Through its various subsidiaries, the Company owns and utilizes in its operations offices in Salt Lake City, Utah used for corporate and banking and lending activities (totaling approximately 80,200 square feet). Subsidiaries of the Company own facilities primarily used for manufacturing located in Georgia and Genk, Belgium (totaling approximately 410,300 square feet) and facilities and land in California and Oregon used for winery operations (totaling approximately 107,100 square feet and 457 acres, respectively).
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. Prior period amounts have been reclassified to reflect the Company's Foreign Real Estate segment as a discontinued operation.
Management's Discussion and Analysis of Financial Condition and Results ------------------------------------------------------------------------ of Operations. --------------
In December 2002, the Company completed a private placement of approximately $150,000,000 of equity securities, based on a common share price of $35.25, to mutual fund clients of Franklin Mutual Advisers, LLC, including the funds comprising the Franklin Mutual Series Funds. The Company issued 2,907,599 common shares and newly authorized Series A Non-Voting Convertible Preferred Stock, that were converted into 1,347,720 common shares in March 2003. The securities sold in the private placement represent 7.1% of the Company's outstanding common shares at March 25, 2003.
In December 2002, the Company completed the acquisition of 44% of the outstanding common stock of WilTel, for an aggregate purchase price, excluding expenses, of $330,000,000. The WilTel stock was acquired by the Company under the chapter 11 restructuring plan of WCG pursuant to a claims purchase agreement with The Williams Companies, Inc. and an investment agreement with WCG. In October 2002, in a private transaction, the Company purchased 1,700,000 shares of WilTel common stock, on a when issued basis, for $20,400,000. Together, these transactions resulted in the Company acquiring 47.4% of the outstanding common stock of WilTel.
WilTel's current focus is to retain its existing business by providing a high quality of service, to obtain new business if it can be done on a profitable basis, to reduce its operating expenses to the greatest extent possible, and to conserve liquidity. At December 31, 2002, WilTel had $291,300,000 of cash and cash equivalents to meet its cash requirements, and believes that it has sufficient liquidity to meet its needs through 2004. WilTel has $375,000,000 of senior debt outstanding under its credit facility, of which approximately $157,000,000 matures during 2005. Unless WilTel is able to generate significant cash flows from operations through revenue growth, expense reductions or some combination of both, it is likely that new capital will have to be raised to meet its maturing debt obligations in 2005.
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 the Company's credit agreement facility and through public financings. In March 2003, the Company entered into a new $110,000,000 unsecured bank credit facility that matures in three years and bears interest based on the Eurocurrency Rate or the prime rate.
As of March 25, 2003, the Company is authorized to repurchase an additional 4,490,000 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.
At December 31, 2002, a maximum of $10,200,000 was available to the Parent as dividends from its regulated subsidiaries without regulatory approval. There are no restrictions on distributions from non-regulated subsidiaries. The Parent also receives tax sharing payments from subsidiaries included in its consolidated income tax return, including certain regulated subsidiaries. Payments from regulated subsidiaries for dividends and tax sharing payments totaled $7,100,000 for the year ended December 31, 2002.
The Company's consolidated banking and lending operations had outstanding loans (net of unearned finance charges) of $373,600,000 and $521,200,000 at December 31, 2002 and 2001, respectively. At December 31, 2002, 55% were loans to individuals generally collateralized by automobiles; 38% were loans to consumers, substantially all of which were collateralized by real or personal property; 4% were loans to small businesses; and 3% were unsecured loans. The banking and lending segment is no longer making consumer loans and is in the process of liquidating its remaining portfolio. These loans were primarily funded by deposits generated by the Company's deposit-taking facilities and by brokers. The Company intends to use the cash flows generated from its loan portfolios to retire these deposits as they mature, which the Company expects will be substantially complete by the end of 2005. The Company's customer banking deposits totaled $392,900,000 and $476,500,000 as of December 31, 2002 and 2001, respectively.
