine Mission Insurance Companies' Trusts 425 Market Street, 23rd Floor San Francisco, CA 94105 Martin J. Whitman 1,281,143 (2)(5) 6.6 c/o Danielson Holding Corporation 767 Third Avenue New York, NY 10017-2023
-20- OFFICERS AND DIRECTORS Martin J. Whitman 1,281,143 (2)(5) 6.6 David M. Barse 183,333 (6) * Samuel Zell 3,900,437 (7) 18.2 Joseph F. Porrino 56,667 (8) * Frank B. Ryan 48,667 (8) * Eugene M. Isenberg 69,924 (9) * Wallace O. Sellers 50,000 (10) * Stanley J. Garstka 51,008 (11) * William Pate 45,000 (12) * Michael Carney 136,667 (13) * All Officers and Directors as a Group (10 persons) 5,822,846 (14) 26.5 - ----------------------------- * Percentage of shares beneficially owned does not exceed one percent of the outstanding Common Stock. (1) Share percentage ownership is rounded to nearest tenth of one percent and reflects the effect of dilution as a result of outstanding options and warrants to the extent such options and warrants are, or within 60 days will become, exercisable. As of March 21, 2001 (the date as of which this table was prepared), there were exercisable options outstanding to purchase 1,641,051 shares of Common Stock and an exercisable warrants to purchase 2,002,568 shares of Common Stock. Shares underlying any option or warrant which was exercisable on March 21, 2001 or becomes exercisable within the next 60 days are deemed outstanding only for purposes of computing the share ownership and share ownership percentage of the holder of such option or warrant. (2) In accordance with provisions of DHC's Certificate of Incorporation, all certificates representing shares of Common Stock beneficially owned by holders of five percent or more of the Common Stock are owned of record by DHC, as escrow agent, and are physically held by DHC in that capacity. (3) Includes shares underlying a Warrant to purchase 1,900,437 shares of Common Stock at an exercise price of $4.74391 per share. -21- (4) Beneficially owned by the Commissioner of Insurance of the State of California in his capacity as trustee for the benefit of holders of certain deficiency claims against certain trusts which assumed liabilities of certain present and former insurance subsidiaries of the Company. (5) Includes 803,669 shares beneficially owned by Third Avenue Value Fund ("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 84,358 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. (6) Includes shares underlying currently exercisable options to purchase an aggregate of 50,000 shares of Common Stock at an exercise price of $5.6875 per share, 50,000 shares of Common Stock at an exercise price of $7.0625 per share, 50,000 shares of Common Stock at an exercise price of $3.65625 per share and 33,333 shares of Common Stock at an exercise price of $5.3125 per share. Does not include shares underlying options to purchase an aggregate of 16,667 shares of Common Stock at an exercise price of $5.3125 per share or 50,000 shares of Common Stock at an exercise price of $4.00 per share which are not currently exercisable nor become exercisable within the next 60 days. (7) Includes 2,000,000 shares of Common Stock owned by SZ Investments, L.L.C. ("SZ"), a company controlled by Mr. Zell, and 1,900,437 shares of Common Stock issuable upon exercise of a Warrant owned by SZ. (8) Includes shares underlying currently exercisable options to purchase an aggregate of 46,667 shares of Common Stock at an exercise price of $3.63 per share. Does not include shares underlying options to purchase an aggregate of 40,000 shares of Common Stock at an exercise price of $4.00. These options are subject to approval and ratification of the shareholders and are thus not exercisable within 60 days. (9) Includes 20,088 shares owned by Mentor Partnership, a partnership controlled by Mr. Isenberg, and 28 shares owned by Mr. Isenberg's wife. Also includes shares underlying currently exercisable options to purchase an aggregate of 46,666 shares of Common Stock at an exercise price of $3.63 per share. Does not include shares underlying options to purchase an aggregate of 40,000 shares of Common Stock at an exercise price of $4.00. These options are subject to approval and ratification of the shareholders and are thus not exercisable within 60 days. (10) Includes shares underlying currently exercisable options to purchase an aggregate of 40,000 shares of Common Stock at an exercise price of $7.00 per share. Does not include shares underlying options to purchase an aggregate of 40,000 shares of Common Stock at an exercise price of $4.00. These options are subject to approval and ratification of the shareholders and are thus not exercisable within 60 days. (11) Includes shares underlying currently exercisable options to purchase an aggregate of 40,000 shares of Common Stock at an exercise price of $5.50 per share. Does not include shares underlying options to purchase an aggregate of 40,000 shares of Common Stock at an exercise price of $4.00. These options are subject to approval and ratification of the shareholders and are thus not exercisable within 60 days. (12) Does not include shares underlying options to purchase an aggregate of 22,800 shares at an excercise price of $4.00 per share which are not currently exercisable nor become exercisable within the next 60 days. (13) Includes shares underlying currently exercisable options to purchase an aggregate of 50,000 shares of Common Stock at an exercise price of $5.6875 per share, 35,000 shares of Common Stock at an exercise price of $7.0625 per share, 35,000 shares of Common Stock at an exercise price of $3.65625 per share and 16,667 shares of Common Stock at an exercise price of $5.3125 per share. Does not include shares underlying options to purchase an aggregate of 8,333 shares of Common Stock at an exercise price of $5.3125 per share or 25,000 shares of Common Stock at an exercise price of $4.00 per share which are not currently exercisable nor become exercisable within the next 60 days. -22- (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 Mr. Barse is the President and Chief Executive 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. In connection with the purchase of Common Stock by SZ, DHC has entered into a non-exclusive investment advisory agreement with Equity Group Investments, LLC ("EGI"), a company controlled by Mr. Zell, pursuant to which EGI has agreed to provide, at the request of DHC, certain investment banking services to the Company in connection with potential transactions. For these services, DHC pays an annual fee of $125,000 to EGI. In the event that any transaction is consummated for which the Acquisition Committee of DHC's Board of Directors determines that EGI provided material services, DHC will pay to EGI a fee in the amount of 1% of the consideration paid by DHC in connection with such transaction. Mr. Zell and Mr. Pate are members of the Acquisition Committee, along with Mr. Whitman and Mr. Barse. DHC has also agreed to reimburse, upon request, EGI's out-of-pocket expenses related to the investment advisory agreement. -23- 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 Restated Certificate of Incorporation of Registrant. (To be included herewith at page 37) 3.2 Bylaws of Registrant. (To be included herewith at page 41) MATERIAL CONTRACTS--MISCELLANEOUS: --------------------------------- 10.1 * Stock Purchase and Sale Agreement dated as of April 14, 1999 between Samstock, L.L.C. and Danielson Holding Corporation. (Filed with Report on Form 10-Q dated June 30, 1999, Exhibit 10.1.) 10.2 * Amendment No. 1, Assignment and Consent to Assignment of Stock Purchase and Sale Agreement dated May 7, 1999 among Samstock, L.L.C., S.Z. Investments, L.L.C. and Danielson Holding Corporation. (Filed with Report on Form 10-Q dated June 30, 1999, Exhibit 10.2.) 10.3 * Investment Agreement dated as of April 14, 1999 among Danielson Holding Corporation, Samstock, L.L.C. and Martin J. Whitman. (Filed with Report on Form 10-Q dated June 30, 1999, Exhibit 10.3.) 10.4 * Assignment and Consent to Assignment of Investment Agreement dated May 7, 1999 among Danielson Holding Corporation, Martin J. Whitman and S.Z. Investments, L.L.C.. (Filed with Report on Form 10-Q dated June 30, 1999, Exhibit 10.4.) 10.5 * Letter Agreement dated April 14, 1999 between Equity Group Investments, L.L.C. and Danielson Holding Corporation. (Filed with Report on Form 10-Q dated June 30, 1999, Exhibit 10.5.) 10.6 * Amendment dated June 2, 1999 to letter agreement dated April 14, 1999 between Equity Group Investments, L.L.C. and Danielson Holding Corporation. (Filed with Report on Form 10-Q dated June 30, 1999, Exhibit 10.6.) -24- MATERIAL CONTRACTS--EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS: -------------------------------------------------------------- 10.7 * 1990 Stock Option Plan. (Filed with Report on Form 8-K dated September 4, 1990, Exhibit 10.8.) 10.8 * 1995 Stock and Incentive Plan. (Included as Exhibit A to Proxy Statement filed on March 30, 1995.) 10.9 * Employment Agreement dated April 14, 1999 between Danielson Holding Corporation and David Barse. (Filed with Report on Form 10-Q dated June 30, 1999, Exhibit 10.7.) 10.10 * Employment Agreement dated April 14, 1999 between Danielson Holding Corporation and Michael Carney. (Filed with Report on Form 10-Q dated June 30, 1999, Exhibit 10.8.) - ------------- (1) Exhibit numbers are referenced to Item 601 of Regulation S-K under the Securities Exchange Act of 1934. * Asterisk indicates an exhibit previously filed with the Securities and Exchange Commission and incorporated herein by reference. ANNUAL REPORT TO SECURITY-HOLDERS: --------------------------------- 13.1 2000 Annual Report of Danielson Holding Corporation. (To be included herewith at page 51.) SUBSIDIARIES: ------------ 21 * Subsidiaries of Danielson Holding Corporation. (Filed with Report on Form 10-K for the fiscal year ended December 31, 1996, Exhibit 21.) CONSENT OF EXPERTS ------------------ (b) During the quarter ended December 31, 2000 for which this Report is filed, DHC filed no reports on Form 8-K. -25- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Danielson Holding Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DANIELSON HOLDING CORPORATION (Registrant) By /s/ Martin J. Whitman -------------------------------- Martin J. Whitman Chief Executive Officer Date: March 30, 2001 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 30, 2001 By /s/ MARTIN J. WHITMAN ----------------------------------- Martin J. Whitman Chief Executive Officer and a Director Date: March 30, 2001 By /s/ DAVID M. BARSE ----------------------------------- David M. Barse President and Chief Operating Officer and a Director Date: March 30, 2001 By /s/ MICHAEL T. CARNEY ----------------------------------- Michael T. Carney Chief Financial Officer Date: March 30, 2001 By /s/ SAMUEL ZELL ----------------------------------- Samuel Zell Chairman of the Board Director Date: March 30, 2001 By /s/ JOSEPH F. PORRINO ----------------------------------- Joseph F. Porrino Director Date: March 30, 2001 By /s/ FRANK B. RYAN ----------------------------------- Frank B. Ryan Director -26- Date: March 30, 2001 By /s/ EUGENE M. ISENBERG ----------------------------------- Eugene M. Isenberg Director Date: March 30, 2001 By /s/ WALLACE O. SELLERS ----------------------------------- Wallace O. Sellers Director Date: March 30, 2001 By /s/ STANLEY J. GARSTKA ----------------------------------- Stanley J. Garstka Director Date: March 30, 2001 By /s/ WILLIAM PATE ----------------------------------- William Pate Director Date: March 30, 2001 By /s/ Harry LeVine ----------------------------------- Harry LeVine Director -27-
DANIELSON HOLDING CORPORATION INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES PAGE NUMBER Independent Auditors' Report.............................................................................. F-2 Danielson Holding Corporation and Consolidated Subsidiaries: Statements of Operations - For the years ended December 31, 2000, 1999 and 1998.................. * Balance Sheets - December 31, 2000 and 1999........................................................... * Statements of Stockholders' Equity - For the years ended December 31, 2000, 1999 and 1998 * Statements of Cash Flows - For the years ended December 31, 2000, 1999 and 1998...................... * Schedule II - Condensed Financial Information of the Registrant.................................... S-1-3 Schedule V - Valuation and Qualifying Accounts.................................................... S-4 Schedule III - Supplemental Information Concerning Property-Casualty and VI Insurance Operations................................................................. S-5
Schedules other than those listed above are omitted because either they are not applicable or not required or the information required is included in the Company's Consolidated Financial Statements. - ---------- * Incorporated by reference to DHC's 2000 Annual Report to Stockholders. F-1 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Danielson Holding Corporation: Under date of March 7, 2001, we reported on the consolidated balance sheets of Danielson Holding Corporation and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2000, as contained in the 2000 annual report to stockholders. These consolidated financial statements and our report thereon are included in the annual report on Form 10-K for the year 2000. 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 7, 2001 F-2
SCHEDULE II DANIELSON HOLDING CORPORATION CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT (Parent Company Only) STATEMENTS OF OPERATIONS (In thousands) FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 2000 1999 1998 ---- ---- ---- REVENUES: Net investment income $ 1,584 $ 504 $ 429 Net realized investment gains 322 3 -- --------- --------- --------- TOTAL REVENUES 1,906 507 429 --------- --------- --------- EXPENSES: Employee compensation and benefits 1,295 1,251 1,177 Professional fees 403 379 427 Other general and administrative fees 839 598 634 --------- --------- --------- TOTAL EXPENSES 2,537 2,228 2,238 --------- --------- --------- Loss before provision for income taxes (631) (1,721) (1,809) Income tax provision 45 16 2 --------- --------- --------- Loss before equity in net income of subsidiaries (676) (1,737) (1,811) Equity in net income of subsidiaries* 1,706 2,992 4,112 --------- --------- --------- NET INCOME $ 1,030 $ 1,255 $ 2,301 ========= ========= =========
*Eliminated in consolidation. See accompanying auditors' report. S-1 SCHEDULE II, CONTINUED DANIELSON HOLDING CORPORATION CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT (Parent Company Only) BALANCE SHEETS (In thousands, except share and per share information)
DECEMBER 31, ------------------------- 2000 1999 ---- ---- ASSETS: Cash $ 2,586 $ 103 Fixed maturities: Available-for-sale at fair value (Cost: $15,780 and $11,513) 14,795 11,505 Equity securities (Cost: $0 and $560) -- 531 Short term investments, at cost which approximates fair value 3,615 5,961 ----------- ----------- TOTAL CASH AND INVESTMENTS 20,996 18,100 Investment in subsidiaries* 60,337 58,146 Accrued investment income 176 85 Other assets 167 201 ----------- ----------- TOTAL ASSETS $ 81,676 $ 76,532 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY: Other liabilities $ 346 $ 306 ----------- ----------- TOTAL LIABILITIES 346 306 Preferred Stock ($0.10 par value; authorized 10,000,000 shares; none issued and outstanding) -- -- Common Stock ($0.10 par value; authorized 100,000,000 shares and 20,000,000 shares; issued 19,306,694 shares and 18,486,994 shares; outstanding 19,295,954 shares and 18,476,265 shares) 1,931 1,849 Additional paid-in capital 62,449 59,491 Accumulated other comprehensive income (loss) (1,064) (2,098) Retained earnings 18,080 17,050 Treasury stock (Cost of 10,740 shares and 10,729 shares) (66) (66) ----------- ----------- TOTAL STOCKHOLDERS' EQUITY 81,330 76,226 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 81,676 76,532 =========== ===========
*Eliminated in consolidation. See accompanying auditors' report. S-2 SCHEDULE II, CONTINUED
