The significant ACL-owned facilities among these properties include the Jeffboat shipbuilding facility in Jeffersonville, Indiana, which is the largest single-site shipyard facility on the Inland Waterways. It is situated on 86 acres with 5,600 feet of frontage on the Ohio River across from Louisville, Kentucky. There are 38 buildings on the property comprising a total of 305,000 square feet under roof.
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.
DHC is a holding company that conducts substantially all of its operations through its subsidiaries. DHC's parent-only operations consist primarily of investment return on portfolio securities and limited administrative and operating expenses, which are not material to DHC on a consolidated basis. DHC possesses approximately $605 million of tax net operating loss carryforwards. DHC's strategic and business plan is to acquire businesses that will allow DHC to earn an attractive return on its investment.
Notwithstanding the foregoing, the financial condition and results of operations of DHC's separate business lines will impact DHC's available capital resources that will be needed for DHC to expand through acquisitions. The net effect of the operations of DHC's subsidiaries on DHC's liquidity is discussed below under "Liquidity and Capital Resources".
Also on May 29, 2002, DHC acquired a 5.4% interest in GMS, an entity in which ACL has a 50% ownership interest. GMS is an owner and operator of 26 marine terminal and warehouse facilities located in the United States and the Netherlands. In addition, GMS has a 27% equity interest in GMSV, a joint venture engaged in the unloading of barges in Venezuela. ACL has a 42% direct ownership interest in GMSV. Danielson, through its ownership of ACL and GMS, has a 57% direct ownership interest in GMSV. Danielson consolidates the financial statements of GMS and GMSV in its financial statements.
four percent or an Alternate Base Rate (as defined in the DIP Credit Facility) plus three percent. There are also certain interest rates in the event of a default under the DIP Credit Facility.
The DIP Credit Facility also contains certain restrictive covenants that, among other things, restrict the Debtors' ability to incur additional indebtedness or guarantee the obligations of others. ACL is also required to maintain minimum cumulative EBITDA, as defined in the DIP Credit Facility, and limit its capital expenditures.
Under Chapter 11, actions by creditors to collect claims in existence at the filing date are stayed or deferred absent specific Bankruptcy Court authorization to pay such pre-petition claims while ACL continues to manage its business as a debtor-in-possession and acts to develop a plan of reorganization for the purpose of emerging from the Chapter 11 proceedings.
The amount of the claims to be filed against ACL by their creditors could be significantly different than the amount of the liabilities recorded by ACL. ACL also has numerous executory contracts and other agreements that could be assumed or rejected during the Chapter 11 proceedings. Parties affected by these rejections may file claims with the Bankruptcy Court in accordance with the reorganization process. Under these Chapter 11 proceedings, the rights of and ultimate payments to pre-petition creditors, rejection damage claimants and equity investors in ACL (which DHC controls through its ownership of ACLines which owns 100% of the interests in ACL's parent, ACL Holdings) may be substantially altered. This could result in claims being liquidated in the Chapter 11 proceedings at less (possible substantially less) than 100% of their face value, and the membership interests of ACL, which are indirectly, wholly-owned by DHC, being substantially or totally diluted or cancelled.
The Chapter 11 process presents inherent material uncertainty. It is not possible to determine the additional amount of claims that may arise or ultimately be filed, or predict (i) the length of time that the Debtors will continue to operate under the protection of Chapter 11, (ii) the outcome of the Chapter 11 proceedings in general, (iii) whether the Debtors will continue to operate in their present organizational structure, or (iv) the effects of the proceedings on the business of ACL, the other Debtors and its non-filing subsidiaries and affiliates, or on the interests of the various creditors, security holders and equity holders. The ultimate recovery, if any, by creditors, security holders and ACL equity holders (100% controlled and indirectly wholly owned by DHC) will not be determined until confirmation of a plan or plans of reorganization. No assurance can be given as to what value, if any, will be ascribed in the bankruptcy proceedings to each of these constituencies, including DHC's equity interest in ACL, which could be substantially or totally diluted or cancelled.
Through May 28, 2002, ACL was in default under its bank and bond debt, as well as its receivables facility, due to nonpayment of interest on the debt as well as other covenant violations. On December 31, 2001, and subsequent thereto, ACL elected not to pay the interest due on its bank and bond debt due to ongoing negotiations with its bankers and note holders regarding the restructuring of the debt. ACL obtained forbearance agreements or waivers which enabled it to complete the Danielson Recapitalization and the debt restructuring described below.
On April 11, 2002, ACL and certain lenders executed an amendment agreement under which the Old Senior Credit Facilities would be amended and restated upon the satisfaction of certain conditions set forth in the amendment agreement, including the consummation of the Danielson Recapitalization.
Also effective May 29, 2002, ACL's receivables facility, which was administered by PNC Bank, N.A., was replaced with a Receivables Purchase Agreement among American Commercial Lines Funding Corporation, ACBL, Jupiter Securitization Corporation and Bank One, NA (the "Pre-Petition Receivables Facility") having substantially the same terms as the previous receivables facility. The Pre-Petition Receivables Facility was retired by ACL on January 31, 2003 with funds from the DIP Credit Facility.
On July 3, 2002, Jeffboat, ACL's marine construction subsidiary, and its unionized employees represented by the International Brotherhood of Teamsters, Local No. 89, agreed upon a new collective bargaining agreement, ending a two month long strike. The previous collective bargaining agreement had expired on April 29, 2002 and the unionized employees chose to strike from April 30, 2002 until July 9, 2002, when they returned to work pursuant to the terms of the new collective bargaining agreement.
ADDITIONAL ACL FINANCIAL RESTRUCTURING PRIOR TO BANKRUPTCY AND ACL CHAPTER 11 FILING
As discussed in this Report at Item 1, Business -- Marine Services -- ACL Bankruptcy Considerations, in response to weak market and poor economic conditions during 2002 and the beginning of 2003, and because of ACL's highly leveraged position, ACL filed for protection under Chapter 11 of the Bankruptcy Code. Prior to the Chapter 11 filing, ACL had been pursuing other financial restructuring alternatives, which are described below.
coverage ratios. Compliance with financial ratios is measured at the end of each quarter. The Indentures also contain certain cross default provisions. ACL's ability to meet the financial ratios is affected by adverse weather conditions, seasonality and other risk factors inherent in its business.
The Senior Credit Facilities also contain provisions which require mandatory prepayments of the Term Loans with net proceeds from certain asset sales, equity issuances, incurrence of indebtedness and sale and leaseback transactions, as well as certain excess cash flow.
Although ACL management had been working on operating and financial plans to comply with its debt covenants in 2003 and thereafter, ACL was unable to complete an out-of-court restructuring and ACL management believed it was probable that ACL would not be in compliance with the covenants in the Senior Credit Facilities at the end of the first quarter 2003, absent another amendment to the Senior Credit Facilities.
On July 24, 2002, NAICC, DHC's primary operating insurance subsidiary, decided to increase the aggregate net written premium run rate of its non-standard private passenger automobile insurance in the State of California and commercial automobile insurance in certain western states, including California, from $30 million to $50 million. This decision was intended to capitalize on favorable loss ratios occurring in NAICC's automobile insurance lines and to solidify the distribution network of NAICC's products.