As shown below, at December 31, 2002, the Company's contractual cash obligations totaled $807,472,000. The Company's debt instruments require maintenance of minimum Tangible Net Worth, limit distributions to shareholders and limit Indebtedness, as defined in the agreements. In addition, the debt instruments contain limitations on investments, liens, contingent obligations and certain other matters. The Company is in compliance with all of these restrictions, and the Company has the ability to incur additional indebtedness or make distributions to its shareholders and still remain in compliance with these restrictions.
The allowance for loan losses is established through a provision that is charged to expense. As of December 31, 2002, the Company's allowance for loan losses was $31,800,000 or 8.5% of the related outstanding loan receivable balance of $373,600,000. The allowance for loan losses is an amount that the Company believes will be adequate to absorb probable losses inherent in its portfolio based on the Company's evaluations of the collectibility of loans and prior loan loss experience. Factors considered by the Company include actual experience, current economic trends, aging of the loan portfolio and collateral value. During periods of economic weakness, delinquencies, defaults, repossessions and losses generally increase. These periods may also be accompanied by decreased demand and declining values of automobiles securing outstanding loans, which weakens collateral coverage and increases the amount of a loss in the event of default. In addition, incentives offered by the automobile industry on new cars affect the supply of used cars and the value the Company may realize upon sale of repossessed automobiles. The allowance is based on judgments and assumptions and the actual loss experience may be different.
The Company accounts for its investment in Berkadia under the equity method of accounting. Although the Company has no cash investment in Berkadia, the Company has a contingent liability resulting from its guarantee of 10% of the third party financing provided to Berkadia. The total amount of the Company's guarantee is $152,500,000 as of March 7, 2003. Since the Company does not expect that Berkadia will suffer losses resulting in the Company having to fund its guarantee obligation, no reserve has been recorded.
As of December 31, 2002, the carrying amount of the Company's investment in the mining properties of MK Gold was approximately $59,300,000. The recoverability of this asset is entirely dependent upon the success of MK Gold's mining project at the Las Cruces copper deposit in the Pyrite Belt of Spain. Mining will be subject to obtaining required permits, obtaining both debt and equity financing for the project, engineering and construction. The market price of copper has been depressed over the past couple of years, reflecting generally weak global economic conditions. The amount of financing that can be obtained for the project and its related cost will be significantly affected by the assessment of potential lenders of the current and expected future market price of copper. In addition, the actual price of copper, the operating cost of the mine and the capital cost to bring the mine into production will affect the recoverability of this asset. Based on the current status of the project and MK Gold's estimate of future financing costs and future cash flows, the Company believes the asset is recoverable.
Finance revenues, which reflect the level and mix of consumer instalment loans, decreased in 2002 as compared to 2001 due to fewer average loans outstanding. Average loans outstanding were $440,800,000, $545,000,000 and $423,000,000 for 2002, 2001 and 2000, respectively. This decline was primarily due to the Company's decision in September 2001 to stop originating subprime automobile loans. Although finance revenues decreased in 2002 as compared to 2001, pre-tax results increased primarily due to a $13,700,000 reduction in interest expense, due to reduced customer banking deposits and lower interest rates thereon, a net change of $10,000,000 in the accounting for the market values of interest rate swaps (discussed below), a decline in the provision for loan losses of $7,100,000, and lower salaries expense and operating costs resulting from the segment's restructuring efforts. These changes were partially offset by higher interest paid on interest rate swaps of $4,100,000.
In 2002, the banking and lending segment's provision for loan losses decreased as compared to the prior year primarily due to the decline in loans outstanding, although as a percent of outstanding loans it increased due to increased loss experience, particularly in the subprime automobile portfolio. The Company believes this loss experience reflects the difficulties experienced by subprime borrowers in the current economy. At December 31, 2002, the allowance for loan losses for the Company's entire loan portfolio was $31,800,000 or 8.5% of the net outstanding loans, compared to $35,700,000 or 6.8% of net outstanding loans at December 31, 2001.