DANIELSON HOLDING CORPORATION CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT (Parent Company Only) STATEMENTS OF CASH FLOWS (In thousands) FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 2000 1999 1998 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,030 $ 1,255 $ 2,301 Adjustments to reconcile net income to net cash used in operating activities: Net realized investment gains (322) (3) -- Change in accrued investment income (91) (25) 2 Depreciation and amortization (450) (79) (252) Equity in net income of subsidiaries (1,706) (2,992) (4,112) Decrease in accrued expenses 28 (1) (132) Other, net 42 (15) (13) -------- --------- --------- Net cash used in operating activities (1,469) (1,860) (2,206) -------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Investments purchased: Fixed income maturities available-for-sale (34,980) (12,723) (11,215) Equity securities (510) (560) -- Proceeds from sales: Fixed income maturities available-for-sale 16,656 741 3,412 Equity Securities 1,353 -- -- Investments, matured or called Fixed income maturities available-for-sale 14,562 7,273 10,037 Purchases of property and equipment (15) (1) (52) -------- --------- --------- Net cash provided by (used in) investing activities (2,934) (5,270) 2,182 -------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of Common Stock 3,040 13,109 -- Dividends from subisiaries 1,500 -- -- -------- --------- --------- Net cash provided by financing activities 4,540 13,109 -- -------- --------- --------- Net increase (decrease) in cash and short term investments 137 5,979 (24) Cash and short term investments at beginning of year 6,064 85 109 -------- --------- --------- CASH AND SHORT TERM INVESTMENTS AT END OF YEAR $ 6,201 $ 6,064 $ 85 ======== ========= =========
See accompanying auditors' report. S-3 SCHEDULE V DANIELSON HOLDING CORPORATION VALUATION AND QUALIFYING ACCOUNTS (in thousands)
ADDITIONS BALANCE AT CHARGED TO COSTS CHARGED TO BALANCE AT BEGINNING OF PERIOD AND EXPENSES OTHER ACCOUNTS DEDUCTIONS END OF PERIOD ------------------- ------------ -------------- ---------- ------------- Allowance for premiums and fees receivable For the year ended December 31, 1998 $ 179 $ 29 $ -- $ 72 $ 136 ========= ========= ========= ======== ======= 1999 $ 136 $ 444 $ -- $ 306 $ 274 ========= ========= ========= ======== ======= 2000 $ 274 $ 726 $ 25 $ 438 $ 587 ========= ========= ========= ======== ======= Allowance for uncollectable reinsurance on paid losses For the year ended December 31, 1998 $ 374 $ -- $ -- $ -- $ 374 ========= ========= ========= ======== ======= 1999 $ 374 $ 28 $ -- $ -- $ 402 ========= ========= ========= ======== ======= 2000 $ 402 $ 221 $ -- $ -- $ 623 ========= ========= ========= ======== ======= Allowance for uncollectable reinsurance on unpaid losses For the year ended December 31, 1998 $ 499 $ 60 $ -- $ -- $ 559 ========= ========= ========= ======== ======= 1999 $ 559 $ -- $ -- $ 313 $ 246 ========= ========= ========= ======== ======= 2000 $ 246 $ -- $ -- $ 145 $ 101 ========= ========= ========= ======== =======
See accompanying auditors' report. S-4 SCHEDULES III AND VI DANIELSON HOLDING CORPORATION SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS (in thousands)
OTHER AFFILIATION DEFERRED RESERVES FOR UNPAID DISCOUNT FROM POLICY CLAIMS WITH ACQUISITION CLAIMS AND CLAIM RESERVES FOR UNEARNED AND BENEFITS NET EARNED INVESTMENT REGISTRANT COSTS ADJUSTMENT EXPENSES UNPAID CLAIMS PREMIUMS PAYABLE PREMIUMS INCOME ---------- ----- ------------------- ------------- -------- ------- -------- ------ Consolidated Property-Casualty Entities: AS OF AND FOR THE YEAR ENDED 12/31/00 $3,665 $ 100,030 $ -- $ 23,207 -- $ 67,034 $ 7,741 ====== ========== ======== ======== ======== ======== ========= As of and for the year ended 12/31/99 $2,522 $ 94,934 $ -- $ 16,239 -- $ 54,040 $ 7,273 ====== ========== ======== ======== ======== ======== ========= As of and for the year ended 12/31/98 $2,381 $ 95,653 $ -- $ 13,705 -- $ 55,411 $ 7,745 ====== ========== ======== ======== ======== ======== ========= CLAIMS AND CLAIM AFFILIATION ADJUSTMENT EXPENSES AMORTIZATION OTHER PAID CLAIMS WITH INCURRED RELATED TO OF DEFERRED OPERATING AND CLAIM NET WRITTEN REGISTRANT CURRENT YEAR PRIOR YEARS ACQUISITION COSTS EXPENSES ADJUSTMENT EXPENSES PREMIUMS ---------- ------------ ----------- ----------------- --------- ------------------- -------- Consolidated Property-Casualty Entities: AS OF AND FOR THE YEAR ENDED 12/31/00 $ 55,269 $ 5,254 $12,153 $ 4,283 $60,440 $ 73,141 ======== ======= ======= ======= ======= ======== As of and for the year ended 12/31/99 $ 43,301 $ 2,491 $10,070 $ 3,794 $43,952 $ 56,605 ======== ======= ======= ======= ======= ======== As of and for the year ended 12/31/98 $ 39,131 $ - $ 9,899 $ 3,401 $47,427 $ 58,880 ======== ======= ======= ======= ======= ========
See accompanying auditors' report. S-5 EX-1 2 dhcannual.txt ANNUAL REPORT 2000 Annual Report As of and for the years ended December 31, ---------------------------------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS, STOCK PRICES AND EMPLOYEES) 2000 1999 1998 - -------------------------------------------------------------------------------- RESULTS OF OPERATIONS Earned premiums ........................ $ 67,034 $ 54,040 $ 55,411 Total revenues ......................... $ 86,237 $ 71,158 $ 64,744 Net income ............................. $ 1,030 $ 1,255 $ 2,301 Net cash provided by (used in) continuing operating activities ................. $ 6,644 $ (6,478) $ (5,170) Net income per diluted share of Common Stock ...................... $ 0.05 $ 0.07 $ 0.14 Combined ratio ......................... 123.1% 125.2% 108.6% ================================================================================ BALANCE SHEET AND OTHER DATA Total investments ...................... $ 154,130 $ 140,391 $ 134,859 Policyholder liabilities ............... $ 123,601 $ 111,987 $ 109,539 Stockholders' equity ................... $ 81,330 $ 76,226 $ 63,273 Book value per share of Common Stock ... $ 4.21 $ 4.13 $ 4.06 Common Stock price range High ................................. $ 7 3/8 $ 7 1/2 $ 8 1/8 Low .................................. $ 3 7/8 $ 2 7/8 $ 3 Shares of Common Stock outstanding at year end .............. 19,295,954 18,476,265 15,576,276 Employees of continuing operations at year end ............... 156 138 155 FINANCIAL TABLE OF CONTENTS --------------------------- Selected Consolidated Financial Data ....................................... 2 Management's Discussion and Analysis of Financial Condition and Results of Operations ............................ 3 Consolidated Statements of Operations ...................................... 9 Consolidated Balance Sheets ................................................ 10 Consolidated Statements of Stockholders' Equity ............................ 11 Consolidated Statements of Cash Flows ...................................... 12 Notes to Consolidated Financial Statements ................................. 13 Independent Auditors' Report ............................................... 25 Responsibility for Financial Reporting ..................................... 25 Quarterly Financial Data ................................................... 26 Stock Market Prices ........................................................ 26 1 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES SELECTED CONSOLIDATED FINANCIAL DATA --------------------------- The following selected financial data of Danielson Holding Corporation and its subsidiaries should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations, included elsewhere in this Report.
YEARS ENDED DECEMBER 31, ----------------------------------------------------------------------------------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) 2000 1999 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------------- A. RESULTS OF OPERATIONS Total revenues ............................... $ 86,237 $ 71,158 $ 64,744 $ 65,746 $ 48,704 Income (loss) from continuing operations before extraordinary items ................. $ 1,030 $ 1,255 $ 2,301 $ 4,589 $ (6,240)(1,2) Net loss from discontinued operations ........ -- -- -- -- $ (633)(3) Loss on disposal of discontinued operations .. -- -- -- -- $ (1,246)(3) Net income (loss) ............................ $ 1,030 $ 1,255 $ 2,301 $ 4,589 $ (8,119)(1,2,3) Diluted earnings (loss) per share of Common Stock: Income (loss) from continuing operations before extraordinary items ............... $ 0.05 $ 0.07 $ 0.14 $ 0.28 $ (0.41)(1,2) Net loss from discontinued operations ...... -- -- -- -- $ (0.04)(3) Loss on disposal of discontinued operations .. -- -- -- -- $ (0.08)(3) Net income (loss) .......................... $ 0.05 $ 0.07 $ 0.14 $ 0.28 $ (0.53)(1,2,3) B. BALANCE SHEET DATA Invested assets .............................. $ 154,130 $ 140,391 $ 134,859 $ 142,823 $ 151,555 Total assets ................................. $ 210,829 $ 194,752 $ 180,895 $ 187,773 $ 196,419 Unpaid losses and loss adjustment expenses ... $ 100,030 $ 94,934 $ 95,653 $ 105,947 $ 120,651 Stockholders' equity ......................... $ 81,330 $ 76,226 $ 63,273 $ 63,920 $ 58,853 Shares of Common Stock outstanding ........... 19,295,954(4) 18,476,265(4) 15,576,276(4) 15,576,287(4) 15,360,238(4)
(1) Includes expenses incurred in connection with the terminated proposed merger with Midland Financial Group, Inc. and non-recurring compensation expenses for death benefits and severance pay. (2) Includes $10 million increase in provision for pre-1980 accident year losses and loss adjustment expenses relating to run-off businesses and $4 million reduction in policyholder dividend accrual. (3) In 1996, DHC sold 100% of the common stock of Danielson Trust Company. Accordingly, Danielson Trust's results are reported herein as discontinued operations and are included in net income (loss). (4) Does not give effect to currently exercisable options and, in 2000 and 1999, warrants to purchase shares of Common Stock. 2 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS --------------------------- GENERAL Danielson Holding Corporation ("DHC") is organized as a holding company with substantially all of its operations conducted by subsidiaries (collectively with DHC, the "Company"). DHC, on a parent-only basis, has limited continuing expenditures for rent and administrative expenses and derives revenues primarily from investment return on portfolio securities. Therefore, the analysis of the Company's financial condition is generally best done on an operating subsidiary basis. For additional information relating to the Company's organization, see Note 1 of the Notes to Consolidated Financial Statements. The Company does not currently pay regular Federal income tax due to its net operating loss carryforwards and the recognition of losses from several trusts that assumed various liabilities of certain present and former subsidiaries of DHC. It is expected that the Company's 2000 consolidated Federal income tax return will report a cumulative net operating loss carryforward currently estimated at $899 million, which will expire in various amounts, if not used, between 2001 and 2019. Exclusive of the trusts' activities, the Company has generated cumulative taxable losses both historically and during the prior three years. Over the past several years, the Company's insurance operations have been generating losses exclusive of net investment income, net realized gains and the trusts' activities. DHC has historically generated losses at the holding company level. Therefore, these tax loss attributes are currently fully reserved, for valuation purposes, on the Company's financial statements. See Note 8 of the Notes to Consolidated Financial Statements. This Management's Discussion and Analysis of Financial Condition and Results of Operations, and certain Notes to Consolidated Financial Statements contain forward-looking statements, including statements concerning plans, capital adequacy, adequacy of reserves, utilization of tax losses, goals, future events or performance and underlying assumptions and other statements which are other than statements of historical facts. Such forward-looking statements may be identified, without limitation, by use of the words "believes", "anticipates", "expects", "intends", "plans", "estimates" and similar expressions. All such statements represent only current estimates or expectations as to future results and are subject to risks and uncertainties which could cause actual results to materially differ from current estimates or expectations. See "RISK FACTORS THAT MAY AFFECT FUTURE RESULTS." RESULTS OF NAICC'S OPERATIONS The operations of the Company's principal subsidiary, National American Insurance Company of California (NAICC), are in property and casualty insurance. PROPERTY AND CASUALTY INSURANCE OPERATIONS Net premiums earned were $67.0 million, $54.0 million and $55.4 million in 2000, 1999 and 1998, respectively. The change in net premiums earned were directly related to the change in net written premiums. Net written premiums were $73.1 million, $56.6 million and $58.9 million in 2000, 1999, and 1998, respectively. The overall increase in net written premiums in 2000 was attributable to growth in our commercial automobile insurance business. Workers' compensation net written premiums increased by $9.3 million during 2000 over the comparable year to date period in 1999 due to increased production primarily outside California, and decreased reinsurance coverage associated with the rescission of a treaty effective in 1999. The commercial automobile net written premiums grew from $12.7 million in 1999 to $23.1 million in 2000 due to increased production primarily in California. New written premiums for personal automobile insurance remained relatively flat during 2000. Premiums and fees receivable, net of allowances, increased by $3.9 million or 34%. The increase is attributable to the growth in installment premiums in our commercial automobile programs. In 1998, the Company introduced automobile programs that have installment features on policy terms in excess of six months. During 2000 these programs experienced significant growth. Premiums from the automobile program that generally offer policy terms less than six months and do not utilize installment plans declined in 2000. The effect of these trends was to increase the installment premium receivable by $4.0 million as well as the related unearned premium on those installment premiums. The Company expects this trend to continue into 2001. The increase in the allowance for premiums and fees receivable during 2000 of $726,000 was attributable to the change in the mix of premiums receivable in 2000 versus 1999. In 2000 the Company experienced significant growth in its automobile programs that have premium installment features as noted above. In conjunction with the increase in installment premiums the Company experienced an increase in collection efforts relating to such premiums, especially non-standard policies. As a result, the Company increased both its allowance for premiums and the amount of write-offs against such allowance. The Company expects this trend to continue in 2001. Net investment income was $7.7 million, $7.3 million and $7.7 million in 2000, 1999, and 1998, respectively. Net investment income has increased as fixed-income invested assets increased by $9.1 million. The increase in invested assets is attributable to increased premium volume and the receipt of the Reliance settlement. As of December 31, 2000 and 1999, the average yield on NAICC's portfolio was 6.6 percent and 6.6 percent, respectively. The estimated average maturity of the portfolio at December 31, 2000 was 3.25 years compared to 3.77 years at December 31, 1999. In January 1999, NAICC entered into a workers' compensation reinsurance agreement with Reliance Insurance Company ("Reliance Agreement") with a term of two years. The Reliance Agreement provided excess of loss coverage down to $10,000 and a 20 percent quota share below the excess retention resulting in a maximum net loss to NAICC of $18,000 per claim. During 1999, Reliance initiated efforts to rescind their workers' compensation reinsurance agreements with several insurance companies, including NAICC. NAICC was originally offered $5 million as a settlement, which was negotiated to $8 million. In determining whether the $8 million proposed settlement amount was reasonable, an antiicpated loss ratio was calculated based on existing reserves, which resulted in an estimated $8 to $9 million that would have been recoverable under the Reliance Agreement, and therefore management believed that the $8 million in present value was a reasonable settlement amount. Management believed it was in the best interest of the Company to accept the offer and agree to rescind the agreement based on several factors: (1) the projected premium and losses for 2000, (2) the negative press Reliance was beginning to receive in the summer of 1999 regarding certain underwriting pools, and, most importantly, (3) the potential for future credit risk of Reliance if the offer was rejected. Reliance did not provide the Company with any estimates of amounts reported under the initial agreements, did not disclose how they arrived at the additional compensation included in the overall settlement amount, and did not provide their reason for requesting rescission of the agreements as of their effective date. In the fourth quarter of 1999, NAICC executed an agreement to rescind the Reliance Agreement retroactive to its effective date. The terms of the rescission included the return of amounts paid during the nine month period the Reliance Agreement was active plus the settlement fee of $8.0 million paid by Reliance to eliminate further obligations under the contract. NAICC recognized a gain of $8,317,000 in the fourth quarter of 1999 as a result of this rescission. The gain represented the difference between the proceeds received of $11.5 million and the reinsurance recoverable balances due from Reliance at September 30, 1999. The results of operations include ceded premiums of $3,875,000, net of ceding commissions, and $417,000 of paid losses and loss adjustment expenses during the nine months the agreement was active. The gain realized should not be considered as an indication of an understatement of reserves or negative trends in this business. 