On December 31, 2003, 36,567 shares plus accrued dividends equal to 937 shares of 10.25% Series A Convertible Preferred Stock were exchanged for 37,504 shares of 5.5% Series B Convertible Preferred Stock. Stockholders’ equity at December 31, 2003 includes $37.5 million of 5.5% Series B Convertible Preferred Stock.
Forward-Looking Statements. Statements contained in this analysis and elsewhere in this document that are not based on historical information are forward-looking statements and are based on management’s projections, estimates and assumptions. In particular, forward-looking statements can be identified by the use of words such as “may”, “will”, “should”, “expect”, “anticipate”, “estimate”, “continue”, or similar words. Management cautions readers regarding its forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Various statements contained in Item 1 - “Business” and Item 7 - “Management’s Discussion and Analysis of Results of Operation and Financial Condition”, are forward-looking statements. These forward-looking statements are based on the intent, belief or current expectations of the Company and members of its senior management team. While USHEALTH’s management believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance, and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements.
Investments. Investment income is an important source of revenue, and the Company’s return on invested assets has a material effect on net income. The Company’s investment policy is subject to the requirements of insurance regulatory authorities. In addition, certain assets are held on deposit in specified states and invested in specified securities in order to comply with state law. Although the Company closely monitors its investment portfolio, available yields on newly invested funds and gains or losses on existing investments depend primarily on general market conditions. The Company’s investment portfolio is managed by Frost National Bank.
Mortgage-backed securities comprised 20.5% of the Company’s fixed maturity portfolio at December 31, 2004 as compared to 24.3% at December 31, 2003. Mortgage-backed securities are subject to risks associated with variable pre-payments. This may result in these securities having a different actual cash flow and maturity than expected at the time of purchase. Securities that have an amortized cost greater than par and are backed by mortgages that prepay faster than expected will incur a reduction in yield or a loss. Those securities with an amortized cost lower than par that prepay faster than expected will generate an increase in yield or a gain. In addition, the Company may incur reinvestment risks if market yields are lower than the book yields earned on the securities. Prepayments occurring slower than expected have the opposite impact. The Company may incur disinvestment risks if market yields are higher than the book yields earned on the securities and the Company is forced to sell the securities. The degree to which a security is susceptible to either gains or losses is influenced by 1) the difference between its amortized cost and par, 2) the relative sensitivity of the underlying mortgages backing the assets to prepayment in a changing interest rate environment and 3) the repayment priority of the securities in the overall securitization structure. There are negligible default risks in the mortgage-backed securities portfolio as a whole as the vast majority of the assets are either guaranteed by U.S. government-sponsored entities or are supported in the securitization structure by junior securities enabling the assets to achieve high investment grade status.
Excludes interest on receivables from agents of $0.4 million, $1.0 million, and $1.5 million for the years ended December 31, 2004, 2003 and 2002, respectively.
The Company’s portfolio has an average effective duration of five years, which reflects the medium-term nature of its liabilities. As a result, a significant portion of the portfolio matures and is reinvested each year.
The scheduled contractual maturities of the Company’s fixed maturity securities, excluding short-term investments at December 31 are shown in the table below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
A premium deficiency exists if the present value of future net cash flows plus future policy benefit and claims reserves at the calculation date is negative or less than net deferred policy acquisition costs. The calculation of future net cash flows includes assumptions as to future rate increases and persistency. The Company routinely evaluates the recoverability of deferred acquisition costs in accordance with GAAP. At December 31, 2004, 2003 and 2002, there were no premium deficiencies requiring recognition.
The Insurance Subsidiaries reinsure risks under each of their respective major medical policies on an excess of loss basis so that its net payments on any one life insured under the policy are limited for any one calendar year to $150,000. Risks under its Medicare Supplement policies are not reinsured. Certain risks under the Insurance Subsidiaries’ Accidental Death policies are one hundred percent (100%) reinsured. Under its life insurance reinsurance agreement, FLICA and NFL retain fifty percent (50%) of the coverage amount of each of its life insurance policies written prior to June 30, 2004 and in force up to a maximum of $65,000. NFL reinsures, through an excess of loss reinsurance treaty, a closed block of annually renewable term life insurance policies. NFL’s retention limit is $25,000 per year. In accordance with industry practice, the reinsurance arrangements in force with respect to these policies are terminable by either party with respect to claims incurred after the termination and expiration dates.
Results of operations for USHEALTH are reported below for the years ended December 31, 2004, 2003 and 2002.
