Pumpkin leases 10,671 square feet of office space in Denver, Colorado for its sales and administrative activities.
The following discussion should be read in conjunction with the financial statements of the Company and the related notes thereto appearing in Item 8 "Financial Statements and Supplementary Data" in this Report on Form 10-K.
Interest expense increased by $320,000 for the year ended December 31, 2000. Without taking into consideration the Health Power acquisition, interest expense increased by $223,000 for the year ended December 31, 2000, as compared to the year ended December 31, 1999. The seasonal products segment's expense decreased by $165,000 due to reduced average debt levels. The educational segment's interest expense increased by $401,000 which was primarily attributable to its inclusion for the full year of 2000 compared to nine months for 1999 due to its April 1999 acquisition.
Interest expense increased by $737,000 for the year ended December 31, 1999. Without taking into consideration the educational segment acquisition, interest expense decreased by $277,000 for the year ended December 31, 1999, as compared to the year ended December 31, 1998. The decrease is primary due to reduced average debt levels of the seasonal products segment.
The Company decreased the valuation allowance for the deferred tax asset by $1,347,000 and $1,149,000 for the years ended December 31, 1999 and 1998, respectively, attributable to the Company's expected utilization of its net operating loss carry forward.
The seasonal products segment, in aggregate, maintains two revolving lines of credit, which had combined balances of $2,700,000 outstanding and $3,204,000 available at December 31, 2000. The low balance was due to its seasonal pattern. The Company's education segment maintains a $2,500,000 revolving line of credit, which had a balance of $500,000 outstanding and $141,000 available at December 31, 2000. The Company's employer cost containment-related services segment maintains an $8,000,000 revolving line of credit, which had a balance of $1,000,000 outstanding and $6,500,000 available at December 31, 2000. Portions of the revolving lines of credit may be limited to a borrowing base as defined in the notes to the audited financial statements included in this Form 10-K. Additionally, the Company had a cash balance of $5,777,000 at December 31, 2000.
The Company's quarterly and annual revenues and other operating results have been and will continue to be affected by a wide variety of factors that could have a material adverse effect on the Company's financial performance during any particular quarter or year. Such factors include, but are not limited to those listed under "Forward Looking Statements". The Company has introduced a
number of new products in its target markets in 2000, 1999 and 1998, and plans to introduce additional products in 2001 which are expected to enhance future revenues and liquidity of the Company. However, there can be no assurance that the Company will be able to implement its plans to introduce such products in a timely fashion, or that such products will meet the expectations of the Company for either revenues or profitability. The Company believes that cash flows from operating activities and the successful introduction of its new products and continued growth of its franchises, as well as its available borrowings under the revolving credit facilities, will be adequate to meet the Company's debt service obligations, working capital needs and planned capital expenditures for at least the next twelve months, although there can be no assurance in this regard.
This Annual Report on form 10-K contains "forward-looking" statements within the meaning of the "safe harbor" provision of the Private Litigation Reform Act of 1995. Such statements are based on managements current expectations and are subject to a number of factors and uncertainties which could cause actual results to differ materially from those described in the forward looking statements. Such factors and uncertainties include, but are not limited to: the level of orders that are received and shipped by the Company in any given quarter, the rescheduling and cancellation of orders by customers, availability and cost of materials, the Company's ability to enhance its existing products and to develop, manufacture, and successfully introduce and market new products, new product developments by the Company's competitors, market acceptance of products of both the Company and its competitors, competitive pressures on prices, the ability to attract and maintain qualified personnel, significant damage to or prolonged delay in operations at the Company's suppliers' manufacturing facility, and interest rate and foreign exchange fluctuations, political stability in the Pacific Rim, and its ability to attract qualified franchisees.
Reports of Independent Auditors 25 Consolidated Financial Statements Consolidated Statements of Income -- For the years ended December 31, 2000, 1999 and 1998 27 Consolidated Balance Sheets - As of December 31, 2000 and 1999 28 Consolidated Statements of Cash Flows -- For the years ended December 31, 2000, 1999 and 1998 29 Consolidated Statements of Stockholders' Equity -- For the years ended December 31, 2000, 1999 and 1998 30 Notes to Consolidated Financial Statement 31
We have audited the accompanying consolidated balance sheet of Security Capital Corporation and subsidiaries (the "Company") as of December 31, 1999 and the related consolidated statements of income, stockholders' equity, and cash flows for each of the two years in the period ended December 31, 1999. 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.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Security Capital Corporation and subsidiaries at December 31, 1999 and the results of their operations and their cash flows for each of the two years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States of America.
