Through its various subsidiaries, the Company owns and utilizes in its operations two offices in Salt Lake City, Utah used for corporate and banking and lending activities (totaling approximately 77,000 sq. ft.). In addition, a subsidiary of the Company owns a facility (totaling approximately 158,500 sq. ft.) primarily used for manufacturing located in Georgia.
The following selected financial data have been summarized from the Company's consolidated financial statements and are qualified in their entirety by reference to, and should be read in conjunction with, such consolidated financial statements and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of this Report.
(b) The Combined Ratio does not reflect the effect of investment income. For 1998, the difference in the accounting treatment for curtailment gains relating to the defined benefit pension plans was the principal reason for the difference between the GAAP Combined Ratio and the SAP Combined Ratio. For 1996 and 1995, a change in the statutory accounting treatment for retrospectively rated reinsurance agreements was the principal reason for the difference between the GAAP Combined Ratios and the SAP Combined Ratios. Additionally in 1998, 1997 and 1996, the difference relates to the accounting for certain costs which are treated differently under SAP and GAAP.
(c) Source: Best's Aggregates & Averages, Property/Casualty, 1998 Edition. Industry Combined Ratios may not be fully comparable as a result of, among other things, differences in geographical concentration and in the mix of property and casualty insurance products.
The purpose of this section is to discuss and analyze the Company's consolidated financial condition, liquidity and capital resources and results of operations. This analysis should be read in conjunction with the consolidated financial statements and related notes which appear elsewhere in this Report.
Leucadia National Corporation (the "Parent") is a holding company whose assets principally consist of the stock of its several direct subsidiaries and cash and liquid investments. The Parent continuously evaluates the retention and disposition of its existing operations and investigates possible acquisitions of new businesses in order to maximize shareholder value. Accordingly, while the Parent does not have any material arrangement, commitment or understanding with respect thereto (except as disclosed in this Report), further acquisitions, divestitures, investments and changes in capital structure are possible. Its principal sources of funds are its available cash resources, bank borrowings, public financings, repayment of subsidiary advances, funds distributed from its subsidiaries as tax sharing payments, management and other fees, and borrowings and dividends from its regulated and non-regulated subsidiaries. It has no substantial recurring cash requirements other than payment of interest and principal on its debt, tax payments and corporate overhead expenses. As of December 31, 1998, the Company's cash, cash equivalents and marketable securities, excluding those amounts held by its regulated subsidiaries and collateralizing letters of credit, totaled approximately $1,219,000,000. In addition, the book value of the principal amount of promissory notes received from Conseco, Inc. upon the 1997 sale of the Colonial Penn Life Group was $400,000,000 at December 31, 1998.
Except for the Euro denominated debt of Fidei, which is described below, the Parent maintains the principal borrowings for the Company and its non-banking subsidiaries and has provided working capital to certain of its subsidiaries. These borrowings have primarily been made from banks through various credit agreement facilities and through public financings. The Company borrowed $62,300,000 under its $100,000,000 bank credit facility to fund the purchase price of Fidei, including expenses. In addition, the Company entered into currency swap agreements to hedge approximately $55,000,000 of its foreign currency exposure. The counterparties to these currency swap agreements are major financial institutions, which management believes are able to fulfill their obligations. The swap agreements mature in tranches in March 2000 and September 2001. At December 31, 1998, $65,500,000 was outstanding under the bank credit facility.
At December 31, 1998, a maximum of approximately $25,200,000 was available to the Parent as dividends from its regulated subsidiaries without regulatory approval. Additional amounts may be available to the Parent in the form of loans or cash advances from regulated subsidiaries, although no amounts were outstanding at December 31, 1998 or borrowed to date in 1999. There are no restrictions on distributions from the non-regulated subsidiaries. The Parent also receives tax sharing payments from subsidiaries included in its consolidated income tax return, including certain regulated subsidiaries. Because of the tax loss carryforwards available to the Parent and certain subsidiaries, together with current interest deductions and corporate expenses, the amount paid by the Parent for income taxes has been substantially less than tax sharing payments received from its subsidiaries. Payments from regulated subsidiaries for dividends, tax sharing payments and other services totaled approximately $1,295,600,000 (including $1,230,000,000 relating to the sales of the Colonial Penn companies in 1997) for the year ended December 31, 1998.