3 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS --------------------------- (CONTINUED) Net losses and loss adjustment expenses (LAE) were $60.5 million, $45.8 million, and $39.1 million in 2000, 1999, and 1998, respectively. The resulting net loss and LAE ratios were 90.3 percent, 84.7 percent and 70.6 percent in 2000, 1999 and 1998, respectively. The increase in the loss and LAE ratio during 2000 was attributable to higher than expected losses in our commercial and private passenger automobile programs and additional development in our run-off lines. The increase in the loss and LAE ratio in 1999 over 1998 was due to higher than expected losses in the California workers' compensation line and developments on certain businesses in run-off. Policy acquisition costs were $16.4 million, $13.9 million, and $13.3 million in 2000, 1999, and 1998. As a percentage of net premiums earned, policy acquisition expenses were 24.5 percent, 25.7 percent, and 24.0 percent in 2000, 1999, and 1998, respectively. Policy acquisition costs include expenses directly related to premium volume (i.e., commissions, premium taxes and state assessments) as well as certain underwriting expenses which are fixed in nature. The decline in the policy acquisition expense ratio in 2000 compared to 1999 was due primarily to an increase in our workers' compensation business which has a lower commission cost than our automobile programs. The increase in the policy acquisition expense ratio in 1999 over 1998 was due in part to an increase in our preferred private passenger automobile line of business. That line of business has higher commission costs than our non-standard private passenger automobile line of business. General and administrative expenses were $5.5 million, $5.8 million, and $7.3 million in 2000, 1999, and 1998, respectively. General and administrative expenses decreased in 2000 due to cost saving measures implemented by the Company at the end of 1999. The decrease in 1999 was in line with the overall premium activity for that year. Policyholder dividends incurred were $(144,817), $2.2 million, and $471,000 in 2000, 1999, and 1998, respectively. The negative policyholder dividend in 2000 was attributable to less participating business on the Montana workers' compensation policies which resulted in the adjustment of prior accruals to reflect aniticipated payments based on experience. The increase in the policyholder dividends during 1999 was attributable to the increase in our Montana workers' compensation policyholder dividends that historically have loss ratios well below those recorded in California. Combined underwriting ratios were 123.1 percent, 125.2 percent, and 108.6 in 2000, 1999, and 1998, respectively. The decrease in the combined ratio in 2000 was due to premium growth and reduced costs associated with producing such premiums. The increase in the combined ratio in 1999 was due to higher than expected loss costs, and policyholder dividends. The insurance operations had income from operations of $1.7 million, $3.0 million, and $4.1 million in 2000, 1999, and 1998, respectively. The decrease for 2000 was attributable to an increase in loss and loss adjustment expenses, which was offset in part by realized gains of $8.4 million. The decrease in 1999 was attributable to the decrease in premium volume, along with an increase in loss and loss adjustment expenses, which was offset in part by the gain on a treaty rescission of $8.3 million. LIQUIDITY AND CAPITAL RESOURCES The Company's insurance subsidiaries require both readily liquid assets and adequate capital to meet ongoing obligations to policyholders and claimants, as well as to pay ordinary operating expenses. The primary sources of funds to meet these obligations are premium revenues, investment income, recoveries from reinsurance and, if required, the sale of invested assets. NAICC's investment policy guidelines require that all liabilities be matched by a comparable amount of investment grade assets. Management believes that NAICC has both adequate capital resources and sufficient reinsurance to meet any unforeseen events such as natural catastrophes, reinsurer insolvencies, or possible reserve deficiencies. The Company meets both its short-term and long-term liquidity requirements through operating cash flows that include premium receipts, investment income, and reinsurance recoveries. To the extent operating cash flows do not provide sufficient cash flow, the Company relies on the sale of invested assets. Cash provided by insurance operations was $8.1 million in 2000 while cash used in insurance operations was $4.6 million and $3.0 million in 1999 and 1998, respectively. The increase in cash provided by insurance operations for 2000 was primarily attributable to amounts received for the rescission of certain reinsurance treaties of $11.5 million offset by an increase in claim payments made under the commercial and private passenger automobile programs. Had the funds related to the rescission not been received in 2000 the cash used in operations would have been approximately $3.4 million. The increase in cash used in insurance operations for 1999 was primarily due to the decline in our non-standard private passenger written premiums, and to the timing difference in receiving payment on the Reliance settlement of $11.5 million in 2000. Had those funds been received in 1999, operations would have provided approximately $6.9 million in cash. The Company believes that its liquidity needs will continue to be met through the same sources in the future. The National Association of Insurance Commissioners provides minimum solvency standards in the form of risk-based capital requirements (RBC). The RBC model for property and casualty insurance companies requires companies to report their RBC ratios based on their statutory annual statements as filed with the regulatory authorities. NAICC has calculated its RBC requirement under the RBC model and believes that it has sufficient capital for its operations. RESULTS OF DHC'S OPERATIONS CASH FLOW FROM PARENT-ONLY OPERATIONS Operating cash flow of DHC on a parent-only basis is primarily dependent upon the rate of return achieved on its investment portfolio and the payment of general and administrative expenses incurred in the normal course of business. For the years ended December 31, 2000, 1999, and 1998, cash used in parent-only operating activities was $1.5 million, $1.9 million, and $2.2 million, respectively. Cash used in operations is primarily attributable to the parent-only net loss from operations for each year, adjusted for non-cash charges such as depreciation and amortization, and the operating working capital requirements of the holding company's business. For information regarding the Company's operating subsidiaries' cash flow from operations, see "RESULTS OF NAICC'S OPERATIONS, PROPERTY AND CASUALTY INSURANCE OPERATIONS." LIQUIDITY AND CAPITAL RESOURCES As of December 31, 2000, cash and investments of DHC were 4 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES approximately $21.0 million. As previously described, the primary use of funds was the payment of general and administrative expenses in the normal course of business. In 2000 and 1999, DHC received cash in the amount of $3.1 million and $13.1 million, respectively, from the sale of newly issued common stock. DHC's sources of funds are its investments as well as dividends received from its subsidiaries. Various state insurance requirements restrict the amounts that may be transferred to DHC in the form of dividends from its insurance subsidiaries without prior regulatory approval. In 2000, NAICC received regulatory approval and paid a $1.5 million dividend to DHC. See Note 4 of the Notes to Consolidated Financial Statements. THE COMPANY'S INVESTMENTS The amount and type of certain of the Company's investments are regulated by California and Montana insurance laws and regulations. The Company's investment portfolio is composed primarily of fixed maturities and is weighted heavily toward investment grade short and medium term securities. NAICC does not invest in high yield non-investment grade securities. See Notes 1(B) and 5 of the Notes to Consolidated Financial Statements. The following table sets forth a summary of the Company's investment portfolio at December 31, 2000, by investment grade (dollars in thousands): Cost Fair Value - -------------------------------------------------------------------------------- Investment by investment grade: Fixed maturities U.S. Government/Agency ............................ $ 34,167 $ 34,682 Mortgage-backed ................................... 37,592 37,640 Asset-backed ...................................... 1,967 1,974 Corporates (AAA to A) ............................. 38,948 39,075 Corporates (BBB to B) ............................. 10,993 9,842 ------------------------ Total fixed maturities .......................... 123,667 123,213 Equity securities ................................... 25,064 24,454 ------------------------ Total ........................................... $148,731 $147,667 ======================== The following table sets forth a summary of the Company's equity securities portfolio at December 31, 2000 (dollars in thousands): Cost Fair Value - -------------------------------------------------------------------------------- Equity securities by type: U.S. domestic securities .......................... $14,726 $14,302 Foreign securities ................................ 10,338 10,152 ------------------------ Total equity securities ......................... $25,064 $24,454 ======================== MARKET RISK The Company's objectives in managing its investment portfolio are to maximize investment income and investment returns while minimizing overall credit risk. Investment strategies are developed based on many factors including underwriting results, overall tax position, regulatory requirements, and fluctuations in interest rates. Investment decisions are made by management and approved by the Board of Directors. Market risk represents the potential for loss due to adverse changes in the fair value of securities. The market risks related to the Company's fixed maturity portfolio are primarily interest rate risk and prepayment risk. The market risks related to the Company's equity portfolio are foreign currency risk and equity price risk. RISKS RELATED TO FIXED MATURITIES The Company's fixed maturities are subject to interest rate risk. The Company's primary interest rate risk exposure is to changes in short-term U.S. prime interest rates. Interest rate risk is the price sensitivity of fixed maturities to changes in interest rates. Management views these potential changes in price within the overall context of asset and liability matching. Management estimates the payout patterns of the Company's liabilities, primarily loss reserves, to determine their duration. Management sets duration targets for the Company's fixed income portfolio after consideration of the duration of its liabilities, which management believes mitigates the overall interest rate risk. Fixed maturities of the Company include Mortgage-Backed Securities (MBS) representing 30.5 percent and 35.1 percent of total fixed maturities at December 31, 2000 and December 31, 1999, respectively. All MBS held by the Company are issued by the Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC), which are both rated Aaa by Moody's Investors Services. Both FNMA and FHLMC are corporations that were created by Acts of Congress. FNMA and FHLMC guarantee the principal balance of their securities. FNMA guarantees timely payment of principal and interest. One of the risks associated with MBS is the timing of principal payments on the mortgages underlying the securities. The principal an investor receives depends upon amortization schedules and the termination pattern (resulting from prepayments or defaults) of the individual mortgages included in the underlying pool of mort- 5 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS --------------------------- (CONTINUED) gages. The principal is guaranteed but the yield and cash flow can vary depending on the timing of the repayment of the principal balance. Securities that have an amortized cost greater than par, which are backed by mortgages that repay faster (or slower) than expected, will incur a decrease (or increase) in yield. Those securities that have an amortized cost lower than par that repay faster (or slower) than expected will generate an increase (or decrease) in yield. The degree to which a security is susceptible to changes in yield is influenced by the difference between its amortized cost and par, the relative sensitivity to repayment of the underlying mortgages backing the securities in a changing interest rate environment, and the repayment priority of the securities in the overall securitization structure. The Company attempts to limit repayment risk by purchasing MBS whose costs are below or do not significantly exceed par, and by primarily purchasing structured securities with repayment protection to provide a more certain cash flow to the investor. There are various types of bonds that may comprise a MBS and they can have differing interest rates and maturities, as well as priorities to the cash flows of the underlying mortgages or assets. MBS with sinking fund schedules are known as Planned Amortization Classes (PAC) and Targeted Amortization Classes (TAC). The structures of PACs and TACs attempt to increase the certainty of the timing of prepayment and thereby minimize the prepayment and interest rate risk. MBS, as well as callable bonds, have a greater sensitivity to market value declines in a rising interest rate environment than to market value increases in a declining interest rate environment. This is primarily due to the ability and the incentive of the payor to prepay the principal or the issuer to call the bond in a declining interest rate scenario. NAICC's MBS by type of instrument are as follows (in thousands): 2000 1999 --------------------------------------------- AMORTIZED PERCENT Amortized Percent COST OF TOTAL Cost of Total - -------------------------------------------------------------------------------- Non-PAC/TAC ..................... $19,774 53% $19,317 48% PAC/TAC ......................... 17,818 47% 20,872 52% --------------------------------------------- $37,592 100% $40,189 100% ============================================= The following table provides information about the Company's fixed maturity investments at December 31, 2000 that are sensitive to changes in interest rates. The table presents expected cash flows of principal amounts and related weighted average interest rate by expected maturity dates. The expected maturity date for other than mortgage-backed securities is the earlier of call date or maturity date, and for mortgage-backed securities is based on expected payment patterns. Actual cash flows could differ, and potentially materially differ from expected amounts considering the weighting of the Company's portfolio towards mortgage-backed securities.