As discussed further in this Report at Item 1, Business -- Marine Services -- ACL Bankruptcy Considerations, ACL filed for protection under Chapter 11 of the Bankruptcy Code. As a result, it was determined for statutory insurance accounting purposes that NAICC's investment in ACL was fully impaired. At December 31, 2002, NAICC recognized a statutory charge to its surplus of $7.4 million. This charge, when combined with NAICC's underwriting results reduced it's statutory surplus level below the Company Action Level of NAICC's risk based capital calculation. In response to the above statutory condition, DHC repaid the $4 million note due May 2004 to NAICC, and further contributed $4 million to NAICC to increase its
DHC 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 DHC's 2002 consolidated Federal income tax return will report a cumulative net operating loss carryforward currently estimated at $606 million, which will expire in various amounts, if not used, between 2003 and 2019. Exclusive of the trusts' activities, DHC has generated cumulative taxable losses both historically and during the prior three years. Over the past several years, DHC's insurance operations have been generating losses exclusive of net investment income, net realized gains and the trusts' activities. In 2002, DHC generated income at the holding company level due to the gain recognized from adjusting the ACL notes to fair value prior to and in connection with the Danielson Recapitalization. Prior to 2002, DHC has historically generated losses at the holding company level. Therefore, these tax loss attributes are currently fully reserved in DHC's financial statements. See Note 14 of the Notes to Consolidated Financial Statements.
YEAR ENDED DECEMBER 27, 2002 COMPARED WITH YEAR ENDED DECEMBER 31, 2001
Marine Services Year Ended December 27, 2002 Compared with Year Ended December 28, 2001
ACL follows a 52/53 week fiscal year ending on the last Friday in December of each year.
a third party barge operator in Venezuela to transport equipment from the United States to Venezuela. The increase was partially offset by the absence of payments for minimum contract tonnage in Venezuela.
Revenue at Jeffboat increased $19.6 million to $81.5 due to increased sales of dry cargo hoppers, partially offset by reduced sales of tank barges. In 2001, $40.8 million of Jeffboat revenue was from the sale of hoppers to Vessel Leasing. This revenue has been eliminated in the pro-forma operating information because Vessel Leasing is now consolidated with ACL.
Terminals revenue increased $6.2 million due to the start of the GMSV operation in 2002 and higher cargo handling revenue from GMS, partially offset by lower revenue from ACL's terminal in Venezuela, lower revenue from ACL's liquid transfer and storage facility and lower storage revenue from GMS.
Domestic barging expenses increased $1.8 million to $596.4 million due to lower gains on property dispositions, higher consulting and legal fees primarily associated with the Danielson Recapitalization, and higher equipment repair expense, partially offset by reduced fuel prices, lower barge freight volume, better operating conditions in the first half of 2002 and lower boat depreciation expense due to a change in the estimated useful life of towboats. Average fuel price before user tax decreased 11 cents per gallon to 71 cents per gallon on a 2002 volume of 105 million gallons.
Jeffboat's expenses increased $24.9 million to $82.2 million due to increased dry cargo hopper production, partially offset by reduced tank barge production.
Net premiums earned were $62.2 million in 2002 as compared to $81.9 million in 2001. The change in net premiums earned during those years is directly related to the change in net premiums written. Net written premiums were $52.6 million and $80.4 million in 2002 and 2001, respectively. Net earned premiums exceeded net written premiums in 2002 due to the decision to cease writing in several lines of business as noted above.
The overall decrease in net written premium for 2002 over the comparable period in 2001 is attributable to significant reduction in our commercial automobile line and the decision made in 2001 to exit both the workers' compensation line of business in all states and private passenger automobile outside of California. Workers' compensation net written premium decreased by $14.1 million during 2002 over the comparable period in 2001. The commercial automobile net written premium decreased from $38.4 million in 2001 to $19.5 million in 2002 due to curtailed underwriting activity. Net written premiums for personal automobile lines increased by $5.3 million during 2002 primarily due to premium growth in the non-standard California private passenger automobile programs in excess of the decline in net written premium outside of California.
Premium and fees receivable, net of allowances, decreased by $7.2 million or 49%. The decrease is attributable to the decision to significantly reduce NAICC's underwriting operations. Prior to that decision, NAICC experienced significant growth in installment premiums related to its commercial automobile program during 2001. NAICC's automobile programs have installment features on policy terms in excess of six months. Premiums from the automobile program that generally offer policy terms less than six months and do not utilize installment plans increased in 2002. The effect of these trends was to magnify the overall decrease in installment premium receivable during 2002.
The increase in the allowance for premiums and fees receivable during 2002 of $0.2 million was attributable to the increase in installment premiums during 2001 prior to the decision to contract underwriting operations in the commercial automobile line. In conjunction with the increase in installment premiums during 2001, NAICC experienced an increase in collection efforts relating to such premiums. As a result, NAICC increased both its allowance for premiums and the amount written-off against such allowance during 2002.
Net investment income was $5.6 million in 2002 compared to $7.6 million in 2001. The net investment income decrease is due primarily to a decrease in the fixed income portfolio. The fixed-income invested asset portfolio decreased by $25.9 million in 2002 compared to an increase of $0.9 million in 2001. The decrease during 2002 is attributable to the conversion of $9.2 million of ACL notes into equity in addition to maturities and pay-downs. As a result of the decrease in written premiums noted above, maturities and pay-downs were not reinvested at the same level as in 2001. As of December 31, 2002 and 2001, the average yield on NAICC's portfolio was 5.9% and 5.8%, respectively. The estimated average duration of the portfolio at December 31, 2002 is 2.7 years compared to 3.2 at December 31, 2001.
Net losses and loss adjustment expenses (LAE) incurred were $59.9 million in 2002 compared to $76.5 million in 2001. The resulting net loss and LAE ratios were 96.3% in 2002 and 93.5% in 2001. The increase in the loss and LAE ratio during 2002 was attributable to higher than expected losses in the California private passenger automobile and commercial automobile programs totaling $2.8 million and $2.0 million, respectively. In addition, NAICC had significant adverse development in the California workers' compensation line and non-California private passenger automobile. Adverse development on prior accident years recognized for workers' compensation in 2002 was $3.6 million. The adverse development for prior accident years related to the private passenger automobile lines placed in run-off was $2.0 million. Adverse development on prior accident years recognized for workers' compensation in 2001 totaled $4.4 million. The
Policy acquisition costs were $14.1 million in 2002 compared to $20.8 million in 2001. As a percent of net premiums earned, policy acquisition expenses were 22.7% in 2002 and 25.3% in 2001. Policy acquisition costs include expenses which are 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 decrease in the policy acquisition expense ratio in 2002, compared to 2001, is due to a reduction of acquisition costs of $1.9 million primarily as the result of the decision in 2001 to exit those lines mentioned above.
General and administrative expenses were $5.9 million in 2002 compared to $8.7 million in 2001. General and administrative expenses have decreased in 2002 due to decreased production and previously implemented cost containment efforts. General and administrative expenses in 2001 also include $0.9 million in amortization of goodwill expense. As a percent of net premiums earned, general and administrative expenses were 9.5% in 2002 and 10.7% in 2001. The decrease in 2002 reflects decreased production in 2002 and the effect of cost saving measures implemented during 2001. The 2001 ratio includes an additional $1.25 million of costs associated with the decision to contract NAICC's underwriting operations. Those costs included employee severance payments of approximately $0.5 million and a write-off of goodwill of approximately $0.7 million. These costs added 1.5% to the 2001 ratio.
Combined underwriting ratios were 128.5% and 129.4% in 2002 and 2001, respectively. The combined ratio decrease in 2002 reflects reductions in both policy acquisition and administrative expenses, that was partially offset by an increase in loss and LAE during 2002 compared to 2001.
Year Ended December 27, 2002 Compared with Year Ended December 31, 2001 -- Parent Company Only Administrative Expense and Danielson Interest Expense
Administrative Expense. Parent company administrative expense increased $2.5 million to $4.9 million for the year ending December 2002 as compared to $2.4 million for the year ending December 2001. The increase is primarily due to expense for stock options, which were modified as of July 24, 2002, one time increases in management compensation related to the resignation of certain DHC management in connection with its acquisition of ACL, higher directors' fees and additional insurance expense. Prior to the acquisition of ACL and shortly thereafter, DHC shared certain personnel and facilities with several affiliated and unaffiliated companies who have certain common directors and officers, and certain expenses were allocated among the various entities. Personnel costs were allocated based upon actual time spent on DHC business. Costs relating to office space and equipment were allocated based upon actual usage. Management believes the methodology used for allocation is appropriate. Total expenses include $1.8 million in 2002 and $1.3 million in 2001 related to expenses allocated to DHC from affiliated entities.