Pre-tax results for the banking and lending segment include income (expense) of $3,500,000 and ($6,500,000) for the years ended December 31, 2002 and 2001, respectively, resulting from mark-to-market changes on its interest rate swaps. The Company uses interest rate swaps to manage the impact of interest rate changes on its customer banking deposits. Although the Company believes that these derivative financial instruments serve as economic hedges, they do not meet certain effectiveness criteria under SFAS 133 and, therefore, are not accounted for as hedges.
For the year ended December 31, 2002, the division recorded an impairment charge of approximately $1,250,000 to write down the book value of certain production lines that the division does not expect will be utilized over the next several years. These lines were initially purchased to provide additional capacity to produce a specific product for a specific customer; however, the customer discontinued the product in 2001 and the Company no longer believes that the cost of these lines are currently recoverable from other business. When the division's customer discontinued the product and terminated their contract in 2001, they were required to pay the division a termination payment of $3,500,000, which was recognized as other income in 2001. The division did not record an impairment charge in 2001 since its expected production volume for these lines would have resulted in future cash flows that did not support an impairment charge at that time.
Revenues from domestic real estate declined in 2002 as compared to 2001 as a result of lower gains from property sales of $16,400,000, and less rent income of $7,300,000 largely due to the sale of one of the Company's shopping centers in 2001 and two shopping centers during 2002, partially offset by increased revenues from the Company's Hawaiian hotel, which the Company began operating in the third quarter of 2001. The decline in pre-tax income also reflects greater operating costs, principally related to the Hawaiian hotel and a $1,300,000 write-down of a mortgage receivable.
The reduction in revenues and pre-tax income from domestic real estate in 2001 as compared to the prior year was principally due to the foreclosure gains recorded in 2000 and lower gains from property sales, net of costs. During 2001, the Company sold 691 residential sites and a school site resulting in pre-tax gains of $18,100,000 at San Elijo Hills.
Investment and other income declined in 2002 as compared to 2001 principally due to reductions in gains from domestic property sales and rent income as discussed above, a reduction of $20,600,000 in investment income resulting from a decline in interest rates and a lower amount of invested assets, a decline of $9,200,000 in revenues from the Company's gas operations principally due to lower production and prices, and the gain recognized in 2001 of $6,300,000 from the sale of the Company's investment in two inactive insurance companies. The decreases were partially offset by a $14,300,000 gain from the sale of certain thoroughbred racetrack businesses and increased revenues from the Company's Hawaiian hotel of $8,200,000.
For 2002, the Company recognized $91,400,000 of pre-tax income from its equity investments in associated companies as compared to $24,600,000 of pre-tax losses for 2001. The increase in 2002 was primarily due to income from the Company's equity investment in Berkadia of $65,600,000 as compared to a loss from this investment of $70,400,000 in 2001, and $24,100,000 of income from the Company's equity investment in Olympus, an investment the Company made in December 2001. These increases were partially offset by a $11,900,000 decline in income from its investment in JPOF II, from which the Company recorded $15,200,000 of income in 2002, and a loss of $13,400,000 from the Company's equity investment in WilTel, representing the Company's share of WilTel's losses under the equity method of accounting.
The book value of the Company's equity investment in Berkadia was negative $72,100,000 and negative $129,000,000 at December 31, 2002 and 2001, respectively. The negative carrying amount principally results from Berkadia's distribution of loan fees received and the Company's recognition in 2001 of its share of FINOVA's losses under the equity method of accounting. This negative carrying amount is being amortized into income over the term of the Berkadia Loan, and effectively represents an unamortized discount on the Berkadia Loan.
Since its acquisition in the fourth quarter of 2002, the Company has recorded its share of WilTel's losses under the equity method of accounting. As a result of its emergence from bankruptcy proceedings and its continued restructuring of its operations, WilTel has reduced its headcount, operating costs and interest expense. However, despite these cost reductions, the Company believes that WilTel will continue to report losses from continuing operations for the foreseeable future. Even if WilTel is able to generate breakeven cash flow from operations, substantial depreciation charges will still result in losses from continuing operations over the next several years. The Company will record its 47.4% share of these losses in its statements of operations, and the recognition of these losses could reduce the carrying amount of its investment in WilTel to zero. The Company will not record any further losses in WilTel if and when its investment is reduced to zero, unless the Company has guaranteed any of WilTel's obligations, or otherwise has committed or intends to commit to provide further financial support. The Company has not provided any such guarantees or commitments.