There- (IN THOUSANDS) 2001 2002 2003 2004 2005 after Total - ----------------------------------------------------------------------------------------------------------------------------------- U.S. Government/Agency $10,506 $ 6,395 $ 2,155 $3,528 $2,700 $ 8,883 $34,167 Average interest rate 6.64% 7.53% 6.76% 5.62% 7.37% 8.35% Mortgage-backed 4,777 4,649 3,940 2,772 3,331 18,123 37,592 Average interest rate 7.21% 7.35% 7.44% 7.52% 7.50% 6.90% Asset-backed 1,967 1,967 Average interest rate 5.81% Corporates (AAA to A) 1,490 3,825 10,900 11,725 7,025 3,983 38,948 Average interest rate 8.08% 7.31% 6.29% 6.07% 6.51% 6.54% Corporates (BBB to B) 1,000 9,993 10,993 Average interest rate 9.50% 8.77% ------------------------------------------------------------------------------------------- Total $19,740 $14,869 $16,995 $18,025 $13,056 $40,982 $123,667 ===========================================================================================
6 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES Management believes that the interest and prepayment risks generally inherent in the Company's fixed maturity portfolio are not significant at December 31, 2000. RISKS RELATED TO EQUITY SECURITIES The increase in the equity portfolio during 1998 was done to diversify NAICC's investments. After consideration of NAICC's relatively conservative capital position, management believed additional diversification was warranted. The Company classifies all of its equity securities, including the foreign exchange listed component, in the reporting category: "available for sale." These securities are marked to the market at the closing U.S. denominated price on the various exchanges and over-the-counter pricing systems. Since the portfolio includes both domestic and foreign securities, the portfolio is subject to foreign currency risk. Foreign currency risk is the sensitivity to exchange rate fluctuations of the market value and investment income related to foreign denominated financial instruments. At December 31, 2000, NAICC held approximately $10.3 million of yen denominated equity securities. See Note 6 of the Notes to Consolidated Financial Statements. Equity price risk is the potential loss arising from changes in the value of equity securities. Typically, equity securities have more year-to-year price volatility than medium term investment grade fixed maturity instruments. The foreign currency and equity price risks inherent in the equity portfolio are subject to several factors beyond the control of management. At December 31, 2000 the only foreign currency exposure was Japenese yen. To manage foreign currency exposure on the Company's foreign equity holdings, the Company reviews the available hedging products. In 1998 the Company entered into a yen put option contract which expired in 1999. At December 31, 2000 there were no hedging instuments in place. It is management's view that the cost of entering into a subsequent hedging instrument would outweigh any potential benefit of such instrument. AUTHORITATIVE ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities"("FAS 133"). FAS 133 is effective for fiscal years beginning after June 15, 2000 and establishes standards for the reporting for derivative instruments. It requires changes in the fair value of a derivative instrument and the changes in fair value of the assets or liabilities hedged by that instrument to be included in income. The Company will adopt FAS 133 on January 1, 2001. The adoption of FAS 133 is not expected to have a material effect on the Company's results of operations or financial condition. Effective January 1, 1999, the Company adopted AICPA Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use (SOP 98-1). The statement establishes the standard in which certain internal costs incurred to develop software used internally can be capitalized. During 1999, the Company capitalized approximately $142,000 of internal costs, mostly salary and benefits, related to software developed. Effective January 1, 1999, the Company adopted AICPA Statement of Position 97-3, Accounting by Insurance and Other Enterprises for Insurance-Related Assessments. The statement establishes the standards for reporting assessments charged to an enterprise. An enterprise is required to recognize a liability for insurance related assessments when an assessment is probable and estimable. The impact of adopting this statement was not material to the consolidated financial statements. In September 2000, the Financial Accounting Standards Board issued FAS Statement 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of FAS 125)" ("FAS 140"). FAS 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures. The statement requires the Company to reclassify certain financial assets pledged as collateral and to disclose certain information about its collateral activities. The company has implemented FAS 140 as of December 31, 2000. There was no impact on the financial results of the Company other than the reclassification and/or disclosure about certain financial assets pledged or accepted as collateral. ECONOMIC CONDITIONS The operating results of a property and casualty insurer are influenced by a variety of factors including general economic conditions, competition, regulation of insurance rates, weather, and frequency and severity of losses. The markets in which NAICC operates have experienced periods of rate adequacy followed by increased competition and rate inadequacy. The general economic conditions in California, where NAICC writes approximately 63 percent of its current business, are currently competitive. The competition, rate regulation and loss experience in the automobile markets are currently such that NAICC is able to write its premium volume profitably. As part of Proposition 103, the California Department of Insurance issued new regulations for private passenger automobile rates requiring that the three mandatory rating factors of (1) driving safety record, (2) number of miles driven annually, and (3) years of driving experience have the first, second and third greatest weights, respectively. Geographic location and other characteristics may still be used as optional rating factors; however, the combined weight of all such optional rating factors may not be greater than the third mandatory rating factor of years of driving experience. Previously, insurers could use geographic location as the primary rating factor. NAICC has made the appropriate modifications to its rating plans in order to comply with the latest regulations. The California workers' compensation market, where NAICC had historically written a significant amount of its premium, continues to be very price competitive. Workers' compensation premium volume has increased slightly as competitors have begun to raise rates during 2000. Despite current rate increases, the Company believes that competitors continue to price policies at rates well below a level necessary to achieve an underwriting profit and the Company's future growth could continue to be limited by such activity. RISK FACTORS THAT MAY AFFECT FUTURE RESULTS As noted above, the foregoing discussion and the Notes to Consolidated Financial Statements may include forward-looking statements that involve risks and uncertainties. In addition to other factors and matters discussed elsewhere herein, some of the important factors that, in the view of the Company, could cause actual results to differ materially from those discussed in the forward-looking statements include the following: 7 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS --------------------------- (CONTINUED) 1. The insurance products sold by the Company are subject to intense competition from many competitors, many of whom have substantially greater resources than the Company. There can be no assurance that the Company will be able to successfully compete in these markets and generate sufficient premium volume at attractive prices to be profitable. 2. In order to implement its business plan, the Company has been seeking to enter into strategic partnerships and/or make acquisitions of businesses that would enable the Company to earn an attractive return on investment. Restrictions on the Company's ability to issue additional equity in order to finance any such transactions exist which could significantly affect the Company's ability to finance any such transaction. The Company may have limited other resources with which to implement its strategy and there can be no assurance that any transaction will be successfully consummated. 3. The insurance industry is highly regulated and it is not possible to predict the impact of future state and federal regulation on the operations of the Company. 4. Unpaid losses and loss adjustment expenses ("LAE") are based on estimates of reported losses, historical Company experience of losses reported by reinsured companies for insurance assumed from such insurers, and estimates based on historical Company and industry experience for unreported claims. Such liability is, by necessity, based upon estimates which may change in the near term, and there can be no assurance that the ultimate liability will not exceed, or even materially exceed, such estimates. 8 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS ---------------------------
For the years ended December 31, -------------------------------------- (IN THOUSANDS, EXCEPT PER SHARE INFORMATION) 2000 1999 1998 REVENUES: - --------------------------------------------------------------------------------------------------------------------------------- Gross premiums earned............................................................... $73,888 63,710 $65,861 Ceded premiums earned............................................................... (6,854) (9,670) (10,450) -------------------------------------- Net premiums earned................................................................. 67,034 54,040 55,411 Net investment income............................................................... 9,326 7,777 8,174 Net realized investment gains (losses).............................................. 8,765 (152) 252 Gain on reinsurance treaty rescission............................................... -- 8,317 -- Other income........................................................................ 1,112 1,176 907 -------------------------------------- TOTAL REVENUES.................................................................... 86,237 71,158 64,744 LOSSES AND EXPENSES: Gross losses and loss adjustment expenses........................................... 71,524 57,610 45,559 Ceded losses and loss adjustment expenses........................................... (11,001) (11,818) (6,428) -------------------------------------- Net losses and loss adjustment expenses............................................. 60,523 45,792 39,131 Policyholder dividends.............................................................. (145) 2,217 471 Policy acquisition expenses......................................................... 16,436 13,864 13,300 General and administrative expenses................................................. 8,259 7,989 9,531 -------------------------------------- TOTAL LOSSES AND EXPENSES......................................................... 85,073 69,862 62,433 -------------------------------------- Income before provision for income tax................................................ 1,164 1,296 2,311 Income tax provision.................................................................. 134 41 10 ====================================== NET INCOME ........................................................................... $ 1,030 $ 1,255 $ 2,301 ====================================== EARNINGS PER SHARE OF COMMON STOCK: Basic................................................................................. $ 0.06 $ 0.08 $ 0.15 Diluted............................................................................... $ 0.05 $ 0.07 $ 0.14
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 9 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ---------------------------
December 31, ----------------------- (IN THOUSANDS, EXCEPT SHARE INFORMATION) 2000 1999 - -------------------------------------------------------------------------------------------------------------------------------- ASSETS: Fixed maturities at fair value (Cost: $123,667 and $113,641)...................................... $123,213 110,841 Equity securities at fair value (Cost: $25,064 and $20,614)....................................... 24,454 21,316 Short term investments, at cost which approximates fair value..................................... 6,463 8,234 ----------------------- TOTAL INVESTMENTS............................................................................. 154,130 140,391 Cash.............................................................................................. 6,082 105 Accrued investment income......................................................................... 1,782 1,499 Premiums and fees receivable, net of allowances of $588 and $274.................................. 15,555 11,619 Reinsurance recoverable on paid losses, net of allowances of $623 and $402........................ 4,020 6,060 Reinsurance recoverable on unpaid losses, net of allowances of $101 and $246...................... 20,641 15,628 Prepaid reinsurance premiums...................................................................... 2,629 1,767 Property and equipment, net of accumulated depreciation of $8,748 and $8,225...................... 1,325 1,762 Deferred acquisition costs........................................................................ 3,665 2,522 Receivable on reinsurance treaty rescission....................................................... -- 11,459 Other assets...................................................................................... 1,000 1,940 ----------------------- TOTAL ASSETS.................................................................................. $210,829 $194,752 ======================= LIABILITIES AND STOCKHOLDERS' EQUITY: Unpaid losses and loss adjustment expenses........................................................ $100,030 $ 94,934 Unearned premiums................................................................................. 23,207 16,239 Policyholder dividends............................................................................ 364 814 Reinsurance premiums payable...................................................................... 1,630 905 Funds withheld on ceded reinsurance............................................................... 1,666 1,708 Other liabilities................................................................................. 2,602 3,926 ----------------------- TOTAL LIABILITIES............................................................................. 129,499 118,526 Preferred Stock ($0.10 par value; authorized 10,000,000 shares; none issued and outstanding).................................................................... -- -- Common Stock ($0.10 par value; authorized 100,000,000 shares; issued 19,306,694 shares and 18,486,994 shares; outstanding 19,295,954 shares and 18,476,265 shares)....................................................................... 1,931 1,849 Additional paid-in capital........................................................................ 62,449 59,491 Accumulated other comprehensive income (loss)..................................................... (1,064) (2,098) Retained earnings................................................................................. 18,080 17,050 Treasury stock (Cost of 10,740 shares and 10,729 shares).......................................... (66) (66) ----------------------- TOTAL STOCKHOLDERS' EQUITY.................................................................... 81,330 76,226 ----------------------- Commitments and contingencies TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................................................... $210,829 $194,752 =======================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 10 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY ---------------------------
For the years ended December 31, ----------------------------------------------------------------- (IN THOUSANDS, EXCEPT SHARE AMOUNTS) 2000 1999 1998 - --------------------------------------------------------------------------------------------------------------------------------- COMMON STOCK Balance, beginning of year.................................. $ 1,849 $ 1,559 $ 1,559 Issuance of Common Stock.................................... 82 290 -- --------- --------- --------- Balance, end of year........................................ 1,931 1,849 1,559 --------- --------- --------- ADDITIONAL PAID-IN CAPITAL Balance, beginning of year.................................. 59,491 46,673 46,673 Issuance of Common Stock.................................... 2,958 12,818 -- --------- --------- --------- Balance, end of year........................................ 62,449 59,491 46,673 --------- --------- --------- RETAINED EARNINGS Balance, beginning of year.................................. 17,050 15,795 13,494 Net income ................................................. 1,030 1,030 1,255 $1,255 2,301 $2,301 --------- ------ --------- ------ -------- ------ Balance, end of year........................................ 18,080 17,050 15,795 --------- --------- --------- ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Balance, beginning of year.................................. (2,098) (688) 2,260 Net unrealized gain (loss) on available-for-sale securities ($1,034, $(1,410), and $(2,948)pre-tax, in 2000, 1999, and 1998 respectively)(1)..................................... 1,034 (1,410) (2,948) ------ ------ ------- Other comprehensive income (loss)........................... 1,034 1,034 (1,410) (1,410) (2,948) (2,948) --------- ------ --------- ------ -------- ------ Total comprehensive income (loss)........................... $2,064 $ (155) $ (647) ====== ======= ====== Balance, end of year........................................ (1,064) (2,098) (688) --------- --------- --------- TREASURY STOCK Balance, beginning and end of year.......................... (66) (66) (66) --------- --------- --------- Total stockholders' equity.............................. $81,330 $76,226 $63,273 ========= ========= ========= - --------------------------------------------------------------------------------------------------------------------------------- COMMON STOCK, SHARES Balance, beginning of year.................................. 18,486,994 15,586,994 15,586,994 Issuance of Common Stock.................................... 819,700 2,900,000 -- Exercise of options to purchase Common Stock................ -- -- -- ---------- ---------- ---------- Balance, end of year........................................ 19,306,694 18,486,994 15,586,994 ========== ========== ========== TREASURY STOCK, SHARES Balance, beginning of year.................................. 10,729 10,718 10,707 Purchased during year....................................... 11 11 11 --------- --------- --------- Balance, end of year........................................ 10,740 10,729 10,718 ========== ========== ==========