Other Expense (Income). Parent company gains on investments increased to $8.8 million for the year ending December 2002 as compared to $0.3 million for the year ending December 2001 due to recognition of $8.4 million in gain on ACL bonds owned by DHC that were contributed as part of the purchase price of ACL Holdings. The remaining $0.4 million gain on investments in 2002 was due to the sale of Home Product Bonds during the fourth quarter and is included in Net, Other Expense (Income).
Insurance Services Year Ended December 31, 2001 Compared with Year Ended December 31, 2000
Net premiums earned were $81.9 million in 2001 compared to $67.0 million in 2000. The change in net premiums earned was directly related to the change in net written premiums. Net written premiums were $80.4 million in 2001 compared to $73.1 million in 2000. Net earned premiums exceeded net written premiums in 2001 due to the decision to cease writing in several lines of business as noted above.
Premiums and fees receivable, net of allowances, decreased by $0.7 million or 4.3%. The decrease is attributable to the decision to reduce NAICC's underwriting operations. Prior to that decision, NAICC experienced significant growth in installment premiums related to its commercial automobile program. NAICC's automobile programs have installment features on policy terms in excess of six months. Premiums from the automobile program that generally offer policy terms less than six months and do not utilize installment plans increased slightly in 2001. The effect of these trends was to mitigate the overall decrease in installment premium receivable during 2001.
The increase in the allowance for premiums and fees receivable during 2001 of $0.8 million was attributable to the increase in installment premiums during 2001 prior to the decision to decrease underwriting operations. In conjunction with the increase in installment premiums, NAICC experienced an increase in collection efforts relating to such premiums, especially non-standard private passenger automobile policies outside of California. As a result, NAICC increased both its allowance for premiums and the amount of write-offs against such allowance.
General and administrative expenses were $8.7 million in 2001 compared to $5.7 million in 2000. As a percent of net premiums earned, general and administrative expenses were 10.7% in 2002 and 8.5% in 2000. General and administrative expenses increased in 2001 due to increased production for the first nine months of 2001 and an additional $1.25 million of costs associated with the decision to reduce NAICC's underwriting operations. Those costs include both severance to terminated employees of approximately $0.5 million and the write-off of goodwill of approximately $0.7 million. These costs added 1.53% to the 2001 ratio.
Combined underwriting ratios were 129.4% in 2001 compared to 123.1% in 2000. The increase in the combined ratio in 2001 was primarily the result of increased loss costs and increased costs associated with the decision to contract NAICC's underwriting operations as discussed above.
The insurance operations had a loss from operations of $13.8 million in 2001, compared to income from operations of $1.8 million in 2000. The increase in the loss for 2001 was primarily attributable to increases in loss and LAE primarily in the non-California private passenger automobile and workers' compensation lines of business. The increase in the loss for 2001 was also attributable to costs associated with the reduction of insurance operations.
Domestic barging demand for bulk, steel and liquid commodities is expected to remain at 2002 levels for the first half of 2003. The domestic barging demand for grain freight is driven by the supply of and demand for corn and other grains. The U.S. Department of Agriculture currently forecasts 2002/2003 crop year corn exports of 1.75 billion bushels and Sparks Company Inc. a private grain forecast service predicts 2002/2003 crop year exports of 1.725 billion bushels as compared to actual exports of 1.89 billion bushels for the 2001/2002 crop year.
NAICC management expects that the business environment in California will remain neutral and competitive. The effect of the decision in 2001 to exit certain lines of business, as expected, was a substantial reduction in the underwriting operations of NAICC in 2002 evidenced by a 35% reduction in net written premium. However, this reduced premium activity did not have the desired impact of improving overall profitability as the loss and loss adjustment costs associated with the lines placed into run-off during 2001 exceeded estimates. As a result, NAICC expects a further reduction of premium volume during 2003. Management is continually evaluating its filed rates and expects to file adjustments as needed. Cost reductions initiated in 2001 and 2002 should mitigate the impact of the expected premium reduction. NAICC is experiencing a condition in which claim payments related to the lines placed into run-off exceed premium receipts from those lines. Management expects the trend in negative cash flow to continue for several years until premium growth in the remaining lines of business becomes sufficient to support operations.
The preparation of financial statements in conformity with generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the same period. Actual results could differ from those estimates.
The primary source of Marine Services' revenue, barge transportation revenue, is recognized on a percentage of completion basis. The proportion of barge transportation revenue to be recognized is determined by applying a percentage to the contractual charges for such services. The percentage is determined by dividing the number of miles from the loading point to the position of the barge as of the end of the accounting period by the total miles from the loading point to the barge destination as specified in the customer's freight contract. The position of the barge at accounting period end is determined by locating the position of the boat
with the barge in tow through use of a global positioning system. The recognition of revenue based upon the percent of voyage completion results in a better matching of revenue and expenses. Marine construction, repair and harbor service revenue is recognized based upon the completed contract method. Losses are accrued if construction costs are expected to exceed construction contract revenue. Terminal revenue is recognized as services are performed.
Harbor and towing service charges are estimated as service incidents occur based upon recent historical charges by vendor for the same type of service event. Service events are recorded by vendor and location in ACL's barge tracking system. Vendor charges are estimated for these events based on current published vendor rates. Vendor charges can vary based upon the number of boat hours required to complete the service, the grouping of barges in vendor tows and the quantity of man hours and materials required. DHC management believes it has recorded sufficient liabilities for these services. Changes to these estimates could have a significant impact on ACL's financial results.
Assets and liabilities of DHC's defined benefit plans are determined on an actuarial basis and are affected by the estimated market value of plan assets, estimates of the expected return on plan assets, and discount rates. Actual changes in the fair market value of plan assets and differences between the actual return on plan assets and the expected return on plan assets will affect the amount of pension expense ultimately recognized, impacting DHC's results of operations. The liability for post-retirement medical and life insurance benefits is also determined on an actuarial basis and is affected by assumptions including the discount rate and expected trends in health care costs. Changes in the discount rate and differences between actual and expected health care costs will affect the recorded amount of post-retirement benefits expense, impacting DHC's results of operations.
ACL is self-insured for the medical benefit plans covering most of its employees. DHC estimates its liability for claims incurred by applying a lag factor to ACL's historical claims and administrative cost experience. The validity of the lag factor is evaluated periodically and revised if necessary. Although management believes the current estimated liabilities for medical claims are reasonable, changes in the lag in reporting claims, changes in claims experience, unusually large claims, and other factors could materially affect the recorded liabilities and expense, impacting financial condition and results of operations.
Statement of Financial Accounting standards No. 123, "Accounting for Stock-Based Compensation," ("SFAS 123") gives companies the choice to account for stock-based compensation using either the fair value method or the intrinsic value method of APB Opinion No. 25, "Accounting for Stock Issued to Employees." Danielson has elected to account for its stock option plans using the intrinsic value method. Because most of the options granted to employees and directors under those plans have had an exercise price equal to the market value of the underlying common stock on the date of grant, only minimal stock-based compensation cost due to modifications had been recognized in the consolidated statements of operations for those options. In 2002, options granted to contractors resulted in more significant expense being recognized under SFAS 123. Had DHC elected to account for all of its stock option grants using the fair value method of SFAS 123, or if accounting rules change to require accounting different than the intrinsic value method, DHC's results of operations could be materially affected.