In 1998, net cash was used for operations, principally to purchase investments classified as trading and for the payment of income taxes, partially offset by the repayment of the Company's bridge financing to PIB, its Russian joint venture described below. In 1997, net cash was used for operations principally to fund the Company's capital commitments and bridge financing to PIB, and for the purchase of investments classified as trading.
In September 1998, the Company reinsured, retroactive to January 1, 1998, substantially all of its remaining life insurance business to Allstate and a subsidiary thereof in an indemnity reinsurance transaction. While the premium received on this transaction was approximately $28,675,000, the gain on the reinsurance transaction was deferred and is being amortized into income based upon actuarial estimates of the premium revenue of the underlying insurance contracts. In December 1998, the Company signed an agreement to sell its
In 1996, the Company formed PIB, a joint venture with PepsiCo, Inc., to be the exclusive bottler and distributor of PepsiCo beverages in a large portion of central and eastern Russia, Kyrgyzstan and Kazakstan. The Company contributed $79,500,000 to PIB for a 75% equity interest. Effective as of January 30, 1998, the Company entered into an agreement with PepsiCo, pursuant to which, among other things, PIB repaid in full the Company's $77,705,000 bridge financing (which was funded in 1997) and the Company's equity interest in PIB was reduced to 37.9%. The agreement relieved the Company of any future funding obligation with respect to PIB and created an option, exercisable by either the Company or PepsiCo, pursuant to which PepsiCo was obligated to purchase all of the Company's interest in PIB (the "Option") for $37,000,000, plus interest. In February 1999, PepsiCo exercised the Option for approximately $39,190,000, including interest, and the Company recognized a pre-tax gain of approximately $29,545,000. However, when combined with the Company's share of the joint venture losses since inception, the Company's net loss from this investment was approximately $40,310,000.
The Company provides collateralized automobile loans to individuals with poor credit histories. Prior to 1998, the Company's loan volume was in decline primarily as a result of heavy competition in this line of business. However, in 1998, the Company began to see growth in its automobile lending business as it expanded into new locations and developed new programs. The Company also benefited from the decline in competition due to the failure of certain competitors and a reduction in capital available for securitizations. In addition, in December 1998, the Company purchased a $36,900,000 sub-prime automobile portfolio. The Company's investment in automobile loans was $140,400,000, $77,607,000 and $96,338,000 at December 31, 1998, 1997 and 1996, respectively. During 1998, the Company's banking and lending subsidiaries sold substantially all of their executive and professional loan portfolios for aggregate proceeds of $89,500,000 and reported a pre-tax gain on these sales of approximately $6,500,000.
The Company's most significant operation is its insurance business, where it is a provider of property and casualty insurance primarily in the New York metropolitan area. For the year ended December 31, 1998, the Company's insurance segment contributed 57% of total revenues from continuing operations and, at December 31, 1998, constituted 25% of total assets.
The Empire Group's combined ratios increased in 1998 primarily due to the reduction in premium volume at a rate greater than the reduction in net underwriting and other costs. In addition, the reduction in servicing fees in 1998 negatively affected the expense ratios. Included in the Empire Group's results for 1998, 1997 and 1996 were approximately $42,000,000, $27,000,000 and $28,000,000, respectively, for reserve strengthening related to losses from prior accident years.
The 1997 reserve strengthening included approximately $11,000,000 for commercial package lines of business and approximately $7,000,000 for voluntary commercial automobile lines of business. During 1997, the Empire Group reviewed the adequacy of the reserves carried for its open claims' files, as part of its normal ongoing practice, focusing on the commercial package, general liability and commercial automobile lines of business. As a result of this review and the continued unfavorable development of prior accident years losses, particularly the 1992 through 1994 accident years, the Empire Group revised its assumptions regarding future increases in average claims severity and reserves were strengthened.
The 1996 reserve strengthening included approximately $20,000,000, for voluntary commercial automobile lines of business and approximately $8,000,000 for commercial package lines of business. Beginning in 1992, the Empire Group entered into new market segments of the voluntary commercial business, including specialty programs for sanitation trucks, gas stations, fuel oil deliveries and limousines. Initially, the Empire Group based its loss ratio estimate upon its experience with similar lines of business, industry statistics and standard actuarial ultimate loss projection techniques, which consider expected loss ratios. During 1996, claims began to develop unfavorably and the Empire Group used such claim development to revise the assumptions that formed the basis of actuarial studies and reserves were increased. With respect to commercial package lines, general liability claims for business written in 1992 through 1994 also developed unfavorably. These claims showed an increased frequency of losses as well as an increase in the time between the date the loss occurred and when the loss was reported compared to prior experience. General liability claims are susceptible to the emergence of losses over an extended period of time.
