ITEM 1. BUSINESS
General
Armco Inc. ("Armco" or the "Company") was incorporated as an Ohio corporation in 1917 as a successor to a New Jersey corporation incorporated in 1899. Based on sales revenues, Armco is the second largest domestic producer of stainless flat-rolled steels and is the largest domestic producer of electrical steels. The Company owns a 50% partnership interest in National- Oilwell, a distributor of oil country tubular goods and a manufacturer of drilling, production and other oil and gas equipment that operates a network of oil field supply stores throughout North America. Armco also owns Douglas Dynamics, Inc., the largest North American manufacturer of snowplows for four- wheel drive pick-up trucks and utility vehicles and provides insurance services through businesses it intends to sell or liquidate.
As part of its strategy to focus on the production of specialty flat- rolled steel, Armco has continued to evaluate the growth potential and profitability of its businesses and investments, and to rationalize or divest those that do not represent a strategic fit or offer growth potential or positive cash flow. In 1992, 1993 and 1994, Armco divested or otherwise rationalized several unprofitable or non-strategic operations.
On January 28, 1994, Armco signed a letter of intent to sell its ongoing insurance operations to Vik Brothers Insurance, Inc. ("Vik Brothers"), a privately owned property and casualty insurance holding company. On August 2, 1994, Armco and Vik Brothers signed a definitive agreement, subject to a number of conditions, including approvals by regulatory authorities. Under the terms of the agreement, Armco would be paid approximately $65 million at closing and $15 million in three years, subject to potential adjustment for adverse experience in certain insurance reserves. As a result of restructuring certain obligations arising from the 1992 merger plan for the insurance companies that are being liquidated, any proceeds from the sale are pledged as security for certain note obligations due to these insurance companies and would be retained in the investment portfolio of these companies.
In April 1994, Armco Steel Company, L.P. ("ASC"), a carbon steel joint venture with Kawasaki Steel Corporation ("Kawasaki"), completed an initial public offering and recapitalization. As part of this transaction, the business and assets of ASC were transferred to a newly formed company named AK Steel Holding Corporation ("AK Steel"). In the recapitalization, Armco received 1,023,987 shares of common stock of AK Steel and was released from certain obligations to make future cash payments to the former joint venture.
In August 1994, Armco sold its conversion business plant in Bridgeville, Pennsylvania, and, in September 1994, sold, to its partner, Acerinox S.A., 90% of its investment in North American Stainless ("NAS"), a 50-percent joint venture that finishes chrome nickel flat-rolled stainless steel. Armco, through its subsidiary, First Stainless, Inc., maintains a five percent limited partnership interest in NAS and Armco will supply NAS with chrome nickel stainless steel coils on an annual contract basis at market rates.
In October 1994, Armco announced that Eastern Stainless Corporation ("Eastern Stainless"), an 84%-owned subsidiary of Armco, and Avesta Sheffield Holding Company ("Avesta Sheffield") reached an agreement in principle for the sale of all of the assets of Eastern Stainless to Avesta Sheffield for cash and the assumption of certain liabilities. A definitive agreement for the sale was signed on February 9, 1995, and on March 14, 1995, Eastern Stainless, Armco and Avesta Sheffield completed the sale. The cash proceeds of the sale were applied to the satisfaction of the Eastern Stainless obligations not assumed by Avesta Sheffield, Armco assumed the net liabilities of Eastern Stainless not assumed by Avesta Sheffield or satisfied by the cash proceeds and Eastern Stainless was dissolved without any shareholder distribution.
In December 1994, Armco sold its Bowman Metal Deck division, a producer of carbon steel roof, floor and bridge deck, its Tex-Tube division, a manufacturer of electric welded steel pipe, and its Armco Stainless & Alloy Products plant in Baltimore, Maryland.
Business Segments
The information on the amounts of revenue, operating results and identifiable assets attributable to each of Armco's business segments, set forth in Note 8 of the Notes to Financial Statements in Armco's Annual Report to Shareholders for the year ended December 31, 1994, is incorporated by reference herein.
Additional information about Armco's business segments and equity investments is set forth in Management's Discussion and Analysis in Armco's Annual Report to Shareholders for the year ended December 31, 1994, which is incorporated by reference herein.
Specialty Flat-Rolled Steel
Plants in Armco's Specialty Flat-Rolled Steel business segment produce and finish stainless and electrical steel sheet and strip. Its principal manufacturing plants are in Butler, Pennsylvania, and Zanesville, Ohio, where Armco produces flat-rolled stainless and electrical steel sheet and strip products, and in Coshocton, Ohio, where Armco finishes premium quality flat- rolled stainless steel in sheet and strip form. Stainless steel plate products were finished at Eastern Stainless, which was sold on March 14, 1995. The segment also includes the results of European trading companies which buy and sell steel and manufactured steel products. Following the start-up of a new thin-slab continuous caster being installed at Armco's Mansfield, Ohio facilities, the segment will also include sales of specialty steels produced by, and the related operating results of, the Mansfield facilities.
The specialty steel industry is a relatively small but distinct segment of the overall steel industry that represented approximately 2% of domestic steel tonnage but accounted for approximately 10% of domestic steel revenues in 1994. Specialty steels refer to alloy tool steel, electrical steel and stainless sheet, strip, plate, bar, rod and wire products. Specialty steels differ from basic carbon steel by their metallurgical composition. They are made with a high alloy content, which enables their use in environments that demand exceptional hardness, toughness, strength and resistance to heat, corrosion or abrasion or combinations thereof. Unlike high-volume carbon steel, specialty steel is generally produced in relatively small quantities utilizing special processing techniques designed to meet more exacting specifications and tolerances.
Stainless steel, which represents the largest part of the specialty steel market, contains elements such as chromium, nickel and molybdenum that give it the unique qualities of resistance to rust, corrosion and heat; high strength; good wear characteristics; natural attractiveness; and ease of maintenance. Stainless steel is used in the automotive and aerospace industries, and in the manufacture of food handling, chemical processing, pollution control, medical and health equipment and other products where its combination of strength, durability and attractiveness is desirable. Electrical steels are iron- silicon alloys and, through special production techniques, possess unique magnetic properties that make them desirable for use as energy efficient core material in such applications as electrical transformers, motors and generators.
Armco expects that the demand for stainless steel will continue to be positively affected by its increasing use in the manufacture of consumer durable goods and industrial applications. Per capita stainless steel usage in many highly developed countries significantly exceeds per capita usage in the United States and Armco believes that this is an indication of the growth potential of demand for stainless steel in the United States. In addition, the 1990 amendments to the Clean Air Act have resulted in the increasing use of corrosion-resistant materials in a number of applications for which stainless steel is well suited, including industrial pollution control devices and motor vehicle exhaust systems for use in the United States, where Armco now has the leading market share. Another factor that Armco believes will affect demand positively is the increasing issuance of new car bumper-to- bumper warranties and the use of stainless steel in passenger restraint systems. Stainless steel products
generate higher average profit margins than carbon steel products and, depending on the stainless grade, sell at average prices of three to five times those of carbon steel.
Armco produces flat-rolled stainless steel and alloy electrical steel sheet and strip products that are used in a diverse range of consumer durables and industrial applications. Since the acquisition of Cyclops Industries, Inc. in April 1992, approximately 70% of Armco's sales of specialty flat- rolled steel has been stainless steel and 30% has been electrical steel. Major markets served are industrial machinery and electrical equipment, automotive, construction and service centers.
In the stainless steel market, Armco is the leading domestic producer of chrome grades used primarily in the domestic market for automotive exhaust components. Stainless steel, which formerly was not used in parts of the exhaust system other than the catalytic converter, is now used in the entire exhaust system from manifold to tailpipe by many auto manufacturers. Armco has developed a number of specialty grades for this application, many of which are patented. Armco is also known for its "bright anneal" chrome grade finishes utilized for automotive and appliance trim and other chrome grades used for cutlery, kitchen utensils, scissors and surgical instruments. Specialty chrome nickel grades produced by Armco are used in household cookware, restaurant and food processing equipment and medical equipment.
Other Armco stainless products include functional stainless steel manufactured for automotive, agricultural, heating, air conditioning and other manufacturing uses. Before the sale of Eastern Stainless in March 1995, Armco's stainless products also included stainless steel plate, principally in flat plate form, for use in industrial applications where high resistance to heat, stress or corrosion is required.
Armco is the only United States manufacturer of a complete line of flat- rolled electrical steel products and is the sole domestic producer of certain high permeability oriented electrical steels. It is also the only domestic manufacturer utilizing laser scribing technology. In this process, the surface of electrical steel is etched with high-technology lasers which refine the magnetic domains of the steel resulting in superior electrical efficiency. Major electrical product categories are: Regular Grain Oriented ("RGO"), used in the cores of energy-efficient power and distribution transformers; Cold Rolled Non-Oriented ("CRNO"), used for electrical motors and lighting ballasts; and TRAN COR[registered trademark]H, which is used in power transformers and is the only high permeability electrical steel made domestically.
Armco had trade orders on hand for its Specialty Flat-Rolled Steel segment (excluding Eastern Stainless) of $187.3 million at December 31, 1994, and $142.1 million at December 31, 1993. The backlog increased in 1994 due to stronger demand and an improving economy. While substantially all of the orders on hand at year-end 1994 are expected to be shipped in 1995, such orders, as is customary in the industry, are subject to modification, extension or cancellation.
Armco's specialty steelmaking operations are concentrated in Pennsylvania and Ohio, which permits cost-efficient materials flow between plants. Armco's Butler, Pennsylvania facility, which is situated on 1,300 acres with 3.2 million square feet of buildings, continuously casts 100% of its steel. At Butler, melting takes place in three 165-ton electric arc furnaces that feed the world's largest (175-ton) argon-oxygen decarburization unit for refining molten metal that, in turn, feeds two double strand continuous casters. The melt capacity at Butler was approximately 875,000 tons by year-end 1994. Butler also operates a hot-strip mill, anneal and pickle units and a fully- automated tandem cold-rolling mill. It also has various intermediate and finishing operations for both stainless and electrical steels.
Armco's Zanesville, Ohio plant, with 508,000 square feet of buildings on 88 acres, is a dedicated finishing plant for some of the steel produced at the Butler facility and has a Sendzimer cold-rolling mill, anneal and pickle facilities, high temperature box anneal and other decarburization and coating units.
The finishing plant in Coshocton, Ohio, located on 650 acres, is housed in a 500,000 square-foot plant and has three Sendzimer mills, four anneal and pickle facilities, three "bright anneal" lines, two 4-high mills for cold reduction and other processing equipment, including temper rolling, slitting and packaging facilities.
Following the startup of a new thin-slab continuous caster being installed at Armco's Mansfield, Ohio facilities, which is expected to be completed early in the second quarter of 1995, the Mansfield facilities will melt and finish specialty steels, including automotive chrome. Production of specialty steel at Mansfield is expected to begin in the third quarter of 1995. Sales of these specialty steel products and the related operating results will be reported in the Specialty Flat-Rolled Steel segment.
In the fourth quarter of 1994, Armco announced an expanded capital improvement program under which it will spend up to $95 million over the next two years to upgrade and expand its specialty steel finishing facilities. The program is intended to reduce existing production constraints, increasing specialty steel finishing capacity by approximately 180,000 tons per year, particularly in electrical steels, specialty sheet and strip products, and non-automotive chrome stainless. About $60 million of this total will be spent to upgrade existing equipment at the Butler, Coshocton, Mansfield and Zanesville plants. The remaining $35 million of investment is targeted for proposed new pickling and box annealing facilities. In addition to increasing revenues as a result of expanded finishing capacity, the capital improvements are expected to provide quality improvements and significant annual cost savings.
Other Steel and Fabricated Products
The businesses currently included in the Other Steel and Fabricated Products segment are described below:
-- Carbon steel operations at Mansfield, Ohio produce commodity grades of carbon steel sheet, much of which is coated at a dedicated galvanizing facility at Dover, Ohio. Under a plan to upgrade the facilities at Mansfield to enhance their steel production capability and improve the operating performance of both the Mansfield and Dover, Ohio operations, Armco has begun installing a thin-slab caster and related plant modifications at Mansfield. Installation is expected to be completed early in the second quarter of 1995. The caster is designed to produce carbon steels, and functional grades of chrome stainless steels and nonoriented grades of electrical steels. The sales of these stainless and electrical steels and the related operating results will be reported in the Specialty Flat-Rolled Steel segment. The Mansfield plant currently consists of a 1.4 million square-foot facility, including a melt shop with two electric arc furnaces (170-ton and 100-ton), a 100-ton argon-oxygen decarburization unit, a six-stand hot strip mill, a five- stand tandem cold rolling mill and a newly retrofitted Sendzimer mill for chrome stainless finishing. In the second quarter of 1994, Armco idled the Mansfield and Dover production facilities. The Mansfield plant is expected to remain idled until the thin-slab caster is completed. The Dover plant resumed limited production in early 1995. Armco recognized a special charge of $20 million in the first quarter of 1994 for the cost of benefits to employees on layoff and other costs of idling the facilities, as well as costs associated with planned permanent work force reductions.