- ---------- (1) Disclosure of reclassification amount 2000 1999 1998 ------- ------- ------- Unrealized holding losses Arising during the period $(7,731) $(1,258) $(3,200) Less: reclassification adjustment for net (gains) losses included in net income (8,765) 152 (252) ------- ------- ------- Net unrealized losses on securities $ 1,034 $(1,410) $(2,948) SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 11 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, --------------------------------------- (IN THOUSANDS) 2000 1999 1998 - --------------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Income from continuing operations................................................... $ 1,030 $ 1,255 $ 2,301 Adjustments to reconcile income from continuing operations to net cash used in operating activities: Net realized investment (gains) losses.......................................... (8,765) 152 (252) Depreciation and amortization................................................... 384 654 855 Change in accrued investment income............................................. (283) (72) 579 Change in premiums and fees receivable.......................................... (3,936) (1,647) (4,534) Change in reinsurance recoverables.............................................. 2,040 1,654 809 Change in reinsurance recoverable on unpaid losses ............................. (5,013) 2,559 1,998 Change in prepaid reinsurance premiums.......................................... (862) (99) 13 Change in deferred acquisition costs............................................ (1,143) (141) (831) Change in unpaid losses and loss adjustment expenses............................ 5,096 (719) (10,294) Change in unearned premiums..................................................... 6,968 2,534 3,456 Change in policyholder dividends payable........................................ (450) 633 (230) Change in reinsurance payables and funds withheld............................... 683 (972) 1,087 Change in receivable on reinsurance treaty rescission........................... 11,459 (11,459) -- Other, net...................................................................... (564) (810) (127) --------------------------------------- Net cash provided by (used in) operating activities........................... 6,644 (6,478) (5,170) --------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales: Fixed income maturities available-for-sale........................................ 16,656 741 3,412 Equity securities................................................................. 26,735 -- 240 Investments, matured or called: Fixed income maturities available-for-sale........................................ 21,829 29,995 52,338 Investments purchased: Fixed income maturities available-for-sale........................................ (48,077) (32,255) (28,408) Equity securities................................................................. (22,462) (560) (19,952) Purchases of property and equipment................................................. (159) (370) (127) Proceeds from sale of property and equipment........................................ -- -- 6 --------------------------------------- Net cash (used in) provided by investing activities........................... (5,478) (2,449) 7,509 --------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of Common Stock.............................................. 3,040 13,109 -- --------------------------------------- Net cash provided by financing activities..................................... 3,040 13,109 -- --------------------------------------- Net increase in cash and short term investments....................................... 4,206 4,182 2,339 Cash and short term investments at beginning of year.................................. 8,339 4,157 1,818 --------------------------------------- Cash and short term investments at end of year........................................ $ 12,545 8,339 4,157 =======================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 12 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------- DECEMBER 31, 2000, 1999, AND 1998 1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES FORMATION AND ORGANIZATION Danielson Holding Corporation ("DHC") is a holding company organized under the General Corporation Law of the State of Delaware. DHC owns all of the voting stock of Mission American Insurance Company ("MAIC"). MAIC owns 100 percent of the voting stock of KCP Holding Company ("KCP"). KCP owns 100 percent of the common stock of National American Insurance Company of California, DHC's principal operating insurance subsidiary, which owns 100 percent of the common stock of Danielson Insurance Company, Danielson National Insurance Company, and Valor Insurance Company, Incorporated ("Valor") (National American Insurance Company of California and its subsidiaries being collectively referred to as "NAICC"). The operations of NAICC are in property and casualty insurance. NAICC writes non-standard and preferred private passenger and commercial automobile, homeowners' and workers compensation insurance in the western United States, primarily California. NAICC writes approximately 63 percent of its insurance in California and 12 percent of its business in Montana. For the years ended December 31, 2000 and 1999, personal lines direct written premiums, representing 28 percent and 36 percent, respectively, of total direct written premiums, were produced through two general agents of NAICC. For the year ended December 31, 1998, private passenger automobile direct written premiums, representing 44 percent of total direct written premiums, were produced through one general agent of NAICC. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. BASIS OF PRESENTATION The accompanying Consolidated Financial Statements of DHC and subsidiaries (collectively with DHC, the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America. All material transactions among consolidated companies have been eliminated. Certian prior year amounts have been reclassified to conform with the current year's financial statement presentation. B. INVESTMENTS The Company classifies its debt and equity securities in one of three categories: trading, available-for-sale or held- to-maturity. Securities which are classified as "trading" are bought and held principally for sale in the near term. Securities which are classified as "held-to-maturity" are securities which the Company has the ability and intent to hold until maturity. All other securities, which are not classified as either trading or held-to-maturity, are classified as "available-for-sale." Fixed maturities classified as available-for-sale are recorded at fair value. Fixed maturities classified as held-to-maturity are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. Amortization and accretion of premiums and discounts on collateralized mortgage obligations are adjusted for principal paydowns and changes in expected maturities. Net unrealized gains or losses on fixed maturities classified as available-for-sale are excluded from earnings and are reported as a separate component of accumulated other comprehensive income (loss) in stockholders' equity until realized. No deferred tax liability has been provided for unrealized appreciation due to the anticipated availability of the Company's net operating tax loss carryforwards, and other various deferred tax assets. A decline in the market value of any security below cost which is deemed to be other than temporary is charged to earnings, resulting in the establishment of a new cost basis for such security. Premiums and discounts of fixed maturities are amortized or accreted based on the effective interest method. Dividend and interest income are recognized when earned. The cost of securities sold is determined using the specific identification method. Equity securities are stated at fair value, and any increase or decrease from cost is reported as accumulated other comprehensive income (loss) in stockholders' equity as unrealized gain or loss. Short term investments are stated at cost which approximates fair value. Investments having an original maturity of three months or less from the time of purchase have been classified as "short term investments." C. REVENUE RECOGNITION Earned premium income is recognized ratably over the contract period of an insurance policy. A liability is established for unearned insurance premiums representing the portion of premiums received that is applicable to the unexpired terms of policies in force. Premiums earned include an estimate for earned but unbilled workers' compensation premiums. Workers' compensation premiums earned but unbilled and included in premiums receivable were $1.2 million and $640,000 at December 31, 2000 and 1999, respectively. The Company estimates its earned but unbilled workers' compensation premium based on past history of additional premiums billed as a result of payroll audits. Payroll audits are conducted between 30 and 60 days after the coverage period. The increase in earned but unbilled premiums reflects the growth in workers' compensation premium during 2000. D. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES Unpaid losses and loss adjustment expenses ("LAE") are based on estimates of reported losses, historical Company experience of losses reported by reinsured companies for insurance assumed from such insurers, and estimates based on historical Company and industry experience for unreported claims. Management believes that the provisions for unpaid losses and LAE are adequate to cover the cost of losses and LAE incurred to date. However, such liability is, by necessity, based upon estimates, which may change in the near term, and there can be no assurance that the ultimate liability will not 13 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------- DECEMBER 31, 2000, 1999, AND 1998 (CONTINUED) exceed, or even materially exceed, such estimates. E. REINSURANCE In the normal course of business, the Company seeks to reduce the loss that may arise from catastrophes or other events which cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. The Company accounts for its reinsurance contracts which provide indemnification by reducing premiums earned by the amounts paid to the reinsurer and establishing recoverable amounts for paid and unpaid losses and LAE ceded to the reinsurer. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Contracts pursuant to which it is not reasonably possible that the reinsurer may realize a significant loss from the insurance risk generally do not meet conditions for reinsurance accounting and are accounted for as deposits. For the years ended December 31, 2000 and 1999, the Company had no reinsurance contracts which were accounted for as deposits. F. DEFERRED ACQUISITION COSTS Deferred acquisition costs, consisting principally of commissions and premium taxes paid at the time of issuance of a policy, are deferred and amortized over the period during which the related premiums are earned. Deferred acquisition costs are limited to the estimated future profit, based on the anticipated losses and LAE (based on historical experience), maintenance costs, policyholder dividends, and anticipated investment income. The amortization of deferred acquisition costs charged to operations in 2000, 1999 and 1998 was $12.2 million, $10.1 million and $9.9 million, respectively. G. POLICYHOLDER DIVIDENDS Policyholder dividends represent management's estimate of amounts to be paid on participating policies which share in positive underwriting results, based on the type of policy plan. Participating policies represent approximately 2.7 percent, 6.1 percent and 8.8 percent of workers' compensation direct written premiums for the years ended December 31, 2000, 1999 and 1998, respectively. An estimated provision for policyholder dividends is accrued during the period in which the related premium is earned. These estimated dividends do not become legal liabilities unless and until declared by the Board of Directors of NAICC. No dividends were declared and unpaid as of December 31, 2000. H. PROPERTY AND EQUIPMENT Property and equipment, which include data processing hardware and software and leasehold improvements, are carried at historical cost less accumulated depreciation. Depreciation of property and equipment is provided over the estimated useful lives of the respective assets. Leasehold improvements are amortized on a straight-line basis over the estimated useful lives of the assets or over the term of the leases, whichever is shorter. The useful lives of all property and equipment range from three to 12 years. I. INCOME TAXES Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax basis thereof. Deferred tax assets and liabilities are measured using enacted tax rates which are expected to apply to taxable income in the years in which those temporary differences are anticipated to be recovered or settled, and are limited, through a valuation allowance, to the amount estimated to be realizable. J. PER SHARE DATA Per share data is based on the weighted average number of shares of common stock of DHC, par value $0.10 per share ("Common Stock") outstanding during each year. Diluted earnings per share computations, as calculated under the treasury stock method, include the average number of shares of additional outstanding Common Stock issuable for stock options and warrants, whether or not currently exercisable. Such average shares were 18,841,925, 16,793,873, and 16,006,708 for the years ended December 31, 2000, 1999 and 1998, respectively. Basic earnings per share are calculated using only the average number of outstanding shares of Common Stock and disregarding the average number of shares issuable for stock options. Such average shares outstanding were 18,482,980, 16,356,821, and 15,576,281, for the years ended December 31, 2000, 1999, and 1998, respectively. K. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties. The carrying values of the Company's cash and short term investments approximate fair value because of the short term maturity of those investments. The fair values of the Company's debt security instruments and equity security investments are based on quoted market prices as of December 31, 2000. The fair value of all other financial instruments approximates their respective carrying value. L. USE OF ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management 14 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Therefore, actual results could differ from such estimates. M. STOCK INCENTIVE COMPENSATION PLANS The Company measures stock-based compensation cost using the intrinsic value based method of accounting prescribed by APB Opinion 25. Accordingly, the Company discloses pro forma net income and earnings per share as if the fair value based method of accounting prescribed by Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" had been applied. N. RECLASSIFICATIONS Certain reclassifications have been made to prior years' amounts to conform to the current year's presentation. 2) REINSURANCE Reinsurance is the transfer of risk, by contract, from one insurance company to another for consideration (premium). Reinsurance contracts do not relieve an insurance company of its obligations to policyholders. The failure of reinsurers to honor their obligations could result in losses to NAICC; consequently, allowances are established for amounts which are deemed uncollectable. NAICC evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. NAICC has reinsurance under both excess of loss and quota share treaties. NAICC cedes reinsurance on an excess of loss basis for workers' compensation risks in excess of $500,000 prior to April 2000 and $200,000 thereafter. For risks other than worker's compensation NAICC cedes reinsurance on an excess of loss basis for risks in excess of $250,000. In 1998, NAICC ceded 25 percent of its private passenger automobile business on a quota share basis. Effective January 1, 1999, the quota share agreement was amended to reduce the cessation rate to 10 percent. The effect of reinsurance on premiums written reflected in the Company's Consolidated Financial Statements is as follows (dollars in thousands): For the years ended December 31, ------------------------------------------ 2000 1999 1998 - -------------------------------------------------------------------------------- Direct ........................... $ 80,856 $ 66,375 $ 69,318 Ceded ............................ (7,715) (9,770) (10,438) ------------------------------------------ Net premium ...................... $ 73,141 $ 56,605 $ 58,880 ========================================== In 1997, NAICC paid $5.9 million in losses and loss adjustment expenses relating to an environmental claim filed by Hughes Aircraft (the "Hughes-Fullerton Claim"). The Hughes-Fullerton Claim alleged that environmental damage occurred continuously over a period of many years. NAICC assumed certain policyholder obligations of a general liability policy issued to Hughes Aircraft for three of those years. The Hughes-Fullerton Claim liability is reinsured under various contracts involving numerous reinsurance companies under which NAICC ceded $5.3 million. In 1999 NAICC collected approximately $5.3 million as settlement on the Hughes-Fullerton Claim from almost all participants. In November 1999, NAICC paid $2.1 million in losses relating to a settlement on an environmental claim filed by Hughes Aircraft (the Hughes-Tucson II Claim). The Hughes-Tucson II Claim also alleged that environmental damage occurred continuously over a period of many years. NAICC assumed certain policyholder obligations of a general liability policy issued to Hughes Aircraft for a portion of those years. The Hughes-Tucson II Claim liability is reinsured under various contracts involving numerous reinsurance companies under which NAICC ceded $3.9 million, which includes loss adjustment expenses not previously ceded of $2.1 million. During 2000, NAICC collected approximately $2.7 million as settlement on the Hughes-Tucson II claim from almost all the participants. At this time the reinsurers have not disputed the submission of amounts ceded and no proceedings are in progress. NAICC believes that the ultimate disposition of the Hughes-Tucson II Claim will not have a material adverse impact on the financial condition of the Company. In February 2000, NAICC paid $1 million in losses relating to settlement on an environmental claim filed by Public Service of Indiana (PSI Claim). The PSI Claim alleged that environmental claim damage occurred continuously over a period of many years. NAICC assumed certain policyholder obligations of a general liability policy issued to PSI for a portion of those years. The PSI Claim liability is reinsured under various contracts involving numerous reinsurance companies under which NAICC ceded $1.2 million, which includes loss adjustment expenses not previously ceded of $295,000. At this time reinsurers have not disputed the unpaid amount ceded in the submission, and no proceedings are in progress. NAICC believes that the ultimate dispositon of the PSI Claim will not have a material adverse impact on the financial condition of the Company. As of December 31, 2000, General Reinsurance Corporation ("GRC") and Mitsui Marine & Fire Insurance Company, Ltd. ("MMF") were the only reinsurers that comprised more than 10 percent of NAICC's reinsurance recoverable on paid and unpaid claims. NAICC monitors all reinsurers, by reviewing A.M. Best reports and ratings, information obtained from reinsurance intermediaries and analyzing financial statements. At December 31, 2000, NAICC had reinsurance recoverables on paid and unpaid claims of $12.3 million and $2.3 million from GRC, and MMF, respectively. Both GRC and MMF have an A.M. Best rating of A+ or better. The unsecured balance from MMF is approximately $1.2 million. In January 1999, NAICC entered into a workers' compensation reinsurance agreement with Reliance Insurance Company ("Reliance Agreement") with a term of two years. The Reliance Agreement provided excess of loss coverage down to $10,000 and a 20 percent quota share below the excess retention resulting in a maximum net loss to NAICC of $18,000 per claim. In the fourth quarter of 1999, NAICC executed an agreement to rescind the Reliance Agreement retroactive to its effective date. The terms of the rescission included the return of amounts paid during the nine month period the Reliance Agreement was active plus a settlement fee of $8.0 million paid by Reliance to eliminate further obligations under the contract. When considering Reliance's settlement offer, management looked at several factors: (1) the projected premium and losses for 2000, (2) the negative press Reliance was beginning to receive in the summer of 1999 regarding certain underwriting pools, and, most importantly, (3) the potential for future credit risk of Reliance if the offer was rejected. NAICC recognized a gain of $8,317,000 in the fourth quarter of 1999 as a result of this rescission. The gain represented the difference between the proceeds received of $11.5 million and the reinsurance recoverable balances due from Reliance at September 30, 1999. The results of operations include ceded premiums of $3,875,000, net of ceding commissions, and $417,000 of paid losses and loss adjustment expenses during the nine months the agreement was active. 