(Loss) income from continuing operations before income taxes (125 ) (282 )
Loss applicable to common stockholders $ (2,713 ) $ (3,107 ) $ (4,194 )
(1) In October 2004, the Company sold its printing subsidiary, Westbridge Printing Services, Inc. (“WPS”). The operating results of WPS are presented as loss from discontinued operations. Reclassifications of prior years' amounts have been made to conform to the 2004 presentation.
Overview. The Company reported net losses of ($2.3) million, ($1.3) million, and ($0.9) million for 2004, 2003 and 2002, respectively. The ($1.0) million increase in the net loss from 2003 to 2004 was principally due to non-recurring charges of ($3.0) million for executive compensation and severance and a ($1.1) million increase in loss from discontinued operations offset by a $3.3 million decrease in interest expense on notes payable to and redeemable preferred stock held by related parties.
On October 29, 2004, the Company sold its printing subsidiary and exited the printing business. The loss from discontinued operations of ($2.1) million for 2004 is comprised of a ($1.4) million loss on sale of the printing subsidiary and a ($0.7) million operating loss compared to a ($1.1) million operating loss for 2003.
Interest expense on the note payable to related party decreased due to the restructuring of the note payable on December 31, 2003 that reduced the interest rate from 12% to 6% per annum. The Company’s preferred stock was converted to common stock on March 15, 2004.
Premium revenue, in thousands, for each major product line is set forth below:
For the past several years, the costs of medical services covered by the Company’s major medical insurance policies has increased significantly, with medical inflation averaging 15% to 20% annually in comparison to an average increase in the consumer price index of 3%. To maintain the 2004 ratio of claims and benefits to premium into future periods, the Company must accurately estimate future medical inflation and implement timely premium rate increases for both new major medical product sales and the majority of its in force insurance policies, including supplemental specified disease and Medicare supplement policies.
General. The primary sources of cash for the Company’s consolidated operations are premiums and fees from insurance policies, sales and maturity of invested assets and investment income while the primary uses of cash are payments of insurance policy benefits, claims and commissions, and general operating expenses. Net cash provided by (used in) operations totaled $1.8 million, ($1.1) million and ($5.0) million for the years ended December 31, 2004, 2003 and 2002, respectively. The increase in cash provided / decrease in cash used by operations from year to year is principally due to a decline in the cash basis ratio of benefits and claims to premiums.
USHEALTH is a holding company, the principal assets of which consist of the capital stock of its subsidiaries and invested assets. USHEALTH’s principal sources of funds are comprised of dividends from its non-insurance subsidiaries. The Insurance Subsidiaries are precluded from paying dividends without prior approval of the Texas Insurance Commissioner, as the Insurance Subsidiaries’ earned surplus is negative due to statutory losses incurred prior to 2003 (see “Business - State Regulation” at Item 1). USHEALTH’s principal uses of cash are for general and administrative expenses and to make discretionary additional investments in its Insurance Subsidiaries in the form of capital contributions to maintain desired statutory capital and surplus levels. USHEALTH funded capital contributions to the Insurance Subsidiaries totaling approximately $812,000 and $2.3 million during 2003 and 2002, respectively, and made no capital contributions during 2004. The Insurance Subsidiaries reported statutory net income (losses) for 2004, 2003, and 2002 of $2.6 million, $1.1 million, and ($2.7) million, respectively. As of December 31, 2004, USHEALTH had approximately $3.5 million in unrestricted cash and invested assets as compared to $2.4 million at December 31, 2003.
Bank Financing. The majority of commission advances to NCM’s and ACB’s agents are financed through Ascent Funding, Inc. (“AFI”), an indirect wholly owned subsidiary of USHEALTH. On December 31, 2003, AFI entered into a Credit Agreement (the “Credit Agreement”) with Frost National Bank (“Frost”) that provides AFI with a $3.0 million revolving loan facility, the proceeds of which are used to purchase agent advance receivables from NCM and other affiliates. As of December 31, 2004 and 2003, $250,000 and $500,000, respectively, were outstanding under the Credit Agreement. The Credit Agreement as amended matures on January 15, 2007, at which time the outstanding principal and interest will be due and payable. The Company maintains an agent receivable financing arrangement to facilitate growth in new business sales.
Inflation. Inflation impacts claim costs and overall operating costs and, although inflation has been lower in the last few years, hospital and medical costs have still increased at a higher rate than general inflation, especially prescription drug costs. New, more expensive and wider use of pharmaceuticals is inflating health care costs. The Company will continue to establish premium rates in accordance with trends in hospital and medical costs along with concentrated efforts in various cost containment programs. However, there can be no assurance that these efforts will fully offset the impact of inflation or that increases in premium rates will equal or exceed increasing healthcare costs.