-- Douglas Dynamics, Inc. is the largest North American manufacturer of snowplows for four-wheel drive pick-up trucks and utility vehicles. Douglas Dynamics, Inc., which is headquartered in Milwaukee, Wisconsin, has snowplow manufacturing plants in Rockland, Maine, Milwaukee, Wisconsin and Johnson City, Tennessee and sells its snowplows and other light truck equipment through independent distributors throughout the United States and Canada.
-- Sawhill Tubular produces steel pipe and tubing, electric welded and mandrel-drawn steel tubing and electric-resistance welded steel pipe at its plants in Pennsylvania and Ohio.
Armco had trade orders on hand for its Other Steel and Fabricated Products segment of $38.6 million at December 31, 1994 and $73.0 million at December 31, 1993. The segment's backlog decreased in 1994 primarily as a result of the idling of the Mansfield and Dover facilities. While
substantially all of the orders on hand at year-end 1994 are expected to be shipped in 1995, such orders, as is customary in these industries, are subject to modification, extension or cancellation.
Employees
At December 31, 1994, Armco had approximately 5,500 employees in its continuing operations and approximately 1,500 employees in its insurance and discontinued operations. Most of Armco's domestic production and maintenance employees are represented by international, national or independent local unions, although some operations are not unionized.
Armco has agreements with the local unions at the specialty steel plants in Butler, Pennsylvania and Zanesville, Ohio which terminate September 30, 1996, and June 30, 1996, respectively. In June 1993, the United Steelworkers of America ("USWA") employees at Armco's Mansfield and Dover, Ohio plants ratified new six-year contracts, which became effective September 1, 1993. In the second half of 1994, the USWA employees and management at the Mansfield and Dover plants reached local agreements which provide for additional improvements in manning levels and work practices.
Competition
Armco faces intense competition from within the domestic steel industry, from manufacturers of competing products other than steel, including aluminum, plastics, composites and ceramics, and from foreign steel producers as well as foreign producers of components and other products. Many of these foreign producers have lower labor costs and many are owned, controlled or subsidized by their respective governments. Their decisions with regard to production and sales may be influenced more by political and social considerations than prevailing market forces. Many foreign steel producers continue to ship into the United States market despite decreasing profit margins or losses. Depending on a number of market factors, including the strength of the dollar, import levels, and the effectiveness of our nation's trade laws, pricing of the Company's products could be adversely affected. Competition is based primarily on price, with factors such as reliability of supply, service and quality also being important in certain segments.
Import penetration for stainless sheet and strip was 23.4% in 1994 compared to 23.9% in 1993. Import penetration of electrical steels was 20.3% in 1994 compared to 22.7% in 1993.
In 1993, Armco, Allegheny Ludlum Corporation, the USWA and the independent unions at Armco's plants in Butler, Pennsylvania and Zanesville, Ohio filed a petition requesting that the U.S. government impose both antidumping and countervailing duties on imports of grain-oriented electrical steel from Italy. In addition, Allegheny Ludlum Corporation and the USWA petitioned the U.S. government to assess antidumping duties on imports of grain-oriented electrical steel from Japan. In 1994, the Department of Commerce announced a countervailing duty margin of 24.42% and anti-dumping duties of 60.79% on imports of oriented electrical steel from Italy, and an anti-dumping duty of 31.08% against Japan. Primarily as a result of the imposition of these duties, imports of oriented electrical steel from these countries were severely curtailed during the latter half of 1994 and Armco was able to improve its position in the market and maintain firmer prices. The foreign producers have filed appeals with the court of international trade.
Control of unfairly traded foreign steel products was made more difficult when, in 1994, the U.S. government agreed to the General Agreement on Tariffs and Trade (or GATT). This agreement weakened existing U.S. trade laws by making it more difficult to win trade cases filed against foreign countries or companies believed to be unfairly selling in the U.S. marketplace.
Competition is also presented by the so-called "mini-mills", which generally have smaller, non-unionized work-forces and are relatively free of many of the employer, environmental and other obligations that traditionally have burdened steel producers. Nucor Corporation, a mini-mill steel company, has announced its intention to enter the automotive chrome stainless steel business, with the addition of an argon-oxygen-decarburization (AOD) vessel at its Crawfordsville, Indiana melt shop. Production is scheduled to begin in the second quarter of 1995, with targeted shipments of 50,000
tons in 1995 and 100,000 tons in 1996. Nucor Corporation's entry will intensify competition in the automotive chrome stainless market, which totals about 400,000 tons per year. Armco is currently the leading U.S. producer of automotive chrome stainless steel.
Raw Materials and Energy Sources
Raw material prices represent a major component of per ton production costs in the specialty steel industry. The principal raw materials used by Armco in the production of specialty steels are iron and steel scrap, molybdenum, chrome and nickel, and their ferroalloys, stainless steel scrap, silicon and zinc. These materials are purchased in the open market from various outside sources. Since much of this purchased raw material is not covered by long-term contracts, availability and price are subject to world market conditions. Chrome and nickel and certain other materials in mined alloy form can be acquired only from foreign sources, many of them located in developing countries that may be subject to unstable political and economic conditions that might disrupt supplies or affect the price of these materials. A significant portion of the chrome and nickel requirements, however, is obtained from stainless steel scrap rather than mined alloys. While certain raw materials have been in short supply from time to time, Armco currently is not experiencing and does not anticipate any problems obtaining appropriate materials in amounts sufficient to meet its production needs. Armco also uses large amounts of electricity and natural gas in the manufacture of its products. It is expected that such energy sources will continue to be reasonably available in the foreseeable future. Compliance with the Clean Air Act, as amended in November 1990, may increase the operating costs of the utilities providing services to Armco's facilities, and in turn may result in increased costs to Armco for utility services.
Environmental Matters
Armco, in common with other United States manufacturers, is subject to various federal, state and local requirements for environmental controls relating to its operations. Armco has devoted, and will continue to devote, significant resources to control air and water pollutants, to dispose of wastes, and to remediate sites of past waste disposal. Armco estimates capital expenditures for pollution control in its manufacturing operations will be about $27 million for the years 1995-1998, with the largest expenditures being made in the Specialty Flat-Rolled Steel segment. Approximately $14 million is related to control of air pollution pursuant to regulations currently promulgated under the Clean Air Act, as amended, and corresponding state laws. These projections, which have been prepared internally and without independent engineering or other assistance, reflect Armco's current analysis of probable required capital projects for pollution control. During the period 1991 through 1994, Armco's capital expenditures for pollution control projects amounted to approximately $10 million including $7 million in 1994. Statutory and regulatory requirements in this area continue to evolve and, accordingly, the type and magnitude of expenditures may change.
Armco has been named as a defendant, or identified as a potentially responsible party, in various governmental proceedings regarding cleanup of certain past waste disposal sites. Armco is also a defendant in various private lawsuits alleging property damage and personal injury from waste disposal sites. Joint and several liability could be imposed on Armco or other parties for these matters, thus, theoretically, one party could be held liable for all costs related to a site. While such governmental and private actions are being contested, the outcome of individual matters cannot be predicted with assurance. However, based on its experience with such cases and a review of current claims, Armco expects that in most cases any ultimate liability will be apportioned between Armco and other financially viable parties.
From time to time, Armco has been and may be subject to penalties or other requirements as a result of administrative actions by regulatory agencies and to claims for indemnification for properties it has previously owned or leased. In addition, environmental exit costs may be incurred if Armco decides to dispose of additional properties. It is Armco's policy not to accrue such costs until a decision is made to dispose of a property.
Based on current facts and circumstances known to Armco, Armco's experience with site remediation, an understanding of current environmental laws and regulations, environmental
assessments, the existence of other financially viable parties, expected remediation methods and the years in which Armco is expected to make payments toward each remediation (which range from the current year to 30 years or more in the future), Armco believes that the ultimate liability for environmental remediation matters identified to date will not materially affect its consolidated financial condition or liquidity. However, it is possible that due to fluctuations in Armco's results, future developments with respect to such matters could have a material effect on the results of operations of future interim or annual periods.
Furthermore, the identification of additional sites, changes in known circumstances with respect to identified sites, the failure of other parties to contribute their share of remediation costs, decisions to dispose of additional properties and other changed circumstances may result in increased costs to Armco, which could have a material effect on its consolidated financial condition, liquidity and results of operations in future interim or annual periods. However, it is not possible to determine whether additional loss, due to changed circumstances, will occur or to reasonably estimate the amount or range of any potential additional loss.
Statutes and regulations relating to the protection of the environment have resulted in higher operating costs and capital investments by the industries in which Armco operates. Although it cannot predict precisely how changes in environmental requirements will affect its businesses, Armco does not believe such requirements would affect its competitive position.
Research and Development
Armco carries on a broad range of research and development activities aimed at improving its existing products and manufacturing processes and developing new products and processes. Armco's research and development activities are carried out primarily at a central research and technology laboratory located in Middletown, Ohio. This laboratory is engaged in applied materials research related to iron and steel, non-ferrous materials and new materials. In addition, the materials and metallurgy departments at each operating unit develop and implement improvements to products and processes that are directly connected with the activities of such operating unit.
Armco spent $14.6 million, $12.9 million and $24.0 million, respectively, on research in the years ended December 31, 1994, 1993 and 1992 (including $0.9 million, $3.9 million and $9.4 million, respectively, funded by affiliates, primarily ASC, which is no longer an affiliate, in 1993 and 1992).
Equity and Other Investments
Armco Steel Company, L.P.
ASC was a joint venture limited partnership formed in 1989 by Armco and Kawasaki. With plants located in Middletown, Ohio and Ashland, Kentucky, ASC produced primarily high strength, low carbon flat-rolled steel. These products were supplied to the automotive, appliance and manufacturing markets, as well as to the construction industry and independent steel distributors and service centers.
In April 1994, ASC completed an initial public offering and recapitalization. As part of this transaction, the business and assets of ASC were transferred to AK Steel. In the recapitalization, Armco received 1,023,987 shares, or 4.2%, of the AK Steel common stock and was released from certain obligations to make future cash payments to the former joint venture. The number of shares received and other terms of the restructuring and recapitalization were determined by arm's-length negotiations.
Armco Financial Services Group
AFSG currently consists primarily of insurance companies that Armco intends to sell (the "AFSG companies to be sold") and companies that have ceased writing new business and are being liquidated (the "runoff companies").
The AFSG companies to be sold provide multiple-line casualty insurance, including personal and commercial automobile, workers' compensation, homeowners, multiperil, personal and commercial property and general liability insurance, and consist primarily of Northwestern National Casualty Company ("NNCC"), Pacific National Insurance Company and Statesman Insurance Company ("Statesman").
On January 28, 1994, Armco signed a letter of intent to sell its ongoing insurance operations to Vik Brothers Insurance, Inc., a privately owned property and casualty insurance holding company. On August 2, 1994, Armco and Vik Brothers signed a definitive agreement, subject to a number of conditions, including approvals by regulatory authorities. The sale is expected to close by April 7, 1995. Under the terms of the agreement, Armco would be paid approximately $65.0 million at closing and $15 million in three years, subject to potential adjustment for adverse experience in certain insurance reserves. As a result of restructuring certain obligations arising from the 1992 merger plan for the runoff companies, any proceeds from the sale are pledged as security for certain note obligations due to the runoff companies and would be retained in the investment portfolio of the AFSG runoff companies.
The insurance business is highly competitive. Many of the competitors of the AFSG companies to be sold offer more diversified lines of insurance and have substantially greater financial resources. In addition, the insurance regulators having supervisory authority over Armco's insurance operations retain substantial control over certain corporate transactions, including the sale of the AFSG companies to be sold and the liquidation of the runoff companies. They also have broad powers to interpret statutory accounting requirements and to initiate rehabilitation and liquidation proceedings.
The liability for unpaid losses and loss adjustment expenses includes an amount determined from loss reports and individual cases and an amount, based on past experience, for losses incurred but not reported. Such liability is necessarily based on estimates and, while management believes that the amount is fairly stated, the ultimate liability may be in excess of or less than the amount provided. The methods for making such estimates and for establishing the resulting liability are continually reviewed and any adjustments resulting therefrom are reflected currently in the earnings of the AFSG companies to be sold. The liability for unpaid losses and loss adjustment expenses is not discounted.
The AFSG companies to be sold estimate losses for reported claims on an individual case basis. Case reserves are based on experience with a particular type of risk and the available information surrounding each individual claim. Case reserves are reviewed on a regular basis. As additional facts become available, the case reserves are adjusted as necessary. The stability of the case reserving process is monitored through comparison with ultimate settlement.
The estimates of losses for incurred but not reported claims (IBNR), as well as additive reserves for reported claims, are developed primarily from an analysis of historical patterns of the development of paid and incurred losses (dollars and claim counts) by accident year for each line of business. Salvage and subrogation estimates are developed from patterns of actual recoveries.
Allocated loss adjustment expense reserves are developed from an analysis of historical patterns of the development of paid allocated loss adjustment expenses to incurred losses, by accident year, by line of business. These historical patterns are then applied to projected ultimate losses for each line of business.
Unallocated loss adjustment expense reserves are developed utilizing a cost accounting system. The cost accounting system is based on historical costs modified for anticipated changes in operations and selections of alternative costs.