15 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------- DECEMBER 31, 2000, 1999, AND 1998 (CONTINUED) 3) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES The following chart summarizes the activity in NAICC's liability for unpaid losses and LAE during the three most recent fiscal years (dollars in thousands): For the years ended December 31, -------------------------------------- 2000 1999 1998 - -------------------------------------------------------------------------------- Net unpaid losses and LAE at January 1 .................... $ 79,306 $ 77,466 $ 85,762 Incurred related to: Current year ........................ 55,269 43,301 39,131 Prior years ......................... 5,254 2,491 -- -------------------------------------- Total incurred ........................ 60,523 45,792 39,131 -------------------------------------- Paid related to: Current year ........................ (26,147) (16,527) (16,169) Prior years ......................... (34,293) (27,425) (31,258) -------------------------------------- Total paid ............................ (60,440) (43,952) (47,427) -------------------------------------- Net unpaid losses and LAE at December 31 .................. 79,389 79,306 77,466 Plus: reinsurance recoverables ........................ 20,641 15,628 18,187 -------------------------------------- Gross unpaid losses and LAE at December 31 .................. $100,030 $ 94,934 $ 95,653 ====================================== The losses and LAE incurred during 2000 related to prior years is attributable to development on the commercial automobile lines and certain lines in run-off. The losses and LAE incured during 1999 related to prior years is primarily attributable to development in the California workers' compensation line. NAICC increased its bulk unpaid liabilities as it has become evident that the loss costs associated with these claims would be greater than previously anticipated. NAICC has claims for environmental clean-up against policies issued prior to 1980 and which are currently in run-off. The principal exposure from these claims arises from direct excess and primary policies of businesses in run-off, the obligations of which were assumed by NAICC. These excess and primary claims are relatively few in number and have policy limits of between $50,000 and $1,000,000, with reinsurance generally above $50,000. NAICC also has environmental claims primarily associated with participation in excess of loss reinsurance contracts assumed by NAICC. These reinsurance contracts have relatively low limits, generally less than $25,000, and estimates of unpaid losses are based on information provided by the primary insurance company. The unpaid losses and LAE related to environmental cleanup is established based upon facts currently known and the current state of the law and coverage litigation. Liabilities are estimated for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific contract of insurance or reinsurance and management can reasonably estimate its liability. Liabilities for unknown claims and development of reported claims are included in NAICC's unpaid losses. The liability for the development of reported claims is based on estimates of the range of potential losses for reported claims in the aggregate. Estimates of liabilities are reviewed and updated continually and there is the potential that NAICC's exposure could be materially in excess of amounts which are currently recorded. Management does not expect that liabilitiies associated with these types of claims will result in a material adverse effect on the future liquidity or financial position of NAICC. However, claims such as these are based upon estimates and there can be no assurance that the ultimate liability will not exceed or even materially exceed such estimates. As of December 31, 2000 and 1999, NAICC's net unpaid losses and LAE relating to environmental claims were approximately $7.6 million and $8.3 million, respectively. 4) REGULATION, DIVIDEND RESTRICTIONS AND STATUTORY SURPLUS DHC's insurance subsidiaries are regulated by various states. For regulatory purposes, separate financial statements which are prepared in accordance with statutory accounting principles are filed with these states. NAICC prepares its statutory financial statements in accordance with accounting practices prescribed or permitted by the California Department of Insurance (the "Insurance Department"). Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners (the "Associ- 16 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES ation"), as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The Company has not applied any permitted accounting practices in its statutory financial statements. As of December 31, 2000 and 1999, DHC's operating insurance subsidiaries had statutory capital and surplus of $50.4 million and $52.5 million, respectively. The combined statutory net income for DHC's operating insurance subsidiaries, as reported to the regulatory authorities for the years ended December 31, 2000, 1999 and 1998, was $0.6 million, $2.5 million and $3.5 million, respectively. The California Department of Insurance has examined the statutory basis financial statements of NAICC through December 31, 1998. No adjustments were proposed to the statutory basis financial statements of NAICC or its subsidiaries. The Montana Department of Insurance has completed its examination of the statuatory basis financial statements of Valor though December 31, 1999. As a result of that examination Valor's surplus was reduced by $197,000 during 2000. In December 1993, the Association adopted a model for determining the risk-based capital ("RBC") requirements for property and casualty insurance companies. Under the RBC model, property and casualty insurance companies are required to report their RBC ratios based on their latest statutory annual statements as filed with the regulatory authorities. NAICC has calculated its RBC requirement under the Association's model, and has capital in excess of any regulatory action or reporting level. Insurance companies are subject to insurance laws and regulations established by the states in which they transact business. The agencies established pursuant to these state laws have broad administrative and supervisory powers relating to the granting and revocation of licenses to transact insurance business, regulation of trade practices, establishment of guaranty associations, licensing of agents, approval of policy forms, premium rate filing requirements, reserve requirements, the form and content of required regulatory financial statements, periodic examinations of insurers' records, capital and surplus requirements and the maximum concentrations of certain classes of investments. Most states also have enacted legislation regulating insurance holding company systems, including with respect to acquisitions, extraordinary dividends, the terms of affiliate transactions and other related matters. DHC and its insurance subsidiaries have registered as a holding company system pursuant to such legislation in California and routinely report to other jurisdictions. The Association has formed committees and appointed advisory groups to study and formulate regulatory proposals on such diverse issues as the use of surplus debentures, accounting for reinsurance transactions and the adoption of RBC requirements. It is not possible to predict the impact of future state and federal regulation on the operations of the Company. Effective January 1, 2001 the Association's codified statutory accounting principles ("SAP") shall be adopted by all U.S. insurance companies. The purpose of such codification is to provide a comprehensive basis of accounting and reporting to insurance departments. Although codificaion is expected to be the foundation of a state's statutory accounting practice, it may be subject to modification by practices presented or permitted by a state's insurance commissioner. Therefore, statutory financial statements will continue to be prepared on the basis of accounting practices prescribed or permitted by the insurance department of the state of domicile. The Company has determined that the adoption of the codification does not have a material effect on the statutory capital of its insurance subsidiaries. Under the California Insurance Code, NAICC is prohibited from paying, other than from accumulated earned surplus, shareholder dividends which exceed the greater of net income or ten percent of statutory surplus without prior approval of the Insurance Department. During 2000, NAICC paid an ordinary dividend of $1,500,000 to DHC from NAICC's accumulated surplus within the limits specified under the California Insurance Code. The overall limit of dividends that can be paid during 2001 is aproximately $3.6 million as long as there is sufficient accumulated surplus to pay such. 5) INVESTMENTS The cost or amortized cost, unrealized gains, unrealized losses and fair value of the Company's investments at December 31, 2000 and 1999, categorized by type of security, were as follows (dollars in thousands): DECEMBER 31, 2000 -------------------------------------------- COST OR AMORTIZED UNREALIZED UNREALIZED FAIR COST GAIN LOSS VALUE - -------------------------------------------------------------------------------- Fixed maturities: U.S. Government/ Agency ......................... $ 34,167 $ 637 $ 122 $ 34,682 Mortgage-backed ................ 37,592 214 166 37,640 Asset-backed ................... 1,967 7 -- 1,974 Corporate ...................... 49,941 372 1,396 48,917 -------- ------ ------ -------- Total fixed maturities ............... 123,667 1,230 1,684 123,213 -------- ------ ------ -------- Equity securities ................ 25,064 1,520 2,130 24,454 -------- ------ ------ -------- Total available-for-sale ......... $148,731 $2,750 $3,814 $147,667 ======== ====== ====== ======== December 31, 1999 -------------------------------------------- Cost or Amortized Unrealized Unrealized Fair Cost Gain Loss Value - -------------------------------------------------------------------------------- Fixed maturities: U.S. Government/ Agency ......................... $ 25,755 $ 100 $ 655 $ 25,200 Mortgage-backed ................ 40,189 67 1,336 38,920 Asset-backed ................... 9,512 -- 8 9,504 Corporate ...................... 38,185 48 1,016 37,217 -------- ------ ------ -------- Total fixed maturities ............... 113,641 215 3,015 110,841 -------- ------ ------ -------- Equity securities ................ 20,614 1,847 1,145 21,316 -------- ------ ------ -------- Total available-for-sale ......... $134,255 $2,062 $4,160 $132,157 ======== ====== ====== ======== Fixed maturities of the Company include mortgage-backed securities ("MBS") representing 30.5 percent and 35.1 percent of the Company's total fixed maturities at December 31, 2000 and 1999, respectively. All MBS held by the Company are issued by the Federal National Mortgage Association ("Fannie 17 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------- DECEMBER 31, 2000, 1999 AND 1998 (CONTINUED) Mae") or the Federal Home Loan Mortgage Corporation ("Freddie Mac"), both of which are rated "Aaa" by Moody's Investors Services. MBS and callable bonds, in contrast to other bonds, are more sensitive to market value declines in a rising interest rate environment than to market value increases in a declining interest rate environment. This is primarily because of payors' increased incentive and ability to prepay principal and issuers' increased incentive to call bonds in a declining interest rate environment. Management does not believe that the inherent prepayment risk in its portfolio is significant. However, management believes that the potential impact of the interest rate risk on the Company's Consolidated Financial Statements could be significant because of the greater sensitivity of the MBS portfolio to market value declines and the classification of the entire portfolio as available-for-sale. The Company has no MBS concentrations in any geographic region. The expected maturities of fixed maturities, by amortized cost and fair value, at December 31, 2000, are shown below. Expected maturities may differ from contractual maturities due to borrowers having the right to call or prepay their obligations with or without call or prepayment penalties. Expected maturities of mortgage-backed securities are estimated based upon the remaining principal balance, the projected cash flows and the anticipated prepayment rates of each security (dollars in thousands): Amortized Fair Maturity Cost Value - -------------------------------------------------------------------------------- Available-for-sale: One year or less ................................. $ 19,740 $ 19,778 Over one year to five years ...................... 74,757 75,601 Over five years to ten years ..................... 26,561 25,365 More than ten years .............................. 2,609 2,469 ------------------------ Total fixed maturities ......................... $123,667 $123,213 ======================== The following reflects the change in net unrealized gain (loss) on available-for-sale securities included as a separate component of accumulated other comprehensive income (loss) in stockholders' equity (dollars in thousands): For the years ended December 31, -------------------------------- 2000 1999 1998 - -------------------------------------------------------------------------------- Fixed maturities $ 2,346 $(5,352) $ 742 Equity securities (1,312) 3,942 (3,690) -------------------------------- $ 1,034 (1,410) $(2,948) ================================ Net realized investment gains (losses) in 2000, 1999, and 1998 were as follows (dollars in thousands): For the years ended December 31, --------------------------- 2000 1999 1998 - -------------------------------------------------------------------------------- Fixed maturities ................................ $ 43 $ 3 $ 198 Equity securities ............................... 8,722 (155) 54 --------------------------- Net realized investment gains (losses) ......... $8,765 $(152) $252 =========================== Gross realized gains relating to fixed maturities were $60,000, $3,000 and $213,000 for the years ended December 31, 2000, 1999 and 1998, respectively. Gross realized losses relating to fixed maturities were $17,000 and $15,000 for the years ended December 31, 2000 and 1998, respectively. Gross realized gains relating to equity securities were $8,734,000 and $54,000 for the years ended December 31, 2000 and 1998, respectively. Gross realized losses relating to equity securities were $12,000 and $155,000 for the years ended December 31, 2000 and 1999, respectively. Net investment income for the past three years was as follows (dollars in thousands): For the years ended December 31, -------------------------------- 2000 1999 1998 - -------------------------------------------------------------------------------- Fixed maturities ........................... $8,621 $7,454 $8,032 Short term investments ..................... 717 363 279 Other, net ................................. 119 61 2 -------------------------------- Total investment income .................. 9,457 7,878 8,313 Less: Investment expense ................... 131 101 139 -------------------------------- Net investment income .................... $9,326 $7,777 $8,174 ================================ There were no investments with a carrying value greater than ten percent of stockholders' equity as of December 31, 2000, 1999, or 1998. In compliance with state insurance laws and regulations, securities with a fair value of approximately $44 million, $41 million and $51 million at December 31, 2000, 1999, and 1998, respectively, were on deposit with various states or governmental regulatory authorities. In addition, at December 31, 2000, 1999, and 1998, respectively, investments with a fair value of $6.5 million, $6.6 million and $6.9 million were held in trust or as collateral under the terms of certain reinsurance treaties and letters of credit. 18 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES 6) FOREIGN CURRENCY TRANSLATION AND FOREIGN INVESTMENTS During 1998, NAICC invested approximately $10.3 million in Japanese yen based equity securities. During the second quarter of 1998, NAICC purchased a foreign currency option at a cost of $155,000 to sell Japanese yen at a fixed price on a given date in April 1999. The foreign currency option expired in April 1999, resulting in a realized loss of $155,000. The foreign currency option is considered a derivative instrument. Foreign currency translation gain as of December 31, 2000 and 1999 was $1.1 million and $2 million, respectively. Foreign currency translation gain as of December 31, 1998 was $855,050, net of an unrealized loss on the foreign currency option for 1998 of $150,000. Assets and liabilities relating to investments in foreign corporations are translated into U.S. dollars using current exchange rates; revenues and expenses, if any, are translated into U.S. dollars using the average exchange rate for the month when incurred. Translation gains and losses, net of applicable taxes, are excluded from income and included in net unrealized loss, reported as accumulated other comprehensive income (loss) in stockholders' equity. 