Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-K
------------------
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 2002
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ___________ to
___________
Commission file number: 1-5721
LEUCADIA NATIONAL CORPORATION
-------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
NEW YORK 13-2615557
- ------------------------------- ------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
315 Park Avenue South
New York, New York 10010
(212) 460-1900
-------------------------------------------------------------------------------
(Address, Including Zip Code, and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
- --------------------------------------------------------------------------------
COMMON SHARES, PAR VALUE $1 PER SHARE NEW YORK STOCK EXCHANGE
PACIFIC EXCHANGE, INC.
7-3/4% SENIOR NOTES DUE AUGUST 15, 2013 NEW YORK STOCK EXCHANGE
8-1/4% SENIOR SUBORDINATED NOTES DUE NEW YORK STOCK EXCHANGE
JUNE 15, 2005
7-7/8% SENIOR SUBORDINATED NOTES DUE NEW YORK STOCK EXCHANGE
OCTOBER 15, 2006
Securities registered pursuant to Section 12(g) of the Act:
None.
-------------------------------------------------------------------------------
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K [x].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [x] No [_]
Aggregate market value of the voting stock of the registrant held by
non-affiliates of the registrant at June 30, 2002 (computed by reference to the
last reported closing sale price of the Common Shares on the New York Stock
Exchange on such date): $1,114,008,000.
On March 25, 2003, the registrant had outstanding 59,617,292 Common Shares.
DOCUMENTS INCORPORATED BY REFERENCE:
Certain portions of the registrant's definitive proxy statement pursuant to
Regulation 14A of the Securities Exchange Act of 1934 in connection with the
2003 annual meeting of shareholders of the registrant are incorporated by
reference into Part III of this Report.
===============================================================================
1
PART I
Item 1. Business.
- ------ --------
THE COMPANY
The Company is a diversified holding company engaged in a variety of
businesses, including telecommunications, banking and lending, manufacturing,
real estate activities, winery operations, development of a copper mine and
property and casualty reinsurance. The Company concentrates on return on
investment and cash flow to build long-term shareholder value, rather than
emphasizing volume or market share. Additionally, the Company continuously
evaluates the retention and disposition of its existing operations and
investigates possible acquisitions of new businesses in order to maximize
shareholder value. In identifying possible acquisitions, the Company tends to
seek assets and companies that are troubled or out of favor and, as a result,
are selling substantially below the values the Company believes to be present.
Shareholders' equity has grown from a deficit of $7,700,000 at December 31,
1978 (prior to the acquisition of a controlling interest in the Company by the
Company's Chairman and President), to a positive shareholders' equity of
$1,534,525,000 at December 31, 2002, equal to a book value per common share of
the Company (a "common share") of negative $.11 at December 31, 1978 and $25.74
at December 31, 2002. The December 31, 2002 shareholders' equity and book value
per share amounts have been reduced by the $811,900,000 special cash dividend
paid in 1999.
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 private placement
included 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 the fourth quarter of 2002, the Company completed the acquisition of 44%
of the outstanding common stock of WilTel Communications Group, Inc. ("WilTel")
for an aggregate purchase price of $330,000,000, excluding expenses. The WilTel
stock was acquired by the Company under the chapter 11 restructuring plan of
Williams Communications Group, Inc. 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 for an aggregate
purchase price of $350,400,000, excluding expenses. WilTel is a publicly traded
telecommunications company that owns or leases and operates a nationwide
inter-city fiber-optic network, extended locally and globally, to provide
Internet, data, voice and video services. WilTel's common stock is traded on the
Nasdaq National Market (Symbol: WTEL).
During 2002, the Internal Revenue Service completed the audit of the
Company's consolidated federal income tax returns for the years 1996 through
1999, without any material tax payment required from the Company. As a result of
this favorable resolution of various federal income tax contingencies, the
income tax provision for 2002 reflects a benefit of approximately $120,000,000.
2
The Company's banking and lending operations have historically consisted of
making instalment loans to niche markets primarily funded by customer banking
deposits insured by the Federal Deposit Insurance Corporation (the "FDIC").
However, as a result of increased loss experience and declining profitability in
its automobile lending program, the segment's largest program, the Company
stopped originating new automobile loans in September 2001. In 2003, the Company
ceased originating all other lending programs. The Company is considering its
alternatives for its banking and lending operations, which could include selling
or liquidating some or all of its loan portfolios, and outsourcing certain
functions.
The Company's manufacturing operations manufacture and market proprietary
lightweight plastic netting used for a variety of purposes including, among
other things, construction, agriculture, packaging, carpet padding, filtration
and consumer products.
The Company's domestic real estate operations include a mixture of
commercial properties, residential land development projects and other
unimproved land, all in various stages of development and all available for
sale. During 2002, the Company sold its interest in Compagnie Fonciere FIDEI
("Fidei"), its foreign real estate subsidiary, for total proceeds of 70,400,000
Euros ($66,200,000) and recorded an increase to shareholders' equity of
$12,100,000.
The Company's winery operations consist of Pine Ridge Winery in Napa
Valley, California and Archery Summit in the Willamette Valley of Oregon. These
wineries primarily produce and sell wines in the luxury segment of the premium
table wine market.
The Company's copper mine development operations consist of its 72.8%
interest in MK Gold Company ("MK Gold"), a publicly traded company listed on the
NASD OTC Bulletin Board (Symbol: MKAU).
The Company's property and casualty reinsurance business is conducted
through its 25% common stock interest in Olympus Re Holdings, Ltd. ("Olympus"),
a Bermuda reinsurance company primarily engaged in the property excess, marine
and aviation reinsurance business.
As used herein, the term "Company" refers to Leucadia National Corporation,
a New York corporation organized in 1968, and its subsidiaries, except as the
context otherwise may require.
Investor Information
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934 (the "Exchange Act"). Accordingly, the Company files
periodic reports, proxy statements and other information with the Securities and
Exchange Commission (the "SEC"). Such reports, proxy statements and other
information may be obtained by visiting the Public Reference Room of the SEC at
450 Fifth Street, NW, Washington, D.C. 20549 or by calling the SEC at
1-800-SEC-0330. In addition, the SEC maintains an Internet site
(http://www.sec.gov) that contains reports, proxy and information statements and
other information regarding the Company and other issuers that file
electronically. In addition, material filed by the Company can be inspected at
the offices of the New York Stock Exchange, Inc. (the "NYSE"), 20 Broad Street,
New York, NY 10005 and the Pacific Exchange, Inc., 115 Sansome Street, San
Francisco, CA 94104, on which the Company's common shares are listed.
The Company does not maintain a website. The Company will provide without
charge upon request copies of its annual report on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K and amendments to those reports filed
or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. Requests
for such copies should be directed to: Leucadia National Corporation, 315 Park
Avenue South, New York, NY 10010 (telephone number (212) 460-1900), Attention:
Corporate Secretary.
3
Financial Information about Segments
The Company's reportable segments consist of its operating units, which
offer different products and services and are managed separately. These
reportable segments are: banking and lending, manufacturing and domestic real
estate. Banking and lending operations historically made collateralized personal
automobile instalment loans to individuals who have difficulty obtaining credit,
at interest rates above those charged to individuals with good credit histories.
Such loans were primarily funded by deposits insured by the FDIC. Manufacturing
operations manufacture and market proprietary lightweight plastic netting used
for a variety of purposes. The Company's domestic real estate operations consist
of a variety of commercial properties, residential land development projects and
other unimproved land, all in various stages of development and all available
for sale. Other operations primarily consist of winery operations and
development of a copper mine.
Associated companies include equity interests in entities that the Company
does not control and that are accounted for on the equity method of accounting.
WilTel, a public telecommunications company that owns or leases and operates a
nationwide fiber optic network over which it provides a variety of
telecommunications services is an associated company, as is Olympus, a
Bermuda-based reinsurance company.
The information in the following table for Corporate assets primarily
consists of investments and cash and cash equivalents. Corporate revenues listed
below primarily consist of investment income and securities gains and losses on
Corporate assets. Corporate assets, revenues, overhead expenses and interest
expense are not allocated to the operating units. The Company has a
manufacturing facility located in Belgium and an interest, through MK Gold, in a
copper deposit in Spain. The Company does not have any other material foreign
operations or investments.