Excludes interest at a rate equal to the Prime Rate, plus one-half percent per annum.
Includes payments under a lease for a printer whereby USHEALTH is contractually a co-lessee. Under terms of the sale and purchase agreement of its printing subsidiary, the former printing subsidiary and the new owner of such former printing subsidiary are primarily liable.
Index to Financial Statements and Financial Statement Schedules Covered by the Following Report of Independent Registered Public Accounting Firm.
Consolidated Statements of Comprehensive (Loss) Income for the Years Ended December 31, 2004,
Available-for-sale, at market value (amortized cost $96,940 and $93,922) $ 99,729
Basic and diluted loss per common share $ (0.07 ) $ (0.48 ) $ (0.64 )
Purchase of fixed maturity investments (19,984 ) (68,054 ) (62,903 )
Net Cash (Used for) Provided by Investing Activities (2,729 ) 5,630
Net Cash Used for Financing Activities (250 ) (4,160 ) (1,956 )
The Company’s operations are comprised of one segment, Accident and Health insurance. The principal products currently underwritten are medical expense reimbursement and supplemental policies. The Company, through applicable subsidiaries, also derives fee and service revenue from (i) telemarketing services, (ii) renewal commissions for prior year sales of both affiliated and unaffiliated insurance products, and (iii) commissions on the sale of the benefits of unaffiliated membership benefit programs.
Investments. The Company’s fixed maturity portfolio is classified as available-for-sale and is carried at estimated market value. Equity securities (common stocks), which are included in other investments, are also carried at estimated market value. Changes in aggregate unrealized appreciation or depreciation on fixed maturity and equity securities are reported directly in stockholders’ equity and, accordingly, will have no effect on current operations.
Future Policy Benefits. Liabilities for future policy benefits not yet incurred are computed primarily using the net level premium method including actuarial assumptions as to investment yield, mortality, morbidity, withdrawals, persistency and other assumptions which were appropriate at the time, the policies were issued. Assumptions used are based on the experience of each of the Insurance Subsidiaries, as adjusted to provide for possible adverse deviation. Generally, these actuarial assumptions are fixed and, absent material adverse benefit experience, are not adjusted.
The following tables reflect the calculation of basic and diluted earnings per share:
Loss applicable to common stockholders (2,713 ) (3,107 ) (4,194 )
Basic and diluted loss per share from continuing operations $ (0.02 ) $ (0.31 ) $ (0.42 )
Use of Estimates. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s significant accounting estimates relate to investments, agent receivables, deferred policy acquisition costs, deferred tax assets, claim reserves, future policy benefit reserves, reinsurance and statutory accounting practices. Important factors known to management that could cause actual results to differ materially from those estimated or contemplated include, but are not limited to:
any limitation imposed on the Insurance Subsidiaries’ ability to control the impact of rising health care costs, especially prescription drugs, and rising medical service utilization rates through product and benefit design, underwriting criteria, premium rate increases, utilization management and negotiation of favorable provider contracts;
USHEALTH’s ability to make additional investment in its Insurance Subsidiaries in the form of capital contributions, if needed, in order for such subsidiary to comply with minimum regulatory capital requirements;
Recently Issued Accounting Pronouncements. In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004) (“FAS 123R”), “Share-Based Payment.” FAS123R eliminates the alternative to use APB No. 25‘s , “Accounting for Stock Issued to Employees”, intrinsic value method of accounting that was provided in Statement 123 as originally issued. This statement establishes standards for accounting for transactions in which an entity exchanges its equity instruments for goods or services. It requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service, usually the vesting period, in exchange for the award. FAS123R is effective as of the beginning of the first interim period or annual reporting period that begins after June 15, 2005. Disclosed at Note 13 - Employee Benefit Plans is the effect on net loss and loss per share for the years presented if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation which the Company does not believe will significantly differ from the effects of adopting FAS123R.
In May 2003, the FASB issued SFAS No. 150, “Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity”. This Statement established standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability measured at fair value. The Statement was effective for financial instruments entered into or modified after May 31, 2003, and otherwise was effective at the beginning of the first interim period beginning after June 15, 2003. Ascent implemented SFAS 150 effective with the beginning of the third quarter 2003. As a result, Ascent’s Series A Redeemable Convertible Preferred Stock of approximately $36.6 million was classified as a liability in the Company’s interim September 30, 2003 balance sheet. At December 31, 2003, the outstanding shares of Ascent’s Series A Redeemable Convertible Preferred Stock were exchanged for shares of Ascent’s Series B Redeemable Convertible Preferred Stock.