SECURITY CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share amounts)
SECURITY CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
SECURITY CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except shares)
SECURITY CAPITAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Primrose recognizes royalties based on the monthly revenues of the franchisees. Franchise fees are collected at various intervals prior to the opening of a school and are deferred until the franchised school has commenced operations. Real estate service fees are recognized as earned. Assignment fees relate to revenue earned for site identification and preparation for the construction of the building, including zoning permits. Assignment fees are recognized upon the closing of the purchase of the property. School tuition revenue is recognized as earned over the school year. All fees received in advance of time of recognition are recorded as unearned revenue.
Employer cost containment-related service contract revenues are derived from claims management, administrative, consulting services and managed care administration services which are recorded as earned based on the requirements and duration of the related contract. Revenue from the managed care administration services is recognized on a monthly basis based on the contracted administrative fee with the Ohio Bureau of Workers' Compensation. In addition, contract revenue is recorded for certain incentive awards when the claims are processed to which the incentive is related and a bonus award is recorded in the year earned. Revenue on certain contracts has been deferred and is recognized in income on a pro rata basis over the related contract periods, which typically range between 3 and 12 months. Commission expense associated with these contracts is also deferred and recognized as an expense on a pro rata basis over the related contract periods. For services related to group rating contracts, fees are paid to the group's sponsor and netted against contract revenues. Contract revenues received in advance are included in deferred revenues.
2000 1999 1998 ------- ----- ----- Balance at beginning of year .... $ 213 $ 214 $ 119 Amount purchased - acquisition of WC Holdings, Inc. ............. 510 -- -- Provisions ...................... 403 182 200 Deductions ...................... (69) (183) (105) ------- ----- ----- Balance at end of year .......... $ 1,057 $ 213 $ 214 ======= ===== =====
Property and equipment are carried at cost. Significant renewals and betterments to property and equipment are capitalized, and maintenance and repairs that do not improve or extend the lives of the assets are expensed as incurred. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from 3 to 27 years. Leasehold improvements are amortized over the shorter of the useful life or the lease term.
Goodwill relates to the cost in excess of the fair value of the net assets acquired in the purchase business combinations of Possible Dreams, Pumpkin, Primrose, and WC Holdings. Goodwill is being amortized over periods of 20 to 25 years. Patent rights, acquired in such acquisitions, are being amortized over the 9 to 17 year remaining lives of the respective patents.
Deferred financing costs are amortized over the term of the related debt.
Franchise agreements, curriculum, and non-compete agreements related to Primrose are being amortized over periods of 21, 10 and 2 years, respectively. All such assets are being amortized on a straight-line basis.
Financial instruments consist of current assets (except inventories), current liabilities, notes receivable, notes payable, additional payment obligations and long-term debt. Current assets and current liabilities are carried at cost, which approximates fair value. Notes receivable, notes payable, the additional payment obligations and long-term debt bear interest at current market rates and, accordingly, the carrying value of the notes receivable and the debt approximates fair value.
The Company reviews long-lived assets, including goodwill and intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is determined based on future undiscounted net cash flows from the use and ultimate disposition of the asset. Impairment loss is calculated as the difference
Basic earnings per common share amounts are based on the weighted average number of Common and Class A Common shares outstanding. The sum of Common Stock and Class A Common Stock is used because the two classes are identical except for certain transfer restrictions. Diluted earnings per common share are based on the weighted average shares outstanding and the dilutive effect, if any, of outstanding stock options and convertible securities.
The Company computes income taxes using the asset and liability method, under which deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the assets and liabilities, using presently enacted rates.
on January 1, 2001, and addresses the accounting for derivative instruments and hedging activities. The Company has not entered into such types of transactions in the past and does not believe that the adoption of this new statement will have a material effect on the Company's financial statements.
In connection with the financing of the acquisition, the Company borrowed funds under bank credit agreements. Under terms of the bank credit agreements, the borrowings are secured by a pledge of all assets of the WC Holdings businesses, and by the capital stock of WC Holdings held by the Company.