4
Certain information concerning the Company's segments for 2002, 2001 and
2000 is presented in the following table. Associated Companies are only
reflected in the table below under Identifiable assets employed. Prior period
amounts have been reclassified to reflect the Company's Foreign Real Estate
segment as a discontinued operation.
2002 2001 2000
---- ---- ----
(In millions)
Revenues:
Banking and Lending $ 95.9 $ 122.4 $ 108.8
Manufacturing 51.0 57.4 65.1
Domestic Real Estate 51.3 65.3 83.1
Other Operations 48.3 39.3 44.9
Corporate (a) (b) (4.7) 89.8 191.5
---------- -------- ---------
Total consolidated revenues (c) $ 241.8 $ 374.2 $ 493.4
========== ========= =========
Income (loss) from continuing operations before income taxes,
minority expense of trust preferred securities and equity in income
(losses) of associated companies:
Banking and Lending $ 1.9 $ (6.1) $ 11.0
Manufacturing 3.1 7.8 11.3
Domestic Real Estate 16.7 30.4 58.8
Other Operations 11.7 8.2 5.2
Corporate (a) (b) (74.9) 32.8 115.0
---------- --------- ---------
Total consolidated income (loss) from continuing operations
before income taxes, minority expense of trust preferred
securities and equity in income (losses) of associated
companies (c) $ (41.5) $ 73.1 $ 201.3
========== ========= =========
Identifiable assets employed:
Banking and Lending $ 481.5 $ 595.7 $ 664.2
Manufacturing 51.5 59.3 63.4
Domestic Real Estate 106.8 176.4 218.1
Other Operations 193.7 171.2 177.1
Investment in Associated Companies:
WilTel 340.6 -- --
Other Associated Companies 397.1 358.8 192.5
Net Assets of Discontinued Operations -- 44.0 156.9
Corporate 970.6 1,063.7 945.6
--------- --------- ---------
Total consolidated assets $ 2,541.8 $ 2,469.1 $ 2,417.8
========= ========= =========
(a) For 2002, includes a provision of $37,100,000 to write down investments
in certain available for sale securities and an equity investment in a
non-public fund. The write down of the available for sale securities
resulted from a decline in market value determined to be other than
temporary.
(b) For 2000, includes, among other items, pre-tax securities gains on sale
of Fidelity National Financial, Inc. ($90,900,000) and Jordan
Telecommunication Products, Inc., ($24,800,000), as described in Note
12 to the Consolidated Financial Statements.
(c) Prior period amounts have been reclassified to exclude equity in income
(losses) of associated companies from these captions.
At December 31, 2002, the Company and its consolidated subsidiaries had
785 full-time employees.
5
TELECOMMUNICATIONS
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 Williams Communications Group, Inc.
("WCG"), the predecessor of WilTel 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. The Company has appointed four members (including the Company's
Chairman and President) to the newly constituted nine member board of directors
of WilTel and has entered into a stockholders agreement with WilTel pursuant to
which the Company has agreed to certain restrictions on its ability to acquire
or sell WilTel stock.
WilTel owns or leases and operates a nationwide inter-city fiber-optic
network, extended locally and globally. WilTel has two reportable operating
segments, Network and Vyvx. Network provides Internet, data, voice, and video
services to companies that use high capacity communications in their businesses.
These companies include regional Bell operating companies, cable television
companies, Internet service providers, application service providers, data
storage service providers, managed network service providers, digital subscriber
line service providers, long distance carriers, local service providers,
utilities, governmental entities, educational institutions, international
carriers, and other companies who desire high-speed communications services.
WilTel also offers rights of use in dark fiber, which is fiber that it installs
but for which it does not provide communications transmission services. Network
has built networks and entered into strategic relationships to provide services
in the United States with connections to Asia, Australia, New Zealand, Canada,
Mexico, and Europe.
Vyvx transmits media for its customers regardless of format (analog or
digital), method (fiber-optics or satellite), or geographic reach (domestic or
international). In 1990, Vyvx provided the first video transmission over a
terrestrial network and carried the first of fourteen consecutive Super Bowls
for the NFL and its broadcasters. Vyvx provides quality, reliable, network-based
methods for aggregating, managing, and distributing content for content owners
and rights holders. Vyvx also offers a fully integrated hybrid
satellite/terrestrial service to support dedicated and occasional requirements
for the distribution of live content for customers like broadcasters CNN and Fox
in their coverage of breaking news events in remote locations.
WilTel's global network is used to provide services to the customers of
both Network and Vyvx and includes ownership interests in or rights to use:
- nearly 30,000 miles of fiber optic cable, of which 28,554 is currently
in service;
- local fiber optic cable networks within 20 of the largest U.S. cities;
- 120 network centers located in 107 U.S. cities;
- operational border crossings between the U.S. and Mexico in California
and Texas, and between the U.S. and Canada in Washington, Michigan,
and New York; and
- capacity on five major undersea cable systems connecting the
continental U.S. with Europe, Asia, Australia, New Zealand, and
Hawaii.
The telecommunications industry has experienced a great deal of instability
during the past several years. During the 1990s, forecasts of very high levels
of future demand brought a significant number of new entrants and new capital
investments into the industry. However, many industry participants have gone
through bankruptcy and those forecasts have not materialized. Telecommunications
capacity now far exceeds actual demand, and the resulting marketplace is
characterized by fierce price competition as traditional and next generation
carriers compete to secure market share. Resulting lower prices have eroded
margins and have kept many carriers--including WilTel--from attaining positive
cash flow from operations. Many network providers, and their customers, have and
are undergoing reorganizations through bankruptcy, contemplating bankruptcy, or
experiencing significant operating losses while consuming much of their
remaining liquidity.
6
WilTel does not know if and when the current state of aggressive pricing
will end, or whether the current instability in the sector will lead to industry
consolidation. If industry consolidation does occur, it would not necessarily
benefit WilTel or assure that pricing rationality will return to the industry.
However, if consolidation does not occur and new investment capital continues to
flow into telecommunications carriers, pricing pressures could continue and
supply may continue to outpace demand for the foreseeable future. While WilTel
will examine opportunities to acquire other carriers or large blocks of business
if such opportunities are presented to WilTel, even if such transactions could
be consummated at prices deemed to be attractive, no assurance can be given that
WilTel could successfully complete such acquisitions or that WilTel could obtain
the necessary capital or lender approvals to do so.
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.
Upon its emergence from bankruptcy proceedings, WilTel adopted fresh start
accounting, resulting in a new reporting entity for accounting purposes as of
October 31, 2002. Accordingly, WilTel's consolidated financial statements for
periods prior to emergence from bankruptcy are not comparable and not combined
with its consolidated financial statements subsequent to emergence. For the two
months ended December 31, 2002, after its emergence from bankruptcy, WilTel
generated revenues of approximately $191,700,000, of which approximately
$168,600,000 were generated from the network segment and approximately
$23,100,000 were generated by Vyvx. For this period, approximately 37% of
WilTel's consolidated revenues were attributed to its single largest customer,
SBC Communications Inc. WilTel's net loss for the two months ended December 31,
2002 was $61,000,000.
For the period from acquisition through December 31, 2002, the Company
recorded $13,400,000 of pre-tax losses from its investment in WilTel 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.
WilTel is subject to federal, state, local, and foreign laws, regulations,
and orders that affect the rates, terms, and conditions of certain of its
service offerings, its costs, and other aspects of its operations. WilTel's
primary federal regulator is the Federal Communications Commission ("FCC").
Regulation of the telecommunications industry varies from state to state and
from country to country, and it changes regularly (sometimes in unpredictable
ways) in response to regulatory proceedings, judicial rulings, technological
developments, competition, and government policies. WilTel's operations also are
subject to a variety of environmental, building, safety, health, and other
governmental laws and regulations. WilTel cannot predict what impact, if any,
regulatory changes may have on its business or results of operations, nor can it
guarantee that domestic or international regulatory authorities will not raise
material issues regarding its compliance with applicable regulations.