Danielson management periodically reviews long-lived assets for impairment. Cash flows by operating unit are estimated based upon long-term historical trends, management's knowledge of the relationship between the supply of barges and the demand for barge transportation and construction services and management's estimates of future trends regarding significant operating revenues and costs. These estimates are subject to uncertainty. ACL's significant assets were preliminarily appraised in conjunction with the ACL acquisition. Based on these preliminary appraisals and the estimates of future cash flows, management believes that ACL's long-lived assets are not impaired.
The Insurance Services group maintains reserves for losses and loss expenses to cover the estimated liability for unpaid claims, including legal and other fees as well as a portion of our general expenses, for reported and unreported claims incurred as of the end of each accounting period. Reserves represent an estimate of the cost of the expected ultimate settlement and administration of the claims. Such estimates are based upon estimates for reported losses and historical company and industry experience for loss development. The ultimate cost of claims is difficult to predict for several reasons. The variables described above are affected by both internal and external events, such as changes in rates of inflation and the legal environment, which create forecasting complications. Court decisions may dramatically increase liability in the time between the dates on which a claim is reported and its resolution. Punitive damage 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.
Due to the factors discussed above and others, the process used in estimating unpaid losses and loss adjustment expenses cannot provide an exact result. Danielson's results of operations for each of the past three years have been adversely affected by insurance loss development related to prior years of $10.4 million, $7.6 million and $5.3 million for 2002, 2001 and 2000, respectively.
See, Note 1 of the Notes to the Consolidated Financial Statements, for a further discussion of significant accounting policies.
Upon consummation of the recapitalization, Danielson acquired 100% of the membership interests of ACL Holdings for $7.0 million in cash paid to preferred unit holders, cash of $25.0 million contributed to ACL Holdings, Old Senior Notes and accrued interest, if any, having an estimated fair value of $43.7 million contributed to ACL Holdings and $6.6 million in fees.
As of December 27, 2002, cash and investments of DHC were approximately $6.4 million.
In 2001, DHC borrowed $4 million from NAICC at an annual interest rate of 6%, to be repaid by 2004. This loan was subsequently repaid in February 2003. In 2002 and 2000 DHC received cash in the amount of $42.2 million and $3.1 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 or loans from its insurance subsidiaries without prior regulatory approval. In 2000, NAICC received regulatory approval and paid a $1.5 million dividend to DHC. As noted above, ACL cannot pay dividends to DHC since it is currently in Chapter 11.
DHC's domestic insurance companies are regulated by the insurance regulatory agencies of the states in which they are authorized to do business. Many aspects of the Company's insurance business are subject to regulation. For example, minimum capitalization must be maintained; certain forms of policies must be approved before they may be offered; reserves must be established in relation to the amounts of premiums earned and losses incurred; and, in some cases, schedules of premium rates must be approved.
As of December 27, 2002, DHC's Marine Services subsidiaries had outstanding indebtedness of $700.5 million, including $313.3 million drawn under ACL's Term Loans, $41.0 million drawn under ACL's Revolving Credit Facility, $137.1 million aggregate principal amount of new 11.25% ACL Senior Notes, $116.1 million of new 12% ACL PIK Notes, $6.5 million of Old Senior Notes and $0.3 million in ACL other debt. Long-term debt also includes $39.7 million in Vessel Leasing bonds guaranteed by the U.S. Maritime Administration, $33.7 million in GMS bank debt, $2.9 drawn under GMS's revolving credit facility, $5.3 million in Illinois Development Finance Authority bond proceeds outstanding to GMS, $0.8 million in GMS other debt, $2.8 million in GMSV bank debt and $1.0 million in GMSV other debt. The ACL debt assumed by Danielson as part of the acquisition was adjusted to fair value at the acquisition date. The total amount of the unamortized discount as of December 27, 2002 is $57.4 million. The difference between the principal amount of the debt and its fair value is being accreted as interest expense over the term of the debt under the effective interest method. Accordingly, as of December 27, 2002, the carrying value of the Senior Notes was $128.5 million, the carrying value of the PIK Notes was $68.8 million and the carrying value of the Old Senior Notes was $5.0 million. As of December 27, 2002, ACL also had $1.6 million and GMS had $1.7 million in outstanding capital lease obligations which are included in other current and long-term liabilities. As of December 27, 2002 ACL had securitized $39.3 million of the trade receivables of two subsidiaries. DHC does not guarantee the debt of ACL, Vessel Leasing, GMS or GMSV.
As of March 27, 2003, ACL had drawn $50.0 million under the DIP Credit Facility. Terms of the DIP Credit Facility are discussed in this Report at Item 1, Business -- Description of Businesses -- ACL Bankruptcy Considerations.
Capital expenditures were $18.2 million for 2002. Cash expenditures in 2002 included $8.1 million for domestic marine equipment acquisitions and $4.5 million for terminal equipment maintenance. The remaining $5.6 million in cash capital expenditures in 2002 was primarily for marine equipment maintenance.
ACL is highly leveraged, which makes it vulnerable to changes in general economic conditions and to worldwide weather conditions, particularly those affecting North and South America, given the nature of ACL's business. ACL's ability to reorganize under Chapter 11 will depend on, among other things, financial, business, market, competitive and other conditions, many of which are beyond ACL's control.
- the absence of unusually adverse weather conditions during 2003, which, if adverse, could reduce or eliminate ACL's ability to navigate on certain river segments, adversely affect ACL's operational efficiencies and reduce overall volumes transported; and
Demand for freight moved by ACL barges is influenced by the economic demand for the cargoes. A decrease in that demand could adversely affect ACL's operating cash flows. Some cargoes are more highly dependent upon general economic conditions, such as certain liquid and steel cargoes which have experienced softening in demand over the past year.
ACL has various environmental matters that could have an impact on its financial condition, results of operations and cash flows. These environmental matters are discussed in this Report at Item 3, Legal Proceedings.
On January 31, 2003, the debt rating agency Standard & Poor's lowered its rating on ACL's Senior Subordinated Notes to "D" from "CC" and its rating on ACL's Senior Credit Facilities was lowered to "D" from "CCC+". The Senior Note debt rating, which had been lowered to "D" on January 2, 2003, remained unchanged. The bank loan and subordinated debt ratings were removed from CreditWatch, where they had been placed November 14, 2002.
DHC'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. NAICC 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. 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. NAICC meets both its short-term and long-term liquidity requirements through operating cash flows that include premium receipts, investment income, realized gains, and reinsurance recoveries. To the extent operating cash flows do not provide sufficient cash flow, NAICC relies on the sale of invested assets.
Cash used in insurance operations was $23.8 million in 2002. Cash used in operations was $3.9 million in 2001. Cash provided by insurance operations was $8.8 million in 2000. The increase in cash used by insurance operations for 2002 as compared to 2001 is primarily attributable to the deterioration of underwriting results and the decision in 2001 to place certain lines of business into runoff. Due to premium growth during the first nine months of 2001, NAICC was able to meet its short-term cash needs primarily through premium receipts. In light of the decision to reduce NAICC's underwriting operations, funds provided from premium receipts
The National Association of Insurance Commissioners ("NAIC") provides minimum solvency standards in the form of risk based capital requirements ("RBC"). The RBC model for property and casualty insurance companies requires that companies are to report their RBC ratios based on their statutory annual statements as filed with the regulatory authorities. NAICC has calculated its RBC requirement under the RBC model and believes that it has sufficient capital for its operations. Further, the NAIC has developed the Insurance Regulatory Information System ("IRIS"). IRIS identifies twelve ratios for property/casualty insurance companies. IRIS specifies ranges of "usual values" for each ratio. Departure from the "usual value" range on four or more ratios may lead to increased regulatory oversight from individual state insurance commissioners. As a result of the losses recognized in 2002 and 2001, NAICC expects that it will fail seven of those regulatory ratios relating to loss development and surplus change. Two of the failures relate strictly to loss development and two relate to surplus changes caused by both loss development and investment losses incurred during 2002. The remaining three ratio failures relate to reduction in writings, overall investment yield and liabilities to liquid assets. The failure of such ratios subjects NAICC to increased regulatory inquiry. Based on the differential between reported surplus and the surplus level requiring further regulatory action, NAICC believes that the failure of those ratios will not have an adverse impact on the operations of NAICC.