Also, under SFAS 150, amounts paid in excess of the initial measurement amount to holders of the mandatorily redeemable preferred stock classified as liabilities are to be reflected in interest cost. All amounts paid to or accrued prior to the reclassification of the stock as a liability shall not be reclassified as interest cost upon implementation. As a result, the Company reflected in interest costs the dividends paid or accrued to the holders of the Series A Redeemable Convertible Preferred Stock for the six-month period ended December 31, 2003. All dividend amounts paid or accrued prior to the implementation of SFAS 150 were reflected as preferred stock dividends.
On October 29, 2004, USHEALTH sold its printing subsidiary, Westbridge Printing Services, Inc. (“WPS”), to an unrelated party and exited the printing business. In accordance with Statement of Financial Accounting Standard No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets”, the Company’s printing subsidiary is reported as discontinued operations in the accompanying consolidated financial statements. The Company’s loss from discontinued operations of approximately ($2.1) million for 2004 was comprised of a ($1.4) million loss on the sale and a ($700,000) operating loss from WPS for the ten months ended October 29, 2004. Included in the loss on sale is a ($912,000) loss for contingencies related to a long-term lease on which USHEALTH remains a co-lessee and collection of certain receivables from WPS. The operating losses of WPS for 2003 and 2002 have been reflected in discontinued operations for comparative purposes. The balance sheet for December 31, 2003 includes assets and liabilities of WPS of approximately $1.1 million and $456,000, respectively. The assets and liabilities of WPS consisted primarily of trade receivables, inventory, equipment and trade payables. Revenues from the discontinued operations of WPS for 2004, 2003 and 2002 were approximately $3.3 million, $3.8 million and $3.4 million, respectively.
On March 15, 2004, USHEALTH’s common shareholders approved an amendment to the Company’s Certificate of Incorporation to increase the authorized number of shares of common stock to 75 million shares from 30 million shares. The approval of this amendment resulted in the automatic conversion of all 37,504 outstanding shares of the Company’s Series B convertible participating preferred stock (“Series B Preferred Stock”) into 43,995,026 shares of common stock. Preferred stock dividends of $430,000 accrued through March 15, 2004, were forgiven by preferred stockholders and, as a result, were credited to capital in excess of par value, and had no impact on total stockholders’ equity. All outstanding shares of the Series B Preferred Stock were held by Special Situations Holdings, Inc. - Westbridge (“SSHW”), the Company’s largest shareholder. The conversion of the Series B Preferred Stock increased the ownership percentage of SSHW in the Company’s common stock to approximately 93% from 49%.
Absent any acceleration following an event of default, the Company may elect to pay interest in kind by issuance of additional notes. During 2004, 2003 and 2002, USHEALTH issued $958,000, $1.7 million and $1.5 million, respectively, in additional notes for payment of interest in kind, which increased the note payable balance at December 31, 2004 to approximately $16.2 million.
AFI’s obligations under the Credit Agreement are secured by liens upon substantially all of AFI’s assets. AFI’s principal assets at December 31, 2004 are net agent receivables of $3.5 million. In addition, NCM, ACB and USHEALTH have guaranteed AFI’s obligation under the Credit Agreement, and have pledged all of the issued and outstanding shares of the capital stock of AFI, NFL, and FLICA as collateral for those guaranties (the “Guaranty Agreements”). USHEALTH, certain of its subsidiaries, CSFBM and Frost have entered into an Intercreditor and Subordination Agreement dated as of December 31, 2003 to give effect to a subordination of the notes payable to CSFBM to up to $10 million in borrowings under the Credit Agreement. As of December 31, 2004, there were no events of default under the Credit or Guaranty Agreements.
Investment securities on deposit with insurance regulators in accordance with statutory requirements at December 31, 2004 and 2003 had a par value totaling $20.4 million and $21.1 million, respectively, and market value totaling $22.1 million and $23.1 million, respectively.
Issues through 1980 are 6.5% graded to 4.5% in 25 years; most 1981 through 1992 issues are 10% graded to 7% in 10 years. Issues for 1993 through 2002 are 7% level. Issues for 2003 and forward are 5% level.