7
BANKING AND LENDING
The Company's banking and lending operations principally are conducted
through American Investment Bank, N.A. ("AIB"), a national bank subsidiary, and
American Investment Financial ("AIF"), an industrial loan corporation. AIB and
AIF take money market and other non-demand deposits that are eligible for
insurance provided by the FDIC. AIB and AIF had aggregate deposits of
$392,900,000 and $476,500,000 at December 31, 2002 and 2001, respectively. AIB
and AIF currently have three deposit-taking branches in the Salt Lake City area,
which have generated approximately three-quarters of their deposit balances.
Various brokers generated the remainder of the Company's deposits. Deposits have
primarily been used to fund consumer instalment loans.
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.
Historically, collateralized personal automobile instalment loans were
primarily made through automobile dealerships to individuals who have difficulty
obtaining credit, at interest rates above those charged to individuals with good
credit histories. These loans were made to consumers principally to purchase
used, moderately priced automobiles. In September 2001, the Company decided to
stop originating subprime automobile loans as a result of increasing loss
experience and the increasingly difficult competitive environment. The Company
continues to service and closely monitor these loans, and takes prompt
possession of the collateral in the event of a default. During 2001 and 2000,
the Company generated $434,700,000 of these loans, which typically had an
initial loan balance of $12,200, an average contractual maturity of 58 months
and an anticipated average life of 26 months.
The Company's remaining consumer lending programs have primarily consisted
of marine, recreational vehicle, motorcycle and elective surgery loans. Due to
current economic conditions, portfolio performance and the relatively small size
of these loan portfolios and target markets, in January 2003 the Company stopped
originating all consumer loans. The Company is considering alternatives for its
banking and lending operations, which could include selling or liquidating some
or all of its loan portfolios, and outsourcing certain functions. The Company
anticipates that it will close its remaining satellite branch in 2003, and
reduce its operating and overhead expenses.
It is the Company's policy to charge to income an allowance for losses
which, based upon management's analysis of numerous factors, including current
economic trends, aging of the loan portfolio, historical loss experience and
collateral value, is deemed adequate to cover probable losses on outstanding
loans. 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.
The Company's policy is to charge-off an account when the property securing
the delinquent loan is repossessed, which generally occurs when the loan is 60
days delinquent. Otherwise, the Company charges off the account due to the
customer's bankruptcy and in no event later than the month in which it becomes
120 days delinquent. The charge-off represents the difference between the net
realizable value of the property and the amount of the delinquent loan,
including accrued interest.
8
Certain information with respect to the Company's banking and lending
segment is as follows for the years ended December 31, 2002, 2001 and 2000
(dollars in thousands):
2002 2001 2000
---- ---- ----
Average loans outstanding $440,810 $545,036 $423,030
Interest income earned on loans $ 86,018 $111,849 $ 87,865
Average loan yield 19.5% 20.5% 20.8%
Average deposits outstanding $454,497 $536,020 $422,607
Interest expense on non-demand deposits $ 18,035 $ 31,499 $ 26,421
Average rate on non-demand deposits 3.9% 5.9% 6.3%
Net yield on interest-bearing assets 11.5% 13.3% 13.1%
Investments held by the banking and lending segment are primarily
short-term bonds and notes of the United States Government and its agencies.
The Company's principal banking and lending operations are subject to
detailed supervision by state authorities, as well as federal regulation
pursuant to the Federal Consumer Credit Protection Act, the Truth in Lending
Act, the Equal Credit Opportunity Act, the Right to Financial Privacy Act, the
Community Reinvestment Act, the Fair Credit Reporting Act and regulations
promulgated by the Federal Trade Commission and the Board of Governors of the
Federal Reserve System. The Company's banking operations are subject to federal
and state regulation and supervision by, among others, the Office of the
Comptroller of the Currency (the "OCC"), the FDIC and the State of Utah. AIB's
primary federal regulator is the OCC, while the primary federal regulator for
AIF is the FDIC.
As previously stated, AIB stopped originating new sub-prime automobile
loans in September 2001, and both AIB and AIF ceased originating all other
consumer loans in January 2003. The FDIC and OCC have supported these actions
taken with respect to the sub-prime portfolio. However, effective February 2003,
AIB entered into a formal agreement with the OCC, agreeing to develop a written
strategic plan subject to prior OCC approval for the continued operations of
AIB, to continue to maintain certain risk-weighted capital levels, to obtain
prior approval before paying any dividends, to provide certain monthly reports
and to comply with certain other criteria. AIB will also be unable to accept
brokered deposits during the period the agreement remains in effect. In the
event AIB fails to comply with the agreement, the OCC would have the authority
to assert formal charges and seek other statutory remedies and AIB may also be
subject to civil monetary penalties. AIB is complying with the agreement and,
given that it has ceased all lending activities, the agreement is not expected
to have a significant impact on its operations. However, no assurance can be
given that other regulatory actions will not be taken.
The Competitive Equality Banking Act of 1987 ("CEBA") places certain
restrictions on the operations of AIB and restricts further acquisitions of
banks and savings institutions by the Company. CEBA does not restrict AIF as
currently operated.
9
MANUFACTURING
Through its plastics division, the Company manufactures and markets
proprietary lightweight plastic netting used for a variety of purposes
including, among other things, construction, agriculture, packaging, carpet
padding, filtration and consumer products. The products are primarily used to
add strength to other materials or act as barriers, such as warning fences and
crop protection from birds. This division is a market leader in netting products
used in carpet cushion, turf reinforcement, erosion control, nonwoven
reinforcement and crop protection. It markets its products both domestically and
internationally, with approximately 16% of its 2002 revenues generated by
customers in Europe, Latin America, Japan and Australia. Products are sold
primarily through an employee sales force, located in the United States and
Europe. Manufacturing revenues were $50,700,000, $53,700,000 and $65,000,000 for
the years ended December 31, 2002, 2001 and 2000, respectively.
New product development focuses on niches where the division's proprietary
technology and expertise can lead to sustainable competitive economic
advantages. Historically, this targeted product development generally has been
carried out in partnership with a prospective customer or industry where the
value of the product has been recognized. The plastics division has also begun
focusing on developing products for which it does not yet have a customer. Over
the last several years, the plastics division has spent approximately 2% to 4%
of annual sales on the development and marketing of new products and new
applications of existing products.
Primarily as a result of a general downturn in the economy, revenues for
the plastics division declined in each of the last two years and the division
currently has excess manufacturing capacity. The plastics division is attempting
to develop new products, applications and markets to replace its lost business
and utilize its excess capacity. In addition, the Company has been focusing on
managing costs and improving service levels by reducing lead times.
The plastics division is subject to domestic and international competition,
generally on the basis of price, service and quality. Additionally, certain
products are dependent on cyclical industries, including the construction
industry. The Company holds patents on certain improvements to the basic
manufacturing processes and on applications thereof. The Company believes that
the expiration of these patents, individually or in the aggregate, is unlikely
to have a material effect on the plastics division.
DOMESTIC REAL ESTATE
At December 31, 2002, the Company's domestic real estate assets had a book
value of $85,200,000. The real estate operations include a mixture of commercial
properties, residential land development projects and other unimproved land, all
in various stages of development and all available for sale. The Company's
largest domestic real estate investment is a fully-renovated 719-room hotel
located on Waikiki Beach in Hawaii. The Company also owns a shopping center on
Long Island, New York that has 60,000 square feet of retail space. During the
fourth quarter of 2002, the Company sold one of its real estate subsidiaries,
CDS Holding Corporation ("CDS"), to HomeFed Corporation ("HomeFed"),
approximately 9.5% and 8.8% of which is owned by the Company's Chairman and
President, respectively. The purchase price for this transaction was
$25,000,000, consisting of $1,000,000 in cash and 24,742,268 shares of HomeFed's
common stock, which represents approximately 30.3% of the outstanding HomeFed
stock. CDS's principal asset is the master-planned community located in San
Diego County, California known as San Elijo Hills. Since 1998, HomeFed has
served as the development manager for this project, for which it was entitled to
certain fees based upon the project's revenues and a success fee, which
represented a substantial portion of the project's future cash flows. HomeFed is
engaged, directly and through subsidiaries, in the investment in and development
of residential real estate projects in the State of California. HomeFed is a
publicly traded company listed on the NASD OTC Bulletin Board (Symbol: HFDC.OB).