For the lines of business discussed above, as well as all other property and casualty lines of business, the Company employs a variety of standard actuarial ultimate loss projection techniques, statistical analyses and case-basis evaluations to estimate its liability for unpaid losses. The actuarial projections include an extrapolation of both losses paid and incurred by business line and accident year and implicitly consider the impact of inflation and claims settlement patterns upon ultimate claim costs based upon historical patterns. These estimates are performed quarterly and consider any changes in trends and actual loss experience. Any resulting change in the estimate of the liability for unpaid losses, including those discussed above, is reflected in current year earnings during the quarter the change in estimate is identified.
The reserving process relies on the basic assumption that past experience is an appropriate basis for predicting future events. The probable effects of current developments, trends and other relevant matters are also considered. Since the establishment of loss reserves is affected by many factors, some of which are outside the Company's control or affected by future conditions, reserving for property and casualty claims is a complex and uncertain process requiring the use of informed estimates and judgements. As additional experience and
other data become available and are reviewed, the Company's estimates and judgements may be revised. While the effect of any such changes in estimates could be material to future results of operations, the Company does not expect such changes to have a material effect on its liquidity or financial condition.
In December 1997, the Company completed the disposition of certain of its manufacturing operations. As a result, since December 1997, the Company's manufacturing operations solely have consisted of its plastics division. In 1998, the gross profit for the plastics division increased by 14% to approximately $21,400,000. This increase was primarily due to greater sales in most of the division's product lines and lower raw material costs. The decline in manufacturing revenues during the last three years was due to the sale of certain divisions and the discontinuance of certain non-performing product lines in 1997 and prior years. The Company recorded charges of $4,300,000 in 1997 and $3,700,000 in 1996 for losses on sales and shutdown expenses, which are primarily reflected in the caption "Selling, general and other expenses."
Income taxes for 1998 reflect a benefit of approximately $39,000,000 for a change in the Company's estimated 1997 federal tax liability and the favorable resolution of certain contingencies. The 1997 and 1996 income tax benefits were greater than the expected normal corporate tax rate primarily due to the favorable resolution of certain contingencies.
As discussed above, in December 1998, the Company signed an agreement to sell its remaining life insurance subsidiaries, Charter and Intramerica, to Allstate. The transaction is subject to regulatory approvals and customary closing conditions and is expected to close in the second quarter of 1999. In 1998, the Company classified these life insurance operations as discontinued operations and the consolidated financial statements for prior periods have been restated to be consistent with such presentation.
The number of shares used to calculate basic earnings (loss) per share was 63,409,000, 62,205,000 and 60,301,000 for 1998, 1997 and 1996, respectively. The number of shares used to calculate diluted earnings (loss) per share was 63,510,000, 62,205,000 and 60,301,000 for 1998, 1997 and 1996, respectively. For diluted per share amounts, the Company's 5-1/4% Convertible Subordinated Debentures due 2003 (which were redeemed in 1997) were not assumed to have been converted since the effect of such assumed conversion would have been to increase earnings per share.
In 1996, the Empire Group began to evaluate its information technology systems and their ability to support future business needs. This led to a decision to acquire new policy management and accounting systems. These systems provide enhanced functionality and improved processing for underwriting, claims, billing, collection, reinsurance, reporting and accounting and are designed to be Year 2000 compliant. The Empire Group anticipates that these new systems will be fully implemented in 1999 and that any non-compliant programs will become compliant during 1999. All but one of the manufacturing operation's material systems (involving the storage of historical information) have tested as being Year 2000 compliant. The Company is exploring alternative systems to maintain this information. Until an acceptable replacement for this system can be found, the Company can maintain these records in hard copy. The banking and lending operations have successfully completed testing of mission critical systems and testing of non-mission critical systems is currently underway. In addition, deposit customers have been sent letters to inform them about the Year 2000 issue and to educate them about the progress made in addressing this issue.
Statements included in this Report may contain forward-looking statements. Such forward-looking statements are made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of