As noted above, ACL filed for protection under Chapter 11 of the Bankruptcy Code. As a result, it was determined for statutory insurance accounting purposes that NAICC's investment in ACL was fully impaired. At December 31, 2002, NAICC recognized a statutory charge to its surplus of $7.4 million. This charge, when combined with NAICC's underwriting results and investment losses reduced its statutory surplus level below the Company Action Level of NAICC's RBC calculation. In response to the above statutory condition, DHC repaid the $4 million note due May 2004 to NAICC, and further contributed $4 million to NAICC to increase its statutory capital during February 2003. With permission from the California Department of Insurance, these transactions were recorded at December 31, 2002. As a condition to granting permission, the Department required NAICC to obtain permission prior to entering into a loan with an affiliate. After consideration for the $8 million noted above, NAICC's reported capital and surplus as of December 31, 2002 was above the Company Action Level of NAICC's RBC calculation.
California and Montana insurance laws and regulations regulate the amount and type of NAICC's investments. NAICC's investment portfolio is comprised primarily of fixed maturities and is weighted heavily toward investment grade short and medium term securities. See Notes 1 and 9 of the Notes to the Consolidated Financial Statements.
NAICC pledges assets and posts letters of credit for the benefit of other insurance companies they do business with in the event that NAICC is not able to pay their reinsurers. NAICC had assets pledged of $9.1 million and had letters of credit outstanding of $2.8 million at December 31, 2002.
* Operating leases having initial or remaining non-cancelable lease terms longer than one year.
Additional disclosures regarding these obligations and commitments can be found in Notes 4 and 17 of notes to the consolidated financial statements.
DHC recorded charter income from UABL of $5.9 million for the period May 29, 2002 through December 27, 2002. DHC also recorded administrative fee expenses to UABL of $4.3 million for the period May 29, 2002 through December 27, 2002. Charter rates are established at fair market value based upon similar transactions. As of December 27, 2002, DHC has recorded $6.3 million in accounts receivable from UABL.
Prior to and shortly after the acquisition of ACL, DHC shared certain personnel and facilities with several affiliated and unaffiliated companies who have certain common directors and officers, and certain expenses were allocated among the various entities. Personnel costs were allocated based upon actual time spent on DHC business. Costs relating to office space and equipment were allocated based upon actual usage. Management believes the methodology used for allocation is appropriate. Total expenses allocated to DHC from affiliated entities were $1.8 million, $1.3 million and $1.3 million for the years ended December 2002, 2001 and 2000, respectively.
In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS 121 and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for the disposal of a segment of business (as previously defined in that Opinion). SFAS 144 also amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The objectives of SFAS 144 are to address significant issues relating to the implementation of SFAS 121 and to develop a single accounting model, based on the framework established in SFAS 121, for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired. ACL adopted SFAS 144 in the first quarter 2002. The provisions of SFAS 144 did not have an impact on Danielson's financial statements during the year ended December 27, 2002.
Global Materials Services LLC ("GMS") is an owner and operator of 26 marine terminal and warehouse facilities located in the United States and the Netherlands. DHC acquired an ownership interest in GMS during 2002 as described in Note 2. GMS' ownership at December 27, 2002 was 5.4% owned by DHC, 50.0% owned by ACL, and in total 55.4% owned by Danielson. The remaining 44.6% is owned by an unaffiliated third party.
Also in 2002 in connection with the ACL acquisition, DHC purchased for approximately $2.8 million a 50% equity interest in Vessel Leasing LLC ("Vessel Leasing"), a special purpose entity that leases barges to ACL's barge transportation operations. DHC also indirectly owns the other 50% equity interest in Vessel Leasing through ACL and, accordingly, Vessel Leasing is consolidated with DHC and with ACL.
The operations of NAICC are in property and casualty insurance. NAICC writes non-standard private passenger and commercial automobile insurance in the western United States, primarily California. NAICC writes approximately 77 percent of its insurance in California and 12 percent of its business in Montana. For the years ended December 2002, 2001 and 2000, 45 percent, 16 percent and 28 percent, respectively, of total personal lines direct written premiums were produced through two general agents of NAICC. In 2001, NAICC, which formerly wrote workers' compensation insurance, decided to exit the workers' compensation business in all states as further discussed in Note 12.
In the second quarter of 2002, DHC changed its presentation of its statement of financial position from an unclassified to a classified statement with the insurance operating assets and liabilities presented separately on an unclassified basis as long-term. The change in the classification of DHC's assets and liabilities is deemed to be more meaningful in light of the significant changes in DHC's operations with the acquisitions of ACL and GMS. Previously reported amounts have been reclassified to conform to the current classifications.
The consolidated financial statements contained herein have been prepared on a going concern basis, which assumes continuity of operations and realization of assets and satisfaction of liabilities in the ordinary course of business. The ability of ACL and the other Debtors to continue as a going concern is predicated, among other things, on the confirmation of a reorganization plan, compliance with the provisions of the DIP Credit Facility (see Note 3), the ability of ACL and the other Debtors to generate the required cash flows from operations and, where necessary, obtaining financing sources sufficient to satisfy future obligations.
ACL's liquidity generally depends on cash provided by operating activities and access to the DIP Credit Facility. The ability of ACL to continue as a going concern (including its ability to meet post-petition obligations) and the continued appropriateness of using the going concern basis for the consolidated financial statements are dependent upon, among other things, (i) ACL's ability to comply with the covenants of the DIP Credit Facility, (ii) the ability of ACL to maintain adequate cash on hand, (iii) the ability of ACL to continue to generate cash from operations, (iv) confirmation of a plan of reorganization under the Bankruptcy Code and the terms of such plan, (v) ability of ACL to attract, retain and compensate key executives and associates and to retain employees generally and (vi) ACL's ability to achieve profitability following such confirmation.
The accompanying consolidated financial statements do not give effect to any adjustment to the carrying value of assets or amounts and classifications of liabilities that might be necessary as a result of resolving the bankruptcy. A plan of reorganization could materially change the amounts recorded in the consolidated financial statements in future periods.
Cash and cash equivalents include short-term investments with a maturity of less than three months when purchased. Danielson has from time to time, cash in banks in excess of federally insured limits. Cash and cash equivalents are at cost which approximates fair value.
Allowances for doubtful accounts are based upon the expected collectibility of accounts.
Materials and Supplies are carried at the lower of cost (average) or market and consist of the following:
Marine Services' properties and the parent company's properties which are minor in amount, are at cost and consist of the following:
Provisions for depreciation of properties are based on the estimated useful service lives computed on the straight-line method. Buildings and Improvements are depreciated from 15 to 45 years. Equipment is depreciated from 5 to 42 years. 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. Marine Services depreciation expense was $40,591 in 2002. Insurance Services depreciation expense was $479 in 2002 and is included in general and administrative expenses on the consolidated statement of operations.
Debt and equity securities can be classified in one of the three categories: trading, available-for-sale, or held-to-maturity. Securities that are classified as "trading" can be classified are bought and held principally to sell in the near term. Securities which are classified as "held-to-maturity" are securities which Danielson 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." Danielson currently classifies all of its debt and equity securities as available-for-sale.
Fixed maturities classified as available-for-sale are recorded at fair value. Premiums and discounts of fixed maturity securities are amortized or accreted based on the effective interest method. 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.
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.
A decline in the market value of any available-for-sale or held-to-maturity 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. Dividend and interest income are recognized when earned. The cost of securities sold is determined using the specific identification method.