In December 1992, the Financial Accounting Standards Board issued SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." The statement establishes the conditions required for a contract to be accounted for as reinsurance and prescribes accounting and reporting standards for those contracts. The AFSG companies to be sold adopted SFAS No. 113 in 1993. Prior to the adoption of the new statement, assets and liabilities were reported net of the effects of reinsurance. Subsequent to the adoption of the new statement, ceded reinsurance balances due from unaffiliated insurers are reported separately as assets. Ceded reinsurance balances due from affiliated insurers continue to be reported in liabilities. As permitted by the statement, prior period financial statements have been restated.
Loss and loss adjustment expense reserves are stated at management's estimate of the ultimate cost of settling all incurred but unpaid claims. Loss and loss adjustment expense reserves are not discounted.
Activity with respect to loss and loss adjustment expense reserves for the last three years is as follows:
The following table reconciles reserves determined in accordance with accounting principles and practices prescribed or permitted by insurance statutory authorities (Statutory reserve) to reserves determined in accordance with generally accepted accounting principles ("GAAP") at December 31, as follows:
Effective on January 1, 1993 the AFSG companies to be sold adopted a new statutory accounting principle allowing the recognition of salvage and subrogation recoverable in the determination of the statutory reserve for losses and loss expenses. Prior year financial statements have not been restated for the change in accounting principle.
Effective on January 1, 1993, the AFSG companies to be sold adopted Statement of Financial Accounting Standards ("SFAS") No. 106 and SFAS No. 112 pertaining to postretirement and postemployment benefits. The new accounting principles were adopted for both statutory and GAAP reporting purposes. However, certain differences exist between statutory and GAAP accounting principles that resulted in larger unallocated loss adjustment expense reserves for statutory reporting purposes.
The following table presents a calendar year runoff of the reserve for losses and loss adjustment expenses for the years 1985 through 1994. The top line of the table shows the reserve for losses and loss adjustment expenses recorded as of December 31 for each of the indicated years. This reserve represents the estimated amount of losses and loss expenses for claims arising in all years that are unpaid at the balance sheet date, including losses and loss adjustment expenses that had been incurred but not yet reported. Each column shows the reserve amount at the indicated calendar year end and cumulative data on payments and the re-estimated reserves for all accident years making up that calendar year end reserve. The last entry for each calendar year in the lower section of the table represents the incurred loss and loss expense developed, subsequent to the balance sheet date, through 1994. The estimates are increased or decreased as more information concerning the frequency and severity of claims becomes available. The deficiency depicted for a given year is cumulative for that year and all prior years.
The following table shows a $50 million deficiency in 1990 and a $36 million deficiency in 1991 on unpaid losses and LAE gross of reinsurance recoverables. The AFSG companies to be sold experienced a significant number of large losses in 1990 and 1991, predominantly in multi-peril and commercial auto. The deficiencies that occurred in 1990 and 1991 are a result of additional unprecedented developments on these large losses. In addition, approximately $13 million of the deficiency for 1990 pertains to additional development and reserve strengthening that occurred on the 1990 and prior accident year loss and loss expense reserves of Statesman, a company acquired in October 1990. The AFSG companies to be sold implemented new reserving procedures to improve the future adequacy of reserve levels.
The AFSG companies to be sold limit the maximum net loss which can arise from large risks by reinsuring (ceding) certain levels of risks with other reinsurers. The table also shows the deficiency on net loss and loss expense reserves, which is significantly lower than the deficiency in the table above. Significant development on large losses exceeding the AFSG companies to be sold net retention during 1990 and 1991 resulted in a significantly smaller impact on reserve adequacy on a net of reinsurance basis.
The table does not present accident or policy year development data which readers may be more accustomed to analyzing; therefore, analysis of the effect of loss and loss expense reserving on any particular accident year cannot be discerned. The table reflects adjustments to income in each year for all prior years. Conditions and trends that have affected development of the reserve in the past may not occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table.
The runoff companies estimate that 60% of future claims will be paid in the next five years and that substantially all of the claims will be paid by the year 2017. The ultimate amount of the claims as well as the timing of the claims payments are estimated based on the annual review of loss reserves performed by the runoff companies' independent and consulting actuaries. While there have been no charges recorded with respect to the runoff companies since 1990, in the future there may be further adverse developments with respect to the runoff companies, which, if not otherwise offset through favorable commutations or other actions, will require additional charges to income.
National-Oilwell
Armco, through a wholly owned subsidiary, has a 50% partnership interest in National-Oilwell, which was formed in 1987 when Armco and USX Corporation each contributed their oil field equipment operations to National-Oilwell in exchange for equal interests in the new partnership. National-Oilwell is a distributor of oil country tubular goods, a manufacturer of drilling, production and other oil and gas equipment, and an operator of satellite repair and service centers and also operates a network of oil field supply stores throughout North America through which it distributes products to the oil and gas industries worldwide. National-Oilwell has operations in the United States, Canada, the United Kingdom, Venezuela, Australia and Singapore. National-Oilwell operates in a highly competitive environment. National- Oilwell is not considered a core business of Armco and, as such, Armco continues to consider various options with respect to its investment in this business.
ITEM 2.
ITEM 2.	PROPERTIES
Armco owns and leases property primarily in the United States. This property includes manufacturing facilities, offices and undeveloped property. The locations of Armco's principal plants and materially important physical properties are described in ITEM 1. "BUSINESS" and are used by the Specialty Flat-Rolled Steel and Other Steel and Fabricated Product businesses. Armco believes that all its operating facilities are being adequately maintained and are in good operating condition.
All of Armco's principal plants and properties are held in fee. Portions of the Houston plant, shutdown in 1983, are leased from the Gulf Coast Waste Disposal Authority (Texas). Armco has an option to purchase the leased facilities at the end of the lease period.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
There are various claims pending against Armco and its subsidiaries involving product liability, patent, insurance arrangements, environmental, antitrust, hazardous waste, employee benefits and other matters arising out of the conduct of the business of Armco.
Reserve Mining Litigation. On July 17, 1992, Armco was sued in the ------------------------- United States District Court, District of Minnesota, Fifth Division, by a group of former salaried employees of Reserve Mining Company ("Reserve"), a joint venture between a subsidiary of Armco and LTV Corporation ("LTV") that produced iron ore pellets. The complaint in Adamson, et al. v. Armco alleges ------------------------ that Armco is liable for certain unpaid welfare benefits, including vacation, severance, supplemental layoff, life insurance and health insurance benefits. While Armco cannot determine the possible exposure, if any, from this lawsuit, plaintiffs preliminarily calculated the benefits at about $12 million. On February 17, 1993, the Court dismissed state law, ERISA and fiduciary claims with prejudice and plaintiffs' independent fiduciary claims without prejudice. Plaintiffs filed an amended complaint, in response to which Armco filed a motion to dismiss. On October 22, 1993, the Court granted Armco's motion to dismiss in its entirety. On November 22, 1993, Plaintiffs filed a notice of appeal on the February 17 and October 22 decisions. The appeal was argued before the Eighth Circuit Court of Appeals on June 13, 1994. On January 5, 1995, the judgment of the District Court was affirmed by the Eighth Circuit Court of Appeals. Plaintiffs filed a Petition for Rehearing on February 1, 1995. On March 24, 1995, the Petition for Rehearing was denied by the Court.
In August 1992, an action styled Warner, Donovan, et al. v. Armco Inc. ------------------------------------- was filed in the U.S. District Court, District of Minnesota by members of the United Steelworkers of America ("USWA")
who declined to participate in the USWA v. Armco settlement. The complaint ------------------------- alleges breaches of the Basic Labor
Agreement, Supplemental Unemployment Benefit Plan, Insurance Agreement, Pension Agreement and Program of Hospital-Medical Benefits for Pensioners and Surviving Spouses and seeks an unspecified amount of damages. On February 17, 1993, the Court granted Armco's motion to dismiss plaintiffs' state law claims. The plaintiffs' claims based on the labor agreements remain pending. Plaintiffs filed an amended complaint, in response to which Armco filed a motion to dismiss certain claims therein. On October 22, 1993, the Court granted Armco's motion. On November 8, 1993, Armco filed an answer to the allegations in the amended complaint not subject to the motion to dismiss. Discovery is in progress.
On April 25, 1994, an action entitled Larry B. Ricke, Trustee v. Armco -------------------------------- was filed in the United States District Court for the District of Minnesota by the Trustee appointed by the Pension Benefit Guaranty Corporation ("PBGC") for the purpose of recovering from Reserve assets to satisfy Reserve's liability for pension benefit entitlements which are in addition to those guaranteed by the PBGC. The complaint alleges that Armco is liable for the unfunded nonguaranteed benefits under the Pension Plan of Reserve in the amount of $9.2 million plus interest. The pension benefits which are the subject of this action were part of the class settlement of USWA v. Armco. Approximately ------------- fifteen hundred members of the class signed individual releases (19 members who did not are plaintiffs in Warner, Donovan, et al. v. Armco Inc.) releasing ------------------------------------- Armco from all claims, liabilities, etc. based upon or which arise out of any Reserve Employee Pension Benefit Plan. Armco filed a Motion to Dismiss the complaint on the basis of said releases which the court denied on March 28, 1995. Armco is considering whether to pursue an appeal of this ruling.
While Armco's management believes that it has substantial defenses against these Reserve-related claims, if these creditors and other Reserve creditors are successful in such claims, Armco could become liable for these and other Reserve nondebt obligations in an amount which could be substantial.
Eastern Stockholder Litigation. On or about March 13, 1995, an action ------------------------------- entitled Pension Benefit Guaranty Corporation vs. Armco Inc. and Eastern ---------------------------------------------------------------- Stainless Corporation was filed in the United States District Court for the --------------------- Southern District of Ohio by the PBGC as a Class B shareholder of Eastern Stainless. The complaint is captioned as a shareholder derivative and class action on behalf of all Class B shareholders. The plaintiffs allege breach of fiduciary duty as well as certain other claims arising from Armco's status as a majority shareholder in Eastern Stainless. The damages are alleged to be in excess of $12 million. The Class B shares were redeemable by Eastern Stainless for $1 a share or approximately $13 million. On March 15, 1995, Eastern Stainless was dissolved without any shareholder distribution. Armco believes that it has substantial defenses available to it with respect to the complaint.
CRS Litigation. On October 31, 1990, a third-party complaint was served --------------- on Armco in the Circuit Court of Montgomery County, Maryland by the owner of a 6.3 mile potable water tunnel designed by defendant, CRS Sirrine ("CRS") and its predecessor companies, and constructed by Armco and Clevecon Inc. ("Clevecon"). Armco built 3.4 miles of the tunnel; Clevecon built the remaining 2.9 miles. No portion of the tunnel, which was completed in early 1984, has ever been functional. Washington Suburban Sanitary Commission filed suit against CRS seeking damages in the amount of $200 million. CRS filed third-party complaints against Armco and Clevecon seeking damages to the extent of any liability of CRS attributable to Armco's or Clevecon's negligence or negligent misrepresentation in connection with the installation of the potable water tunnel and the third-party defendants' alleged defective workmanship in connection with the same. Armco's motion to dismiss or, in the alternative, for summary judgment was denied by the Court. CRS subsequently settled the claims against it by Washington Suburban Sanitary Commission and continued to prosecute its third-party claims against Armco and Clevecon. Oral argument on Armco's re-filed summary judgment motion was held on January 3, 1994. The circuit court denied Armco's summary judgment motion and the case proceeded to trial. On January 28, 1994, a directed verdict was entered by the court in favor of Armco. On January 9, 1995, the Court of Special Appeals of Maryland affirmed, per curiam, Armco's directed verdict against CRS. CRS has petitioned the Maryland Court of Appeals (the state's highest court) for discretionary leave to appeal the judgment of the Court of Special Appeals and Armco has filed a response in opposition.
Cornerstones Litigation. An action was filed by Cornerstones Municipal ------------------------ Utility District ("Cornerstones") and William St. John, as representative of a class of owners of real property situated within Cornerstones, in the District Court of Harris County, Texas, in July 1989, alleging that Armco Construction Products supplied defective pipe for a sanitary sewer system in three residential subdivisions. The petition sought in excess of $40 million in damages. On May 29, 1991, plaintiffs filed a Third Amended Petition adding Kingsbridge Municipal Utility District ("Kingsbridge") and John Keplinger, as representative of a class of owners of real property situated within Kingsbridge, as additional plaintiffs. The residents of Kingsbridge made similar allegations and sought certification of the class of Kingsbridge homeowners in an effort to recover damages for an allegedly faulty sanitary sewer system in four residential subdivisions. The amended petition sought in excess of $40 million in damages on behalf of the Kingsbridge and the Cornerstones plaintiffs. On January 13, 1992, the Court granted Armco's Motion for Summary Judgment and dismissed all of the Cornerstones plaintiffs' claims on the basis of the statute of limitations. The plaintiffs appealed the decision to the Fourteenth Court of Appeals. On May 21, 1992, since defendants had not moved for summary judgment against Kingsbridge, the Court of Appeals dismissed Kingsbridge from the appeal. In January 1993, the Court of Appeals reversed the dismissal of the Cornerstones action and remanded it to the trial court. In May 1993, the Supreme Court of Texas granted Armco's application for leave to appeal the judgment of the Court of Appeals and heard argument on the matter on September 14, 1993. On November 24, 1993, the Supreme Court reversed the judgment of the Court of Appeals and remanded the case to the lower court for disposition of unaddressed issues. On remand, in an opinion filed on November 10, 1994, the Court of Appeals reinstated the trial court's grant of summary judgment in favor of Armco on the basis that the Cornerstones claims are barred by the statute of limitations. On December 8, 1994, the Court of Appeals denied plaintiffs' petition for rehearing. On March 1, 1995, the Cornerstones plaintiffs filed an application for writ of error to the Supreme Court of Texas. Armco is preparing a response in opposition. The Kingsbridge action remains pending before the trial court.