OTHER OPERATIONS
The Company owns two wineries, Pine Ridge Winery in Napa Valley, California
and Archery Summit in the Willamette Valley of Oregon. Pine Ridge, which was
acquired in 1991, has been conducting operations since 1978, while the Company
started Archery Summit in 1993. These wineries primarily produce and sell wines
in the luxury segment of the premium table wine market. During 2002, the
wineries sold approximately 77,700 9-liter equivalent cases of wine generating
wine revenues of $15,700,000. Approximately 8% of the revenues of the wineries
and 24% of case sales were derived from a wine that is not in the luxury segment
and is made from purchased grapes. Since acquisition, the Company's investment
in winery operations has grown, principally to fund the Company's acquisition of
land for vineyard development and to increase production capacity and storage
facilities at both of the wineries. It can take up to five years for a new
vineyard property to reach full production and, depending upon the varietal
produced, up to three years after grape harvest before the wine can be sold. For
the 2002 harvest, approximately 94% of the Company's vineyards were producing
grapes and the balance was under development. At December 31, 2002, the
Company's combined investment in these wineries was $60,900,000.
10
The Company's 72.8% interest in MK Gold, a company that is traded on the
NASD OTC Bulletin Board, had a net carrying value of $49,200,000 at December 31,
2002. MK Gold's subsidiary, Cobre Las Cruces, S.A., a Spanish company, holds the
exploration and mineral rights to the Las Cruces copper deposit in the Pyrite
Belt of Spain. An independent feasibility study of this project was completed by
Bechtel International, Inc. in 2001. This study is based on proven and probable
reserves of 15,800,000 metric tonnes grading 5.94% copper overlain by a
gold-bearing gossan (which has not been evaluated) and by 150 meters of
unconsolidated overburden. Independent Mining Consultants, Inc. performed the
reserve calculations used in the feasibility study. Based on the feasibility
study, cash operating costs are estimated to average $.33 per pound of copper
and the estimated capital cost to bring the mine into production is
approximately $290,000,000, excluding interest and other financing costs. These
estimates are subject to a number of risks and uncertainties, including
fluctuations in the value of the euro relative to the U.S. dollar. Since the
feasibility study was completed, the value of the euro has appreciated against
the U.S. dollar, which if sustained, or if it appreciates further, will increase
the actual operating and capital costs.
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. Environmental approval of the project has been obtained from
the Spanish and Andalusian government agencies. Mining and water concession
applications have been submitted to the applicable governmental agencies, but
approval has not yet been received. MK Gold currently anticipates that these
operating permits will be received in the second half of 2003, that final
design, construction and mine development will begin in 2004 and copper
production will begin in 2006. Although MK Gold believes the necessary
permitting and financing will be obtained, no assurances can be given that they
will be successful. Further, there may be other political and economic
circumstances that could prevent or delay development of Las Cruces.
OTHER INVESTMENTS
In December 2002, the Company entered into an agreement to purchase certain
debt and equity securities of WebLink Wireless, Inc. ("WebLink"), for an
aggregate purchase price of $19,000,000. Pursuant to the agreement, the Company
acquired outstanding secured notes of WebLink with a principal amount of
$36,500,000 (representing 91% of the total outstanding debt) and, upon receipt
of approval from the FCC, will acquire approximately 80% of the outstanding
common stock of WebLink. WebLink, a privately held company, is in the wireless
messaging industry, providing wireless data services and traditional paging
services.
The Company has an investment in Berkadia LLC, an entity jointly owned by
the Company and Berkshire Hathaway Inc. ("Berkshire"). In 2001, Berkadia lent
$5,600,000,000 on a senior secured basis to FINOVA Capital Corporation (the
"Berkadia Loan"), the principal operating subsidiary of The FINOVA Group Inc.
("FINOVA"), to facilitate a chapter 11 restructuring of the outstanding debt of
FINOVA and its principal subsidiaries. Berkadia also received newly issued
shares of common stock of FINOVA representing 50% of the stock of FINOVA
outstanding on a fully diluted basis. In 2001, the Company entered into a
ten-year management agreement with FINOVA, for which it receives an $8,000,000
annual fee that it shares equally with Berkshire. FINOVA is a financial services
holding company that, prior to its filing for bankruptcy, provided a broad range
of financing and capital markets products, primarily to mid-size businesses.
Since its chapter 11 restructuring, FINOVA's business activities have been
limited to the orderly collection and liquidation of its assets and FINOVA has
not engaged in any new lending activities.
11
Berkadia financed the Berkadia Loan with bank financing that is guaranteed,
90% by Berkshire and 10% by the Company (with the Company's guarantee being
secondarily guaranteed by Berkshire). As of March 7, 2003, principal payments
have reduced the outstanding amount of Leucadia's guarantee to $152,500,000. All
income related to the Berkadia Loan, after payment of financing costs, is shared
90% to Berkshire and 10% to the Company.
At December 31, 2002, the book value of the Company's equity investment in
Berkadia was negative $72,100,000. 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. For the year ended December 31, 2002, the Company
recorded $65,600,000 of pre-tax income from this investment, of which
$59,000,000 related to the amortization of the discount on the Berkadia loan.
At December 31, 2002, the book value of the Company's investment in Olympus
was $155,700,000. For the year ended December 31, 2002, the Company recorded
$24,100,000 of pre-tax income from this investment under the equity method of
accounting. Olympus was formed in 2001 to take advantage of the lack of capacity
and favorable pricing in the reinsurance market. It has entered into a quota
share reinsurance agreement with Folksamerica Reinsurance Company, an affiliate
of White Mountains Insurance Group, Ltd. ("WMIG"), and will also seek to obtain
reinsurance business from other sources as well. When the market opportunity to
underwrite reinsurance business on favorable terms recedes, the by-laws of
Olympus include mechanisms to return its capital to its investors, subject to
Bermuda insurance regulations and other laws restricting the return of capital.
At December 31, 2002, the book value of the Company's equity investment in
Jefferies Partners Opportunity Fund II, LLC ("JPOF II"), a registered
broker-dealer, was $115,200,000. JPOF II is managed and controlled by Jefferies
& Company, Inc., a full service investment bank to middle market companies. JPOF
II invests in high yield securities, special situation investments and
distressed securities and provides trading services to its customers and
clients. For the year ended December 31, 2002, the Company recorded $15,200,000
of pre-tax income from this investment under the equity method of accounting;
this amount was distributed to the Company in February 2003.
The Company owns 375,000 common shares that represent approximately 4.5% of
WMIG. WMIG is a publicly traded, Bermuda domiciled financial services holding
company, principally engaged through its subsidiaries and affiliates in property
and casualty insurance and reinsurance. At December 31, 2002, the Company's
investment had a market value of $121,100,000.
The Company owns approximately 36% of the common stock of Light & Power
Holdings Ltd., the parent company of The Barbados Light and Power Company
Limited, the primary generator and distributor of electricity in Barbados. As of
December 31, 2002, the Company's investment of $12,100,000 was accounted for on
the cost method of accounting, due to currency exchange restrictions and stock
transfer restrictions.
The Company owns equity interests representing more than 5% of the
outstanding capital stock of each of the following domestic public companies at
March 25, 2003: AmeriKing, Inc. ("AmeriKing") (6.8%), Carmike Cinemas, Inc.
("Carmike") (11.1%), GFSI Holdings, Inc. ("GFSI") (6.9%), HomeFed (30.3%),
Jackson Products, Inc. ("Jackson") (8.8%), Jordan Industries, Inc. ("JII")
(10.1%), and WilTel (47.4%).
Since 1982, a subsidiary of the Company has had a partnership interest in
The Jordan Company LLC and Jordan/Zalaznick Capital Company, entities that have
specialized in structuring leveraged buyouts in which the owners are given the
opportunity to become equity participants. However, in the fourth quarter of
2002, members of The Jordan Company raised a new $1.5 billion fund through which
they will conduct their investment activities. As a result, the Company's
partnership participation arrangement with The Jordan Company ended. The Company
has committed to invest $10,000,000 in the general partner of the new fund, and
will retain the investments obtained through its prior partnership interest.