Insurance Services' deferred acquisition costs, consisting principally of commissions and premium taxes paid at the time of issuance of the insurance policy, are deferred and amortized over the period during which the related insurance premiums are earned. Deferred acquisition costs are limited to the estimated future profit, based on the anticipated losses and loss adjustment expenses ("LAE") (based on historical experience), maintenance costs, policyholder dividends, and anticipated investment income. Deferred acquisition costs which amounted to $1,612 at the year ended December 2002 and $2,209 at December 2001 are included with other assets under Insurance Services. The amortization of the deferred acquisition costs charged to operations in 2002, 2001 and 2000 was $11,437, $16,174 and $12,153, respectively.
Marine Services amortizes debt costs over the term of the debt. Amortization expense was $1,150 in 2002.
("APB 25") for Danielson directors and employees. The fair value based method of accounting prescribed by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," ("SFAS 123"), is used to measure stock-based compensation for Danielson contractors. Pro forma net income and earnings per share are disclosed below as if the fair value based method of accounting under SFAS 123 had been applied to all stock-based compensation awards.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supercedes SFAS 121, and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for the disposal of a segment of a business (as previously defined in that Opinion). SFAS 144 also amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements", to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The objectives of SFAS 144 are to address significant issues relating to the implementation of SFAS 121 and to develop a single accounting model, based on the framework established in SFAS 121, for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired. DHC adopted SFAS 144 in Danielson's first quarter 2002. The provisions of SFAS 144 did not have an impact on DHC's financial statements in 2002.
The acquired companies operating results are included in DHC's consolidated statement of operations since the date of the Danielson Recapitalization, May 29, 2002. Following is a condensed consolidated balance sheet disclosing the amounts preliminarily assigned to assets and liabilities of the acquired companies at the date of the acquisition.
DHC believes no significant intangibles were acquired in the Danielson Recapitalization. The purchase price allocation has not been finalized as the allocations are subject to revision once appraisals and other evaluations of the fair value of the assets acquired and liabilities assumed are completed. Accordingly, actual amounts assigned could differ from current estimates.
ACL and the other Debtors are continuing to operate their businesses as debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. As debtors-in-possession, the Debtors may not engage in transactions outside of the ordinary course of business without approval, after notice and hearing, of the Bankruptcy Court. As part of the Chapter 11 cases, the Debtors intend to develop and propose for confirmation pursuant to Chapter 11 a plan of reorganization that will restructure the operations and liabilities of the Debtors to the extent necessary to result in the continuing viability of ACL. A filing date for such a plan has not been determined; however, the Debtors have the exclusive right to file a plan any time during the 120 day period following the Petition Date. If the exclusivity period were to expire, other parties, such as the creditors of the Debtors, would have the right to propose alternative plans for reorganization.
The Debtors have entered into a Bankruptcy Court approved debtor-in-possession financing arrangement (which was originally entered into on January 31, 2003 and which was subsequently amended, the "DIP Credit Facility") that provides up to $75 million of financing. Participating bank commitments under the DIP Credit Facility total $60 million, of which the Debtors have drawn $50 million, which was used to retire ACL's Pre-Petition Receivables Facility (see Note 5) and which continues to be used to fund the Debtors' day-to-day cash needs. The DIP Credit Facility is secured by the same and additional assets that collateralized the Senior Credit Facilities (see Note 4) and ACL's Pre-Petition Receivables Facility, and bears interest, at ACL's option, at LIBOR plus four percent or an Alternate Base Rate (as defined in the DIP Credit Facility) plus three percent. There are also certain interest rates applicable in the event of a default under the facility.
The United States Trustee has appointed an unsecured creditors' committee. The official committee and its legal representatives have a right to be heard on all matters that come before the Bankruptcy creditors.
The Chapter 11 process presents inherent material uncertainty; it is not possible to determine the additional amount of claims that may arise or ultimately be filed, or predict the length of time that the Debtors will continue to operate under the protection of Chapter 11, the outcome of the Chapter 11 proceedings in general, whether the Debtors will continue to operate in their present organizational structure, or the effects of the proceedings on the business of ACL, the other Debtors and its non-filing subsidiaries and affiliates, or on the interests of the various creditors and the equity holder. The ultimate recovery, if any, by creditors, and the equity holder will not be determined until, at the earliest, confirmation of a plan of reorganization. No assurance can be given as to what value, if any, will be ascribed in the bankruptcy proceedings to each of these constituencies. While it cannot be presently determined, Danielson, as the holder of 100% of the membership interests of ACLines, may receive little or no value with respect to its equity interest in ACL Holdings or ACL.
DHC management cannot determine with certainty the ultimate outcome of the Chapter 11 proceedings; however, it is possible that the following outcomes could result:
- ACL could reorganize, and their creditors could receive all or a portion of their claims.
- The creditors could assume ownership and continue to operate ACL.
As part of the Danielson Recapitalization, ACL's debt was restructured. ACL's existing credit facility was amended and restated as of April 11, 2002 (the amended and restated credit facilities are hereafter referred to as the "Senior Credit Facilities") to, among other things, modify financial and restrictive covenants thereunder, prepay $25,000 of term loans thereunder from the $25,000 in cash contributed by Danielson and convert $50,000 of revolving credit loans thereunder into a new tranche of term loans having an interest rate and other terms substantially similar to the revolving credit loans under the senior credit facility.
ACL's debt was adjusted to fair value as of the date of the Danielson Recapitalization. The difference between the principal amount of the debt and its fair value is being accreted as interest expense over the term of the debt under the effective interest method.
The new Senior Notes are due January 1, 2008 and bear interest at an annual rate of 11.25%, payable semi-annually. The PIK Notes are due July 1, 2008 and bear interest at an annual rate of 12%. ACL has the option of issuing new PIK Notes in lieu of paying cash interest on such notes each June 30 and December 31 until maturity. After 2 years from issuance, interest accretes at 13.5% per annum if ACL elects to not pay the interest due in cash. The interest rate remains 12% if the interest is paid in cash. The Old Senior Notes are due June 30, 2008 and bear interest at an annual rate of 10.25%.
In connection with the Exchange Offer, ACL completed a consent solicitation of the holders of the Old Senior Notes, which resulted in the elimination or amendment of substantially all the restrictive covenants contained in the indenture governing the Old Senior Notes, the subordination of the subsidiary guarantees of the Old Senior Notes to the subsidiary guarantees of the Senior Credit Facilities, the Senior Notes and the PIK notes and the waiver of any and all defaults under the indenture governing the Old Senior Notes through the effective date of the Exchange Offer, May 29, 2002.
The Senior Credit Facilities and the indentures governing the Senior Notes and the PIK Notes (the "Indentures") contain a number of covenants with specified financial ratios and tests including, with respect to the Senior Credit Facilities, maximum leverage ratios, rent adjusted maximum leverage ratios and interest coverage ratios. Compliance with financial ratios is measured at the end of each quarter. The Indentures also contain certain cross default provisions. ACL's ability to meet the financial ratios is affected by adverse weather conditions, seasonality and other risk factors inherent in its business. The Senior Credit Facilities also contain mandatory prepayments of the Term Loans with net proceeds from certain asset sales, equity issuances, incurrence of indebtedness and sale and leaseback transactions, as well as excess cash flow, as defined in the Senior Credit Facilities.
On December 31, 2002, ACL elected to exercise its rights under the Indentures to postpone the interest payments due on the Senior Notes and Old Senior Notes for thirty days. This resulted in an event of default under the Senior Credit Facilities and the Pre-Petition Receivables Facility.
As of December 27, 2002, GMSV had $2,850 in loans outstanding from the International Finance Corporation which bear interest at LIBOR plus a margin of 4.75% and mature May 2007. ACL currently guarantees the outstanding loan amounts.