In addition, there are three multiple-party homeowners actions which remain pending on behalf of property owners in the Cornerstones Municipal Utility District. The first of these actions, Vincent and Linda Adduci, et ----------------------------- al. v. Armco Steel Corporation, et al., was filed in the 127th District Court -------------------------------------- of Harris County, Texas on or about April 3, 1992, by approximately 87 residents, including the lead plaintiffs, against the same defendants as in the Cornerstones case. On or about September 11, 1992, Harris W. Arthur and ------------ other plaintiff homeowners commenced a similar action, styled Harris W. --------- Arthur, et al. v. Monsanto Company, et al., in the 133rd Judicial District ------------------------------------------ Court of Harris County. On or about March 22, 1993, a third action, captioned William C. Irons, et al. v. Turner, Collie & Braden, Inc., et al., was filed ----------------------------------------------------------------- in the 152nd Judicial District Court of Harris County by the lead plaintiff and approximately 100 additional residents. All three cases are substantially based upon the same theories as the Cornerstones case and were separately ------------ filed after an effort to have the Cornerstones complaints certified as a class ------------ action was denied by the court. These three actions each seek an unspecified amount of damages.
Armco Chile Prodein, S.A. Litigation. On or about November 15, 1991, ------------------------------------- Armco and Armco Chile Prodein, S.A. ("Armco Chile") were sued for damages in the United States District Court for the Southern District of Alabama by a maritime cargo carrier. The plaintiff's claims were based upon allegations of fraud, negligent misrepresentation, negligent interference with contractual relations and wrongful arrest. Plaintiff's allegations arose out of a series of transactions in which it was engaged by Armco Chile to transport fiberglass reinforced pipe from Jacksonville, Florida to Talcahuano, Chile. The plaintiff made three such shipments of pipe. After discovering damage to the first and second shipments of pipe, which defendants contended was due to negligence by plaintiff, Armco Chile arrested, pursuant to Chilean law, the vessel which plaintiff utilized to carry the third shipment of pipe. The plaintiff alleged, among other things, that the arrest was wrongful and that the alleged wrongful arrest resulted in such severe damage to the plaintiff's business interests and reputation that the plaintiff went out of business. The plaintiff's experts claimed that the damages suffered by plaintiff range from $38 million to $47 million. Both Armco and Armco Chile filed motions for summary judgment. On January 25, 1993, the court granted summary judgment discharging Armco and subsequently denied plaintiff's motions for reconsideration of the summary judgment granted to Armco. On April 30, 1993, a jury verdict on plaintiff's wrongful arrest and lost profits claims was
rendered in favor of the plaintiff and against Armco Chile in the amount of $10,500,000. Judgment on the verdict was entered by the Court on May 7, 1993. Thereafter, Armco Chile filed a motion seeking judgment as a matter of law or, alternatively, for a new trial. On October 12, 1993, finding that the jury's verdict on liability and damages was against the weight of the evidence, the trial court granted the defendant's post-trial motion, entering judgment in favor of Armco Chile against the plaintiff. The court also granted Armco's motion for a conditional new trial in the event the judgment was overturned on appeal. The plaintiff appealed this ruling to the Eleventh Circuit Court of Appeals. On September 12, 1994, the Eleventh Circuit Court of Appeals affirmed per curiam the ruling of the district court. The plaintiff filed a petition for rehearing en banc which was denied by the Eleventh Circuit of Appeals on November 14, 1994. The time for filing a petition for writ of certiorari to the U.S. Supreme Court has expired.
Environmental Proceedings. Some of Armco's operations are subject to -------------------------- consent orders or judgments under local, state or federal environmental laws and regulations which require Armco to comply with certain discharge standards and to add certain pollution abatement equipment. Armco has received a number of notices identifying Armco as a potentially responsible party under federal or state laws imposing liability for costs in connection with alleged releases of hazard substances from various waste treatment or disposal sites. It is routinely asserted that joint and several liability will be applied; thus, a single party could be held liable for all costs related to a site. However, Armco's experience has been that liability is usually apportioned on the basis of volume and/or toxicity of materials sent to a site. In many cases, Armco is one of several hundred parties. In a few instances, Armco is one of only a few parties or solely liable. In most instances, Armco expects that any ultimate liability will be apportioned between Armco and other financially viable parties. Armco has also received some claims for indemnification for properties it previously owned or leased. Armco intends to assert all meritorious legal and equitable defenses which are available to it with respect to environmental matters. See "Item 1 - BUSINESS--Environmental Matters". The following paragraphs provide information about unresolved environmental matters that have been reported in previous 10-K or 10-Q filings and certain new matters.
On July 31, 1989, the United States filed a civil action in the United States District Court for the Southern District of Texas, Houston Division, against 85 parties under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") for cost recovery and injunctive relief associated with the French Limited Superfund site (the "French Limited Site") near Crosby, Texas. Concurrently, the United States government filed a Consent Decree requiring the defendants to reimburse the United States in the amount of $1.3 million, to pay certain future oversight costs and to undertake remedial action at the French Limited Site. The Decree was approved and entered by the court. The remedy outlined in the Decree has been implemented and remediation is expected to be complete in 1996. Armco's estimated remaining share of costs, which is fully accrued, is approximately $1.3 million.
Armco was one of four remaining defendants in several class actions filed on behalf of residents near the French Limited Site; these actions were settled in late 1992 and dismissed with prejudice. Approximately 300 individuals who chose not to settle in the original actions were joined in the case, Rosa Ann Barrett, et al. v. Atlantic Richfield Company ("ARCO"), et al., ----------------------------------------------------------------------- which was in the United States District Court for the Southern District of Texas, Houston Division ("Houston"). On June 20, 1994, the court granted summary judgment against all but two of the Barrett plaintiffs on the grounds ------- that they had not established a factual basis for their personal injury claims. Settlement of the claims of the two remaining plaintiffs subsequently was finalized, and Armco's share of the settlement was $1,356. On September 20, 1994, the court entered a final order denying plaintiffs' motion for rehearing or new trial and dismissing all of plaintiffs' claims in this case. The Barrett plaintiffs filed a notice of appeal on October 19, 1994. In ------- another case, which was filed in the Houston court, Rhonda Sills v. ARCO, et. ------------------------- al., which also alleged personal injury, the court entered its order granting --- summary judgment against the plaintiffs on October 17, 1994. Plaintiffs filed a notice of appeal on February 6, 1995. In the case styled John D. Bertling, ----------------- et al. v. ARCO, et al., which was filed in the Houston Court in May 1994 and ---------------------- raised claims of business losses, Mr. Bertling has accepted a settlement offer made by Armco and two other defendants. Armco's share of the settlement is $4,244.36.
Armco and Traverse Bay Area Intermediate School District ("TBA") entered into a Consent Decree with the State of Michigan in May 1994, resolving claims of contamination of TBA property. Under the Consent Decree, Armco paid $528,070 for past costs; and will pay 60% of additional state oversight costs as well as for part of the site remediation. Armco's share of the remediation cost is expected to be about $530,000.
An action styled The United States of America, State of Maryland v. -------------------------------------------------- Azrael, et al. v. Armco Steel Corporation, et al. was filed in the United ------------------------------------------------- States District Court for the District of Maryland pursuant to Section 107 of CERCLA to recover monies expended by the United States and the State of Maryland in response to a release and threatened release (federal allegation) and an imminent and substantial danger to the public health or welfare presented by the release or substantial threat of release (state allegation) of hazardous substances from a waste disposal site at the intersection of Kane and Lombard Streets in Baltimore, Maryland. Armco was served with a third- party complaint on April 19, 1991. The third-party complaint alleges that Armco arranged for the disposal and/or treatment or arranged with a transporter for transport for disposal or treatment of hazardous waste to the Kane and Lombard site. A determination has not been made as to how much waste, if any, Armco sent to the site. Based on settlement discussions to date, Armco expects to settle the suit at an amount that is not material.
On or about September 29, 1989, the United States filed a civil action in the United States District Court for the District of Minnesota under CERCLA for declaratory relief and cost recovery associated with the Arrowhead Refining Superfund site (the "Arrowhead Site") in Hermantown, Minnesota, naming Armco as a defendant. The current estimated cost to clean up the Arrowhead Site is about $20 million. Armco settled the case with the United States Environmental Protection Agency ("USEPA") and other potentially responsible parties (PRP's") for payment of $4,988,920 in November 1994 (which is in addition to $2.4 million Armco paid in prior years and credit for $2.5 million which was previously paid by LTV). Armco expects no further payment requirements for remediation of this site.
On July 19, 1993, Armco received a request from USEPA under Section 3007 of the Resource Conservation and Recovery Act ("RCRA") for information as part of an ongoing investigation into compliance with a Consent Agreement and Final Order dated October 27, 1988, (the "Consent Order") relating to two inactive waste surface impoundments located at the former E.G. Smith plant in Cambridge, Ohio. Armco had sold the Flour City Cambridge, Ohio plant in February, 1993, but retained title to 21.5 acres of the Cambridge facility, including the surface impoundments. Armco submitted a revised closure plan for this site in September 1993. Armco has established reserves which it believes will be adequate to cover the required closure. The Department of Justice notified Armco in March 1994 that it was prepared to file a complaint in this matter alleging that there was non-compliance with the Consent Order in about 1989 and 1990. A tentative settlement with the Department of Justice has been reached but a consent order implementing the settlement has not yet been negotiated. A penalty of $100,000 is expected; other costs are not expected to be material.
In September 1992, National Supply Company, Inc., a wholly owned subsidiary of Armco ("National Supply") and a 50% general partner in National- Oilwell, received a letter from USEPA, which asserted that National Supply and/or National-Oilwell was a PRP under CERCLA with respect to the Odessa Drum Company, Inc. Superfund site located in Odessa, Ector County, Texas. Armco settled this matter for $119.
Armco is one of four companies that are identified by the USEPA as PRP's at the Fultz Landfill Superfund site in Byesville, Ohio; Armco received the initial CERCLA information request about this site in 1985. USEPA's estimate for remediation costs is about $15 million. Armco is negotiating jointly with USEPA and the Department of Justice to settle its liability. The initial proposal from the Department of Justice was unacceptable to Armco and Armco is preparing a counter proposal. The outcome of negotiations or litigation can not be determined at this time, however, even if Armco were to have accepted the Department of Justice's initial proposal, the amount which would be expected to be paid out over the next several years would not be material to Armco.
Armco received a unilateral order in September 1994 from USEPA to complete remediation of contaminated soil on certain property in New Boston, Ohio which had been sold to New Boston Industrial Corporation several years ago. Prior to the sale, the salvage contractor hired by the current owner (which was then occupying the property as a tenant) engaged in intentional conduct which resulted in contamination. Armco and the current owner have collected $825,000 on a $1 million performance bond which had been obtained to secure the contractor's performance. These funds were used for remediation and oversight of the cleanup. Armco is conducting the remaining cleanup which is estimated to cost about $5.2 million; all contaminated soil which had previously been excavated has been shipped off-site; additional soil samples will be taken to determine whether additional excavation is necessary. Armco is seeking contribution from other PRPs, but no estimate as to the amount of such contribution can be made at this time.
In July of 1990, Eastern Stainless Corporation entered into a Consent Order with the Maryland Department of Environment to resolve a complaint alleging various violations of environmental requirements. This Order was followed by a voluntary Consent Judgment on April 17, 1992 and an amendment of the Consent Judgment in August of 1993. Pursuant to the Order and Judgment, Eastern Stainless spent a total of about $5.4 million in 1991 through 1994 on various pollution prevention projects. In addition, Eastern Stainless paid a $0.3 million penalty. Armco believes Eastern Stainless was in compliance with the Consent Judgment at the time Eastern Stainless was sold to Avesta Sheffield, Inc. By Court Order, dated March 10, 1995, Avesta was substituted for Eastern Stainless as the responsible party under the Consent Order, and Armco expects to have no further liability in regard to the Consent Judgment.
On July 22, 1993, Armco received a request from the Kansas Department of Health and Environment ("KDHE") for information regarding a former Armco Construction Products Division plant located in Topeka, Kansas and now owned by Contech Construction Products, Inc. ("Contech"). Armco answered KDHE's information request in August 1993 and KDHE has indicated it will pursue Contech and two other parties regarding this matter. Armco is working with Contech to resolve any indemnification obligation Armco may have under the agreement conveying the property to Contech. Based on the type of contamination at issue and the presence of other potentially responsible parties, Armco does not believe its liability will be material.
In December 1993, Armco and one other company received a notice of nonbinding preliminary allocation of proportionate responsibility from the Pennsylvania Department of Environmental Resources ("PADER") for the William Taylor Estate site. PADER has decided to conduct additional investigations at this site. Based on current information about type of contamination and the presence of other potentially responsible parties, Armco does not expect its liability to be material.