For 2001, the Company recognized $24,600,000 of pre-tax losses from its equity investments in associated companies as compared to $29,300,000 of pre-tax income for 2000. The loss in 2001 was primarily due to a loss of $70,400,000, representing the Company's share of the loss recorded by Berkadia, as described above. The Company's loss related to Berkadia was partially offset by income from other equity investments, the most significant of which related to JPOF II. The Company recognized income from its investment in JPOF II of $27,100,000 and $17,300,000 in 2001 and 2000, respectively.
Selling, general and other expenses increased in 2001 as compared to the prior year primarily due to higher provisions for loan losses and charges recorded in connection with consolidating the banking and lending operations referred to above, partially offset by lower expenses related to MK Gold.
Income taxes for 2002 reflect the reversal of tax reserves aggregating $120,000,000, as a result of the favorable resolution of certain federal income tax contingencies discussed above. Income taxes for 2001 reflect a benefit of $36,200,000 for the favorable resolution of federal and state income tax contingencies, and in 2000, the Company's effective income tax rate did not vary materially from the expected statutory federal rate.
In December 2001, upon approval by the Company's Board of Directors to commence an orderly liquidation of the Empire Group, the Company classified as discontinued operations the property and casualty insurance operations of the Empire Group. The Empire Group had historically engaged in commercial and personal lines of property and casualty insurance, principally in the New York metropolitan area. The Empire Group only accepts new business that it is obligated to accept by contract or New York insurance law; it does not engage in any other business activities except for its claims runoff operations. The voluntary liquidation is expected to be substantially complete by 2005. In December 2001, the Company wrote down its investment in the Empire Group to its estimated net realizable value based on expected operating results and cash flows during the liquidation period, which indicated that the Company is unlikely to realize any value once the liquidation is complete. Accordingly, the Company recorded a $31,100,000 after-tax charge (net of taxes of $16,800,000) as a loss on disposal of discontinued operations to fully write-off its investment. While this estimated net realizable value represents management's best estimate, the amount the Company will ultimately realize could be, but is not expected to be, greater. The Company has no obligation to contribute additional capital to the Empire Group.
o general economic and market conditions or prevailing interest rate levels; o changes in foreign and domestic laws, regulations and taxes; o changes in competition and pricing environments; o regional or general changes in asset valuation; o the occurrence of significant natural disasters, the inability to reinsure certain risks economically, increased competition in the reinsurance markets, the adequacy of loss and loss adjustment expense reserves; o weather related conditions that may affect the Company's operations or investments; o changes in U.S. real estate markets, including the residential market in Southern California and the commercial and vacation markets in Hawaii; o increased competition in the luxury segment of the premium table wine market; o adverse economic, political or environmental developments in Spain that could delay or preclude the issuance of permits necessary to obtain the Company's copper mining rights or could result in increased costs of bringing the project to completion, increased costs in financing the development of the project and decreases in world wide copper prices; o increased competition in the international and domestic plastics market and increased raw material costs; o increased default rates and decreased value of assets pledged to the Company; o further adverse regulatory action by the OCC; o any deterioration in the business and operations of FINOVA, in the ability of FINOVA Capital to repay the Berkadia Loan, further deterioration in the value of the assets pledged by FINOVA and FINOVA Capital in connection with the Berkadia Loan; o deterioration in the business and operations of WilTel and the ability of WilTel to generate operating profits and positive cash flows, WilTel's ability to retain key customers and suppliers, regulatory changes in the telecommunications markets and increased competition from reorganized telecommunication companies; and o changes in the composition of the Company's assets and liabilities through acquisitions or divestitures.