At December 27, 2002 ACL had $39,300 outstanding under its pre-petition accounts receivable securitization facility agreement and had $27,603 of net residual interest in the securitized receivables which is included in Accounts Receivable, Net on the consolidated statement of financial position. The fair value of the net residual interest is measured at the time of the sale and is based on the sale of similar assets. In 2002, Danielson received gross proceeds of $20,300 from the sale of receivables and made gross payments of $23,600 under this agreement.
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 and 2001, NAICC collected approximately $2.7 million and $0.5 million, respectively, 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 its financial condition.
In February 2000, NAICC paid $1,000 in losses relating to settlement on an environmental claim filed by Public Service of Indiana ("PSI Claim"). The PSI 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 PSI for a portion of those years. The PSI Claim liability is reinsured under various contracts involving numerous reinsurance companies under which NAICC ceded $1,200, which includes LAE not previously ceded of $295. To date, the reinsurers have paid approximately $646. 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 disposition of the PSI Claim will not have a material adverse impact on the financial condition of Danielson.
In 2000, NAICC received $11,459 related to the rescission in 1999 of a workers' compensation reinsurance agreement with Reliance Insurance Company.
The losses and LAE incurred during 2002 related to prior years is attributable to adverse development on both the California workers' compensation line totaling $3,500, certain private passenger automobile programs totaling $4,700 and commercial automobile totaling $2,000. The losses and LAE incurred during 2001 related to prior years is attributable to adverse development on both the California workers' compensation line totaling $4,400 and certain private passenger automobile programs, primarily outside of California, totaling $1,700. All of the workers' compensation lines and the private passenger automobile programs that caused higher than expected losses were placed in run-off during 2001. The losses and LAE incurred during 2000 related to prior years is attributable to adverse developments on the commercial automobile lines and certain lines in run-off.
A model for determining the risk-based capital ("RBC") requirements for property and casualty insurance companies was adopted in December 1993 and companies are required to report their RBC ratios based on their statutory annual statements. As discussed in Note 3, ACL filed for protection under Chapter 11 of the Bankruptcy Code. As a result, for statutory accounting purposes, it was determined that NAICC's investment in ACL was fully impaired. At December 31, 2002, NAICC recognized a statutory charge to its surplus of $7.4 million. This charge, when combined with NAICC's underwriting results, reduced it's statutory surplus level below the company action level per NAICC's RBC calculation.
In response to the above statutory condition, in 2003, DHC repaid a $4 million note due May 2004 to NAICC, and further contributed $4 million to NAICC to increase its statutory capital. With permission from the CDI, these transactions were recorded at December 31, 2002 in NAICC's statutory-basis annual statement. After consideration for the $8 million noted above, NAICC's reported statutory-basis capital and surplus as of December 31, 2002 was above the company action level of the RBC calculation.
Insurance companies are subject to insurance laws and regulations established by the states in which they transact business. The governmental agencies established pursuant to these state laws have broad administrative and supervisory powers over insurance company operations. These powers include granting and revoking of licenses to transact business, regulating trade practices, establishing guaranty associations, licensing agents, approving policy forms, filing premium rates on certain business, setting reserve requirements, determining the form and content of required regulatory financial statements, conducting periodic examination of insurers' records, determining the reasonableness and adequacy of capital and surplus, and prescribing the maximum concentrations of certain classes of investments. Most states have also enacted legislation regulating insurance holding company systems, including acquisitions, extraordinary dividends, the terms of affiliate transactions
Fixed maturities of DHC include mortgage-backed securities ("MBS") representing 31.7% and 23.5% of the total fixed maturities at years ended December 2002 and 2001, respectively. All MBS held by Danielson are issued by the Federal National Mortgage Association ("Fannie Mae") or the Federal Home Loan
Mortgage Corporation ("Freddie Mac"), both of which are rated "Aaa" by Moody's Investors Services. MBS and callable bonds, in contrast to other bonds, are more sensitive to market value declines in a rising interest rate environment than to market value increases in a declining interest rate environment. This is primarily because of payors' increased incentive and ability to prepay principal and issuers' increased incentive to call bonds in a declining interest rate environment. Management does not believe that the inherent prepayment risk in its portfolio is significant. However, management believes that the potential impact of the interest rate risk on Danielson'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. Danielson has no MBS concentrations in any geographic region.
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:
At December 31, 2001, Danielson held $58,493 face amount of American Commercial Lines LLC ("ACL") Senior Notes 10.25%, due 6/30/08, at a cost of $30,026 and a fair value of $31,952, representing 42.9% of stockholders' equity. These notes were contributed to ACL Holdings in 2002 in connection with the
Assets and liabilities relating to investments in foreign operations are translated into U. S. dollars using current exchange rates; revenues and expenses are translated into U. S. dollars using the average exchange rate during the period When the functional currency is the local currency, the translation gains and losses are excluded from income and are recorded in the other comprehensive income component of stockholders' equity. If the functional currency is the U. S. dollar, the translation gains and losses are recorded as other income or expense in the consolidated statement of operations.
At December 31, 2001, Insurance Services held $768 in a Japanese Yen denominated security. During 2002 the remaining Yen denominated security was sold. The foreign currency translation gain of $15 and $1,100 on these securities is included in other comprehensive income for the years ended December 2001 and 2000.
Through its investment in GMS, DHC recognized $453 in foreign currency translation gains in 2002 related to the Netherlands terminal. This amount is recorded as other comprehensive income.
Insurance Services' receivables as of the years ended December 2002 and 2001 consist of the following:
Insurance Services' objective is to underwrite business that is expected to yield an underwriting profit. Insurance Services has made a determination that certain lines of insurance may not be sustainable in the current rate environment. Competitive and regulatory pressures have resulted in a general market for premium rates in these lines that is well below a level necessary in order to achieve a profit, especially in light of increasingly unfavorable loss history. Rather than continue to sustain losses, Insurance Services will exit the workers' compensation line in all states and the non-standard private passenger automobile program written outside of California. The last workers compensation policy outside Montana was issued in July 2001 and the last Montana workers compensation policy was issued in January 2002. Costs incurred in 2001 associated with this process totaled approximately $1,250 and are included in General and Administrative Expenses. The remaining lines written by Insurance Services will be non-standard private passenger automobile in the State of California and commercial automobile in certain western states.
On September 4, 2001, DHC's stockholders approved an amendment to DHC's Certificate of Incorporation increasing DHC's authorized Common Stock from 100,000,000 shares to 150,000,000 shares.
During the second quarter of 2002, DHC consummated a rights offering to provide funds for the acquisition of ACL and related entities as discussed in Note 2. 8,705,219 shares of Common Stock were issued at $5 per share pursuant to the rights offering in exchange for $42,228 in net proceeds, net of expenses. Expenses included a $1,000 backstop fee paid to SZ Investments LLC, a major stockholder of DHC. In addition, 2,002,558 shares were issued pursuant to warrants exercised that were previously held by SZ Investments LLC in connection with the rights offering for proceeds of $9,500 and 264,582 shares were issued pursuant to the exercise of options for proceeds of $1,087.
In connection with the ACL acquisition, 339,040 shares of restricted DHC Common Stock were issued to ACL management. These restricted shares have been valued at fair value at the date of issuance and vest one third annually over a three year period. The full value of these shares is recorded as paid in capital with an offset to unearned compensation in stockholders' equity. As employees render service over the vesting period, compensation expense is recorded and unearned compensation is reduced.
Therefore, due to the absence of a reliable taxable income stream, Danielson has recorded a valuation allowance for the amount by which its deferred tax assets exceed its deferred tax liabilities and, as a result, DHC has not recorded any liability or asset for deferred taxes.
DHC's ability to utilize its net operating 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. DHC will be treated as having had an "ownership change" if there is more than a 50% increase in stock ownership during a three 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 its 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 DHC expects that they will remain in force as long as the net operating loss carryforwards are available to DHC. 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 convert into Common Stock) might result in an ownership change under the Internal Revenue Code.