Based on industry tables published in 1974 by Tillinghast, Nelson and Warren, Inc. and the 1985 NAIC cancer tables, as well as other population statistics and morbidity studies. Issues for 2003 and forward are based on the July 2002 Milliman Health Cost Guidelines adjusted for the Insurance Subsidiaries’ anticipated claims levels.
The following table provides a reconciliation of the beginning and ending claim reserve balances, on a gross-of-reinsurance basis, for 2004, 2003 and 2002, to the amounts reported in the Company’s consolidated balance sheets:
Claims incurred related to prior years for 2004 provided a benefit of $1.8 million, which was primarily attributable to actual medical trends for the latter part of 2003 developing more favorably than management’s estimate. Claims incurred related to prior years were a $0.2 million benefit and a $0.4 million expense for 2003 and 2002, respectively and approximated 1% of the prior year claim liability for both years.
Prior to March 2004, the Company and its wholly-owned subsidiaries filed a consolidated federal income tax return. On March 15, 2004, upon the conversion of USHEALTH’s convertible preferred stock into common stock (see Note 4 - Conversion of Convertible Redeemable Preferred Stock) SSHW, USHEALTH’s largest stockholder, increased its ownership interest from approximately 49% to approximately 93%. Pursuant to applicable federal tax regulations, USHEALTH and its non-life subsidiaries are required to join in the consolidated return of SSHW for the period beginning March 16, 2004. However, the provisions of Subchapter L of the Internal Revenue Code prohibit the Insurance Subsidiaries from participating in the consolidated tax returns of a new affiliated group for five years, beginning with the tax year ended December 31, 2004. Accordingly, for periods subsequent to March 15, 2004, NFL and FLICA will file separate federal tax returns and NFIC will file a consolidated federal tax return with its subsidiary, AICT.
The differences between the effective tax rate and the amount derived by multiplying the loss before income taxes by the federal income tax rate for the Company’s last three years is shown below. The change in valuation allowance results from current year losses and the true-up of prior year deferred tax items.
Under the provisions of pre-1984 life insurance tax regulations, NFL was taxed on the lesser of taxable investment income or income from operations, plus one-half of any excess of income from operations over taxable investment income. One-half of the excess (if any) of the income from operations over taxable investment income, an amount which was not currently subject to taxation, plus special deductions allowed in computing the income from operations, were placed in a special memorandum tax account known as the policyholders’ surplus account. The aggregate accumulation in the account at December 31, 2004 approximated $2.5 million. Federal income taxes will become payable on this account at the then current tax rate when, and to the extent that, the account exceeds a specific maximum, or when and if distributions to stockholders, other than stock dividends and other limited exceptions, are made in excess of the accumulated previously taxed income. The Company does not anticipate any transactions that would cause any part of the amount to become taxable and, accordingly, deferred taxes that would approximate $0.9 million have not been provided on such amount.
Under the applicable laws of the states in which insurance companies are licensed, the companies are required to maintain minimum amounts of capital and surplus. The Insurance Subsidiaries are all domiciled in Texas and are therefore subject to regulation under Texas laws. Under the Texas Insurance Code, the insurance subsidiaries are required to maintain aggregate capital and surplus of $1.4 million.
As a result of losses from major medical products marketed prior to July 2000, FLICA required significant capital contributions during 2002 and 2001 to comply with minimum statutory capital and surplus requirements. In April 2001, USHEALTH obtained debt financing of $11 million from a subsidiary of CSFB. The proceeds of this loan were used to fund an $11 million capital contribution to FLICA. Major medical claims experience adverse to management’s current estimates or adverse claims experience for other insurance products may cause USHEALTH to make capital contributions to the Insurance Subsidiaries in excess of those currently projected for 2005. As a result, adverse claims experience could have a material adverse effect on USHEALTH’s liquidity and capital resources and results of operations.
The Texas Department of Insurance adopted the NAIC’s Model Act during 2000. NFL’s and FLICA’s statutory annual statements for the year ended December 31, 2004 filed with the Texas Department of Insurance reflect total adjusted capital in excess of Company Action Level RBC.
In 1998, NFIC and AICT entered into a voluntary consent order, pursuant to Article 1.32 of the Texas Insurance Code, providing for the continued monitoring of the operations of NFIC and AICT by the Texas Department of Insurance in response to losses sustained in 1997 and 1998 as well as the projected inability to meet RBC requirements. Both NFIC and AICT ceased the sale and underwriting of new business in 1998. At December 31, 2004, AICT’s RBC exceeded Company Action Level RBC; however, NFIC’s RBC only exceeded Regulatory Action Level RBC. Both NFIC and AICT are in compliance with the terms of the voluntary consent order.
