NAICC's headquarters is located in a leased office facility near Long Beach, California, pursuant to a five-year lease which is scheduled to expire in 2004. NAICC is in current negotiation with various potential lessors for new office space in the Long Beach metropolitan area. It is anticipated that a new lease will be signed in 2004 for five years at square footage and total rent costs that are substantially less than what it currently maintains and incurs.
See Note 16 of the Notes to Consolidated Financial Statements for additional information on NAICC's leases.
As a result of the consummation of the Covanta acquisition on March 10, 2004, the future performance of DHC will predominantly reflect the performance of Covanta's operations which are significantly larger than DHC's insurance operations. As a result, the nature of DHC's business, the risks attendant to such business and the trends that it will face will be significantly altered by the acquisition of Covanta. Accordingly, DHC's prior financial performance and results of operations will not be indicative of its future performance. - ---------------
Certain statements in the Annual Report on Form 10-K may constitute "forward-looking" statements as defined in Section 27A of the Securities Act of 1933 (the "Securities Act"), Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"), the Private Securities Litigation Reform Act of 1995 (the "PSLRA") or in releases made by the SEC, all as may be amended from time to time. Such forward looking statements involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of DHC and its subsidiaries, or industry results, to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Statements that are not historical fact are forward-looking statements. Forward looking statements can be identified by, among other things, the use of forward-looking language, such as the words "plan", "believe", "expect", "anticipate", "intend", "estimate", "project", "may", "will", "would", "could", "should", "seeks", or "scheduled to", or other similar words, or the negative of these terms or other variations of these terms or comparable language, or by discussion of strategy or intentions. These cautionary statements are being made pursuant to the Securities Act, the Exchange Act and the PSLRA with the intention of obtaining the benefits of the "safe harbor" provisions of such laws. DHC cautions investors that any forward-looking statements made by DHC are not guarantees or indicative of future performance. Important assumptions and other important factors that could cause actual results to differ materially from those forward-looking statements with respect to DHC, include, but are not limited to, the risks and uncertainties affecting the businesses described in Item 1.
Although DHC believes that its plans, intentions and expectations reflected in or suggested by such forward-looking statements are reasonable, actual results could differ materially from a projection or assumption in any of its forward-looking statements. DHC's future financial condition and results of operations, as well as any forward-looking statements, are made only as of the date hereof and DHC does not have or undertake any obligation to update or revise any forward-looking statements whether as a result of new information, subsequent events or otherwise, unless otherwise required by law.
However, as a result of the consummation of the Covanta acquisition on March 10, 2004, the future performance of DHC will predominantly reflect the performance of Covanta's operations which are significantly larger than DHC's insurance operations. As a result, the nature of DHC's business, the risks attendant to such business and the trends that it will face will be significantly altered by the acquisition of Covanta. Accordingly, DHC's prior financial performance will not be indicative of its future performance.
Accordingly, DHC wrote off its remaining investment in ACL at the end of the first quarter of 2003 as an other than temporary asset impairment (see Note 20 of the Notes to Consolidated Financial Statements).
As a result of the bankruptcy filing, while DHC continues to exercise influence over the operating and financial policies of ACL, it no longer maintains control of ACL. Accordingly, for the year ended December 31, 2003, DHC has accounted for its investments in ACL, GMS and Vessel Leasing using the equity method of accounting. Under the equity method of accounting, DHC reports its share of the equity investees' income or loss based on its ownership interest.
Since DHC wrote of its investment in ACL in 2003 and did not have any Marine Services' operations in 2001 and, since neither DHC nor the other Marine Services subsidiaries (GMS and Vessel Leasing) are guarantors of ACL's debt nor are they liable for any of ACL's liabilities, the commentary included in this Item 7 with respect to the financial condition and results of operations of Marine Services is limited. An expanded discussion and analysis would not reflect DHC's current or future operations and, accordingly, would not be meaningful.
The change in net earned premiums during those years is directly related to the change in net written premiums. Net written premiums were $30.4 million and $52.7 million in 2003 and 2002, 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 $1.2 million net decrease in the allowance for premiums and fees receivable during 2003 was primarily attributable to the write-off of $1.4 million of outstanding balances from 2001 and 2002 against the allowance. These write-offs were partially offset by an increase in the allowance of $0.2 million during 2003. NAICC made changes to its commercial auto installment plans for policies written in 2003, which improved overall collection rates. The net increase in the allowance for premiums and fees receivable during 2002 of $0.2 million was attributable to the increase in installment written premiums during 2001 prior to the decision to contract underwriting operations in the commercial automobile line. As a result, NAICC increased both its allowance for premiums and the amount written-off against such allowance during 2002.
Net investment income decreased primarily due to a decrease in the fixed income portfolio basis as well as a reduction in the portfolio yield. Fixed-income invested asset portfolio decreased by $5.6 million in 2003, despite net loss and LAE reserves declining by $8.6 million. The differential was a result of NAICC disposing of substantially all of its equity security holdings in the 4th quarter of 2003 and reinvesting those proceeds, approximately $4.1 million, in fixed income securities. Additionally, NAICC received from DHC $2.0 million in additional paid-in capital at year-end. Due to the decrease in written premiums on business placed in run-off noted above, NAICC also experienced negative underwriting cash flows. As of December 31, 2003 and 2002, the weighted average yield on NAICC's portfolio was 4.9% and 5.9%, respectively. The effective duration of the portfolio at December 31, 2003 was 2.29 years which management believes is appropriate given the relative short-tail nature of the auto programs and projected run-off of all lines of business.