On February 16, 1994, the Missouri Department of Natural Resources and the USEPA jointly issued a Part B permit to the Kansas City facility under RCRA. Armco petitioned the Environmental Appeals Board for review of most of such permit provisions. The appeal was resolved through negotiation. Armco is initiating the investigation and remediation required under the revised permit which was issued in November, 1994. Initial investigation costs may reach $1 million; there is not sufficient information regarding soil and groundwater conditions to reasonably estimate remediation costs at the present time.
The Malitovsky Drum Superfund site in Pittsburgh, Pennsylvania, in which Armco was a named PRP was resolved through entry of a Consent Decree on February 21, 1995, in the U.S. District Court for the Western District of Pennsylvania. Armco had previously deposited $118,333 in a PRP trust fund as its share of liability in this matter. No further liability is anticipated for this matter.
On January 18, 1994, Armco received a 104(e) request for information under CERCLA from USEPA regarding shipments to the Granville Solvents site in Ohio. In August 1994, USEPA entered into an Administrative Order on Consent ("AOC") with a number of potentially responsible parties at the Granville Solvents Site in Ohio. Armco did not sign the AOC because the terms were deemed unacceptable. Issues of particular concern were stipulated penalties for migration of contaminants,
lack of specificity as to what remediation would be required at the site and lack of a meaningful procedure to resolve disputes between the parties and USEPA. Four of the signatories to the AOC, who claim to have an assignment of rights by other companies who signed the AOC, initiated a contribution action on September 9, 1994, in the U.S. District Court for the Southern District of Ohio against all the potentially responsible parties, including Armco, who did not sign the AOC. Armco made a settlement offer to all the AOC signatories under which Armco would pay about 15% of remediation costs, which are currently estimated at $5 million. This offer was rejected by the plaintiffs and has been withdrawn. A scheduling order for discovery is being developed.
On February 27, 1995, the Ohio Environmental Protection Agency issued a Notice of Violation ("NOV") to Armco's Zanesville, Ohio facility alleging noncompliance with both a 1993 Order and various state regulations regarding hazardous waste management. Armco is reviewing the NOV, implementing appropriate corrective measures and preparing a response. No proposed penalties were included in the NOV and Armco cannot reasonably estimate potential penalties based on current information.
	In the opinion of management, the ultimate liability resulting from the claims described in the preceding paragraphs in the "Legal Proceedings" section will not materially affect the consolidated financial position or liquidity of Armco and its subsidiaries; however, it is possible that due to fluctuations in Armco's operating results, future developments with respect to such matters could have a material effect on its financial condition, liquidity and results of operations in future interim or annual periods.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the security holders of Armco during the fourth quarter of the year ended December 31, 1994.
Executive Officers of Armco
The executive officers of Armco as of March 15, 1995, were as follows*:
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated herein by reference from pages 38, 45 and 48 of the Annual Report to Shareholders for the year ended December 31, 1994.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information required by this Item is incorporated herein by reference from pages 12-22 following the caption "Management's Discussion and Analysis" of the Consolidated Financial Statements in the Annual Report to Shareholders for the year ended December 31, 1994.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is incorporated herein by reference from pages 23-43 of the Annual Report to Shareholders for the year ended December 31, 1994.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
	None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item as to executive officers of Armco is contained in Part I of this report under "Executive Officers of Armco" and is incorporated herein by reference. The information required as to directors is incorporated herein by reference from the information set forth under the caption "ELECTION OF DIRECTORS" in the registrant's Proxy Statement for the 1995 Annual Meeting of Shareholders filed with the Securities and Exchange Commission pursuant to Rule 14a-6 of the Securities Exchange Act of 1934, as amended (the "Proxy Statement").
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference from the information set forth in the Proxy Statement under the caption "EXECUTIVE COMPENSATION".
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The security ownership in Armco stock of directors, certain executive officers and directors and executive officers as a group and of persons known by Armco to be the beneficial owners of more than five percent of any class of Armco's voting securities is incorporated herein by reference from the information set forth in the Proxy Statement under the caption "MISCELLANEOUS -- Stock Ownership".
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
I.	Documents Filed as a Part of this Report
A. Financial Statements and Financial Statement Schedules Page
1. Statement of Consolidated Operations for the Years Ended December 31, 1994, 1993 and 1992 *
2. Statement of Consolidated Financial Position as of December 31, 1994 and 1993 *
3. Statement of Consolidated Cash Flows for the Years Ended December 31, 1994, 1993 and 1992 *
4. Notes to Financial Statements *
5. Independent Auditors' Report *
6. Independent Auditors' Report 26
7. Financial Statement Schedule for the Years Ended December 31, 1994, 1993 and 1992
II-- Valuation and Qualifying Accounts 27
8. Responsibility for Financial Reporting *
9. National-Oilwell Consolidated Financial Statements and Financial Statement Schedules as of December 31, 1994 and 1993 and for the years ended December 31, 1994, 1993 and 1992 28 - 43
10. Armco Financial Services Group companies to be sold Consolidated Financial Statements and Financial Statement Schedules as of December 31, 1994 and 1993 and for the years ended December 31, 1994, 1993 and 1992 44 - 72
---------------
* Incorporated in this annual report on Form 10-K by reference to pages 23-43 of the Annual Report to Shareholders for the year ended December 31, 1994.
Financial Statements and Financial Statement Schedules Omitted
The financial statements and financial statement schedules for Armco Inc. and consolidated subsidiaries, and for Armco Financial Services Group companies to be sold and National-Oilwell, other than those listed above, are omitted because of the absence of conditions under which they are required, or because the information is set forth in the notes to financial statements.
B. Exhibits
The following is an index of the exhibits included in the Form 10-K Annual Report.
3(a). Articles of Incorporation of Armco Inc., as amended as of May 12, 1993 (1)
3(b). Regulations of Armco Inc. (2)
4. Armco hereby agrees to furnish to the Securities and Exchange Commission, upon its request, a copy of each instrument defining the rights of holders of long-term debt of Armco and its subsidiaries, omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K.
10(a). Deferred Compensation Plan for Directors*
10(b). 1993 Long-Term Incentive Plan of Armco Inc. (3)*
10(c). Severance Agreements (4)*
10(d). 1988 Restricted Stock Plan (5)*
10(e). Executive Supplemental Deferred Compensation Plan Trust (6)*
10(f). Executive Supplemental Deferred Compensation Plan (7)*
10(g). Pension Plan for Outside Directors (8)*
10(h). Rights Agreement dated as of June 27, 1986 between Armco Inc. and Fifth Third Bank, as successor to Harris Trust and Savings Bank, as amended as of June 24, 1988 (9)
10(i). Key Management Severance Policy (10)*
10(j). Minimum Pension Plan (11)*
10(k). Stainless Steel Toll Rolling Services Agreement (12)
10(l) Equity Exchange Agreement (13)
10(m) Stock Purchase Agreement among Armco Inc., Armco Financial Services Corporation and Vik Brothers Insurance, Inc. (14)
10(n) Asset Sale Agreement By and Among Armco Inc., Eastern Stainless Corporation, Avesta Sheffield East, Inc. and Avesta Sheffield Holding Co. dated as of February 9, 1995 (15)
11. Computation of Income (Loss) Per Share
13. Annual Report to Shareholders for the year ended December 31, 1994. (Filed for information only, except for those portions that are specifically incorporated in this Form 10-K Annual Report for the year ended December 31, 1994.)
21. List of subsidiaries of Armco Inc.
23. Independent Auditors' Consents
27. Financial Data Schedule
28. Schedule P - Analysis of Losses and Loss Expenses
99. Description of Armco Capital Stock
The annual reports (Form 11-K) for the year ended December 31, 1994 for the Armco Inc. Retirement and Savings Plan and the Armco Inc. Thrift Plan for Hourly Employees will be filed by amendment as exhibits hereto, as permitted under Rule 15d-21.
* Management contract or compensatory plan or arrangement required to be filed as an exhibit to the Form 10-K pursuant to Item 14(c) of Form 10-K. ______________________
(1) Incorporated by reference from Exhibit 4.2 to Armco's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993.
(2) Incorporated by reference from Exhibit 3.2 to Armco's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994.
(3) Incorporated by reference from Exhibit 10 to Armco's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993.
(4) Incorporated by reference from Exhibit 10(a) to Armco's Quarterly Report on Form 10-Q for the quarter ended June 30, 1988 (SEC File No. 001-00873).
(5) Incorporated by reference from Exhibit 10(i) to Armco's Annual Report on Form 10-K for the year ended December 31, 1988 (SEC File No. 001-00873).
(6) Incorporated by reference from Exhibit 10(b) to Armco's Quarterly Report on Form 10-Q for the quarter ended June 30, 1988 (SEC File No. 001-00873).
(7) Incorporated by reference from Exhibit 10(c) to Armco's Quarterly Report on Form 10-Q for the quarter ended June 30, 1988 (SEC File No. 001-00873).
(8) Incorporated by reference from Exhibit 10(p) to Armco's Annual Report on Form 10-K for the year ended December 31, 1989 (SEC File No. 001-00873).
(9) Incorporated by reference from Exhibit 1 to Armco's Form 8-A dated July 7, 1986 and Exhibit 1.1 to Armco's Form 8 dated July 11, 1988 (SEC File No. 001-00873).
(10) Incorporated by reference from Exhibit 10(p) to Armco's Annual Report on Form 10-K for the year ended December 31, 1990.
(11) Incorporated by reference from Exhibit 10(r) to Armco's Annual Report on Form 10-K for the year ended December 31, 1991.
(12) Incorporated by reference from Exhibit 10(s) to Armco's Annual Report on Form 10-K for the year ended December 31, 1993.
(13) Incorporated by reference from Exhibit 2 to Armco's Form 8-K dated April 7, 1994.
(14) Incorporated by reference from Exhibit 10 to Armco's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994.
(15) Incorporated by reference from Exhibit 2 to Armco's Form 8-K dated March 14, 1995.
------------------
II. Reports on Form 8-K
The following reports on Form 8-K were filed by Armco since September 30, 1994:
Report Date Description ----------- ----------- October 3, 1994 Reporting that Armco, Eastern Stainless, an 84%- owned subsidiary of Armco, and Avesta Sheffield reached an agreement in principle for the sale of all of the assets of Eastern Stainless to Avesta Sheffield for cash and the assumption of certain liabilities.
March 14, 1995 Reporting that on March 14, 1995, Armco, Eastern Stainless, an 84%-owned subsidiary of Armco, and Avesta Sheffield completed the sale of substantially all of the assets of Eastern Stainless to Avesta Sheffield and providing pro forma financial information with respect to the sale. Also reporting that a minority shareholder of Eastern Stainless filed a complaint against Armco and Eastern Stainless seeking various relief based upon Armco's relationship with Eastern Stainless.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized as of March 31, 1995.
ARMCO INC.
By JAMES F. WILL ------------------------------- James F. Will President and Chief Executive Officer
	Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated as of March 31, 1995.
By JAMES F. WILL By PAUL H. HENSON ------------------------------- ------------------------------- James F. Will Paul H. Henson President, Director Chief Executive Officer and Director
By DAVID G. HARMER By ------------------------------- ------------------------------- David G. Harmer John H. Ladish Vice President and Director Chief Financial Officer
By PETER G. LEEMPUTTE By BRUCE E. ROBBINS ------------------------------- ------------------------------- Peter G. Leemputte Bruce E. Robbins Vice President and Controller Director
By By BURNELL R. ROBERTS ------------------------------- ------------------------------- John J. Burns, Jr. Burnell R. Roberts Director Director
By DAVID A. DUKE By JOHN D. TURNER ------------------------------- ------------------------------- David A. Duke John D. Turner Director Director
By JOHN C. HALEY ------------------------------- John C. Haley Director
INDEPENDENT AUDITORS' REPORT
Armco Inc.:
We have audited the consolidated financial statements of Armco Inc. and consolidated subsidiaries as of December 31, 1994 and 1993, and for each of the three years in the period ended December 31, 1994, and have issued our report thereon dated February 3, 1995, which report includes an explanatory paragraph for changes in Armco Inc.'s methods of accounting for postretirement benefits other than pensions, income taxes, certain investments in debt and equity securities, and postemployment benefits; such consolidated financial statements and report are included in your 1994 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the consolidated financial statement schedule of Armco Inc. and consolidated subsidiaries, listed in Item 14. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Pittsburgh, Pennsylvania February 3, 1995
[LOGO]ERNST & YOUNG LLP *One Houston Center *Phone: 713 750 1500 Suite 2400 713 750 1501 1221 McKinney Street Houston, Texas 77010-2007
Report of Independent Auditors ------------------------------
Partners National-Oilwell
We have audited the accompanying consolidated balance sheets of National- Oilwell and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, partners' capital, and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of National-Oilwell and subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
January 26, 1995
NATIONAL-OILWELL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1994
1. Organization and Basis of Presentation
National-Oilwell ("Company") is a partnership organized under the laws of Delaware. The partnership was formed in April 1987 to consolidate the oilfield manufacturing and distribution operations of Armco Inc. ("Armco") and USX Corporation ("USX"). National-Oilwell is a general partnership between National Supply Company, Inc., a wholly-owned subsidiary of Armco and Oilwell, Inc., a wholly-owned subsidiary of USX. Each of the partners has a 50% interest in the partnership. All references to the Company in these financial statements are synonymous with National-Oilwell as previously described.