These investments include AmeriKing, Carmike, GFSI, Jackson, JII, JZ Equity
Partners PLC (a British company traded on the London Stock Exchange in which the
Company holds a 6.5% equity interest), and a total of 34 other private
companies. These investments are carried in the Company's consolidated financial
statements at $62,000,000, of which $43,700,000 relates to public companies
carried at market value.
12
For further information about the Company's business, including the
Company's investments, reference is made to Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" of this Report and
Notes to Consolidated Financial Statements.
Item 2. Properties.
- ------ ----------
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 Company and its subsidiaries lease numerous manufacturing, warehousing,
office and headquarters facilities. The facilities vary in size and have leases
expiring at various times, subject, in certain instances, to renewal options.
See Notes to Consolidated Financial Statements.
Item 3. Legal Proceedings.
- ------ -----------------
The Company and its subsidiaries are parties to legal proceedings that are
considered to be either ordinary, routine litigation incidental to their
business or not material to the Company's consolidated financial position. The
Company does not believe that any of the foregoing actions will have a material
adverse effect on its consolidated financial position, consolidated results of
operations or liquidity.
Item 10. Executive Officers of the Registrant.
- ------- ------------------------------------
All executive officers of the Company are elected at the organizational
meeting of the Board of Directors of the Company held annually and serve at the
pleasure of the Board of Directors. As of March 25, 2003, the executive officers
of the Company, their ages, the positions held by them and the periods during
which they have served in such positions were as follows:
Name Age Position with Leucadia Office Held Since
- ---- --- ---------------------- -----------------
Ian M. Cumming 62 Chairman of the Board June 1978
Joseph S. Steinberg 59 President January 1979
Thomas E. Mara 57 Executive Vice President May 1980;
and Treasurer January 1993
Joseph A. Orlando 47 Vice President and January 1994;
Chief Financial Officer April 1996
Barbara L. Lowenthal 48 Vice President and April 1996
Comptroller
Mark Hornstein 55 Vice President July 1983
H.E. Scruggs 46 Vice President August 2002
Mr. Cumming has served as a director and Chairman of the Board of the
Company since June 1978 and as Chairman of the Board of FINOVA since August
2001. In addition, he has served as a director of Allcity since February 1988,
MK Gold since June 1995 and WilTel since October 2002. Mr. Cumming has also been
a director of Skywest, Inc., a Utah-based regional air carrier, since June 1986,
a director of HomeFed since May 1999 and a director of Carmike since January
2002.
13
Mr. Steinberg has served as a director of the Company since December 1978
and as President of the Company since January 1979. In addition, he has served
as a director of Allcity since February 1988, MK Gold since June 1995, JII since
June 1988, HomeFed since August 1998, FINOVA since August 2001, WMIG since June
2001 and WilTel since October 2002.
Mr. Mara joined the Company in April 1977 and was elected Vice President of
the Company in May 1977. He has served as Executive Vice President of the
Company since May 1980 and as Treasurer of the Company since January 1993. In
addition, he has served as a director of Allcity since October 1994, MK Gold
since February 2000 and FINOVA since September 2002.
Mr. Orlando, a certified public accountant, has served as Chief Financial
Officer of the Company since April 1996 and as Vice President of the Company
since January 1994. In addition, he has served as a director of Allcity since
October 1998.
Ms. Lowenthal, a certified public accountant, has served as Vice President
and Comptroller of the Company since April 1996.
Mr. Hornstein joined the Company as Vice President in July 1983.
Mr. Scruggs joined the Company in 1995, served as Vice President from March
2000 through December 2001, and from August 2002 until the present. Mr. Scruggs
has been Chairman of AIB since 1997, Chairman and President of the Empire Group
since October 2000, Chairman of Conwed Plastics since January 2000 and a Senior
Vice President of WilTel since October 2002. In addition, he has served as a
director of MK Gold since March 2001.
14
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
- ------ ---------------------------------------------------------------------
The common shares of the Company are traded on the New York Stock Exchange
and Pacific Exchange, Inc. under the symbol LUK. The following table sets forth,
for the calendar periods indicated, the high and low sales price per common
share on the consolidated transaction reporting system, as reported by the
Bloomberg Professional Service provided by Bloomberg L.P.
Common Share
------------
High Low
---- ---
2001
First Quarter $35.70 $30.50
Second Quarter 34.90 30.58
Third Quarter 33.65 28.25
Fourth Quarter 31.96 26.31
2002
First Quarter $36.04 $28.00
Second Quarter 38.16 30.95
Third Quarter 36.37 27.62
Fourth Quarter 40.27 32.85
2003
First Quarter (through March 25, 2003) $38.60 $32.59
As of March 25, 2003, there were approximately 2,976 record holders of the
common shares.
In 2002 and 2001, the Company paid cash dividends of $.25 per common share.
The payment of dividends in the future is subject to the discretion of the Board
of Directors and will depend upon general business conditions, legal and
contractual restrictions on the payment of dividends and other factors that the
Board of Directors may deem to be relevant.
In connection with the declaration of dividends or the making of
distributions on, or the purchase, redemption or other acquisition of common
shares, the Company is required to comply with certain restrictions contained in
certain of its debt instruments. The Company's regulated subsidiaries are
restricted in the amount of distributions that can be made to the Company
without regulatory approval. For further information, see Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included in this Report.
The Company and certain of its subsidiaries have or have had tax loss
carryforwards and other tax attributes, the amount and availability of which are
subject to certain qualifications, limitations and uncertainties. In order to
reduce the possibility that certain changes in ownership could impose
limitations on the use of the tax loss carryforwards, the Company's certificate
of incorporation contains provisions which generally restrict the ability of a
person or entity from accumulating five percent or more of the common shares and
the ability of persons or entities now owning five percent or more of the common
shares from acquiring additional common shares. The restrictions will remain in
effect until the earliest of (a) December 31, 2005, (b) the repeal of Section
382 of the Internal Revenue Code (or any comparable successor provision) and (c)
the beginning of a taxable year of the Company to which certain tax benefits may
no longer be carried forward.
15
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 private placement
included 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 private placement was exempt from registration under Section
4(2) of the Securities Act of 1933 as a transaction not involving a public
offering.
On May 14, 2002, shareholders approved the Company's reorganization from
New York, its current state of incorporation, to Bermuda. The Company continues
to evaluate the possibility of reorganizing as a Bermuda company and would not
implement the reorganization unless the estimated cost of the reorganization is
acceptable given the anticipated benefits. If the Board of Directors has not
determined to implement the reorganization before the 2005 annual meeting of
shareholders, management will either abandon the reorganization or resubmit it
for shareholder approval at the 2005 annual meeting of shareholders. In
addition, the Board of Directors may determine to abandon the reorganization for
other reasons deemed to be in the Company's best interests and/or the best
interest of its shareholders.
16
Item 6. Selected Financial Data.
- ------ -----------------------
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.