Net losses and LAE ratios were 102.3% in 2003 and 96.3% in 2002. The increase in the loss and LAE ratio during 2003 was attributable to further recognition of prior accident year reserve development on workers' compensation and commercial automobile insurance. NAICC has historically priced its non- standard private passenger and commercial auto premium at 68% to 69% of its expected loss and allocated loss adjustment expense ("ALAE") costs in order to balance its expense structure and market conditions. In 2003, NAICC believed it had a far more successful underwriting year, posting loss and ALAE ratios of 60.4% and 59.5% for its California non-standard auto and entire commercial auto program. These results were commensurate with industry results for 2003 driven primarily by the hard insurance market. Non-standard private passenger and commercial auto claim frequency was 10.4 and 7.9 vehicles per claim in accident year 2003 compared to 8.8 and 7.7 in 2002, respectively. Severity was favorable for both lines as well in 2003 compared to 2002 by reduction of average cost per claim of 3% and 6% for the personal and commercial auto lines, respectively. Although both these indicators were favorable in 2003, the average premium per vehicle on commercial lines had the most significant effect on the loss and ALAE ratio. The average premium per vehicle on commercial lines increased 17.8% for the 2003 accident year. With respect to the personal automobile insurance, the mix of business moving towards non-owner policies 28% in 2003 versus 10% in 2002
Policy acquisition costs as a percentage of net earned premiums were 22.2% in 2003 and 22.7% in 2002. 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 vary with and are directly related to policy issuance. The modest decrease was a result of change in the mix of business and a favorable renegotiation by NAICC of its commission structure with its general agent in the fourth quarter of 2003.
General and administrative expenses increased in 2003 primarily due to recording an additional allowance for uncollectable reinsurance recoverable of $1.3 million and $0.2 million in employee severance expenses related to business contraction. Exclusive of the two items noted above, expenses decreased $0.7 million compared to 2002 due to decreased production and previously implemented cost containment efforts. NAICC continues to examine its expense structure; however, given the decision to reduce net writings and its obligation to run-off several lines of business, a core amount of fixed governance costs is required and consequently its expense ratio will be higher than industry averages until it can increase premium production.
As a result of ACL's continued losses and DHC management's belief that it may recover little, if any, of its investment in ACL, DHC wrote off its remaining investment in ACL during the first quarter of 2003. The equity in net loss of unconsolidated Marine Services subsidiaries included a loss from ACL of $47.0 million, an other than temporary impairment of the remaining investment in ACL of $8.2 million, and income from GMS and Vessel Leasing of $0.3 million. The GMS and Vessel Leasing investments are not considered to be impaired. (The Marine Services subsidiaries' operating results in 2002 were consolidated in DHC's operating
The decline in net earned premiums 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.
Net investment income was $5.6 million in 2002 compared to $7.6 million in 2001. The net investment income decrease was due primarily to a decrease in the fixed income portfolio. The fixed-income invested asset portfolio decreased by $25.9 million in 2002. Such decrease was attributable to the conversion of $9.2 million of ACL notes into equity. As a result of the decrease in written premiums on business placed in run-off noted above, NAICC also experienced negative underwriting cash flows. 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 was 2.7 years compared to 3.2 years at December 31, 2001.
Net realized investment gains were relatively comparable due to the gain recognized on the conversion of ACL bonds to equity. Otherwise the net realized losses of 2002 and gains in 2001 were consistent with the general economic trends for those periods.
Marine Services -- Year Ended December 27, 2002 Compared with Year Ended December 28, 2001
Investment Income. Total parent company investment income increased to $9.5 million for the year ending December 2002 as compared to $2.0 million for the year ending December 2001 primarily 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.
Interest Expense -- Year Ended December 27, 2002 Compared with Year Ended December 31, 2001
Due to the factors discussed above and others, the process used in estimating unpaid losses and LAE cannot provide an exact result. DHC's results of operations for each of the past three years have been adversely affected by insurance loss development related to prior years of $13.5 million, $10.4 million and $7.6 million for 2003, 2002 and 2001, respectively.
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." DHC has elected to account for its stock option plans using the intrinsic value method for grants to employees and directors. Because all of the options granted to employees and directors under those plans have had an exercise price equal to or greater than the market value of the underlying common stock on the date of grant, only minimal stock-based compensation cost due to modifications has been recognized in the consolidated statements of operations for those options. DHC accounts for its stock options granted to contractors using the fair value method of 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 significantly affected.
Note 1 in Item 8, Financial Statements -- Significant Accounting Policies, includes supplemental information, including pro forma net loss and loss per share, as if stock-based compensation cost for all of the stock option grants had been determined using the fair value method of SFAS 123. The fair value of these options was estimated at the date of grant or modification using a Black-Scholes option pricing model with
assumptions about the dividend yield, risk-free interest rate, expected option life, and expected stock price volatility. These assumptions can be highly subjective. Because stock options have characteristics different from those of traded options, changes in the subjective assumptions can materially affect the fair value of stock options. Using different assumptions, the supplemental information provided in Note 1 of the Notes to the Consolidated Financial Statements, could be significantly different.
See Note 1 of the Notes to the Consolidated Financial Statements for further discussion of DHC's significant accounting policies.
On a parent-only basis, at December 31, 2003, DHC owed $40 million plus accrued interest of $0.4 million on a bridge financing agreement relating to the Covanta acquisition. This debt accrues interest at 12% through July 15, 2004 and 16% thereafter and has a scheduled maturity date of January 2, 2005. DHC plans to repay this obligation with proceeds from the rights offering. Under the terms of the note purchase agreement, DHC is obligated to file a registration statement with the SEC to register the rights offering not later than May 24, 2004, 75 days following the closing of the Covanta acquisition. If DHC does not repay all of the outstanding debt through the rights offering proceeds, the remaining balance will be converted into Common Stock, subject to certain limitations. Additionally, Laminar has agreed, under the note purchase agreement, to convert an amount of their notes to acquire up to 8.75 million shares of Common Stock at $1.53 per share, based on public participation in the rights offering. DHC has also agreed to sell up to 3 million shares of Common Stock to certain creditors of Covanta for $1.53 per share, based on public participation in the rights offering and subject to other limitations.
DHC's sources of funds are its investments as well as dividends, if any, received from its insurance subsidiary. 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. Currently, NAICC cannot pay dividends or make loans to DHC.
For the year ended December 2003, cash provided by parent-only operating activities was $0.1 million. For the years ended December 2002 and 2001, cash used in parent-only operating activities was $4.8 million and $0.9 million, respectively. Cash used in operations is primarily attributable to wages and benefit costs, professional fees, directors' fees, insurance and other working capital requirements of the holding company's business. The increase in cash used in 2002 as compared to 2001 is due to additional insurance premium payments, one time increases in management compensation related to the resignation of certain DHC management in connection with its acquisition of ACL and higher director's fees.