The Company distributes an extensive line of oilfield supplies, oilfield equipment and tubular products and designs and manufactures a variety of oilfield equipment for use in oil and gas drilling, completion and production activities. The Oilfield Distribution segment is comprised of the Distribution Services and Tubular Distribution business units. This segment distributes products through a large network of oilfield supply stores and also procures and distributes oil country tubular goods manufactured by third parties. The Oilfield Equipment segment consists of the Drilling Systems and Equipment and Pumping Systems business units. This segment designs and manufactures drilling equipment, marine equipment, and an extensive line of pumps used in a variety of oil and gas and industrial applications.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Substantially all of the Company's subsidiaries have elected a December 31 year-end. All significant intercompany transactions and balances have been eliminated in consolidation.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Expenditures for major improvements which extend the lives of property and equipment are capitalized while minor replacements, maintenance and repairs are charged to operations as incurred. Disposals are removed at cost less accumulated depreciation with any resulting gain or loss reflected in operations. Depreciation is provided using the straight-line method over the estimated useful lives of individual items.
Inventories
Inventories consist of (a) standardized oilfield products and oil country tubular goods, (b) manufactured equipment and (c) spare parts for the manufactured equipment. Inventories are stated at the lower of cost or market using the first-in, first-out (FIFO) or average cost method of valuing inventories.
Foreign Currency
The functional currency for the Company's Canadian, United Kingdom, Australian and Venezuelan subsidiaries is the local currency. The cumulative effects of translating the balance sheet accounts from the functional currency into the U.S. dollar at current exchange rates are included in cumulative foreign currency translation adjustment in partners' equity. The U.S. dollar is used as the functional currency for the Singapore subsidiary. For all operations, gains or losses from remeasuring foreign currency transactions into the functional currency are included in income.
NATIONAL-OILWELL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Concentration of Credit Risk
The Company grants credit to its customers which are primarily in the oil and gas industry. The Company performs periodic credit evaluations of its customers' financial conditions and generally does not require collateral. Receivables are generally due within 30 days. The Company maintains reserves for potential losses and such losses have consistently been within management's expectations.
Income Taxes
The Company provides for income taxes under the liability method pursuant to Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax reporting basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company made income tax payments of $557,000, $392,000 and $573,000 during the years ended December 31, 1994, 1993 and 1992, respectively.
Revenue Recognition
Revenue from the sale of products is recognized upon passage of title to the customer, which in most cases coincides with shipment of the related products.
Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash and cash equivalents, receivables, payables, and debt instruments. Cash equivalents include only those investments having a maturity of three months or less at the time of purchase. The book values of these financial instruments are considered to be representative of their respective fair values. See Note 5 for the terms and carrying values of the Company's various debt instruments.
Research and Development Costs
Research and development costs are expensed as incurred. During 1994, 1993 and 1992, research and development costs were $579,000, $1,115,000, and $2,077,000, respectively.
Reclassifications
Certain amounts from the prior year financial statements have been reclassified to conform with the 1994 presentation.
3. Inventories
Inventories consist of:
NATIONAL-OILWELL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
4. Property, Plant, and Equipment
Property, plant, and equipment consist of:
Equipment included in gross assets acquired under capital leases totaled -0- at December 31, 1994 and $3,379,000 at December 31, 1993. Related amortization included in the accumulated depreciation and amortization balance totaled -0-, and $2,105,000 at December 31, 1994 and 1993, respectively.
5. Notes Payable
At December 31, 1994, the Company had bank lines of credit totaling approximately $50 million, of which $20 million had been utilized for letters of credit with no loans outstanding. The primary revolving credit agreement (the Credit Agreement) expires in March 1995 and is secured by inventory, receivables, property, plant and equipment, and the stock of the Company's subsidiaries. The Credit Agreement contains certain financial covenants relative to net worth, leverage ratio, working capital and cash flow. The Company has complied with all covenants. A weekly borrowing base formula is used to determine credit availability. The interest rate in the Credit Agreement fluctuates with short-term interest rates. The interest rate in effect at December 31, 1994 was 10.25%. A commitment fee of 1/2% per annum is charged on the unused portion of the Credit Agreement. The weighted average interest rate was approximately 8.5% and 8.0% for 1994 and 1993, respectively. Interest paid was $3,444,000 during 1994, $3,693,000 during 1993 and $4,943,000 during 1992.
During the year, the Credit Agreement was amended to allow for the sale of certain production equipment product lines with the resultant adjustments to the financial covenants. Other amendments and consents were processed during the year as appropriate.
The Company is currently negotiating a new revolving credit facility (the "Revolver"). The Revolver is expected to consist of a three-year nonamortizing credit facility which includes a sub-facility for issuance of letters of credit.
In October 1994, the Company paid all outstanding principal and interest due to the Company's two owners relative to each of their $6,500,000 subordinated notes due March 1995.
NATIONAL-OILWELL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
6. Commitments and Contingencies
Commitments
The Company leases land, buildings and storage facilities, vehicles, and data processing equipment under operating leases extending through the year 2004. The Company's annual lease commitments for operating leases at December 31, 1994 were as follows:
Rent expense for the years ended December 31, 1994, 1993 and 1992 was $8,691,000, $10,372,000 and $11,325,000, respectively.
Contingencies
The Company is the subject of, or a party to, various claims, regulatory agency audits, and pending or threatened legal actions involving a variety of matters. The total liability on these matters at December 31, 1994 cannot be determined; however, in the opinion of management, any ultimate liability resulting, to the extent not otherwise provided for, should not materially affect the financial position, liquidity, or results of operations of the Company.
7. Pension Plans
The Company and its consolidated subsidiaries have several pension plans covering substantially all of its employees. The two largest are considered defined-contribution pension plans and cover most of the domestic employees and employees of the Canadian subsidiary. Contributions to the plans are based on employees' years of service equating to a percentage of current earnings. For the years ended December 31, 1994, 1993 and 1992, domestic pension expense for the defined-contribution plan was $1,745,000, $1,812,000 and $1,888,000 respectively, and the funding is current. Pension expense of the foreign operations for the defined-contribution plan totaled $169,000 for 1994, $193,000 for 1993, and $154,000 for 1992.
National-Oilwell (U.K.) Ltd., the Company's U.K. subsidiary, has a defined- benefit pension plan covering substantially all employees in that country. Benefits paid to retirees are based upon age at retirement, years of credited service, and average compensation. Contributions to the plan are determined by an independent actuary on the basis of annual valuations. The U.K. pension plan assets are invested primarily in U.K. and overseas equities, U.K. government securities, overseas bonds, and cash deposits. There are no unamortized prior service costs. The plan assets at fair market value were $27,389,000 at December 31, 1994 and $30,666,000 at December 31, 1993. The projected benefit obligation was $20,630,000 at December 31, 1994 and $22,440,000 at December 31, 1993. Net periodic pension cost recognized as (income)/expense for the years ended December 31, 1994, 1993 and 1992 was ($69,000), $699,000 and $986,000, respectively.
NATIONAL-OILWELL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
8. Other Postretirement Benefit Plans
In addition to the Company's defined-contribution and defined-benefit pension plans, the Company has defined-benefit postretirement plans covering most of the domestic employees. One plan provides life insurance benefits for most domestic employees. The other plan provides medical and life benefits for former hourly employees associated with a discontinued manufacturing facility and medical benefits for their spouses. The medical plan allows for basic or optional coverage. The basic component is noncontributory and the optional coverage rates are based upon pro rata level of cost sharing between the Company and its retirees. The life insurance plans are noncontributory. None of the plans were amended during 1994, 1993 or 1992. The Company's policy is to fund the cost of postretirement health care and life benefits as they are incurred.
In 1992, the Company adopted Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." The Company elected immediate recognition of the transition obligation at January 1, 1992 as a cumulative effect of a change in accounting principle. The effect of adopting the new rules increased 1992 net periodic postretirement benefit cost for the above defined-benefit plans by $195,000 and the cumulative effect adjustment as of January 1, 1992 increased net loss by $3,337,000. The following table shows the plans' combined funded status reconciled with amounts recognized in the Company's Consolidated Balance Sheet at December 31, 1994 and 1993:
The recorded benefit obligation in excess of the accumulated postretirement benefit obligation represents unrecognized gains. The 1994 actuarial valuation for the medical and life benefit plan related to the discontinued manufacturing facility includes a change in assumption related to cost-sharing considerations with participants' current employers. The resulting unrecognized gain is being amortized over the average remaining service period of active plan participants.
Net periodic retirement benefit cost includes the following components:
NATIONAL-OILWELL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
The annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) for the medical plan is 10.0% for 1995, 9.5% for 1996, decreasing by 0.5% per year to 5.5% by 2005, and 5.5% per year thereafter. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation for the medical plan as of December 31, 1994 by $61,000, and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1994 by $6,000.
The weighted-average discount rate used to determine the accumulated postretirement benefit obligation was approximately 8% at December 31, 1994 and 7% at December 31, 1993.
9. Income Taxes
As a partnership, the Company is not subject to U.S. federal taxes on its income. The general partners include in their federal and state tax returns the partnership's results of operations. Accordingly, no provision for U.S. federal income taxes has been made by the Company.
The Company adopted the liability method of accounting for income taxes as required by the Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," effective January 1, 1992. The cumulative effect of adopting Statement 109 decreased net loss by $4,473,000 in 1992 (there was no pretax effect of adopting the Statement).
The geographical sources of income (loss) before income taxes and cumulative effect of changes in accounting principles were as follows:
Tax rates related to foreign income range from 30% to 50%.
Significant components of the Company's deferred tax assets and liabilities were as follows:
NATIONAL-OILWELL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
The income tax liability of the Company's foreign and domestic subsidiaries is reflected in the Company's financial statements. Deferred income taxes, attributable to the foreign subsidiaries, result primarily from temporary differences in depreciation and other expenses for tax and financial statement purposes. At December 31, 1994, the Company had tax loss carryforwards available at certain foreign subsidiaries totaling $21 million. The tax loss carryforwards have no expiration date; however, they are only available against income arising from the same line of business.
10. Special Charges/(Credits)
Special charges/(credits) consist of the following:
Sales of Product Lines
---- The Company completed the sales of certain production equipment product lines not considered part of its core businesses under asset sales agreements during the last half of 1994. Sale of the fluid control systems, rod pump, sucker rod, and hydraulic product lines resulted in a gain of $15.6 million. Proceeds received in 1994 totaled approximately $41.0 million and were used to reduce debt. As a result of the sales, the Company will no longer manufacture these products but will continue as a distributor. It is estimated future revenues will be reduced by approximately $18.0 million due to these product line sales; however, the impact on net income in 1994, as well as in subsequent years, was not and is not expected to be significant.
---- During 1993, the Company implemented a business strategy to focus on its core businesses and divest marginal or unprofitable product lines. In the fourth quarter of 1993, the Company recorded a $10.0 million charge for the estimated loss on the sale of its wellhead business under an asset sales agreement signed in December 1993. This charge included an $8.5 million writedown of inventories and property, plant and equipment to estimated net realizable values and $1.5 million for transition and other direct costs of disposal. Proceeds from the wellhead business sale of $28.7 million, which closed in January 1994, were used to reduce debt. There were no significant costs expensed in 1994 related to the disposition of this product line.
Employee Termination Benefits
---- In conjunction with the formal announced shutdown of the Stockport, England, plant on January 9, 1995, the Company expensed approximately $3.2 million in 1994 relating to employee termination benefits. These benefits are calculated pursuant to the terms of the United Kingdom preexisting employee benefit plan. Benefit payments of $1.2 million were paid in the fourth quarter of 1994 related to the termination of 77 employees. Approximately $0.5 million of these benefit payments were accrued in 1992. The remaining reserve of $2.5 million is for 115 employees and will be paid in 1995.
NATIONAL-OILWELL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
---- The majority of the employee termination benefits in 1992 related to the Company's United Kingdom operations. In connection with the closing of the London, England, office and the rationalization of the Company's subsea wellhead manufacturing efforts in the United Kingdom, the Company recorded employee termination benefits of $3.8 million in 1992 related to approximately 225 employees. Approximately 77, 124, and 20 employees were actually terminated in 1994, 1993 and 1992, respectively, with the actual cost charged against the reserve. As of December 31, 1994, the reserve for these employee terminations is -0-.
Exit Costs
---- The consolidation of the Company's Houston, Texas, manufacturing operations resulted in exit costs of $0.6 million in 1994. These costs primarily included equipment relocation costs and lease termination costs. The remaining liability at December 31, 1994 represents $0.2 million for lease termination costs related to abandoned facilities.
1993 and 1992 ------------- The 1992 decision to close the Company's New Iberia, Louisiana, oilfield equipment manufacturing facility resulted in exit costs of approximately $0.9 million which primarily consisted of inventory writedowns and relocation of machinery and equipment. The plant closure was completed in 1993 for a total cost of approximately $1.3 million. Accordingly, the reserve for this plant closure was -0- at December 31, 1993.