Year Ended December 31,
-----------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED INCOME STATEMENT DATA:
Revenues (a) $241,805 $374,161 $493,408 $460,814 $199,070
Expenses 283,330 301,079 292,105 226,171 183,968
Income (loss) from continuing operations before
income taxes, minority expense of trust
preferred securities and equity in income
(losses) of associated companies (41,525) 73,082 201,303 234,643 15,102
Income from continuing operations before minority
expense of trust preferred securities and
equity in income (losses) of associated
companies (b) 103,340 84,423 133,087 195,175 45,814
Minority expense of trust preferred securities,
net of taxes (5,521) (5,521) (5,521) (5,521) (8,248)
Equity in income (losses) of associated
companies, net of taxes 54,712 (15,974) 19,040 (1,906) 15,138
Income from continuing operations 152,531 62,928 146,606 187,748 52,704
Income (loss) from discontinued operations,
including gain (loss) on disposal, net of taxes 9,092 (70,847) (30,598) 27,294 1,639
Cumulative effect of a change in accounting
principle -- 411 -- -- --
Net income (loss) 161,623 (7,508) 116,008 215,042 54,343
Per share:
Basic earnings (loss) per common share:
Income from continuing operations $ 2.74 $ 1.13 $ 2.64 $ 3.16 $ .83
Income (loss) from discontinued operations,
including gain (loss) on disposal .16 (1.28) (.55) .46 .03
Cumulative effect of a change in accounting
principle -- .01 -- -- --
------- -------- ------- --------- --------
Net income (loss) $ 2.90 $ (.14) $ 2.09 $ 3.62 $ .86
======= ======== ======= ========= ========
Diluted earnings (loss) per common share:
Income from continuing operations $ 2.72 $ 1.13 $2.64 $ 3.16 $ .83
Income (loss) from discontinued operations,
including gain (loss) on disposal .16 (1.28) (.55) .46 .03
Cumulative effect of a change in accounting
principle -- .01 -- -- --
------- -------- ------- --------- --------
Net income (loss) $ 2.88 $ (.14) $ 2.09 $ 3.62 $ .86
======= ======== ======= ========= ========
17
At December 31,
---------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED BALANCE SHEET DATA:
Cash and investments $1,043,471 $1,080,271 $ 998,892 $ 759,089 $1,485,107
Total assets 2,541,778 2,469,087 2,417,783 2,255,239 2,920,916
Debt, including current maturities 233,073 252,279 190,486 268,736 473,226
Customer banking deposits 392,904 476,495 526,172 329,301 189,782
Shareholders' equity 1,534,525 1,195,453 1,204,241 1,121,988 1,853,159
Book value per common share $25.74 $21.61 $21.78 $19.75 $29.90
Cash dividends per common share $ .25 $ .25 $ .25 $13.58 $ --
(a) Prior period amounts have been changed to reclassify equity in income
(loss) of associated companies such that it is no longer classified as
revenues. Includes net securities gains (losses) of $(37,066,000),
$28,450,000, $124,964,000, $16,268,000 and $(66,159,000) for the years
ended December 31, 2002, 2001, 2000, 1999 and 1998, respectively.
(b) During 2002, the Internal Revenue Service completed the audit of the
Company's consolidated federal income tax returns for the years 1996
through 1999, without any material tax payment required from the Company.
As a result of this favorable resolution of various federal income tax
contingencies, the income tax provision for 2002 reflects a benefit of
approximately $120,000,000.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
------------------------------------------------------------------------
of Operations.
--------------
The purpose of this section is to discuss and analyze the Company's
consolidated financial condition, liquidity and capital resources and results of
operations. This analysis should be read in conjunction with the consolidated
financial statements and related notes which appear elsewhere in this Report.
Liquidity and Capital Resources
Parent Company Liquidity
Leucadia National Corporation (the "Parent") is a holding company whose
assets principally consist of the stock of its direct subsidiaries, cash and
cash equivalents and other investments. The Parent continuously evaluates the
retention and disposition of its existing operations and investigates possible
acquisitions of new businesses in order to maximize shareholder value.
Accordingly, while the Parent does not have any material arrangement, commitment
or understanding with respect thereto (except as disclosed in this Report),
further acquisitions, divestitures, investments and changes in capital structure
are possible. Its principal sources of funds are its available cash resources,
bank borrowings, public and private capital market transactions, repayment of
subsidiary advances, funds distributed from its subsidiaries as tax sharing
payments, management and other fees, and borrowings and dividends from its
regulated and non-regulated subsidiaries. It has no substantial recurring cash
requirements other than payment of interest and principal on its debt, tax
payments and corporate overhead expenses.
As of December 31, 2002, the Company's readily available cash, cash
equivalents and marketable securities, excluding those amounts held by its
regulated subsidiaries, totaled $680,000,000. This amount is comprised of cash
and short-term bonds and notes of the United States Government and its agencies
of $375,600,000 (55%), the equity investment in WMIG of $121,100,000 (18%)
(which can be sold privately or otherwise in compliance with the securities laws
and is subject to a registration rights agreement), and other publicly traded
debt and equity securities aggregating $183,300,000 (27%). Additional sources of
liquidity as of December 31, 2002 include $170,100,000 of cash and marketable
securities primarily collateralizing letters of credit.
18
During 2002, the Internal Revenue Service completed the audit of the
Company's consolidated federal income tax returns for the years 1996 through
1999, without any material tax payment required from the Company. As a result of
this favorable resolution of various federal income tax contingencies, the
income tax provision for 2002 reflects a benefit from the reversal of tax
reserves aggregating approximately $120,000,000.
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.
The Company entered into a stockholders agreement with WilTel pursuant to
which the Company designated four members of WilTel's newly constituted nine
member board of directors. As long as the Company maintains an ownership
interest in WilTel of at least 20%, WilTel agreed to use its best efforts to
cause WilTel's board to nominate four Leucadia nominees in the future. In
addition, the Company agreed to certain restrictions on its ability to increase
its ownership in WilTel above 49% during the first two years after its
acquisition, and certain other restrictions on its ability to increase its
ownership during the first five years after its acquisition. While the
stockholders agreement and WilTel's charter restrict the transferability of
WilTel's securities, the Company does have the ability to sell an amount of
WilTel shares equal to 15% of the total outstanding WilTel shares. The Company
has no current intention to sell its WilTel stock, and although it has a
registration rights agreement with respect to its interest in WilTel, the
Company does not consider this investment to be liquid.
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.
In December 2002, the Company entered into an agreement to purchase certain
debt and equity securities of WebLink, for an aggregate purchase price of
$19,000,000. Pursuant to the agreement, the Company acquired outstanding secured
notes of WebLink with a principal amount of $36,500,000 and, upon receipt of
approval from the FCC, will acquire approximately 80% of the outstanding common
stock of WebLink.
19
During the second quarter of 2002, the Company sold its interest in Fidei,
its foreign real estate subsidiary, to an unrelated third party for total
proceeds of 70,400,000 Euros ($66,200,000), and recorded an increase to
shareholders' equity of $12,100,000. Although the Euro denominated sale proceeds
were not converted into US dollars immediately upon receipt, the Company did
enter into a participating currency derivative, which expired in September 2002.
Upon expiration, net of the premium paid to purchase the contract, the Company
received $67,900,000 in exchange for 70,000,000 Euros and recognized a foreign
exchange gain of $2,000,000. In connection with the sale, the Company classified
its foreign real estate operations as discontinued operations.
In November 2002, the Company sold its 40% equity interest in certain
thoroughbred racetrack businesses for net proceeds of approximately $28,000,000,
and recorded a pre-tax gain of $14,300,000. As part of this transaction, the
Company has an approximately 15% profits interest in a joint venture formed with
the buyer of the businesses to pursue the potential development and management
of gaming ventures in Maryland, including slot machines and video lottery
terminals (if authorized by state law). The Company has no funding obligations
for this joint venture. The Company is unable to currently determine the value,
if any, of this profits interest.
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.
Based on discussions with commercial and investment bankers, the Company
believes that it has the ability to raise additional funds under acceptable
conditions for use in its existing businesses or for appropriate investment
opportunities. Standard & Poor's and Duff & Phelps Inc. have rated the Company's
senior debt obligations as investment grade since 1993, while Moody's Investors
Services, Inc. rates the Company's senior debt obligations below investment
grade. Ratings issued by bond rating agencies are subject to change at any time.
Consolidated Liquidity
In 2002, net cash was provided by operating activities, principally as a
result of a reduction to the Company's investment in the trading portfolio. In
2001 and 2000, net cash was used for operations, reflecting lower investment
income on corporate investments as a result of the special dividend payment of
$811,900,000 in 1999, payment of the Parent's interest and overhead expenses and
a reduction of payables related to the trading portfolio.
20
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 previously stated, AIB stopped originating new sub-prime automobile
loans in September 2001, and both AIB and AIF ceased originating all other
consumer loans in January 2003. The FDIC and OCC have supported these actions
taken with respect to the sub-prime portfolio. However, effective February 2003,
AIB entered into a formal agreement with the OCC, agreeing to develop a written
strategic plan subject to prior OCC approval for the continued operations of
AIB, to continue to maintain certain risk-weighted capital levels, to obtain
prior approval before paying any dividends, to provide certain monthly reports
and to comply with certain other criteria. AIB will also be unable to accept
brokered deposits during the period the agreement remains in effect. In the
event AIB fails to comply with the agreement, the OCC would have the authority
to assert formal charges and seek other statutory remedies and AIB may also be
subject to civil monetary penalties. AIB is complying with the agreement and,
given that it has ceased all lending activities, the agreement is not expected
to have a significant impact on its operations. However, no assurance can be
given that other regulatory actions will not be taken.