In 2002, DHC paid cash of $42.7 million, including $6.6 million in fees, for the acquisition of ACL, 50% of the common interest of Vessel Leasing and 5.4% of the equity of GMS. This was financed through rights offering proceeds of $42.2 million, the exercise of Common Stock warrants of $9.5 and the exercise of Common Stock options of $1.1 million. As part of the transaction, $6.0 million was advanced to an ACL affiliate. This was subsequently repaid in February of 2003.
Net cash provided by financing activities was $36.0 million for the year ended December 31, 2003 and was comprised of $40.0 million of borrowings under the bridge financing agreement related to the Covanta acquisition less $4.0 million of repayments paid to NAICC. DHC borrowed $4.0 million from NAICC in 2001 at an interest rate of 6%. The loan was scheduled to be repaid in 2004, but was repaid early, in February 2003.
receipts, investment income and reinsurance recoveries. To the extent operating cash flows do not provide sufficient cash flow, NAICC relies on the sale of invested assets. NAICC's investment policy guidelines require that all net policyholder liabilities be matched by a comparable amount of investment grade assets. Management believes that NAICC has sufficient available resources to meet its present capital needs.
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 10 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 pledged assets of $7.2 million and had letters of credit outstanding of $2.8 million at December 31, 2003.
A summary of DHC's contractual commitments under debt and lease agreements appears below.
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 and $1.3 million for the years ended December 2002 and 2001, respectively.
In connection with the DHC Recapitalization of ACL described in Note 3 of the Notes to the Consolidated Financial Statements, DHC provided SZ Investments unlimited demand registration rights with respect to the ACL Senior Notes and ACL PIK Notes held by HY I Investments, L.L.C. ("HYI"), an affiliate of SZ Investments. Mr. Zell and Mr. Tinkler, DHC's Chief Financial Officer, are affiliated with SZ Investments and HYI. HYI is a holder of approximately 42% of ACL's Senior Notes and PIK Notes. Mr. Pate, a member of DHC's Board of Directors, is affiliated with SZ Investments and HYI and is an executive officer of EGI. A special committee of DHC's Board of Directors composed solely of disinterested directors oversees DHC's investment in ACL and related Chapter 11 bankruptcy proceedings.
On April 14, 1999, DHC entered into a non-exclusive investment advisory agreement with EGI pursuant to which EGI agreed to provide, at the request of DHC, certain investment banking services to DHC in connection with potential transactions. For these services, in 2002, DHC paid a fee of $0.1 million to EGI. The agreement provided that, in the event that a transaction was consummated for which the Acquisition Committee of DHC's Board of Directors determined that EGI provided material services, DHC would pay to EGI a fee in the amount of 1% of the aggregate consideration in connection with such transaction (including indebtedness assumed or outstanding). As a result of services provided to DHC during the DHC Recapitalization of ACL, DHC and EGI agreed that the fee for EGI's services was $3.0 million. DHC also agreed to reimburse, upon request, EGI's out-of-pocket expenses related to services provided under the investment advisory agreement. For providing a standby commitment to purchase any DHC shares that were unsubscribed in the rights offering conducted by DHC as part of its acquisition of ACL, DHC paid SZ Investments a fee of $1.0 million. Messrs. Zell and Pate were members of the Acquisition Committee at the time of the DHC Recapitalization of ACL, along with Messrs. Whitman and Barse, all of whom are Directors of DHC. On December 1, 2003, DHC and EGI terminated this agreement.
DHC obtained the financing necessary for the Covanta acquisition pursuant to a note purchase agreement dated December 2, 2003, from the Bridge Lenders. Pursuant to the note purchase agreement, the Bridge Lenders provided DHC with $40.0 million of bridge financing in exchange for notes convertible under certain circumstances into shares of Common Stock at a price of $1.53 per share. These notes have a scheduled maturity date of January 2, 2005 and an extended maturity date of July 15, 2005, and bear interest at a rate of 12% per annum through July 15, 2004 and 16% per annum thereafter. In the event of a default or the failure to pay a convertible note on its maturity, the interest rate under the note increases by 2%.
In the event, that the issuance of shares of Common Stock under the notes trigger certain ownership change limitations, as defined by the Internal Revenue Code of 1986, the terms of the convertible notes may be modified. In the event of a non-ownership change rollover event (as defined in the note purchase agreement), the notes will bear interest at 18% per annum, compounded quarterly on the last day of each calendar quarter. In the event of an ownership change rollover event (as defined in the note purchase agreement), amounts in excess $8.0 million shall be subject to the non-ownership change rollover terms, unless prepaid in full in cash. In the first year in which notes are outstanding under the ownership change rollover terms, interest will be 12% per annum. Thereafter, interest on the notes will be 14.5% per annum, calculated quarterly and payable in arrears on the last day of each calendar quarter.
In consideration for the $40.0 million of bridge financing, the agreement by the Bridge Lenders to arrange or provide for the second lien letter of credit facility and for Laminar to arrange or provide for the Covanta Power International Holding revolving credit facility, DHC issued to the Bridge Lenders an aggregate of 5,120,853 shares of Common Stock. The Bridge Lenders are bound to participate fully in the rights offering in respect of the rights accruing pursuant to these shares of Common Stock.
DHC expects to refinance the notes through a previously announced rights offering. If DHC does not refinance all of the outstanding notes, the remainder of the notes would be convertible, without action on the part of the Bridge Lenders, into shares of Common Stock at the rights offering price of $1.53 per share, subject to agreed upon limitations necessitated by DHC's NOLs.
The note purchase agreement provides for DHC to comply with certain covenants including, among others:
The note purchase agreement further restricts, without a certain specified percentage of consents being obtained from the Bridge Lenders, DHC's ability to, among others:
- incur any debt for borrowed money in an aggregate principal amount in excess of $250,000, or incur liens on DHC property;
- any voluntary proceeding under any provision relating to bankruptcy, insolvency, reorganization, liquidation, or otherwise to the relief of debtors or the readjustment of indebtedness;
- any general assignment for the benefit of creditors or a composition or similar arrangement with such creditors; or
A required majority of the Bridge Lenders shall have the right to declare all or any portion of the unpaid principal of and accrued interest on the notes immediately due and payable, subject to certain cure periods, in the event:
- DHC accelerates any its indebtedness due to a default for borrowed money in excess of $5 million;
- a judgment or judgments are rendered against DHC that involves an amount in excess of $5 million, to the extent not covered by insurance;
- up to 10% of DHC's outstanding shares for a period of one year following March 10, 2004;
- up to an additional 5% of DHC's outstanding shares, or an aggregate of 15% of DHC's outstanding shares, during the period beginning one year following March 10, 2004 and ending two years following March 10, 2004;
In connection with this letter agreement, a special committee of disinterested members of DHC's Board of Directors has determined that sales of Common Stock in accordance to the foregoing limitations will not create an unreasonable risk of an ownership change under Article Fifth of DHC's charter, subject to confirmation at the time of such transfers by DHC's tax counsel.