Marine Services sponsors or participates in defined benefit plans covering both salaried and hourly employees. The plans provide for eligible employees to receive benefits based on years of service and either compensation rates near retirement or at a predetermined multiplier factor. Contributions to the plans are sufficient to meet the minimum funding standards set forth in the Employee Retirement Income Security Act
In addition to the defined benefit pension and related plans, Marine Services has a defined benefit post-retirement plan covering most full-time employees. The plan provides medical benefits and is contributory, with retiree contributions adjusted annually, and contains other cost-sharing features such as deductibles and coinsurance. The accounting for the health care plan anticipates future cost-sharing changes to the written plan that are consistent with Marine Services' expressed intent to increase the retiree contribution rate annually.
Marine Services also sponsors certain contributory defined contribution plans covering eligible employee groups. Contributions to such plans are based upon a percentage of employee contributions and were $1,274 in 2002.
KCP, the former parent company of NAICC and first tier subsidiary of DHC, maintained an Employee Stock Ownership Plan ("ESOP") of KCP and Subsidiaries covering all of its employees. All of the shares of Common Stock held by the ESOP are deemed to be outstanding for earnings per share computations. KCP 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 NAICC Salary Deferred Plan and Trust ("401(k) Plan"). The participating employers contributed 50% of the first 6% of employee-contributed compensation to the 401(k) Plan. The shares of Common Stock owned by the ESOP as of the years ended December 2002 and 2001 were zero and 58,977, respectively. The ESOP was terminated in February 2002, and all shares held by it were distributed to participants.
On January 1, 1988, Insurance Services adopted a non-contributory defined benefit pension plan (the "Pension Plan") covering substantially all of its employees. Pension benefits are based on an employee's years of service and average final compensation. The funding policy of the Pension Plan is for the employers to contribute the minimum pension costs equivalent to the amount required under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. Vested benefits are fully funded. Any liability associated with the Pension Plan is reflected in the consolidated financial statements.
The following table sets forth the Pension Plan's funded status as of the years ended December 2002 and 2001, valued at January 1, 2003 and 2002, respectively:
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 6.75%, 7.00% and 7.25% for 2002, 2001 and 2000, respectively. The projected long-term rate of return on assets was 7.0% for 2002 and 2001, and 7.5% for 2000. The average rate of compensation increase used in determining the actuarial present value of the projected benefit obligation was 0% for 2002, 4.5% for 2001 and 4.5% for 2000.
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 the years ended December 2002 and 2001 (dollars in thousands):
On January 1, 1988, NAICC established a 401(k) Plan in which all employees of NAICC, and effective April 1, 1993, the Danielson Trust are eligible to participate. Under the 401(k) Plan, employees may elect to contribute up to 20 percent of the eligible compensation to a maximum dollar amount allowed by the IRS. Effective January 1, 2002, NAICC suspended it's matching contribution to the 401(k) Plan. Prior to January 1, 2002, the Company matched 50 percent of the first six percent of compensation contributed by employees to the 401(k) Plan. In the years ended December 2001 and 2000, NAICC's matching contribution to the 401(k) Plan was satisfied through cash payments totalling $139 and $146, respectively.
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.
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 Danielson to provide incentives to increase the personal financial identification of key personnel with the long-term growth of Danielson and the interests of DHC's stockholders through the ownership and performance of DHC's Common Stock, to enhance DHC's ability to retain key personnel, and to attract outstanding prospective employees and Directors. The 1995 Plan became effective as of March 21, 1995. In September 2001, DHC's stockholders approved amendments to the 1995 Plan which increases the aggregate number of shares available
for option grants from 1,700,000 to 2,540,000 and provides for options to be awarded to independent contractors to enable Danielson to attract, retain and give incentives to highly qualified persons who provide valuable services to DHC. No awards 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.
As of December 27, 2002, options for shares were outstanding in the following price ranges:
Insurance Services has 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 $1,387, $1,446 and $1,398 for the years ended December 2002, 2001 and 2000, respectively. At year end December 2002, future net minimum operating lease rental payment commitments were as follows:
Marine Services recorded charter income from UABL of $5,936 in 2002. Marine Services also recorded administrative fee expenses to UABL of $4,306 in 2002. At December 27, 2002 Marine Services had receivables of $6,341 from UABL.
Prior to and shortly after the acquisition of ACL, DHC shared certain personnel and facilities with several affiliated and unaffiliated companies who have certain common directors and officers, and certain expenses were allocated among the various entities. Personnel costs were allocated based upon actual time spent on DHC business. Costs relating to office space and equipment were allocated based upon actual usage. Management believes the methodology used for allocation is appropriate. Total expenses allocated to DHC from affiliated entities were $1,765, $1,334 and $1,310 for the years ended December 2002, 2001 and 2000, respectively.
DHC has agreed to provide SZ Investments, LLC ("SZI") unlimited demand registration rights with respect to the ACL Senior Notes and ACL PIK Notes held by SZI, LLC and its affiliates, including HY I Investments, LLC ("HYI"). Mr. Zell, DHC's President and Chief Executive Officer and Chairman of DHC's Board of Directors, and Mr. Tinkler, DHC's Chief Financial Officer, are affiliated with SZI and HYI. Mr. Pate, a member of DHC's Board of Directors, is affiliated with SZI.
Insurance Services 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." 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 DHC's consolidated results of operations, financial position or cash flow.
The carrying amounts (net of debt discounts) and fair values of financial instruments are as follows:
The fair values of the Interest Rate Cap, Home Product Bonds, Fixed Maturity Securities, Equity Securities, Interest Rate Swaps, new Senior Notes, Senior Subordinated Notes and old Senior Notes payable are based on quoted market values. The carrying values of all Revolving Credit Facilities, Term Loans, GMS Bank Note, Illinois Development Finance Authority and IFC Note all of which bear interest at floating rates, approximate their fair values. The Bonds guaranteed by the Maritime Administration were recently issued and, accordingly, the carrying amount approximates fair value.
With the acquisition of ACL, DHC assumed an interest rate cap agreement. The interest rate cap has a notional amount of $201,800 and a fair value of zero as of December 27, 2002 and is effective through August 11, 2003. Marine Services accounts for the interest rate cap as a cash flow hedge whereby the fair value of the interest rate cap is reflected as an asset or liability in the consolidated statement of financial position. The cap rate (hedging instrument) is the same interest rate index as the base interest rate for the floating rate debt (hedged item). When the interest rate index exceeds the interest rate cap, a portion of the change in fair value of the instrument represents a change in intrinsic value which is an effective hedge. This portion of the change in value will be recorded as other comprehensive income (loss).
The following is a reconciliation of segment (loss) earnings to consolidated totals.
Accumulated other comprehensive income (loss) as of December 27, 2002 and December 31, 2001 consists of the following:
The following financial information is presented to meet the requirements of S-X Rule 3-10 with respect to guarantor's of the above noted debt of ACL. Separate financial statements of the Guarantor Subsidiaries are not presented because management has determined they would not be material to investors. The following supplemental financial information sets forth on a combined basis, combining statement of operations, statement of financial position, and statement of cash flows for the Parent Company and Nonguarantor Subsidiaries and the Guarantor Subsidiaries for the year ended December 27, 2002. It should be noted that the amounts shown under the caption "Parent Company and Nonguarantor Subsidiaries" include amounts related to the Insurance Services' subsidiaries of Danielson as well as Marine Services' subsidiaries which are not guarantors of the above noted debt of ACL.
We have audited the accompanying consolidated statement of financial position of Danielson Holding Corporation as of December 27, 2002, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year ended December 27, 2002. Our audit also included the financial statement schedules listed in the index at Item 15(a) for the year ended December 27, 2002. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audit.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Danielson Holding Corporation and subsidiaries at December 31, 2001, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules for each of the years in the two-year period ended December 31, 2001, 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.