The Company and certain of its subsidiaries have or have had tax loss
carryforwards and other tax attributes, the amount and availability of which are
subject to certain qualifications, limitations and uncertainties. In order to
reduce the possibility that certain changes in ownership could impose
limitations on the use of the tax loss carryforwards, the Company's certificate
of incorporation contains provisions which generally restrict the ability of a
person or entity from accumulating five percent or more of the common shares and
the ability of persons or entities now owning five percent or more of the common
shares from acquiring additional common shares. The restrictions will remain in
effect until the earliest of (a) December 31, 2005, (b) the repeal of Section
382 of the Internal Revenue Code (or any comparable successor provision) and (c)
the beginning of a taxable year of the Company to which certain tax benefits may
no longer be carried forward.
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.
Payments Due by Period (in thousands)
-----------------------------------------------------------------------
Less than 1
Contractual Cash Obligations Total Year 1-3 Years 4-5 Years After 5 Years
- ---------------------------- ----- ----------- --------- --------- -------------
Customer Banking Deposits $392,904 $283,613 $ 89,959 $ 19,332 $ --
Long-Term Debt 233,073 3,647 27,124 39,815 162,487
Operating Leases, net of Sublease Income 83,295 4,946 7,770 6,829 63,750
Preferred Securities of Subsidiary Trust 98,200 -- -- -- 98,200
-------- -------- -------- -------- --------
Total Contractual Cash Obligations $807,472 $292,206 $124,853 $ 65,976 $324,437
======== ======== ======== ======== ========
21
Off-Balance Sheet Arrangements
At December 31, 2002, the Company's off-balance sheet arrangements consist
of guarantees aggregating $265,500,000. The Company's guarantee of 10% of
Berkadia's financing incurred in connection with the Berkadia Loan represents
$217,500,000 of that total, $65,000,000 of which expired in connection with
payments of principal on the Berkadia Loan in the first quarter of 2003. To the
extent that future principal payments are received under the Berkadia Loan prior
to maturity, such amounts will be used to paydown the Berkadia financing and the
remaining $152,500,000 guarantee will expire proportionally at such times. The
Berkadia Loan matures in August 2006.
Prior to the sale of CDS, the Company had agreed to provide project
improvement bonds primarily for the benefit of the City of San Marcos for the
San Elijo Hills project, which are required prior to the commencement of any
project development. These bonds provide funds primarily to the City in the
event that CDS is unable or unwilling to complete certain infrastructure
improvements in the San Elijo Hills project. CDS is responsible for paying all
third party fees related to obtaining the bonds. Should the City or others draw
on the bonds for any reason, CDS and one of its subsidiaries would be obligated
to reimburse the Company for the amount drawn. At December 31, 2002, the amount
of outstanding bonds was $30,000,000, of which $25,400,000 expires in less than
one year. The Company's remaining guarantee at December 31, 2002 is an
$18,000,000 indemnification in connection with the financing of a real estate
property.
Results of Operations
Critical Accounting Policies and Estimates
The Company's discussion and analysis of its financial condition and
results of operations are based upon its consolidated financial statements,
which have been prepared in accordance with generally accepted accounting
principles. The preparation of these financial statements requires the Company
to make estimates and assumptions that affect the reported amounts in the
financial statements and disclosures of contingent assets and liabilities. On an
on-going basis, the Company evaluates all of these estimates and assumptions.
Actual results could differ from those estimates.
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 records a valuation allowance to reduce its deferred taxes to
the amount that is more likely than not to be realized. If the Company were to
determine that it would be able to realize its deferred tax assets in the future
in excess of its net recorded amount, an adjustment would increase income in
such period. Similarly, if the Company were to determine that it would not be
able to realize all or part of its net deferred taxes in the future, an
adjustment would be charged to income in such period. The Company also records
reserves for contingent tax liabilities related to potential exposure.
22
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.
Banking and Lending
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.
The Company's remaining consumer lending programs have primarily consisted
of marine, recreational vehicle, motorcycle and elective surgery loans. Due to
current economic conditions, portfolio performance and the relatively small size
of these loan portfolios and target markets, in January 2003 the Company stopped
originating all consumer loans. The Company is considering its alternatives for
its banking and lending operations, which could include selling or liquidating
some or all of its loan portfolios, and outsourcing certain functions.
23
Although finance revenues increased in 2001 as compared to 2000, pre-tax
results declined primarily due to a larger provision for loan losses, changes in
market values of interest rate swaps, higher interest paid on interest rate
swaps, charges recorded in connection with the Company's decision to stop
originating new subprime automobile loans and to consolidate all operations in
Salt Lake City, and higher interest expense due to the increased customer
banking deposits through September of 2001. In 2001, the banking and lending
segment's provision for loan losses increased $13,000,000 as compared to the
prior year. This increase primarily reflected higher net charge-offs, for which
the Company believes a weaker economy and increased bankruptcies were
contributing factors, and an increase in the rates used by the Company to
establish the allowance for loan losses in recognition of its increased loss
experience. Pre-tax results for the banking and lending segment for 2001 also
included $7,100,000 of charges related to consolidating all operations in Salt
Lake City.
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.
Manufacturing
Manufacturing revenues for the plastics division declined approximately 5%
in 2002 as compared to 2001 primarily due to reductions in the consumer products
market of $3,800,000, partially offset by increases in the construction market
of $1,200,000. The reductions in the consumer products market resulted from the
loss of a customer for the Asian market and for its consumer dust wipe products,
and reduced demand for one of the Company's healthcare products. Gross profit
was largely unchanged for 2002 as compared to 2001, reflecting cost reduction
initiatives that reduced labor costs, improved material utilization and reduced
non-resin raw material costs.
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.
Manufacturing revenues, gross profit and pre-tax results for the plastics
division declined in 2001 as compared to 2000. Of the $11,400,000 decline in
manufacturing revenues in 2001, the most significant reduction was in the
consumer products market, which declined by $7,300,000. This decline was
primarily due to a customer for the Asian market no longer using one of the
Company's products and a lower than anticipated demand for consumer dust wipe
products. In addition, increased competition in the agriculture, home furnishing
and packaging markets and customer inventory reductions in the construction and
certain industrial markets also contributed to the reduction in sales in 2001.
Gross profit for 2001 declined primarily due to the decline in sales and higher
fixed costs related to the Belgium manufacturing facility. The decline in
pre-tax income in 2001 was partially offset by the contract termination gain
referred to above.
24
Domestic Real Estate
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.
During the fourth quarter of 2002, the Company sold one of its real estate
subsidiaries, CDS, to HomeFed for a purchase price of $25,000,000, consisting of
$1,000,000 in cash and 24,742,268 shares of HomeFed's common stock, which
represents approximately 30.3% of the outstanding HomeFed stock. CDS's principal
asset is the master-planned community located in San Diego County, California
known as San Elijo Hills, for which HomeFed has served as the development
manager since 1998. The deferred gain on this sale of approximately $12,100,000
at December 31, 2002, will be recognized into income as the San Elijo Hills
project is developed and sold. The Company is accounting for its investment in
HomeFed under the equity method of accounting. Income recognized representing
its share of HomeFed's earnings in 2002 was not material. Prior to the sale to
HomeFed, the Company recognized pre-tax gains of $7,800,000 from sales of
residential sites at San Elijo Hills during 2002.
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.
Other
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.
Investment and other income declined in 2001 as compared to 2000 in part
from non-recurring income recognized in 2000 totaling $25,900,000, primarily
consisting of foreclosure gains from certain domestic real estate properties of
$10,700,000, a prepayment penalty related to certain promissory notes of
$7,500,000 and a gain from the sale of a corporate owned aircraft of $7,700,000.
In addition, investment and other income declined in 2001 due to decreased gains
from sales of various domestic real estate properties of $8,500,000 and a
reduction in revenues related to MK Gold of $10,100,000. Such decreases were
partially offset by the 2001 gain from the sale of the Company's investment in
two inactive insurance companies referred to above and increased revenues from
the Company's oil and gas operations of $6,200,000.