Covanta has entered into two credit facilities to provide letters of credit in support of its domestic operations. Specifically, Covanta has entered into a letter of credit facility, secured by a first priority lien on Covanta's domestic assets, consisting of commitments for the issuance of letters of credit in the aggregate face amount of up to approximately $138 million with respect to Covanta's Detroit facility. This first lien credit facility has a term of five years, requires cash collateral to be posted for issued letters of credit and bears interest at the rate of 3% over the Base Rate (being the higher of (i) the prime rate or (ii) 0.5% in excess of the federal funds effective rate) on issued letters of credit (increasing to 5% over the Base Rate in specified default situations). Covanta also paid a 1% upfront fee (approximately $1.38 million) upon entering into the first lien credit facility, and will pay with respect to each issued letter of credit (i) a fronting fee equal to the greater of $500 and 0.25% per annum of the daily amount available to be drawn under such letter of credit, (ii) a letter of credit fee equal to 2.5% per annum of the daily amount available to be drawn under such letter of credit, and (iii) an annual fee of $1,500.
Additionally, Covanta has entered into a letter of credit facility, secured by a second priority lien on Covanta's domestic assets, consisting of commitments for the issuance of standby letters of credit in the aggregate face amount of up to $118 million. This second lien credit facility also provides for up to $10 million in cash borrowings, on a revolving basis, by Covanta to fund working capital requirements and for general corporate purposes. The amount available for the issuance of standby letters of credit will be reduced by the amount of outstanding loans under the revolving loan component. Among other things, the second lien credit facility provides Covanta with the ability to issue letters of credit as may be required with respect to various domestic waste-to-energy facilities, including a new letter of credit in favor of the Northeast Maryland Waste Disposal Authority in connection with the facility operated by Covanta Montgomery, Inc. This second lien credit facility has a term of five years. The letter of credit component of the second lien credit facility requires cash collateral to be posted for issued letters of credit and bears interest at the rate of 4.5% over the Base Rate on issued letters of credit (increasing to 6.5% over the base rate in specified default situations). The revolving loan component of the second lien credit facility bears interest at either (i) 4.5% over the Base Rate or (ii) 6.5% over a formula Eurodollar rate, the applicable rate to be determined by Covanta (increasing by 2% over the then applicable rate in specified default situations). Covanta also paid an upfront fee of $2.36 million upon entering into the second lien credit agreement, and will pay (i) a commitment fee equal to 0.5% per annum of the daily calculation of available credit, (ii) an annual agency fee of $30,000, and (iii) with respect to each issued letter of credit an amount equal to 6.5% per annum of the daily amount available to be drawn under such letter of credit.
The terms of both domestic credit facilities require Covanta to comply with certain covenants including, among others:
- that Covanta shall furnish the lenders with periodic financial, operating and other information;
- that Covanta shall comply with all applicable laws, rules, regulations and orders, and timely pay all taxes; and
The domestic credit facilities further restricts, without a certain specified percentage of consents being obtained from the lenders, Covanta's ability to, among others:
- pay any dividends on or repurchase any of its outstanding securities, subject to specific exceptions;
- a judgment or judgments are rendered against Covanta that involve an amount in excess of $5 million, to the extent not covered by insurance;
- the domestic intercreditor agreement or any security agreement ceases to be in full force and effect;
- any securities issuance or equity contribution which is reasonably expected to have a material adverse effect on the availability of net operating losses.
Covanta Power International Holdings, Inc. ("Covanta Power International"), a subsidiary of Covanta, and each of its subsidiaries, including certain domestic entities holding the equity interests in Covanta's foreign operations, which holds the assets and operations of Covanta's international independent power production business, entered into two credit facilities: a new revolving credit facility secured by a first priority lien on substantially all of Covanta Power International's assets, junior only to duly perfected and unavoidable prior liens, consisting of commitments for cash borrowings of up to $10 million for purposes of supporting the international independent power production business, and a term loan facility of up to $95 million secured by a second priority lien on substantially all of Covanta Power International's assets, junior only to duly perfected and unavoidable prior liens, including the lien with respect to the new Covanta Power International revolving credit facility.
The material terms of the reorganization plan notes are as follows:
The indenture, dated as of March 10, 2004, relating to the high yield notes requires Covanta to comply with certain covenants, including among others:
The high yield notes shall become immediately due and payable in the event that Covanta or certain of its affiliates become subject to specified events of bankruptcy or insolvency, and shall become immediately due and payable, upon action taken by the trustee under the indenture or holders of a certain specified percentage of principal under outstanding high yield notes, in the event that any of the following occurs after expiration of applicable cure periods:
- a judgment or judgments are rendered against Covanta that involve an amount in excess of $10 million, to the extent not covered by insurance; and
- a failure by Covanta to comply with its obligations under the indenture
Unsecured Indenture and Notes Covanta has authorized the issuance of up to $50 million in principal of unsecured global notes to certain creditors of Covanta under an indenture with a maturity date of eight years after Covanta's emergence from bankruptcy. Interest will be payable semi-annually at a rate of 7.5%. Annual amortization payments of approximately $3.9 million, paid at the end of the year, will be paid beginning in year two, with the balance due on maturity. The unsecured notes are subordinated in right of payment to all senior indebtedness including, the first lien letter of credit facility, the second lien letter of credit facility, the new high yield secured notes, and any other indebtedness of Covanta with a principal amount of up to $50 million that is designated by its express terms to be senior to the unsecured notes. The unsecured notes will otherwise rank equally with, or be senior to, all other indebtedness of Covanta. There are no mandatory sinking fund provisions and Covanta may redeem the unsecured notes at any time without penalty or premium. Upon the occurrence of a change of control event and certain sales of assets, Covanta is obligated to offer to repurchase all or any part of the unsecured notes at 101% of par on the accreted value.