7) STOCKHOLDERS' EQUITY On August 12, 1999, pursuant to a Stock Purchase and Sale Agreement with Samstock, L.L.C. ("Samstock"), which agreement was assigned with the Company's consent by Samstock to its sole member, SZ Investments, L.L.C. ("SZ"), pursuant to an amendment and assignment agreement (such Purchase and Sale Agreement, as amended and assigned, the "Purchase Agreement"), the Company sold to SZ, for consideration of $9 million, 2,000,000 shares of Common Stock and a four year warrant (subject to extension in certain circumstances) to purchase an additional 2,000,000 shares of Common Stock at $4.75 per share. The warrant is subject to two types of downward price adjustments: (1) A pro-rata price adjustment if DHC issues additional shares for less than $4.75; (2) A formulaic adjustment to the warrant purchase price if certain insurance liabilities are actually paid in excess of $5 million of what was reported on the balance sheet at December 31, 1998. In order to provide sufficient available shares of Common Stock for this transaction, on July 20, 1999, DHC's stockholders approved an amendment to DHC's Certificate of Incorporation increasing DHC's authorized common stock from 20,000,000 shares to 100,000,000 shares. The stockholders also approved amendments to eliminate cumulative voting for Directors and to eliminate a prohibition on issuing non-voting equity securities. On December 29, 2000 and 1999, the Company sold, for aggregate cash consideration of $3,073,875 and $4,162,500, respectively, 819,700 and 900,000 newly issued shares of Common Stock, respectively. The sales were private placements to accredited investors made pursuant to Regulation D under the Securities Act of 1933. In 2000 and 1999, brokerage commissions of $33,900 and $54,000, respectively, were paid to M.J. Whitman, Inc., an affiliate of DHC, in connection with the placement of certain of those shares by M.J. Whitman, Inc. As of December 31, 2000, there were 19,306,694 shares of Common Stock issued of which 19,295,954 were outstanding; the remaining 10,740 shares of Common Stock issued but not outstanding are held as treasury stock. In connection with efforts to preserve the Company's net operating tax loss carryforwards, DHC has imposed restrictions on the ability of holders of five percent or more of DHC Common Stock to transfer the Common Stock owned by them and to acquire additional Common Stock, as well as the ability of others to become five percent stockholders as a result of transfers of Common Stock. 8) INCOME TAXES DHC files a Federal consolidated income tax return with its subsidiaries. DHC's Federal consolidated income tax return includes the taxable results of certain grantor trusts. These trusts were established by certain state insurance regulators and the courts as part of the 1990 reorganization from which the Mission Insurance Group, Inc. ("Mission") emerged from Federal bankruptcy and various state insolvency court proceedings as DHC. These trusts were created for the purpose of assuming various liabilities of their grantors, certain present and former subsidiaries of DHC (the "Mission Insurance Subsidiaries"). This allowed the state regulators to administer the continuing run-off of Mission's insurance business, while DHC and the Mission Insurance Subsidiaries were released, discharged and dismissed from the proceedings free of any claims and liabilities of any kind, including any obligation to provide further funding to the trusts. The agreements establishing the trusts provide the grantor of each trust with a certain "administrative power" which, as specified in Section 675(4)(C) of the Internal Revenue Code, requires that DHC include the income and deductions of each trust on its consolidated Federal income tax returns. This was to ensure that DHC's net operating loss carryforward would remain available to offset any post-restructuring taxable income of the trusts, thereby maximizing the amounts available for distribution to trust claimants. The Insurance Commissioner of the State of California and the Director of the Division of Insurance of the State of Missouri, as the trustees, have sole management authority over the trusts. Neither DHC nor any of its subsidiaries has any power to control or otherwise influence the management of the trusts nor do they have any rights with respect to the selection or replacement of the trustees. At the present time, it is not anticipated that any of the Mission Insurance Subsidiaries will receive any distribution with regard to their residual interests in the existing trusts. Since DHC does not have a controlling financial interest in these trusts, they are not consolidated with DHC for financial statement purposes. As of the close of 2000, the Company had a consolidated net operating loss carryforward of approximately $899 million for Federal income tax purposes. This estimate is based upon Federal consolidated income tax losses for the periods through December 31, 1999 and an estimate of 2000 taxable results. The net operating loss carryforward will expire in various amounts, if not used, between 2001 and 2019. The Internal Revenue Service has not audited any of the Company's tax returns for any of the years during the carryforward period including those returns for the years in which the losses giving rise to the net operating loss carryforward were reported. SFAS No. 109, which provides guidance on reporting for income taxes, requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Pursuant to SFAS No. 109, DHC makes periodic determinations of whether it is "more likely than not" that all or a portion of the Company's deferred tax assets will be realized. In making these determinations, the Company considers all of the relevant factors, both positive and negative, which may impact upon its future taxable income including the size and operating results of NAICC, the competitive environment in which NAICC operates and the impact of the grantor trusts. Exclusive of the trusts' activities, the Company has generated cumulative taxable losses on a historical basis. Over the past several years, the Company's insurance and holding company operations have been generating combined losses exclusive of net investment income, net realized gains and the trusts' activities. Therefore, due to the absence of a reliable taxable income stream, the Company has recorded a valuation allowance for the amount by which its deferred tax assets exceeds its deferred liabilities and, as a result, the Company has not recorded any liability or asset for deferred taxes. See Note 7 "STOCKHOLDERS' EQUITY" for a description of certain restrictions on the transfer of Common Stock. The Company's net operating tax loss carryforwards will expire, if not used, in the following amounts in the following years (dollars in thousands): Year Ending Amount of Carryforward December 31, Expiring ------------------------------------------------------------- 2001......................153,397 2002......................139,613 2003...................... 60,849 2004...................... 69,947 2005......................106,225 2006...................... 92,355 19 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------- DECEMBER 31, 2000, 1999, AND 1998 (CONTINUED) 2007......................89,790 2008......................31,688 2009......................39,689 2010......................23,600 2011......................19,755 2012......................38,255 2019......................33,636 ---------- $898,799 ========== The Company has made provisions for certain state and other taxes. Tax filings for these jurisdictions do not consolidate the activity of the trusts referred to above, and reflect preparation on a separate company basis. Tax expense consists of the following amounts (dollars in thousands): For the years ended December 31, ------------------------------- 2000 1999 1998 - -------------------------------------------------------------------------------- Federal income tax ........................... $ -- $ -- $ -- State and other .............................. 134 41 10 ------------------------------- $134 $ 41 $ 10 =============================== The following reflects a reconciliation of income tax expense computed by applying the applicable Federal income tax rate of 34 percent to continuing operations for 2000, 1999 and 1998, as compared to the provision for income taxes (dollars in thousands): For the years ended December 31, ----------------------------------------- 2000 1999 1998 - -------------------------------------------------------------------------------- Computed "expected" tax expense...................... $ 396 $ 462 $ 794 Change in valuation allowance ..... (89,394) (56,837) (12,573) Decrease (increase) in losses from the trusts.................. 30,303 (13,289) 7,125 Expiring NOL....................... 60,209 69,315 4,944 State and other tax expense........ 134 41 10 Other, net......................... (1,514) 349 (290) ----------------------------------------- Total income tax expense........... $ 134 $ 41 $ 10 ========================================= The tax effects of temporary differences that give rise to the deferred tax assets and liabilities at December 31, 2000 and 1999, respectively, are presented as follows (dollars in thousands): For the years ended December 31, ------------------------ 2000 1999 - ------------------------------------------------------------------------------- Deferred tax assets Loss reserve discounting ......................... $ 5,347 $ 5,032 Unearned premiums ................................ 1,605 984 Net operating loss carryforwards .................................. 305,592 395,800 Allowance for doubtful accounts ....................................... 200 93 Policyholder dividends ........................... 124 277 Unrealized loss on available- for-sale securities ............................ 72 713 Capital loss carryforwards ....................... -- 1,463 Other ............................................ 169 164 AMT credit carryforward .......................... 1,986 375 ------------------------ Total gross deferred tax asset ................... 315,095 404,901 Less: Valuation allowance ........................ (313,616) (403,649) ------------------------ Total deferred tax asset ......................... $ 1,479 $ 1,252 ------------------------ Deferred tax liabilities Deferred acquisition costs ....................... 1,246 857 Difference in tax basis of bonds ....................................... 166 127 Difference in tax basis of property and equipment ......................... 67 268 ------------------------ Total deferred tax liability ..................... 1,479 1,252 ------------------------ Net deferred tax asset ........................... $ -- $ -- ======================== 9) EMPLOYEE BENEFIT AND STOCK OPTION PLANS 1990 STOCK OPTION PLAN The 1990 Stock Option Plan (the "1990 Plan") of DHC was intended to attract, retain and provide incentives to key employees of DHC by offering them an opportunity to acquire or increase a proprietary interest in DHC. Options under the 1990 Plan were granted to existing officers or employees of DHC. Options under and outside the 1990 Plan would have been granted for, in the aggregate, the purchase of up to 2,030,000 shares of Common Stock. On March 13, 1991, options to purchase an aggregate of 630,000 shares were granted with an exercise price of $3.00 per share, the arithmetic average of the closing prices of the Common Stock on the American Stock Exchange for the 30 days prior to the date of grant. An additional 630,000 options were granted outside the 1990 Plan as of that date to Junkyard Partners, L.P. ("Junkyard Partners"), upon similar terms as those granted on that date under the 1990 Plan. During 1994, Junkyard Partners transferred 257,910 of its 630,000 options to one of its limited partners. On December 29, 1994, DHC issued 257,910 restricted shares of Common Stock upon the exercise of such transferred options. In connection therewith, DHC received a total exercise price of $773,730. Effective May 19, 1995, DHC purchased 69,453 of the remaining 372,090 options 20 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES to purchase Common Stock owned by Junkyard Partners. The options were exercisable at the time of such purchase and otherwise would have expired on March 13, 2001. The aggregate purchase price paid by DHC for the options was approximately $286,500, which was equal to the difference between the closing price of Common Stock on May 19, 1995 ($7.125 per share), the effective date of such purchase, and the exercise price of such options ($3.00 per share), or $4.125 per share. Effective November 12, 1997, DHC purchased 20,920 of the remaining 302,637 options to purchase Common Stock owned by Junkyard Partners. The options were exercisable at the time of such purchase and otherwise would have expired on March 13, 2001. The aggregate purchase price paid by DHC for the options was $107,215, which was equal to the difference between the closing price of Common Stock on November 12, 1997 ($8.125 per share), the effective date of such purchase, and the exercise price of such options ($3.00 per share), or $5.125 per share. On September 16, 1991, DHC granted, outside the 1990 Plan, options to purchase an aggregate of 140,000 shares of Common Stock with an exercise price of $3.63, the arithmetic average of the closing prices of the Common Stock on the American Stock Exchange for the thirty days prior to the date of grant. On this date, the Compensation Committee of the Board of Directors of DHC resolved that it intended to refrain from granting any additional options under the 1990 Plan. On June 13, 1997, options to purchase 210,000 shares of Common Stock granted under the 1990 Plan were exercised at their exercise price of $3.00. As a result, DHC received $630,000. As of December 31, 2000, 841,717 options granted under and outside the 1990 Plan were exercisable and unexercised. All such options expire ten years after the date of grant. The Board of Directors has voted to seek shareholder approval for an extension of 140,000 of these options held by three current directors for a term of an additional ten years. 1995 STOCK AND INCENTIVE PLAN The 1995 Stock and Incentive Plan (the "1995 Plan") is a qualified plan which provides for the grant of any or all of the following types of awards: stock options, including incentive stock options and non-qualified stock options; stock appreciation rights, whether in tandem with stock options or freestanding; restricted stock; incentive awards; and performance awards. The purpose of the 1995 Plan is to enable DHC to provide incentives to increase the personal financial identification of key personnel with the long term growth of the Company and the interests of DHC's stockholders through the ownership and performance of DHC's Common Stock, to enhance the Company's ability to retain key personnel, and to attract outstanding prospective employees and Directors. The 1995 Plan became effective as of March 21, 1995. No incentive stock options may be granted under the 1995 Plan after March 21, 2005. The 1995 Plan will remain in effect until all awards have been satisfied or expired. The aggregate number of shares of Common Stock which may be issued under the 1995 Plan, or as to which stock appreciation rights or other awards may be granted, may not exceed 1,700,000. On April 25, 1995, options to purchase 40,000 shares were granted under the 1995 Plan. The exercise price for such options is $7.00 per share (the mean of the high and low prices of the Common Stock on the American Stock Exchange on the date of grant). On January 15, 1996, options to purchase an aggregate of 158,900 shares of Common Stock were granted under the 1995 Plan. The exercise price for such options is $6.6875 per share (the mean of the high and low prices of the Common Stock on the American Stock Exchange on the date of grant). In 1997, 22,800 of such options expired. In 1999, 10,000 of such options expired. On September 17, 1996, options to purchase an aggregate of 120,000 shares of Common Stock were granted under the 1995 Plan. The exercise price for such options is $5.50 per share (the mean of the high and low prices of the Common Stock on the American Stock Exchange on the date of grant). On September 19, 1996, options to purchase an aggregate of 125,000 shares of Common Stock were granted under the 1995 Plan. The exercise price for such options is $5.6875 per share (the mean of the high and low prices of the Common Stock on the American Stock Exchange on the date of grant). In 1997, 1,500 of such options expired. In 2000, 5,000 of such options expired. On December 17, 1996, options to purchase an aggregate of 35,000 shares of Common Stock were granted under the 1995 Plan. The exercise price for all of such options is $4.9375 per share (the mean of the high and low prices of the Common Stock on the American Stock Exchange on the date of grant). In 1999, 10,000 of such options expired. On March 31, 1997, options to purchase 6,100 shares of Common Stock were exercised at their exercise price of $6.6875. As a result, DHC received $40,794. On July 1, 1997, options to purchase an aggregate amount of 10,000 shares of Common Stock were granted under the 1995 Plan. The exercise price for such options is $8.0625 (the mean of the high and low prices of the Common Stock on the American Stock Exchange on the date of the grant). In 1999, all of such options expired. On December 15, 1997, options to purchase an aggregate amount of 155,000 shares of Common Stock were granted under the 1995 Plan. The exercise price for such options is $7.0625 (the mean of the high and low prices of the Common Stock on the American Stock Exchange on the date of the grant). In 1999, 7,500 of such options expired. In 2000, 5,000 of such options expired. On December 2, 1998, options to purchase an aggregate amount of 167,500 shares of Common Stock were granted under the 1995 Plan. The exercise price for such options is $3.65625 (the mean of the high and low prices of the Common 21 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------- DECEMBER 31, 2000, 1999, AND 1998 (CONTINUED) Stock on the American Stock Exchange on the date of the grant). In 1999, 5,000 of such options expired. In 2000, 10,000 of such options expired. On December 8, 1999, options to purchase an aggregate amount of 142,500 shares of Common Stock were granted under the 1995 Plan. The exercise price for such options is $5.3125 (the mean of the high and low prices of the Common Stock on the American Stock Exchange on the date of the grant). In 2000, 10,000 of such options expired. On December 12, 2000, options to purchase an aggregate amount of 192,500 shares of Common Stock were granted under the 1995 plan. The exercise price for such options is $4.00 (the mean of the high and low prices of the Common Stock on the American Stock Exchange on the date of the grant). The Board of Directors has voted to seek shareholder approval and ratification of an amendment to the plan that will allow an additional grant of options to purchase 40,000 shares of Common Stock for each qualified outside Director. If that amendment is approved by shareholders and these grants are ratified, an additional 200,000 options shall be deemed issued as of December 12, 2000 at an exercise price of $4.00. At present, these options are not exercisable. As of December 31, 1999, 731,000 options granted under the 1995 Plan were exercisable. Options granted under the 1995 Plan generally become exercisable over three years and expire ten years after the date of grant. The Company applies APB Opinion 25 and Related Interpretations in accounting for the Stock Option Plans. Accordingly, no compensation cost has been recognized. Had compensation cost been determined based on the fair value at the grant date of the options consistent with the method of SFAS Statement 123, the net income and earnings per share would have been reduced to the pro forma amounts indicated below (dollars in thousands except per share amounts): 2000 1999 1998 - -------------------------------------------------------------------------------- Net income As reported ........................ $ 1,030 $1,255 $2,301 Pro forma .......................... $ 733 987 1,827 Diluted earnings per share As reported ........................ $ 0.05 $ 0.07 $ 0.14 Pro forma .......................... $ 0.04 0.06 0.11 The fair value of the option grants are estimated as of the date of grant using the Black-Scholes option pricing model with the following assumptions: dividend yield of 0% per annum; an expected life of approximately 8 years; expected volatility of 36%-59%; and a risk free interest rate of 6%. The pro forma effect on net income may not be representative of the effects on net income for future years. EMPLOYEE BENEFIT PLANS KCP maintains an Employee Stock Ownership Plan ("ESOP") of KCP and Subsidiaries covering all of its employees. The ESOP originally acquired common stock of KCP in February 1990, financed by a loan from KCP in the principal amount of $998,000 bearing interest at an annual rate of ten percent. Shares of DHC Common Stock were substituted for the KCP stock held by the ESOP as of December 31, 1991. The loan, which is guaranteed by KCP and collateralized by the DHC Common Stock held by the ESOP, was paid in full during 1997. All shares have been released from collateral and allocated to employees. All of the shares of Common Stock held by the ESOP are deemed to be outstanding for earnings per share computations. KCP has elected to include the value of the Common Stock allocated annually to participants under the ESOP in the calculation of its matching contribution to the KCP and Subsidiaries Salary Deferred Plan and Trust ("401(k) Plan"). The participating employers contributed 50 percent of the first six percent of employee-contributed compensation to the 401(k) Plan. The shares of Common Stock owned by the ESOP as of December 31, 2000 and 1999 were 60,728 and 76,893, respectively. KCP maintains a non-contributory defined benefit pension plan (the "Pension Plan") covering substantially all of its employees. Benefits under the Pension Plan are based on an employee's years of service and average final compensation. The funding policy of the Pension Plan provides for the participating employers to contribute the minimum pension costs equivalent to the amount required under the Employee Retirement Income Security Act of 1974, as amended, and the Internal Revenue Code of 1986, as amended. Vested benefits under the Pension Plan are fully funded. Any liability associated with the Pension Plan is reflected in the Company's Consolidated Financial Statements. The following table sets forth the Pension Plan's funded status at December 31, 2000 and 1999, valued at January 1, 2001 and 2000, respectively (dollars in thousands): 2000 1999 - ------------------------------------------------------------------------------- Actuarial present value of benefit obligations: Accumulated benefits obligation, including vested benefits of $1,482 for 2000 and $1,560 for 1999 ..................... $ 1,766 $ 1,749 ======================== Projected benefit obligation ....................... $ 1,769 $ 1,793 Plan assets at fair value .......................... 1,235 1,399 ------------------------ Projected benefit obligation in excess of plan assets ................................... (534) (394) Unrecognized net loss .............................. 201 76 Unrecognized prior service cost .................... 41 49 Adjustment required to recognize minimum liability ................................ -- -- ------------------------ (Accrued) prepaid pension cost ................... $ (292) $ (269) ======================== 22 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES Net pension costs for the years ended December 31, 2000, 1999, and 1998 include the following components: For the years ended December 31, ------------------------------ 2000 1999 1998 - -------------------------------------------------------------------------------- ------- Service cost ................................ $ 250 $ 243 $ 207 Interest cost ............................... 116 112 133 Expected (return) loss on plan assets ....... (25) (101) (128) Net amortization and deferral ............... (65) 8 8 ------------------------------ Net pension cost .......................... $ 276 $ 262 $ 220 ============================== The Pension Plan's assets consist of U.S. Government obligations, registered equity mutual funds and insured certificates of deposit. The average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.25 percent for 2000 and 1999 and 7.0 percent for 1998 . The projected long-term rate of return on assets was 7.5 percent for 2000, 1999 and 1998. The average rate of compensation increase used in determining the actuarial present value of the projected benefit obligation was 4.5 percent for 2000, 1999 and 1998. The following tables provide a reconciliation of the changes in the Pension Plan's benefit obligation and the fair value of plan assets as of December 31, 2000 and 1999 (dollars in thousands): 2000 1999 - ------------------------------------------------------------------------------- Reconciliation of Benefit Obligation Benefit Obligation, beginning of year ............ $ 1,793 $ 1,801 Service Cost ..................................... 250 243 Interest Cost .................................... 116 112 Actuarial (gain) loss ............................ 53 9 Benefits paid .................................... (443) (372) ------------------------ Benefit Obligation, end of year ............... $ 1,769 $ 1,793 ======================== Reconciliation of Plan Assets Plan Assets, beginning of year ................... $ 1,399 $ 1,490 Actual return on plan assets ..................... 25 101 Employer contributions ........................... 254 180 Benefits paid .................................... (443) (372) ------------------------ Plan Assets, end of year ...................... $ 1,235 $ 1,399 ======================== The prior service costs are amortized on a straight-line basis over the average remaining service period of active participants. Gains and losses in excess of 10 percent of the greater of the benefit obligation and the fair value of related plan assets are amortized over the average remaining service period of active participants. NAICC recognized $281,777, $134,745 and $246,838 in accrued pension benefit for the years ended December 31, 2000, 1999 and 1998, respectively. KCP maintains a 401(k) Plan in which all employees of KCP are eligible to participate. Under the 401(k) Plan, employees may elect to contribute up to 20 percent of their eligible compensation to a maximum dollar amount allowed by the IRS. KCP and subsidiaries contributed 50 percent of the first six percent of employee-contributed compensation. The participating employers have opted to include the value of the Common Stock allocated annually to participants under the ESOP in the calculation of their matching contribution. In 1999, 1998 and 1997, the employers' matching obligation to the 401(k) Plan was satisfied through ESOP shares, cash and forfeitures totaling $146,000, $129,000, and $156,000, respectively, in value. 10) LEASES DHC and its subsidiaries and affiliates have entered into various non-cancelable operating lease arrangements for office space and data processing equipment. The terms of the operating leases generally contain renewal options and escalation clauses based on increases in operating expenses and other factors. Rent expense under operating leases was $1.6 million for each of the years ended December 31, 2000 and 1999 and $1.5 million for the year ended December 31, 1998. At December 31, 2000, future net minimum operating lease rental payment commitments were as follows (dollars in thousands): Years Ending Minimum Operating Lease December 31, Rental Payments - -------------------------------------------------------------------------------- 2001................................................. $1,396 2002................................................. 1,319 2003................................................. 654 2004................................................. 433 2005 and thereafter.................................. -- ------ Total commitments.................................... $3,802 ====== 23 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------- DECEMBER 31, 2000, 1999, AND 1998 (CONTINUED) 11) ALLOWANCES The following table sets forth the activity related to the premiums and fees receivable at December 31, 2000 and 1999: 2000 1999 -------------------------- Beginning Balance: $ 274,028 $ 135,853 Increase to Allowance Charges to Expenses 726,426 444,244 Increase to Allowance Charges to Other Accounts 24,868 -- Deductions (437,693) (306,069) -------------------------- Ending Balance $ 587,629 $ 274,028 ========================== The increase in the allowance and related reductions to the allowance during the year are attributable to the growth in our automobile programs that have premium installment features. In conjunction with the increased installment premiums the Company experienced increased collection efforts relating to such premiums, especially for non-standard policies. 12) COMMITMENTS AND CONTINGENCIES NAICC is involved in litigation relating to losses arising from insurance contracts in the normal course of business which are provided for under "unpaid losses and loss adjustment expenses." NAICC also is involved in other litigation relating to environmental claims as well as general corporate matters. While litigation is by nature uncertain, management, based in part on advice from counsel, believes that the ultimate outcome of these actions will not have a material adverse effect on the consolidated financial position of DHC. On June 22, 1999, the Missouri Court of Appeals reversed a decision to award interest on claims under a plan of distribution of assets of the Mission Reinsurance Corporation Trust (the "Trust"). The effect of the decision of the Court of Appeals would have been to return to the Company the surplus existing in the Trust, which was one of the trusts that had been created in connection with the insolvency and reorganization of Mission Insurance Group, Inc. and its subsidiaries from which the Company emerged, which surplus was believed to approximate $14 million. The Missouri Department of Insurance appealed the decision of the Court of Appeals and the decision was reversed by the Supreme Court of Missouri. As a result, the Missouri Department of Insurance is permitted to pay interest on claims, and it is anticipated that there will be no surplus remaining in the Trust after payment of the interest. 13) RELATED PARTY TRANSACTIONS DHC shares certain personnel and facilities with several affiliated and unaffiliated companies who have certain common directors and officers, and certain expenses are allocated among the various entities. Personnel costs are allocated based upon actual time spent on DHC's business. Costs relating to office space and equipment are allocated based upon actual usage. Management believes the methodolgy used for allocation is appropriate. Total expenses allocated to DHC from affiliated entitites were $1,309,748, $1,193,941 and $1,168,226, for the years 2000, 1999 and 1998, respectively. Samuel Zell, the Chairman of the Board of DHC is the Chairman of Equity Group Investments, LLC ("EGI"). DHC has entered into a non-exclusive investment advisory agreement with EGI, pursuant to which EGI has agreed to provide certain investment banking services to the Company in connection with potential transactions. For these services, DHC pays an annual fee of $125,000 to EGI. In the event that any transaction is consummated for which the Acquisition Committee of DHC's Board of Directors determines that EGI provided material services, DHC will pay to EGI a fee in the amount of 1% of the consideration paid by DHC in connection with such transaction. Samuel Zell and Willaim Pate, who serves as Director of Mergers and Acquisitions for EGI, are both members of DHC's four member Acquisition Committee. DHC has also agreed to reimburse, upon request, EGI's out-of-pocket expenses related to the investment advisory agreement. 24 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES INDEPENDENT AUDITORS' REPORT --------------------------- The Board of Directors and Stockholders Danielson Holding Corporation We have audited the accompanying consolidated balance sheets of Danielson Holding Corporation and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally acccepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Danielson Holding Corporation and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally acccepted in the United States of America. /s/ KPMG LLP New York, New York March 7, 2001 RESPONSIBILITY FOR FINANCIAL REPORTING --------------------------- The Consolidated Financial Statements of Danielson Holding Corporation and subsidiaries are the responsibility of the Company's management, and have been prepared in accordance with accounting principles generally accepted in the United States of America. To help ensure the accuracy and integrity of its financial data, the Company maintains a strong system of internal controls designed to provide reasonable assurances that assets are safeguarded and that transactions are properly executed and recorded. The internal control system and compliance therewith are monitored by the Company's financial management. The Consolidated Financial Statements have been audited by the Company's independent auditors, KPMG LLP. The independent auditors, whose appointment by the Board of Directors was ratified by the Company's stockholders, express their opinion on the fairness of presentation, in all material respects, of the Company's Consolidated Financial Statements based on procedures which they consider to be sufficient to form their opinion. The Audit Committee of the Board of Directors meets periodically with representatives of KPMG LLP and the Company's financial management to review accounting, internal control, auditing and financial reporting matters. 25 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES QUARTERLY FINANCIAL DATA --------------------------- (UNAUDITED) The following table presents unaudited quarterly financial data for the years ended December 31, 2000 and 1999. In the opinion of management, all adjustments necessary to present fairly the results of operations for such periods are reflected. Total revenues and net income include gains on sales of investments. Quarterly financial results are not necessarily indicative of the results that may be expected for the year and hence, caution should be used in drawing conclusions from quarterly consolidated results. (In thousands, First Second Third Fourth except per share amounts) Quarter Quarter Quarter Quarter - -------------------------------------------------------------------------------- 2000: TOTAL REVENUES ....................... $20,859 $18,952 $21,389 $25,037 NET INCOME ........................... 3,435 1,324 1,267 (4,996) NET INCOME PER DILUTED SHARE ......... .18 .07 .07 (.27) 1999: Total revenues ....................... $14,585 $14,312 $15,415 $26,846 Net income ........................... 101 266 466 422 Net income per diluted share ......... .01 .01 .03 .02 STOCK MARKET PRICES --------------------------- Danielson Holding Corporation Common Stock is listed and traded on the American Stock Exchange (symbol: DHC). On March 21, 2001, there were approximately 1,361 holders of record of Common Stock. The following table sets forth the high, low and closing stock prices of the Company's Common Stock for the last two years, as reported on the American Stock Exchange Composite Tape. 2000 1999 ------------------------------------------------------ HIGH LOW CLOSE High Low Close ------------------------------------------------------ First Quarter.......... 7 3/8 4 3/4 6 3/8 4 5/8 2 7/8 2 7/8 Second Quarter......... 6 1/4 4 5/8 4 7/8 5 3/4 2 7/8 5 3/8 Third Quarter.......... 5 3 7/8 4 2/16 7 1/2 5 1/4 5 5/8 Fourth Quarter......... 4 9/16 3 9/16 4 9/16 6 1/8 4 5/8 5 3/4 ------------------------------------------------------ 26 DANIELSON HOLDING CORPORATION AND SUBSIDIARIES CORPORATE OFFICERS Martin J. Whitman Chief Executive Officer David M. Barse President and Chief Operating Officer Michael T. Carney Chief Financial Officer and Treasurer W. James Hall General Counsel and Secretary BOARD OF DIRECTORS David M. Barse President and Chief Operating Officer, Danielson Holding Corporation Stanley J. Garstka Deputy Dean and Professor in the Practice of Management, Yale University School of Management Eugene M. Isenberg Chairman of the Board and Chief Executive Officer, Nabors Industries, Inc. William Pate Director of Mergers and Acquisitions, Equity Group Investments, LLC Joseph F. Porrino Counsellor to the President, New School University Frank B. Ryan Professor of Mathematics, Rice University Wallace O. Sellers Vice Chairman and Director, Enhance Financial Services Group, Inc. Martin J. Whitman Chief Executive Officer, Danielson Holding Corporation Samuel Zell Chairman, Equity Group Investments, LLC Harry LeVine State of California Department of Insurance Form 10-K A copy of Danielson's Form 10-K as filed with the Securities and Exchange Commission may be obtained without charge by writing to: Danielson Holding Corporation 767 Third Avenue - Fifth Floor New York, NY 10017-2023 Attention: Lisa Morris Investor Relations 212/888-0347 Stock Transfer Agent and Registrar American Stock Transfer and Trust Company 40 Wall Street New York, NY 10005 718/921-8261 Independent Certified Public Accountants KPMG LLP 757 Third Avenue New York, NY 10017 -----END PRIVACY-ENHANCED MESSAGE-----