(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, a change in the statutory accounting treatment for retrospectively rated reinsurance agreements was the principal reason for the difference between the GAAP Combined Ratio and the SAP Combined Ratio. Additionally, for all years presented, the difference relates to the accounting for certain costs which are treated differently under SAP and GAAP.
Management's Discussion and Analysis of Financial Condition and - ------- --------------------------------------------------------------- Results of Operations. ----------------------
Leucadia National Corporation (the "Parent") is a holding company whose assets principally consist of the stock of its several direct subsidiaries, cash and other 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 and private capital market transactions, 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, 2000, the Company's readily available cash, cash equivalents and marketable securities, excluding those amounts held by its regulated subsidiaries, totaled $643,400,000. Additional sources of liquidity as of December 31, 2000 include $156,800,000 of marketable securities collateralizing letters of credit and $183,100,000 of cash, cash equivalents and marketable securities held by Fidei.
During 2000, the Company invested $100,000,000 in the equity of JPOF II, a limited liability company that is a registered broker-dealer. JPOF II is managed and controlled by Jefferies & Company, Inc. JPOF II invests in high
During 2000, the Company repurchased 1,505,000 Common Shares for an aggregate cost of $32,100,000. As of March 19, 2001, the Company is authorized to repurchase an additional 4,495,000 Common Shares. Such purchases may be made from time to time in the open market, through block trades or otherwise. Depending on market conditions and other factors, such purchases may be commenced or suspended at any time without prior notice.
In February 2001, the Company, Berkshire Hathaway Inc., and Berkadia LLC, an entity jointly owned by the Company and Berkshire Hathaway, announced a commitment to lend $6,000,000,000 on a senior secured basis to FINOVA Capital Corporation, the principal operating subsidiary of FINOVA, to facilitate a chapter 11 restructuring of the outstanding debt of FINOVA and its principal subsidiaries. Under the commitment, Berkadia's funding obligations to FINOVA Capital have been guaranteed, 90% by Berkshire Hathaway and 10% by the Company (with the Company's guarantee being secondarily guaranteed by Berkshire Hathaway). The parties intend to finance this commitment; such financing is expected to be similarly guaranteed. The commitment, which expires on August 31, 2001, or earlier if certain events occur or conditions are not satisfied, provides that Berkadia will receive $6,000,000,000 principal amount of newly issued five year senior notes of FINOVA Capital, secured by substantially all of the assets of FINOVA and its subsidiaries (the "Secured Note"). The notes will also be guaranteed on a secured basis by FINOVA and substantially all of the subsidiaries of FINOVA and FINOVA Capital. Berkadia's obligation to make the loan is subject to a number of conditions, including Berkadia's satisfaction with the chapter 11 reorganization plan of the FINOVA companies, including bankruptcy court and necessary creditor approvals, the issuance to the Company and Berkshire Hathaway of newly issued common stock of FINOVA totaling 51% of the stock of FINOVA to be outstanding on a fully diluted basis, and Berkadia being able to designate a majority of the Board of Directors of FINOVA.
As indicated above, the completion of the loan is subject to a number of conditions and there can be no assurance that it ultimately will be consummated.
Based on discussions with commercial and investment bankers, the Company believes that it has the ability to raise additional funds under acceptable conditions for use in its existing businesses or for appropriate investment opportunities. Since 1993, the Company's senior debt obligations have been rated as investment grade by S&P and Duff & Phelps Inc. Ratings issued by bond rating agencies are subject to change at any time.
In 2000 and 1999, net cash was used for operations principally as a result of a decrease in premiums written and the payment of claims at the Empire Group. As discussed above, it is currently anticipated that the premiums of the Empire Group will continue to decline while the Empire Group runs off its claims liabilities. This is expected to result in a continued net use of cash for the Empire Group's operations over the next several years.
The investment portfolio of the Company's insurance subsidiaries principally consists of fixed maturity investments; the balance of their portfolio consists largely of preferred securities. Of the fixed maturity securities, the majority consists of those rated "investment grade" or U.S. governmental agency issued or guaranteed obligations, although limited investments in "non-rated" or rated less than investment grade securities have been made from time to time.
In the past, the Company has at times funded the construction and/or expansion of its manufacturing facilities with industrial revenue bonds. At December 31, 2000, the Company has $9,800,000 principal amount outstanding for such financing. The Company expects to finance the construction of the plastics division's Belgium facility, estimated to aggregate $18,500,000, with available cash resources.
As of December 31, 2000, the principal amount of Fidei's Euro denominated outstanding debt, all of which is non-recourse to the Company, was $184,000,000 (195,200,000 Euros). Inasmuch as Fidei's Euro denominated cash, cash equivalents
and marketable securities approximate its Euro denominated debt, there is currently no need to acquire a currency hedge for Fidei's debt.