- restrictions on the payment of dividends, the repurchase of stock, the incurrence of indebtedness and liens and the repayment of subordinated debt, unless certain specified financial and other conditions are met;
- restrictions on the sale of certain material amounts of assets or securities, unless certain specified conditions are met;
In January 2003, the FASB issued FASB Interpretation 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 (FIN 46). In December 2003, the FASB modified FIN 46 to make certain technical corrections and address certain implementation issues that had arisen, including deferral of certain provisions to 2004. FIN 46 provides a new framework for identifying variable interest entities ("VIEs") and determining when a company should include the assets, liabilities, noncontrolling interests and results of activities of a VIE in its consolidated financial statements. FIN 46 was effective immediately for VIEs created after January 31, 2003. The provisions of this statement did not have an impact on DHC's financial statements in 2003. DHC does not expect FIN46 will have a significant impact on its financial statements in 2004.
Danielson Holding Corporation ("DHC") is a holding company whose subsidiaries consist principally of insurance operations in the western United States, primarily California, and American Commercial Lines LLC ("ACL"), an integrated marine transportation and service company. ACL provides barge transportation and ancillary services throughout the inland United States and Gulf Intracoastal Waterway Systems, which include the Mississippi, Ohio and Illinois Rivers and their tributaries and the Intracoastal canals that parallel the Gulf Coast. In addition, ACL provides barge transportation services on the Orinoco River in Venezuela and the Parana/Paraguay River System serving Argentina, Brazil, Paraguay, Uruguay and Bolivia. ACL, through its subsidiary Jeffboat LLC, also provides marine construction and repair services.
DHC holds all of the voting stock of DHC Indemnity Company ("DIND"). DIND owns 100 % of the common stock of National American Insurance Company of California, DHC's principal operating insurance subsidiary, which owns 100% of the common stock of Valor Insurance Company, Incorporated ("Valor") (National American Insurance Company of California and its subsidiaries being collectively referred to as "NAICC").
ACL, which was acquired on May 29, 2002, and certain of its subsidiaries, filed a petition on January 31, 2003 with the U.S. Bankruptcy Court for the Southern District of Indiana, New Albany Division to reorganize under Chapter 11 of the U.S. Bankruptcy Code. As a result of this filing, while DHC continues to exercise significant influence over the operating and financial policies of ACL, it no longer maintains control of the activities of ACL. Accordingly, DHC no longer includes ACL and its subsidiaries as consolidated subsidiaries in DHC's financial statements. DHC's investments in these entities are presented using the equity method effective as of the beginning of the year ending December 31, 2003. DHC has direct ownership interest in two 50% owned subsidiaries of ACL. It owns 5.4% of the remaining 50% interest in Global Materials Services, LLC ("GMS") and the remaining 50% interest in Vessel Leasing, LLC ("Vessel Leasing"). These direct ownership interests are also reported using the equity method of accounting since DHC has the ability to exercise significant influence over the operating and financial policies of these companies. Under the equity method of accounting, DHC reports its share of ACL's, GMS's, and Vessel Leasing's ("Investees") income and loss for the period based on its ownership interest. DHC, GMS and Vessel Leasing are not guarantors of ACL's debt nor are they liable for any of ACL's liabilities. Accordingly, under the equity method of accounting, DHC does not recognize ACL's losses in excess of the investment in ACL.
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 until realized.
Any decline in the market value of any available-for-sale security or held-to-maturity security below cost which is deemed to be "other than temporary" is written down to fair value, resulting in losses that are included in realized investment gains and losses. A new cost basis is established for such security. Dividend
and interest income is recognized when earned. Investment gains or losses realized on the sale of securities are determined using the specific identification method.
Insurance Services' deferred policy 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 policy 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 policy acquisition costs of $833 at December 2003 and $1,612 at December 2002 are included with other assets under Parent Company and Insurance Services. The amortization of deferred acquisition costs charged to operations in 2003, 2002 and 2001 was $6,610, $11,437 and $16,174, respectively.
DHC recorded $7,169 of deferred financing costs in connection with the note purchase agreement described in Note 2. These costs are being amortized over the expected period that the bridge financing will be outstanding. Amortization for 2003 was $1,024 and is included in interest expense on the consolidated statement of operations.
In the normal course of business, Insurance Services seeks to reduce the loss that may arise from catastrophes or other events which cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers.
Insurance Services' earned premium income is recognized ratably over the contract period of an insurance policy. A liability is established for unearned insurance premiums that represent the portion of premium received which is applicable to the remaining portion of the unexpired terms of the related policies.
Reinsurance premiums are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts.
Stock-based compensation cost is measured using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25"), and related interpretations for directors and employees. The fair value based method of accounting prescribed by Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," ("SFAS 123"), is used to measure stock-based compensation for contractors.
Additional information related to DHC's stock option plan is detailed in Note 15.
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax basis thereof. Deferred tax assets and liabilities are measured using enacted tax rates which are expected to apply to taxable income in the years in which those temporary differences are anticipated to be recovered or settled, and are limited, through a valuation allowance, to the amount estimated to be realizable.
calculated using only the average number of outstanding shares of Common Stock. Such average shares were 30,783,216, 26,258,499, and 19,465,104 for the years 2003, 2002 and 2001, respectively. Diluted earnings per share computations, as calculated under the treasury stock method, include the average number of shares of additional outstanding Common Stock issuable for stock options and warrants, whether or not currently exercisable. Diluted earnings per share for all periods presented do not include average shares related to stock options and warrants because their effect is anti-dilutive.
Materials and Supplies are carried at the lower of cost (average) or market and consist of the following as of December 27, 2002:
Properties are at cost and consist of the following as of December 27, 2002:
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.
Marine Services' barge transportation revenue is recognized proportionately as shipments move from origin to destination. Terminal, repair and other revenue is recognized as services are provided. Marine construction revenue and related expense is primarily recognized on the completed-contract method, due to the short-term nature of contracts.