Cumulative capital contributions to insurance subsidiaries (39,561 ) (39,561 ) (39,001 )
Consolidated GAAP net loss $ (2,283 ) $ (1,348 ) $ (931 )
In addition, the Company paid severance expense of approximately $727,000 to its former Chairman.
In September 1986, a subsidiary of the Company established a retirement savings plan (“401(k) plan”) for its employees. As amended in August 1999, such employees are eligible to participate in the 401(k) plan upon completion of six months of service. The 401(k) plan is qualified under Section 401(a) of the Internal Revenue Code (“IRC”) and the trust established to hold the assets of the 401(k) plan is tax-exempt under Section 501 (a) of the IRC. The subsidiary is the plan administrator, and may amend, terminate or suspend contributions to the plan at any time it may deem advisable. Employees of this subsidiary who participate may contribute up to 100% of pre-tax compensation, including commissions, bonuses and overtime, but not to exceed $13,000. This subsidiary may make discretionary contributions, determined by its Board of Directors, up to 50% of the employees’ first 6% of deferred compensation, but not to exceed a matching contribution of $6,150 per plan participant. Certain IRC required limitations, may be imposed for participants who are treated as “highly compensated employees” for purposes of the IRC. Participants vest 25% after one year of service, 50% after two years of service, 75% after three years of service and 100% after 4 years of service. Employee contributions are invested in any of ten investment funds at the discretion of the employee. Contributions to the 401(k) plan in 2004, 2003 and 2002 by the Company’s subsidiaries approximated $120,000, $119,000 and $72,000, respectively.
The weighted average option exercise price was $2.17, $2.32 and $2.30 for options outstanding at December 31, 2004, 2003 and 2002, respectively. For options granted in 2002, weighted average exercise price was $0.65. For options forfeited/cancelled/expired in 2004, 2003 and 2002, the weighted average exercise price was $3.82, $2.59 and $3.23, respectively. For options exercised in 2004, 2003 and 2002, the weighted average exercise price was $0.01.
The weighted average fair values of Mr. Cutler's options deemed granted during 2004 and options granted under the 1999 stock option plan in 2002 were $0.30 and $0.47, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following significant weighted-average assumptions used for grants in 2004 and 2002, respectively: dividend yield of 0% for both years; expected volatility of 1.012 and 1.214; risk-free interest rate of 3.36% for 2004 and 4.32% for 2002; expected life of 5 years for 2004 and 3 years for 2002. The Company did not grant any stock options in 2003.
Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because change in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
The Company currently applies the intrinsic value method, in accordance with APB 25, in accounting for its stock options issued to employees and non-employee directors. Accordingly, no compensation expense has been recognized for options granted with an exercise price equal to market value at the date of grant. The Company applies the fair value method in accounting for stock options issued to consultants (including marketing agents).
Compensation cost recognized in the income statement for stock-based employee and consultants (including marketing agents) compensation awards was approximately $1,000 in 2004, $6,000 in 2003, and $55,000 in 2002.
The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
(Loss) income from continuing operations $ (156 ) $ (282 ) $ 494
Pro forma loss applicable to common stockholders $ (2,849 ) $ (3,413 ) $ (4,467 )
Basic and diluted - pro forma $ (0.05 ) $ (0.17 ) $ (0.22 )
Summarized quarterly financial information for each of the Company’s last two years of operations is as follows:
Net realized (loss) gain on investments (2 ) (3 ) (15 )
Loss from discontinued operations (1) (200 ) (185 ) (1,458 ) (284 )
Basic and diluted loss per common share $ (0.02 ) $ 0.02
Basic and diluted loss per share from continuing operations $ (0.06 ) $ (0.05 ) $ (0.11 ) $ (0.08 )
For the quarters ended September 2003 and December 2003, Series A redeemable convertible preferred stock dividends of $914 and $937, respectively, were recorded as interest expense as required under FAS150.
disposal in 2004 of ($1,369) (2,127 ) (1,066 ) (1,425 )
Loss applicable to common shareholders $ (2,713 ) $ (3,107 ) $ (4,194 )
Unrealized holding (loss) gain during period (120 ) (160 ) 3,494
Comprehensive (loss) income $ (2,518 ) $ (1,746 ) $ 2,647
Equity in undistributed net income of subsidiaries (4,146 ) (4,038 ) (1,959 )
Net change in short-term and other investments (1,086 ) (392 )