Net earned premium revenues of the Empire Group were $108,500,000, $145,200,000 and $228,600,000 for the years ended December 31, 2000, 1999 and 1998, respectively. While earned premiums declined in almost all lines of business during 2000 and 1999, the most significant reductions during 2000 were in assigned risk automobile ($14,700,000) and voluntary private passenger automobile ($14,700,000), and during 1999 were in assigned risk automobile ($24,100,000), voluntary private passenger automobile ($26,900,000) and commercial package policies ($11,600,000). Effective January 1, 2000, all policy renewal obligations for assigned risk contracts were assigned to another insurance company. However, the Empire Group remains liable for the claim settlement costs for assigned risk claims that occurred during the policy term. The decline in voluntary private passenger automobile resulted from tighter underwriting standards, increased competition and the Empire Group's decision in 1999 to no longer accept new policies from those agents who historically have had poor underwriting results. The Empire Group's termination of certain unprofitable agents also adversely affected premium volume in other lines of business.
During 2000, the Empire Group experienced unfavorable development principally in the 1996 through 1999 accident years in the private passenger automobile line ($9,200,000), the commercial auto line ($6,200,000), the assigned risk automobile line ($4,800,000) and the commercial package policies line ($15,000,000). In addition, the Empire Group increased its estimate for loss adjustment expenses by $11,000,000 as a result of the decision to outsource a significant amount of claim handling functions in 2000. Claim files for workers' compensation, automobile no-fault and automobile and other liability claims were outsourced at a cost greater than the reserves previously recorded to handle the claims internally. The Empire Group has outsourced almost two-thirds of its claims. Currently, the Empire Group is primarily handling complex claims, first party claims and certain automobile liability and general liability claims internally. Complex claims generally consist of those that have potentially large settlement exposure and are not expected to settle quickly. The Empire Group has also increased its reserve estimate for claims handled internally.
As a consequence of its reserve increases, the Empire Group has reduced premiums and pre-tax profits to recognize reinsurance premiums due for 1995 and prior years under retrospectively rated reinsurance agreements. Such amounts totaled $4,500,000, $4,600,000, and $2,000,000 for the years ended December 31, 2000, 1999 and 1998, respectively. The Empire Group has not entered into retrospectively rated reinsurance agreements after 1995.
Finance revenues, which reflect the level and mix of consumer instalment loans, increased in each of the last two years due to greater average loans outstanding. Average loans outstanding were $423,200,000, $238,600,000 and $148,700,000 for 2000, 1999 and 1998, respectively. The increase in 2000 was primarily due to the acquisition in 1999 of Tranex and increased new loan originations. Pre-tax results declined in 2000 as compared to 1999 primarily due to an increase in the provision for loan losses, higher interest expense due to increased customer banking deposits and higher interest rates thereon, and higher salaries expense.
The higher loan losses were principally caused by the poor performance of the subprime automobile portfolio purchased from Tranex, for which the actual collection experience was less than expected, a larger amount of loans
outstanding, including the Tranex purchased portfolio, that are reaching the age of peak losses, generally twelve to eighteen months after origination, and the increased loan originations. The Company also believes that a weaker economy has contributed to its loan losses.
Equity in income (losses) of associated companies increased in 2000 primarily due to income of $17,300,000 related to JPOF II, described above. Equity in income (losses) of associated companies declined in 1999 as compared to 1998, primarily due to income of $30,800,000 recorded in 1998 from an investment partnership that was subsequently liquidated.
The increase in selling, general and other expenses in 2000 principally reflects higher provisions for loan losses, as described above, and expenses related to MK Gold. The increase in selling, general and other expenses in 1999 as compared to 1998 principally relates to expenses incurred by Fidei, higher provisions for loan losses, expenses incurred in connection with the Dividend and the recognition in 1998 of net curtailment gains relating to the Company's pension plan.
Income taxes for 1999 reflect a benefit of $40,100,000 from the utilization of capital loss carryforwards, of which $33,300,000 was previously included in the valuation allowance. Income taxes for 1999 also reflect a benefit of $3,400,000 for the favorable resolution of certain federal income tax contingencies. Income taxes for 1998 reflect a benefit of $39,000,000 for a change in the Company's estimated 1997 federal tax liability and the favorable resolution of certain contingencies.
The number of shares used to calculate basic earnings (loss) per share was 55,529,000, 59,338,000 and 63,409,000 for 2000, 1999 and 1998, respectively. The number of shares used to calculate diluted earnings (loss) per share was 55,598,000, 59,352,000 and 63,510,000 for 2000, 1999 and 1998, respectively.
could delay or preclude the issuance of permits necessary to develop the Company's Spanish mining rights, changes in the commercial real estate market in France, the success of ultimate negotiations with the FINOVA companies and their creditors, approval of a FINOVA chapter 11 plan having materially different terms than those set forth in the commitment letter of Berkadia LLC filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 2000, and changes in the composition of the Company's assets and liabilities through acquisitions or divestitures. Undue reliance should not be placed on these forward-looking statements, which are applicable only as of the date hereof. The Company undertakes no obligation to revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this Report or to reflect the occurrence of unanticipated events.