On May 29, 2002, ACL issued new debt which was recorded at fair value. The difference between the principal amount of the notes and the fair value (discount) is being amortized using the effective interest method over the life of the notes. The amortization of the discount was $2,882 in 2002 and is included in interest expense on the consolidated statement of operations.
In January 2003, the FASB issued FASB Interpretation 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51" ("FIN 46"). In December 2003, the FASB modified FIN 46 to make certain technical corrections and address certain implementation issues that had arisen, including deferral of certain provisions to 2004. FIN 46 provides a new framework for identifying variable interest entities ("VIEs") and determining when a company should include the assets, liabilities, noncontrolling interests and results of activities of a VIE in its consolidated financial statements. FIN 46 was effective immediately for
DHC expects to refinance the notes pursuant to a rights offering. If DHC does not refinance all of the outstanding notes, the remainder of the notes would be convertible into shares of Common Stock, without action by the Bridge Lenders, at the rights offering price of $1.53 per share, subject to certain agreed upon limitations necessitated by DHC's NOL's.
In addition, under the note purchase agreement, Laminar has agreed to convert an amount of notes to acquire up to an additional 8.75 million shares of the Common Stock at $1.53 per share based upon the levels of public participation in the rights offering. Further, DHC has agreed, in connection with the note purchase agreement, to sell up to an additional 3 million shares of Common Stock at $1.53 per share to certain creditors of Covanta based upon the levels of public participation in the rights offering and subject to change of ownership and other limitations.
The fair value of the consideration given by DHC includes the $7,000 in cash paid to preferred unitholders, cash of $25,000, the Old Senior Notes and accrued interest having an estimated fair value of $43,650 contributed to ACL Holdings and $6,606 in costs directly associated with the acquisition.
The acquired companies operating results are included in DHC's consolidated statement of operations from the date of the DHC Recapitalization, May 29, 2002. A condensed consolidated balance sheet disclosing the amounts assigned to assets and liabilities of the acquired companies at the date of the acquisition follows:
Following are the pro forma unaudited results of operations for the years ended December 27, 2002 and December 31, 2001, assuming consummation of the acquisitions and recapitalization of ACL Holdings as of January 1, 2001:
During 2002 and 2003, ACL experienced a decline in barging rates, reduced shipping volumes and excess barging capacity during a period of slow economic growth. Due to these factors, ACL's revenues and earnings
The obligations of the Debtors under the DIP Credit Facility, by court order, have super-priority administrative claim status as provided under the Bankruptcy Code. Under the Bankruptcy Code, a super-priority claim is senior to secured and unsecured pre-petition claims and all administrative expenses incurred in the Chapter 11 case. In addition, with certain exceptions (including a carve-out for unpaid professional fees and disbursements), the DIP Credit Facility obligations are secured by (1) a first-priority lien on all unencumbered pre- and post-petition property of the Debtors, (2) a first-priority priming lien on all property of the Debtors that is encumbered by the existing liens securing the Debtors' pre-petition secured lenders and (3) a junior lien on all other property of the Debtors that is encumbered by the pre-petition liens.
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, limit its capital expenditures to defined levels and restrict advances to certain subsidiaries.
The DIP Credit Facility will terminate and the borrowings there under will be due and payable upon the earliest of (i) July 31, 2004 (with borrowings repayable on August 2, 2004), (ii) the date of the substantial consummation of a plan of reorganization that is confirmed pursuant to an order by the Bankruptcy Court, or (iii) the acceleration of the term loans or the revolving credit loans made by any of the banks who are a party to the DIP Credit Facility and the termination of the total commitment under the DIP Credit Facility pursuant to the DIP Credit Facility.
The amount of the claims to be filed against the Debtors by their creditors could be significantly different than the amount of the liabilities recorded by the Debtors. The Debtors also have 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 ACL's equity investor 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's equity investor being diluted or cancelled. The Debtors have not yet proposed a plan of reorganization. The Debtors' pre-petition creditors and ACL's equity investor will each have a vote in the plan of reorganization.
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 equity holder. The ultimate recovery, if any, by creditors and 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. While it cannot be presently determined, DHC believes it will receive little or no value with respect to its equity interest in ACL Holdings or ACL. Accordingly, DHC wrote off its remaining investment in ACL at the end of the first quarter of 2003 as an other than temporary asset impairment (see Note 20).
The note purchase agreement restricts DHC's ability to, among other covenants and restrictions: purchase or sell any material amount of assets, enter into a merger transaction, liquidate or dissolve; incur any debt for borrowed money in an aggregate principal amount in excess of $250, or incur liens on DHC property; and enter into any material transactions with affiliates.
As part of the DHC 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 DHC 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 ACL's old senior credit facility.
ACL's revolving credit facility (the "Revolving Credit Facility"), which provides for revolving loans and letters of credit not to exceed the aggregate principal amount of $50,000, matures June 30, 2005, but each loan must be repaid within one year. The Revolving Credit Facility bears interest at a rate equal to LIBOR plus a margin based on ACL's performance. The interest rate as of December 27, 2002 ranged from 5.8125% to 6.0625%.
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 New 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.
As of December 27, 2002, there were $37,740 outstanding in bonds (the "MARAD Bonds") issued by Vessel Leasing, which bear interest at fixed rates of 5.65% and 6.14% (Tranche 1 and 2) and LIBOR plus .4% (Tranche 3). All three tranches mature in 2016. The MARAD Bonds are guaranteed by the U.S. Maritime Administration. Neither DHC nor ACL guarantees payment of the MARAD Bonds.
The effect of ceded reinsurance on loss and LAE incurred was a decrease of $2,982, $10,401 and $1,801 for the years ended December 2003, 2002 and 2001, respectively.
The net losses and LAE incurred during 2003 related to prior years is attributable to recognition of unfavorable development in: commercial auto of $5,500 for accident years 2000 through 2002, workers' compensation of $5,500 of which $3,900 was attributable to Valor, and property and casualty of $1,500, most of which stems from unallocated LAE reserves. The net 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.