The following unaudited pro forma financial information presents the combined results of the Company and Health Power, Inc as if the acquisition had taken place at the beginning of each period presented. The pro forma amounts give effect to certain adjustments including the amortization of goodwill and intangibles, increased interest expense and income tax effects. This pro forma information does not necessarily reflect the results of operations as they would have been if the business had been managed by the Company during these periods and is not indicative of results that may be obtained in the future:
YEAR ENDED YEAR ENDED DEC. 31, 2000 DEC. 31,1999 Pro-forma: (unaudited) (unaudited)
Goodwill ............................................ $ 18,937 Intangibles, principally franchise agreements ....... 9,522 Other assets ........................................ 1,773 Unearned revenue .................................... (1,600) Accrued liabilities ................................. (1,244) -------- Total ............................................... $ 27,388 ========
Revenue ........................... $40,655 Net income ........................ 1,396 Basic earnings per share .......... .22 Diluted earnings per share ........ $ .22
Land and improvements ............... $ 370 $ 370 Buildings and improvements .......... 1,218 909 Computer equipment and software ..... 6,362 478 Machinery and equipment ............. 428 328 Furniture and fixtures .............. 1,739 174 -------- -------
Possible Dreams' agreement is a $10,000 line of credit, under which borrowing capacity is limited to a defined borrowing base, of which $2,700 and $750 was borrowed at December 31, 2000 and 1999, respectively, at the commercial paper rate of interest plus 4% (10.5% and 9.52% at December 31, 2000 and 1999, respectively). Additional borrowing capacity at December 31, 2000 was $1,644. The agreement expires in 2003.
Primrose's agreement is a $2,500 line of credit, under which $500 was borrowed at both December 31, 2000 and December 31, 1999 at the greater of the prime rate plus 2% or the federal funds rates plus 2.5% (11.5% and 10.5% at December 31, 2000 and 1999, respectively). Additional borrowing capacity under the line was $141 at December 31, 2000. The agreement expires in 2002.
Maturities of long-term debt and other obligations for the next five years are as follows:
$7,840 - 2001; $13,958 - 2002; $12,554 - 2003; $3,314 - 2004; $2,834 - 2005; and $2,834 - thereafter.
The maturities of the Possible Dreams Tranche A and Tranche B term loans and of the Pumpkin Tranche B term loan are subject to acceleration if defined cash flow thresholds are not achieved. Such borrowings are also subject to prepayment penalties.
The Company has a tax sharing agreement with its subsidiaries, under which income tax liabilities at each subsidiary are determined on a stand-alone basis, with amounts payable to
Security Capital as the consolidated taxpayer. With respect to Possible Dream's, Primrose's, Pumpkin's and WC Holdings and subsidiaries' term loan and bank credit arrangements, any amounts remitted to Security Capital in excess of amounts approved by the lender are required to be set aside, and are pledged to the lenders as additional collateral for the borrowings at such subsidiaries. At December 31, 2000, no such amounts were set aside and pledged as collateral under such arrangements.
WC Holdings leases computer equipment under an agreement which is classified as a capital lease. Equipment subject to capital leases with a cost of $360 and accumulated depreciation of $187 at December 31, 2000 is included in property and equipment. At December 31, 2000, future minimum lease payments under the capital lease obligations for the periods ending December 31 are as follows:
Warrants to acquire shares of Possible Dreams, Pumpkin and Primrose are redeemable at the election of the warrant holders for cash. The estimated fair value of the warrants are recorded as liabilities and changes in the estimated fair value of the warrants during a period are included in the results of operations. Warrant expense, classified as "Other (expense) income" was $559, $290 and $180 in the years ended December 31, 2000, 1999 and 1998, respectively. Warrant liabilities, included in "other long-term obligations," were $3,026 and $2,466 at December 31, 2000 and 1999, respectively.
During 2000, the Company retired all of the 318,575 shares held in its treasury returning them to their status of authorized and unissued shares of Common and Class A Common Stock.
The owners of the minority interests in Health Power, Pumpkin and Primrose have each entered into agreements with the Company providing for restrictions on the transfer of such shares, and other related share rights. The minority shareholders of Pumpkin have the right to put their shares of Pumpkin to the Company for cash and the Company has the right to call the shares for cash upon the earlier of (1) June 2003, (2) payment in full of the acquisition indebtedness or (3) anytime after Pumpkin's average EBITDA exceeds $2,500 for a four year period commencing in 1997. The put and call price is determined by using a formula of EBITDA. At the mutual agreement of the parties, settlement can occur in Security Capital Common Stock. If the lender objects to settlement in cash, the Company may issue a subordinate note. Future cash settlement of such puts and calls would result in additional purchase price consideration payable to the former owners of Pumpkin and would result in the recording of additional goodwill relating to the acquisition.