Net securities gains (losses) for 2002 include a provision of $37,100,000
to write down the Company's investments in certain available for sale securities
and its equity investment in a non-public fund. The write down of the available
for sale securities resulted from a decline in market value determined to be
other than temporary. Net securities gains (losses) for 2000 include pre-tax
security gains related to the Company's investments in Fidelity National
Financial, Inc. ($90,900,000) and Jordan Telecommunication Products, Inc.
($24,800,000).
25
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.
For 2002, the Company's equity in the income of Berkadia consisted of
pre-tax income of $59,000,000 related to the amortization of the discount on the
Berkadia Loan and $6,600,000 from its share of the net interest spread on the
Berkadia Loan. For 2001, the Company's equity in the loss of Berkadia consisted
of a pre-tax loss of $94,400,000 for its share of FINOVA's losses under the
equity method of accounting, $20,100,000 of pre-tax income related to the
amortization of the discount on the Berkadia Loan and $3,900,000 of pre-tax
income from its share of the net interest spread on the Berkadia Loan. As more
fully described in Note 3 to the Company's consolidated financial statements,
Berkadia's initial investment in the FINOVA stock and the Berkadia Loan are
determined based upon the relative fair values of the securities received in
exchange for the funds transferred to FINOVA. The fair value assigned to the
FINOVA stock was based upon the trading price of FINOVA's common stock on the
day the FINOVA stock was received, was far in excess of FINOVA's net worth and
was inconsistent with the Company's view that the FINOVA common stock has a very
limited value. Subsequent to acquisition, and principally as a result of the
terrorist attacks on September 11, 2001, Berkadia recorded its share of FINOVA's
losses in an amount that reduced Berkadia's investment in FINOVA's common stock
to zero in 2001.
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.
26
The decline in interest expense for 2002 as compared to 2001 primarily
reflects lower interest expense at the banking and lending segment due to
reduced customer banking deposits and lower interest rates thereon.
Salaries expense in 2001 primarily reflects decreased expenses related to
lower bonus expense.
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.
Property and Casualty Insurance--Discontinued Operation
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.
Recently Issued Accounting Standards
In July 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"), which is effective
for exit or disposal activities initiated after December 31, 2002. SFAS 146
addresses issues regarding the recognition, measurement and reporting of costs
associated with exit and disposal activities, including restructuring
activities. SFAS 146 requires a liability be recognized at fair value for costs
associated with exit or disposal activities only when the liability is incurred
as opposed to at the time the Company commits to an exit plan as permitted under
Emerging Issues Task Force Issue No. 94-3. In November 2002, the FASB issued
FASB Interpretation No. 45 ("FIN 45"), which requires a guarantor for certain
guarantees to recognize, at the inception of a guarantee, a liability for the
fair value of the obligation undertaken in issuing the guarantee. The initial
recognition and initial measurement provisions of FIN 45 are applied on a
prospective basis to guarantees issued or modified after December 31, 2002. In
addition, FIN 45 modified the disclosure requirements for such guarantees
effective for interim or annual periods ending after December 15, 2002; the
Company has adopted these disclosure requirements. In January 2003, the FASB
issued FASB Interpretation No. 46 ("FIN 46"), which addresses consolidation of
variable interest entities, which are entities in which equity investors do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
27
additional subordinated financial support from other parties. FIN 46 is
effective immediately to variable interest entities created after January 31,
2003, and to variable interest entities in which an enterprise obtains an
interest after that date. FIN 46 applies in the first fiscal year or interim
period beginning after June 15, 2003, to variable interest entities in which an
enterprise holds a variable interest that it acquired before February 1, 2003.
FIN 46 may be applied prospectively with a cumulative effect adjustment as of
the date on which it is first applied or by restating previously issued
financial statements with a cumulative effect adjustment as of the beginning of
the first year restated. The Company is reviewing the impact of the
implementation of SFAS 146, the initial recognition and measurement provisions
of FIN 45, and the implementation of FIN 46.
Cautionary Statement for Forward-Looking Information
Statements included in this Report may contain forward-looking statements.
Such forward-looking statements are made pursuant to the safe-harbor provisions
of the Private Securities Litigation Reform Act of 1995. Such statements may
relate, but are not limited, to projections of revenues, income or loss, capital
expenditures, plans for growth and future operations, competition and
regulation, as well as assumptions relating to the foregoing.
Forward-looking statements are inherently subject to risks and
uncertainties, many of which cannot be predicted or quantified. When used in
this Report, the words "estimates", "expects", "anticipates", "believes",
"plans", "intends" and variations of such words and similar expressions are
intended to identify forward-looking statements that involve risks and
uncertainties. Future events and actual results could differ materially from
those set forth in, contemplated by or underlying the forward-looking
statements.
The factors that could cause actual results to differ materially from those
suggested by any such statements include, but are not limited to, those
discussed or identified from time to time in the Company's public filings,
including:
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.
28
Undue reliance should not be placed on these forward-looking statements,
which are applicable only as of the date hereof. The Company undertakes no
obligation to revise or update these forward-looking statements to reflect
events or circumstances that arise after the date of this Report or to reflect
the occurrence of unanticipated events.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
- ------- ----------------------------------------------------------
The following includes "forward-looking statements" that involve risk and
uncertainties. Actual results could differ materially from those projected in
the forward-looking statements.
The Company's market risk arises principally from interest rate risk
related to its investment portfolio, its borrowing activities and the banking
and lending activities of certain subsidiaries.
The Company's investment portfolio is primarily classified as available for
sale, and consequently, is recorded on the balance sheet at fair value with
unrealized gains and losses reflected in shareholders' equity. Included in the
Company's investment portfolio are fixed income securities, which comprised
approximately 69% of the Company's total investment portfolio at December 31,
2002. These fixed income securities are primarily rated "investment grade" or
are U.S. governmental agency issued or guaranteed obligations. The estimated
weighted average remaining life of these fixed income securities was
approximately 4.6 years at December 31, 2002. The Company's fixed income
securities, like all fixed income instruments, are subject to interest rate risk
and will fall in value if market interest rates increase. The Company's
investment portfolio also includes its investment in WMIG, carried at its
aggregate market value of $121,100,000. This investment is approximately 19% of
the Company's total investment portfolio, and its value is subject to change if
the market value of the WMIG stock rises or falls. At December 31, 2001, fixed
income securities comprised approximately 68% of the Company's total investment
portfolio and had an estimated weighted average remaining life of 2.0 years. At
December 31, 2002 and 2001, the Company's portfolio of trading securities was
not material.
The Company is subject to interest rate risk on its long-term fixed
interest rate debt and the Company-obligated mandatorily redeemable preferred
securities of its subsidiary trust holding solely subordinated debt securities
of the Company. Generally, the fair market value of debt and preferred
securities with a fixed interest rate will increase as interest rates fall, and
the fair market value will decrease as interest rates rise.
The Company's banking and lending operations are subject to risk resulting
from interest rate fluctuations to the extent that there is a difference between
the amount of the interest-earning assets and the amount of interest-bearing
liabilities that are prepaid/withdrawn, mature or reprice in specified periods.
The principal objectives of the Company's banking and lending asset/liability
management activities are to provide maximum levels of net interest income while
maintaining acceptable levels of interest rate and liquidity risk and to
facilitate funding needs. The Company utilizes an interest rate sensitivity
model as the primary quantitative tool in measuring the amount of interest rate
risk that is present. The model quantifies the effects of various interest rate
scenarios on the projected net interest margin over the ensuing twelve-month
period. Derivative financial instruments, including interest rate swaps, may be
used to modify the Company's indicated net interest sensitivity to levels deemed
to be appropriate based on risk management policies and the Company's current
economic outlook. Counterparties to such agreements are major financial
institutions, which the Company believes are able to fulfill their obligations;
however, if they are not, the Company believes that any losses are unlikely to
be material.
29
The following table provides information about the Company's financial
instruments used for purposes other than trading that are primarily sensitive to
changes in interest rates. For investment securities and debt obligations, the
table presents principal cash flows by expected maturity dates. For the variable
rate notes receivable and variable rate borrowings, the weighted average
interest rates are based on implied forward rates in the yield curve at the
reporting date. For loans, securities and liabilities with contractual
maturities, the table presents contractual principal cash flows adjusted for the
Company's historical experience and prepayments of mortgage-backed securities.
For banking and lending's variable rate products, the weighted average variable<