DHC's insurance subsidiaries are regulated by various states. For regulatory purposes, separate financial statements which are prepared in accordance with statutory accounting principles are filed with these states. Insurance Services prepares it's statutory-basis financial statements in accordance with accounting practices prescribed or permitted by the California Department of Insurance (the "CDI"). Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners, as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed (see below for discussion of Insurance Services' permitted practice). The Association has adopted a comprehensive set of accounting principles for qualification as an Other Comprehensive Basis of Accounting which was effective in 2001. Insurance Services has determined that application of these comprehensive accounting principles did not have a material impact on its financial condition upon adoption. As of the years ended December 2003 and 2002, DHC's operating insurance subsidiaries had statutory capital and surplus of $16,011 and $19,473, respectively. The combined statutory net loss for DHC's operating insurance subsidiaries, as reported to the regulatory authorities for the years ended December 2003, 2002 and 2001, was $10,135, $22,500 and $8,800, respectively.
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 4, 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 $7,400. This charge, when combined with NAICC's underwriting results, reduced its statutory surplus level below the Company action level per NAICC's 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 and other related matters. DHC and its insurance subsidiaries have registered as holding company systems pursuant to such legislation in California and routinely report to other jurisdictions.
Under the California Insurance Code, NAICC is prohibited from paying shareholder dividends, other than from accumulated earned surplus, exceeding the greater of net income or ten percent of the preceding year's statutory surplus, without prior approval of the CDI. No dividends were paid in 2003, 2002 or 2001. The overall limit of dividends that can be paid during 2004 is approximately $1,600 as long as there is sufficient accumulated earned surplus to pay such. As of the year ended December 2003, NAICC did not have sufficient accumulated earned surplus, as defined by the CDI, to pay further ordinary dividends.
All of the fixed maturity investments noted above were acquired in 2003 and are investment grade securities rated A or better. The number of U.S. Treasury obligations, Federal agency mortgage backed securities, and corporate bonds temporarily impaired are 3, 10, and 4, respectively. No security has a fair value less than 3% below its amortized cost.
DHC's fixed maturity and equity securities portfolio is classified as "available for sale" and is carried at fair value. Changes in fair value are credited or charged directly to stockholders' equity as unrealized gains or losses, respectively. "Other than temporary" declines in fair value are recorded as realized losses in the statement of operations and the cost basis of the security is reduced.
The following reflects the change in net unrealized (loss) gain on available-for-sale securities included as a separate component of accumulated other comprehensive income (loss) in stockholders' equity:
DHC considers the following factors in determining whether declines in the fair value of securities are "other than temporary":
c. whether the unrealized loss is credit-driven or a result of changes in market interest rates,
Gross realized gains relating to fixed maturities were $968, $14,848 and $370 for the years ended December 2003, 2002 and 2001, respectively. Gross realized losses relating to fixed maturities were $16, $21 and $24 for the years ended December 2003, 2002 and 2001, respectively. Gross realized gains relating to equity securities were $2,043, $100 and $2,427 for the years ended December 2003, 2002 and 2001, respectively. Gross realized losses relating to equity securities were $2,005, $5,080 and $1,215 for the years
ended December 2003, 2002 and 2001, respectively. Net investment income for the years ended December 2003, 2002 and 2001 was:
At December 31, 2001, DHC held $58,493 face amount of ACL Senior Notes 10.25%, due June 30, 2008, 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 acquisition discussed in Note 3. There were no other investments with a carrying value greater than ten percent of stockholders' equity as of years ended December 2003, 2002 or 2001.
In compliance with state insurance laws and regulations, securities with a fair value of approximately $43,400, $45,000 and $45,000 as of the years ended December 2003, 2002 and 2001, respectively, were on deposit with various states or governmental regulatory authorities. In addition, as of the years ended December 2003, 2002 and 2001, investments with a fair value of $7,200, $6,400 and $6,600, respectively, were held in trust or as collateral under the terms of certain reinsurance treaties and letters of credit. NAICC has letters of credit outstanding of $2,800 as of December 31, 2003.
During the second quarter of 2002, DHC consummated a rights offering to provide funds for the acquisition of ACL and related entities. 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. In addition, 2,002,558 shares were issued pursuant to warrants exercised that were previously held by SZ Investments 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.
Also, as of December 31, 2003, there were 10,000,000 shares of preferred stock authorized, with none issued or outstanding. The preferred stock may be divided into a number of series as defined by the Board of Directors. The Board of Directors is authorized to fix the rights, powers, preferences, privileges and restrictions granted to and imposed upon the preferred stock upon issuance, with prior approval of the stockholders required for any series of preferred stock issued to any holder of 1% or more of the outstanding Common Stock.
A substantial portion of DHC's net assets are restricted. Various state insurance requirements restrict the amounts that may be transferred to DHC in the form of dividends or loans from its Insurance Services
subsidiaries without prior regulatory approval. Various debt covenants and regulatory requirements also restrict the amounts that may be transferred to DHC in the form of cash dividends or loans from its Marine Services subsidiaries. DHC's investment in the net assets of its Insurance Services subsidiaries and its Marine Services subsidiaries, GMS and Vessel Leasing, amount to approximately $17,300 and $4,400 at December 31, 2003, respectively.
This was to ensure that DHC's NOLs would remain available to offset any post-restructuring taxable income of the trusts, thereby maximizing the amounts available for distribution to trust claimants. The Insurance Commissioner of the State of California and the Director of the Division of Insurance of the State of Missouri, as the trustees, have sole management authority over the trusts. Neither DHC nor any of its subsidiaries has any power to control or otherwise influence the management of the trusts nor do they have any rights with respect to the selection or replacement of the trustees. At the present time, it is not anticipated that any of the Mission Insurance Subsidiaries will receive any distribution with regard to their residual interests in the existing trusts. Since DHC does not have a controlling financial interest in these trusts, they are not consolidated with DHC for financial statement purposes.
As of the close of 2003, DHC had consolidated NOLs of $651,872 for Federal income tax purposes. The NOLs will expire in various amounts, if not used, between 2004 and 2023. The Internal Revenue Service has not audited any of DHC's tax returns for any of the years during the carryforward period including those returns for the years in which the losses giving rise to the NOLs were reported.
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. In 2003, NAICC matched 50% of the first 4% of compensation contributed by employees to the 401(k) Plan. In 2002, NAICC suspended its 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 2003 and 2001, NAICC's matching contribution to the 401(k) Plan was satisfied through cash payments totaling $46 and $139, respectively.