Exit costs in 1992 also included $1.1 million in the U.K. related to lease termination costs as a result of management's plans to vacate the London, England, and Aberdeen, Scotland, wellhead sales, service and administrative offices. The remaining reserve at December 31, 1994 of approximately $0.3 million represents the future lease costs of the Aberdeen, Scotland, office.
Reversal of Reserves
The reversal of reserves in 1994, 1993, and 1992 were recorded as credits to special charges. These items primarily relate to an $18.5 million reserve initially recorded in 1991 to accrue for the estimated loss on the shutdown and disposition of the plant and related machinery and equipment at Garland, Texas. The $1.3 million reversal primarily relates to excess transition expense accruals no longer needed when the plant shutdown was completed in 1992. The $1.8 million reversal primarily related to excess machinery, equipment and inventory relocation accruals no longer needed after movement to the Company's other facilities was completed in 1993. The $2.1 million reversal primarily related to excess accruals for potential demolition and environmental cleanup no longer needed when the facility was finally sold in 1994.
11. Related Party Transactions
The Company maintains ongoing business relationships with Armco Inc. and USX Corporation, the parent companies of the general partners, and their subsidiaries. Significant related party transactions with these companies included:
NATIONAL-OILWELL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
At December 31, 1994, the Company leases office space for its headquarters facility, as well as other operating locations, from the parent companies or their subsidiaries. Future minimum lease payments applicable to these leasing agreements total $5,031,000. Rental expense to related parties totaled $1,342,000, $1,165,000 and $1,203,000 for 1994, 1993 and 1992, respectively, and is excluded from purchases.
A $31 million cash distribution was made to the owners in December 1994.
12. Business Segments and Geographic Areas
The Company's operations consist of two segments, the oilfield distribution segment and the oilfield equipment segment. The oilfield distribution segment distributes an extensive line of oilfield supplies, oilfield equipment and tubular products. The oilfield equipment segment designs and manufactures a variety of oilfield equipment for use in oil and gas drilling, completion and production activities. Intersegment sales and transfers are accounted for at commercial prices.
During the years ended December 31, 1994, 1993 and 1992, no single customer accounted for 10% or more of consolidated revenues.
Summarized financial information with respect to business segments and geographic areas is as follows:
Business Segments (in thousands)
NATIONAL-OILWELL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Geographic Areas (in thousands)
Corporate general and administrative expense related to worldwide manufacturing and other support functions benefit both United States and international operations. An allocation has been made to each business segment and geographic area based on an estimate of the corporate effort attributable to the respective business segment or geographic area. The expenses allocated totaled approximately $18,000, $21,700 and $24,000 for the years ended December 31, 1994, 1993 and 1992, respectively.
NATIONAL-OILWELL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
13. Quarterly Financial Data (Unaudited):
INDEPENDENT AUDITORS' REPORT
Armco Inc.:
We have audited the statement of consolidated net assets of Armco Financial Services Group - Companies to be Sold as of December 31, 1994 and 1993 and the related consolidated statements of operations and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included Financial Statement Schedule I, Summary of Investments - Other than Investments in Related Parties; Schedule II, Condensed Financial Information; Schedule IV, Reinsurance; Schedule V, Valuation and Qualifying Accounts; and Schedule VI, Supplemental Information Concerning Property-Casualty Insurance Operations. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Armco Financial Services Group - Companies to be Sold at December 31, 1994 and 1993 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
As discussed in Notes 3 and 7 to the consolidated financial statements, effective January 1, 1993 the Company changed its method of accounting for reinsurance contracts and postretirement benefits other than pensions. As discussed in Note 1 to the consolidated financial statements, effective December 31, 1993 the Company changed its method of accounting for investments in debt securities.
/s/ Deloitte & Touche LLP
Milwaukee, Wisconsin March 15, 1995
(continued)
ARMCO FINANCIAL SERVICES GROUP - COMPANIES TO BE SOLD
ARMCO FINANCIAL SERVICES GROUP - COMPANIES TO BE SOLD
Notes to Consolidated Financial Statements For the Years Ended December 31, 1994, 1993 and 1992
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Armco Financial Services Group - Companies to be Sold (AFSG - Companies to be Sold or the Company) consists of the net assets of Armco Inc.'s (Armco) insurance companies which Armco intends to sell and which continue underwriting activities. These activities principally represent the transactions of Northwestern National Holding Company, Inc. (NNHC), which is a wholly owned subsidiary of Armco Financial Services Corporation (AFSC), which is a wholly owned subsidiary of Armco. Prior to 1993, Armco accounted for the operating results of the AFSG companies to be sold under the cost recovery method, whereby net income was not recognized until realized through a sale of the businesses, while net losses were charged against income as incurred. Armco now presents these businesses as discontinued operations.
NNHC owns 100% of the common and preferred stock of Northwestern National Casualty Company and its wholly owned subsidiaries, NN Insurance Company and SICO, Inc. and its wholly owned subsidiary, Statesman Insurance Company (Statesman), and Statesman's wholly owned subsidiary Timeco, Inc. (collectively, SICO) (collectively, NNCC), Pacific National Insurance Company and its wholly owned subsidiary, Pacific Automobile Insurance Company (collectively, PNIC), and Certified Finance Corporation (CFC). CFC had not commenced operations as of December 31, 1994.
Principles of Consolidation - The consolidated financial statements include the accounts of NNHC and its subsidiaries NNCC, PNIC and CFC (collectively, the Company). Significant intercompany accounts and transactions have been eliminated.
Business Segment - The Company operates in a single business segment, property and casualty insurance.
Basis of Presentation - The accompanying financial statements have been prepared on the basis of generally accepted accounting principles (GAAP) which vary from statutory reporting practices prescribed for insurance companies by regulatory authorities (see Note 9).
Investments - Fixed maturity investments include bonds and mortgage-backed securities. Fixed maturity investments which the Company has the positive intent and ability to hold to maturity ("held to maturity") are reported at amortized cost. Fixed maturity investments which are available for sale ("available for sale") are reported at market value. Equity securities are common stocks which are reported at market value. The difference between cost and market value of fixed maturity investments available for sale is reflected as a component of net assets. Short-term investments (cash equivalents) are reported at cost which approximates market value.
In May 1993, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The statement requires fixed maturity investments which are available for sale to be recorded at market value. The Company adopted SFAS No. 115 on December 31, 1993 and reclassified certain investments from the "held to maturity" class into the "available for sale" class on the same date. The financial statement effect of adopting the statement was to increase investments by $13,321,000 and net assets by $13,321,000. Amounts reported in the Statement of Consolidated Cash Flows for 1993 are based on the classification of securities prior to the adoption of SFAS No. 115.
Investment income consists primarily of interest which is recognized on an accrual basis. Interest income on mortgage-backed securities is determined on the effective yield method based on estimated principal payments. Realized capital gains and losses, calculated as the difference between proceeds and book value, are determined by specific identification of the investments sold.
Recognition of Premium Revenues - Premiums, net of reinsurance ceded, are earned on a pro rata basis over the term of the policy.
Deferred Policy Acquisition Costs - Policy acquisition costs that vary with and are directly related to the production of premiums are deferred and amortized over the terms of the policies to which they relate. Amortization for the years ended December 31, 1994, 1993 and 1992 was $45,837,000 , $46,456,000 and $49,912,000, respectively. The Company does not include anticipated investment income when assessing the recoverability of deferred policy acquisition costs.
Depreciation - Depreciation on property and equipment is provided primarily on the straight-line basis over the estimated useful lives of the respective assets. Depreciation periods range from 3 to 10 years for personal property and from 5 to 40 years for real property.
Goodwill - Goodwill, which represents the excess of cost over the fair value of net assets of acquired subsidiaries, is amortized on a straight-line basis over periods not exceeding 40 years. The Company assesses whether its goodwill is impaired at each balance sheet date based on an evaluation of undiscounted projected cash flows through the remaining amortization period. If an impairment is determined, the amount of such impairment is calculated based on the estimated fair value of the asset.
Cash Flow - For purposes of reporting cash flows, the Company considers all highly liquid short-term investments purchased with maturities of three months or less to be cash equivalents.
Insurance Liabilities - The liability for unpaid losses and loss adjustment expenses includes an amount determined from loss reports and individual cases and an amount, based on past experience, for losses incurred but not reported. Such liability is necessarily based on estimates and, while management believes that the amount is fairly stated, the ultimate liability may be in excess of or less than the amount provided. The methods for making such estimates and for establishing the resulting liability are continually reviewed and any adjustments resulting therefrom are reflected in earnings currently. The Company does not discount the liability for unpaid losses and loss adjustment expenses. The liability for losses and loss adjustment expenses is reported net of a receivable for salvage and subrogation of $8,033,000, $7,746,000 and $7,523,000 at December 31, 1994, 1993 and 1992, respectively.
Participating Policy Contracts - Participating business represents approximately 13%, 14% and 13% of total premiums in force at December 31, 1994, 1993 and 1992, respectively. Participating business is composed entirely of workers' compensation policies. The amount of dividends to be paid on these policies is determined based on the provisions of the individual policies. Dividend expense for the years ended December 31, 1994, 1993 and 1992, was $2,579,000, $2,414,000 and $2,966,000, respectively.
2. INVESTMENTS
The amortized cost and market value of the Company's fixed maturity investments as of December 31, 1994 that are designated as held to maturity are as follows:
The amortized cost and market value of the Company's fixed maturity investments as of December 31, 1994 that are designated as available for sale are as follows:
The amortized cost and market value of the Company's fixed maturity investments as of December 31, 1993 that are designated as held to maturity are as follows:
The amortized cost and market value of the Company's fixed maturity investments as of December 31, 1993 that are designated as available for sale are as follows:
Net assets decreased by $33,065,000 from December 31, 1993 to December 31, 1994 due to unrealized losses on fixed maturity investments designated as available for sale.
The amortized cost and market value of the Company's fixed maturity investments at December 31, 1994, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Proceeds from fixed maturity investment sales and gross realized gains and losses during 1994 are as follows:
Proceeds from fixed maturity investment sales and gross realized gains and losses during 1993 are as follows:
Proceeds from sales and maturities of investments during 1992 were $267,030,000. Gross gains of $11,060,000 and gross losses of $978,000 were realized on those sales.
At December 31, 1994 and 1993, the Company's fixed maturity investments carried at amortized cost of $53,169,000 and $52,845,000, respectively, were on deposit with regulatory authorities.
Total investment income, investment expense and net investment income for the years ended December 31, 1994, 1993 and 1992 were as follows:
3. REINSURANCE ACTIVITY
The Company limits the maximum net loss which can arise from large risks or risks in concentrated areas of exposure by reinsuring (ceding) certain levels of risks with other insurers, either on an automatic basis or under general reinsurance contracts known as "treaties" or by negotiation on substantial individual risks.
Reinsurance contracts do not relieve the Company from its obligations to policyholders. In the event that reinsuring companies are unable to meet their obligations under the agreements, the Company would continue to have primary liability to policyholders for losses incurred. The Company evaluates the financial condition of its reinsurers and evaluates concentrations of credit risk when determining reinsurance placements. At December 31, 1994 reinsurance receivables of $28,674,000 and prepaid reinsurance premiums of $2,014,000 were associated with a single reinsurer. The Company has never suffered a significant loss due to reinsurers being unable to meet their obligations.
The following tables summarize amounts related to reinsurance assumed and ceded as of December 31, 1994, 1993 and 1992 and for the years then ended, respectively.
In December 1992, the FASB issued SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." The statement establishes the conditions required for a contract to be accounted for as reinsurance and prescribes accounting and reporting standards for those contracts. The Company adopted SFAS No. 113 on January 1, 1993. Prior to the adoption of the new statement, assets and liabilities were reported net of the effects of reinsurance. Subsequent to the adoption of the new statement, ceded reinsurance balances due from unaffiliated insurers are reported separately as assets. Ceded reinsurance balances due from affiliated insurers continue to be reported in liabilities. As permitted by the statement, prior period financial statements have been restated.
4. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
	The following table provides a reconciliation of the beginning and ending reserve balances for unpaid losses and loss adjustment expenses, on a gross of reinsurance basis, to the gross amounts reported in the Company's Statement of Consolidated Net Assets.
The preceding reconciliation shows that a deficiency of $455,000, $5,294,000 and $10,852,000 emerged in 1994, 1993 and 1992, respectively, on prior accident year claims. These deficiencies resulted primarily from settling case basis reserves for private passenger auto liability established in prior years for amounts more than were expected. A portion of the increases in ultimate incurred losses and LAE for those years also pertains to charges for future unallocated loss adjustment expenses on claims already incurred.
The Company's exposure to environmental and asbestos-related claims has generally involved insureds that are a peripheral defendant with de minimus exposure. In establishing the liability for losses and loss adjustment expenses related to environmental and asbestos claims, management considers facts currently known and the current state of the law and coverage litigation. Case reserves have been established when sufficient information has developed to indicate the involvement of a specific insurance policy. In addition, liabilities have been established to cover additional exposures on both known and unasserted claims, and costs related to litigation. The methodology for estimating incurred but not reported reserves is based on historical claim development information by line of business and accident year, without segregation of environmental and asbestos-related claim data. Estimates of the liabilities are reviewed and updated continually.