On January 1, 1988, Insurance Services adopted a non-contributory defined benefit pension plan (the "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 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. Effective December 31, 2001, Insurance Services amended the Plan to cease future service credit for active employees.
The following table sets forth the Plan's funded status as of the years ended December 2003 and 2002, valued at January 1, 2004 and 2003, respectively:
Net pension cost for the years ended December 2003, 2002 and 2001 include the following components:
The following tables provide a reconciliation of the changes in the Plan's benefit obligation and the fair value of plan assets as of the years ended December 2003 and 2002:
The assumptions used to determine net periodic pension cost for the years ended December 31, 2003, 2002 and 2001 are as follows:
The overall expected long-term rate of return on plan assets was based on the performance of the Plan during the past five years and on the expected performance of the plan assets over the next five years pursuant to the investment policies and strategies as described below.
To ensure adequate diversification, no more than 25% of the total market value of Plan assets shall be invested in a single asset other than pooled funds and mutual funds where underlying diversification shall be considered. The portfolio shall satisfy the diversification requirements of ERISA at all times as well as the liquidity requirements of the Plan. NAICC expects to contribute $370 to the Plan in 2004.
ACL 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 of 1974 ("ERISA"), as amended. Plan assets consist primarily of common stocks, corporate bonds and cash and cash equivalents.
ACL's post-retirement benefit obligation was determined using the assumption that the health care cost trend rate for retirees was 10.0% for 2002, decreasing gradually to a 5.0% trend rate by 2009 and remaining at that level thereafter.
Options under the 1990 Stock Option Plan (the "1990 Plan") of DHC were granted to officers or employees of DHC. On September 16, 1991, the Compensation Committee of the Board of Directors of DHC resolved that it intended to refrain from granting any additional options under the 1990 Plan. The 1990 Plan terminated in 2001. The following table summarizes the options under the 1990 Plan:
In September 2001, DHC's stockholders approved amendments to the 1995 Plan which increased 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 DHC 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.
In September, 2001, 140,000 options owned by certain directors of DHC lapsed and were reissued under the 1995 Stock and Incentive Plan, as amended and approved by DHC's Board.
During 2003, options for 829,375 shares of Common Stock were forfeited due to terminations and ACL not achieving the performance targets.
As of December 31, 2003, options for shares were outstanding in the following price ranges:
Samuel Zell, the Chairman of the Board, Chief Executive Officer and President of DHC, is the Chairman of Equity Group Investments, L.L.C. ("EGI"). Commencing April 16, 2003, EGI provides administrative services for DHC. These services include financial, tax, accounting, SEC filings and related administrative costs. DHC paid EGI $170 for these services in 2003. ACL was paid a fee of $52 in 2003 for providing these services prior to April 16, 2003.
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 and $1,334 for the years ended December 2002 and 2001, respectively.
In connection with the DHC Recapitalization of ACL described in Note 3, DHC provided SZ Investments unlimited demand registration rights with respect to the ACL Senior Notes and ACL PIK Notes held by HY I Investments, L.L.C. ('HYI'), an affiliate of SZ Investments. Mr. Zell and Mr. Tinkler, DHC's Chief Financial Officer, are affiliated with SZ Investments and HYI. HYI is a holder of approximately 42% of ACL's Senior Notes and PIK Notes. Mr. Pate, a member of DHC's Board of Directors, is affiliated with SZ Investments and HYI and is an executive officer of EGI. A special committee of DHC's Board of Directors composed solely of disinterested directors oversees DHC's investment in ACL and related Chapter 11 bankruptcy proceedings.
EGI a fee in the amount of 1% of the aggregate consideration in connection with such transaction (including indebtedness assumed or outstanding). As a result of services provided to DHC during the DHC Recapitalization of ACL, DHC and EGI agreed that the fee for EGI's services was $3,000. DHC also agreed to reimburse, upon request, EGI's out-of-pocket expenses related to services provided under the investment advisory agreement. For providing a standby commitment to purchase any DHC shares that were unsubscribed in the rights offering conducted by DHC as part of its acquisition of ACL, DHC paid SZ Investments a fee of $1,000. Messrs. Zell and Pate were members of the Acquisition Committee at the time of the DHC Recapitalization of ACL, along with Messrs. Whitman and Barse, all of whom are Directors of DHC. On December 1, 2003, DHC and EGI terminated this agreement.
The carrying amounts and fair values of financial instruments are as follows as of December 31, 2003:
The fair values of the Fixed Maturity Securities and Equity Securities are based on quoted market values. The carrying values of the Bridge Financing Loans approximate their fair values since these loans were recently obtained in December 2003.
As discussed in Note 4, DHC wrote off its investment in ACL during the quarter ended March 28, 2003. The GMS and Vessel Leasing investments are not considered by DHC to be impaired. The reported net loss for the year ended December 31, 2003 includes, under the caption "Equity in Net Loss of Unconsolidated Marine Services Subsidiaries", the following components:
Management evaluates performance based on segment earnings, which is defined as operating income before income taxes. The accounting policies of the reportable segments are consistent with those described in the summary of significant accounting policies.
Accumulated other comprehensive (loss) as of December 31, 2003 and December 27, 2002 consists of the following:
On March 5, 2004, the Bankruptcy Court confirmed the proposed plans discussed in Note 2 and, on March 10, 2004, DHC purchased 100% of the equity of the energy and water businesses of Covanta in connection with its emergence from Chapter 11 bankruptcy proceedings.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of DHC at December 31, 2003 and December 27, 2002, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules for the years ended December 31, 2003 and December 27, 2002, when considered in relation to the 2003 and 2002 basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
/s/ ERNST & YOUNG, LLP Louisville, Kentucky February 20, 2004, except for Note 24 as to which the date is March 10, 2004
We have audited the accompanying consolidated statements of operations, stockholders' equity and comprehensive income, and cash flows of Danielson Holding Corporation and subsidiaries for the year ended December 31, 2001. Our audit also included the financial statement schedules listed in the index at Item 15(a) for the year ended December 31, 2001. These consolidated financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Danielson Holding Corporation and subsidiaries for the year ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedules for the year 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.