5. TRANSACTIONS WITH AFFILIATES
The Company has entered into a number of agreements or arrangements with affiliated companies in connection with intercompany services. The net amounts charged to operations during 1994, 1993 and 1992, were as follows:
The net amount due from affiliates at December 31, 1994 and 1993, which includes fees and assessments paid by the Company on behalf of affiliates, were $90,000 and $803,000, respectively.
6. INCOME TAXES
Armco and the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS No. 109) effective January 1, 1993. SFAS No. 109 requires an asset and liability approach for financial accounting. Armco accounted for the operating results of the AFSG - Companies to be Sold under the cost recovery method, whereby net income is not recognized until realized through a sale of the business, while net losses are charged against income as incurred. These businesses are now presented as discontinued operations with a portion of the consolidated Armco federal tax provision/benefit being allocated to the Company in accordance with the intraperiod tax allocation provisions of SFAS No. 109. In 1994, Armco's total federal income tax benefit was allocated to its continuing operations because it related primarily to changes in circumstances that caused a change in judgment about the realization of deferred tax assets in future years. In 1993, because Armco was in a consolidated net operating loss position for both financial reporting and federal income tax purposes, no federal income tax provision or benefit was allocated to the Company. Because Armco accounts for the Company as an investment which it intends to sell, the cumulative effect of adopting SFAS No. 109 and the deferred federal tax assets and liabilities applicable to the Company are recorded on the books of Armco, rather than by the Company.
The Company and its subsidiaries file state income tax returns in several states on both a separate company and combined basis. A provision (benefit) of $52,000, $223,000 and $(166,000) is reported in the Statement of Consolidated Operations for the years ended December 31, 1994, 1993 and 1992, respectively. The entire 1994 provision represents a current year state income tax provision of $52,000. The 1993 provision includes a current year state income tax provision of $224,000 and adjustments to prior years state income taxes of $(1,000). The 1992 benefit includes a current year state income tax provision of $27,000 and a refund from prior year state income taxes of $(193,000).
7. PENSION, PROFIT SHARING AND BENEFIT PLANS
Armco sponsors a separate noncontributory, trusteed retirement plan covering substantially all of the Company's employees. Pension costs relating to this retirement plan are computed based on accepted actuarial methods. It is the Company's policy to fund pension costs as they accrue, but, in no event at less than the amount required by, nor more than the maximum amount allowable under, the Employee Retirement Income Security Act of 1974 (ERISA). Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future.
The following table sets forth the retirement plan's funded status and amounts recognized in the financial statements of the Company at December 31, 1994, 1993 and 1992:
The following assumptions were used in determining the actuarial present value of the projected benefit obligation as of December 31, 1994, 1993 and 1992.
The Company, along with other affiliates, has a benefit plan which provides medical and dental benefits for eligible retired employees. Substantially, all employees become eligible for these benefits if they reach normal retirement age while working for the Company. These benefits are funded as claims are paid. In December 1990, the FASB issued SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." The standard requires the accrual of expense for these benefits during the years the employee is actively employed. The Company adopted SFAS No. 106 on January 1, 1993. The cumulative effect of the accounting change resulted in a decrease in 1993 income of $14,000,000.
The following table sets forth the benefit plan's funded status and amounts recognized in the balance sheets of the companies participating in the plan as of December 31, 1994 and 1993.
The accrued postretirement benefit liability applicable solely to the Company was $16,081,000 and $14,633,000 as of December 31, 1994 and December 31, 1993, respectively.
Net postretirement benefit cost for 1994 and 1993 includes the following components:
Net postretirement benefit cost applicable solely to the Company for the years ended December 31, 1994 and December 31, 1993 was $1,912,000 and $15,174,000, respectively.
The following table sets forth key assumptions used in reporting year-end disclosures.
The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by one percentage point in each year would increase the plan's accumulated postretirement benefit obligation as of December 31, 1994 by $2,228,000, and the aggregate service cost and interest cost components of the plan's net periodic postretirement benefit cost for the year by $372,000.
The Company also has a noncontributory, trusteed profit sharing plan. Annual contributions to the plan (limited to a maximum of 15% of participating salaries) are based upon operating results of the Company. No expense was recorded for the years ended December 31, 1994, 1993 and 1992.
The Company provides medical, dental and life insurance benefits to eligible participants on long-term disability, at no cost to the participant. Prior to 1993, the Company expensed these benefits on a pay-as-you-go basis. In December 1992, the FASB issued SFAS No. 112, "Employers' Accounting for Postemployment Benefits." This statement requires recognition of an employer's obligation to provide benefits to former and inactive employees after employment but before retirement. The Company adopted SFAS No. 112 in 1993. The cumulative effect of the accounting change, reported on the Statement of Consolidated Operations as a component of other expenses, resulted in a decrease in 1993 income of $715,000. The liability for postemployment benefits at December 31, 1994 and 1993 were $686,000 and $715,000, respectively.
8. NOTE PAYABLE
As partial financing of the acquisition of SICO, the Company entered into a $14,000,000 term loan agreement with a local bank in 1990. Under the terms of the loan agreement, the Company was required to make principal payments of $700,000 at each quarter end. On March 31, 1994, the Company made a principal payment of $700,000. On April 18, 1994, the outstanding balance of $2,100,000 was repaid in full.
9. NET ASSETS
NNHC depends on dividends from its subsidiaries to service debt and pay expenses. The payment of shareholder dividends by insurance companies without the prior approval of the state insurance regulators is limited to formula amounts based on net investment income, and capital and surplus determined in accordance with statutory accounting principles. At December 31, 1994, approximately $2.1 million of dividends are available without prior regulatory approval.
On April 25, 1994, NNHC contributed to NNCC all of the issued and outstanding capital stock of SICO, Inc. and its subsidiaries.
NNCC paid dividends to NNHC of $795,000, $3,170,000 and $3,896,500 during the years ended December 31, 1994, 1993 and 1992, respectively.
In accordance with the terms of an order dated April 10, 1985 of the Insurance Commissioner of the State of California (the Commissioner), PNIC may not pay any dividend or other distribution unless the dividend is approved by the Commissioner. PNIC received approval for and paid dividends to NNHC of $1,000,000 during the year ended December 31, 1992.
SICO paid dividends to NNHC of $2,110,000 during the year ended December 31, 1994 and $1,500,000 during the year ended December 31, 1992.
The Company prepares statutory-basis financial statements in accordance with accounting practices prescribed by domiciliary insurance departments. Prescribed statutory accounting practices include state laws, regulations and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). The following information has been prepared on the basis of prescribed statutory accounting principles which differ from GAAP. The principal differences relate to deferred acquisition costs and assets not admitted for statutory reporting.
10. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires disclosure of the fair value of financial instruments. In developing the fair value of financial instruments, the Company uses available market quotes and data, provided by external pricing services, as well as valuation methodologies where appropriate. As considerable judgment is required in interpreting market data and performing valuation methodologies, the fair value estimates presented below are not necessarily indicative of the amounts the Company might pay or receive in actual current market transactions. Furthermore, as a number of the Company's significant assets and liabilities are excluded from the provisions of SFAS No. 107, the disclosures below do not reflect the Company's statement of net assets on a fair value basis, nor the fair value of the Company as a whole.
The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
Financial Assets
Fair values for fixed maturity investments are based on quoted market prices.
Equity securities are valued based on quoted market prices.
Cash and cash equivalents are highly liquid investments with maturities of less than three months; carrying value approximates fair value.
Accrued investment income is valued at carrying value as it is short-term in nature.
Insurance premium balances receivable are generally collected on a monthly basis. Due to the short-term nature of these receivables, their carrying value approximates fair value.
Financial Liabilities
The Company's insurance reserves are specifically excluded from the provisions of SFAS No. 107.
Other financial liabilities are valued at their carrying value due to their short-term nature. As permitted under SFAS No. 107, other financial liabilities exclude postretirement and postemployment benefit obligations for purposes of this disclosure.
The fair value of the Company's note payable is based on current rates offered to the Company for debt of the same remaining maturities.
11. COMMITMENTS
The Company leases certain office facilities and equipment under operating leases. Minimum rental commitments under noncancelable leases are as follows:
Total rental expense was $2,541,000, $2,512,000 and $2,291,000 in 1994, 1993 and 1992, respectively.
12.	LITIGATION
The Company is involved in various lawsuits that have arisen from the normal conduct of business. These proceedings are handled by corporate and outside counsel. It is the opinion of management that the outcome of these proceedings will not have a material effect on the Company's financial condition or liquidity; however, it is possible that due to fluctuations in the Company's results, future developments with respect to changes in the ultimate liability could have a material effect on future interim or annual results of operations.
13.	PENDING TRANSACTION
On August 2, 1994, Armco entered into a definitive purchase agreement to sell the Company to Vik Brothers Insurance, Inc., a privately held, Raleigh, North Carolina based property and casualty insurance holding company. The sale is expected to close by April 7, 1995. In connection with the transaction, Vik would pay approximately $65 million at closing, and approximately $15 million, in three years, reduced by a potential adjustment for adverse experience in insurance reserves.
ARMCO FINANCIAL SERVICES GROUP - SCHEDULE II COMPANIES TO BE SOLD (Parent Only)
Condensed Financial Information Notes to Condensed Financial Information for the Years Ended December 31, 1994, 1993 and 1992
1. The accompanying condensed financial information should be read in conjunction with the consolidated financial statements of the AFSG - Companies to be Sold.
2. Long-term debt consists of the following:
As partial financing of the acquisition of SICO, the Company entered into a $14,000,000 term loan agreement with a local bank in 1990. Under the terms of the loan agreement, the Company was required to make principal payments of $700,000 on March 31 and each quarter end thereafter until repaid in full. On March 31, 1994, the Company made a principal payment of $700,000. On April 18, 1994, the outstanding balance of $2,100,000 was repaid in full.
3. NNHC depends on dividends from its subsidiaries to service debt and pay expenses. The payment of shareholder dividends by insurance companies without the prior approval of the state insurance regulators is limited to formula amounts based on net investment income, and capital and surplus determined in accordance with statutory accounting principles. At December 31, 1994, approximately $2.1 million of dividends are available without prior regulatory approval.
On April 25, 1994, NNHC contributed to NNCC all of the issued and outstanding capital stock of SICO, Inc. and its subsidiaries.
NNCC paid dividends to NNHC of $795,000 , $3,170,000 and $3,896,500 during the years ended December 31, 1994, 1993 and 1992, respectively.
In accordance with the terms of an order dated April 10, 1985 of the Insurance Commissioner of the State of California (the Commissioner), PNIC may not pay any dividend or other distribution unless the dividend is approved by the Commissioner. PNIC received approval for and paid dividends to NNHC of $1,000,000 during the year ended December 31, 1992.
SICO paid dividends to NNHC of $2,110,000 during the year ended December 31, 1994 and $1,500,000 during the year ended December 31, 1992.
4. In May 1993, the FASB issued SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The statement requires fixed maturity investments which are available for sale to be recorded at market value. The Company adopted SFAS No. 115 on December 31, 1993.
ARMCO FINANCIAL SERVICES GROUP - COMPANIES TO BE SOLD
Disclosure of Certain Data on Loss and Loss Expense Reserves
The liability for unpaid losses and loss adjustment expenses includes an amount determined from loss reports and individual cases and an amount, based on past experience, for losses incurred but not reported. Such liability is necessarily based on estimates and, while management believes that the amount is fairly stated, the ultimate liability may be in excess of or less than the amount provided. The methods for making such estimates and for establishing the resulting liability are continually reviewed and any adjustments resulting therefrom are reflected in earnings currently. The Company does not discount the liability for unpaid losses and loss adjustment expenses.
AFSG - Companies to be sold estimates losses for reported claims on an individual case basis. Case reserves are based on experience with a particular type of risk and the available information surrounding each individual claim. Case reserves are reviewed on a regular basis. As additional facts become available, the case reserves are adjusted as necessary. The stability of the case reserving process is monitored through comparison with ultimate settlement.
The estimates of losses for incurred but not reported claims (IBNR), as well as additive reserves for reported claims, are developed primarily from an analysis of historical patterns of the development of paid and incurred losses (dollars and claim counts) by accident year for each line of business. Salvage and subrogation estimates are developed from patterns of actual recoveries.
Allocated loss adjustment expense reserves are developed from an analysis of historical patterns of the development of paid allocated loss adjustment expenses to incurred losses, by accident year, for each line of business. These historical patterns are then applied to projected ultimate losses for each line of business.
Unallocated loss adjustment expense reserves are developed utilizing a cost accounting system. The cost accounting system is based on historical costs modified for anticipated changes in operations and selections of alternative costs.
In December 1992, the FASB issued SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration contracts." The statement establishes the conditions required for a contract to be accounted for as reinsurance and prescribes accounting and reporting standards for those contracts. The Company adopted SFAS No. 113 in 1993. Prior to the adoption of the new statement, assets and liabilities were reported net of the effects of reinsurance. Subsequent to the adoption of the new statement, ceded reinsurance balances due from unaffiliated insurers are reported separately as assets. Ceded reinsurance balances due from affiliated insurers continue to be reported in liabilities. As permitted by the statement, prior period financial statements have been restated.
Loss and loss adjustment expense reserves are stated at management's estimate of the ultimate cost of settling all incurred but unpaid claims. Loss and loss adjustment expense reserves are not discounted.