Possible Dreams - Options to acquire 175 shares of Possible Dreams at approximately $1,900 per share were granted in 1996, which were cancelled on January 1, 2000. Options to acquire 87.5 shares at $1,905 per share and 87.5 shares at $3,810 per share of Possible Dreams stock were granted on July 1, 2000. Such options vest over five years and expire in 2009. The Company, but not the holder, has the right to settle the options in cash. In addition, warrants to purchase 250 shares of Possible Dreams Class B common shares were issued in 1996 and remain outstanding at December 31, 2000. The warrants are exercisable at the earlier of (1) May 17, 2001 or (2) repayment in full of the acquisition note and any related interest, at a price of $.01 per share and expire in 2006. Such Class B common shares would be non-voting, but would be convertible at the option of the holder into Class A voting common shares. The holder may exercise the warrants for cash. If all such outstanding options and warrants had been exercised for Possible Dream's shares at December 31, 2000, the Company's ownership share of Possible Dreams would have been 78%.
Pumpkin - Options to acquire a total of 39 Class A common shares of Pumpkin at $1,754 per share were issued in 1997 and 1998. Such options are fully vested and expire in 2007 and 2008. The holder, has the right to settle the options in cash at the earlier of (1) three years of employment (2) June 27, 2003 (3) repayment in full of the acquisition note and any related interest or (4) any time after average EBITDA exceeds $2,500 for a four year period commencing in 1997. In addition, warrants to purchase 100 shares of Pumpkin's Class B common stock at $.01 per share were issued in 1997 and remain outstanding at December 31, 2000. Class B common shares would be non-voting, but would be convertible into Class A voting shares at the option of the holder. The warrants are exercisable at the earlier of (1) June 27, 2002 or (2) repayment in full of the acquisition note and any related interest. Such warrants expire in 2007. The holder may exercise the warrants for cash. If all such outstanding options and warrants had been exercised for Pumpkin shares at December 31, 2000, the Company's ownership share of Pumpkin would have been 69%.
Primrose - Options to acquire 2,311 common shares of Primrose at $500 per share were issued in 1999 and expire in 2009. 462 options are currently exercisable. The holder has the right to settle the options in cash. Warrants to acquire 2,415.3 shares of Primrose at $.01 per share were issued in connection with the acquisition in 1999. The holder may exercise the warrants at the earlier of (1) April 6, 2004 (2) any public offering of Primrose pursuant to a registration statement, a private placement or otherwise or (3) any private sale of Primrose representing 20% or more of Primrose stock, for shares of Primrose, exchange value of the warrants for an equivalent value of shares of Security Capital, or be paid for the value of the warrants in cash. If all such outstanding options and warrants had been exercised for Primrose shares at December 31, 2000, the Company's ownership share of Primrose would have been 83%.
The Company sponsors defined contribution 401(k) plans at each of its subsidiaries for which qualifying employees of the Company may participate. Employees must be twenty-one years of age to participate. Under these plans - some of which include Company matching contributions - participants may elect to make pretax contributions of up to 15% of their eligible earnings.
Options granted under the 2000 long-term incentive plan are exercisable at the market price at the date of grant and, subject to termination of employment, expire ten years from the date of grant, are not transferable other than on death, and are exercisable in four equal annual installments commencing one year from the date of grant.
Pro forma information regarding net income and earnings per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 2000: risk-free interest rate of 5.16% and dividend yield of 0%; volatility factors of the expected market price of the Company's common stock of .32 and a
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes 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.
A summary of the Company's stock option activity, and related information for the year ended December 31, 2000 follows:
Exercisable at the end of the year 16 $6.125 ====== ======
Interest income ............. $ 25 $ 33 $ 347 Warrant expense ............. (559) (290) (180) Other ....................... 27 21 32 ----- ----- -----
The Company has an agreement with Capital Partners, Inc. ("CPI"), a shareholder of the Company. CPI and its affiliates and principals owned 83% of the Company's common shares at both December 31, 2000 and 1999. Under the agreement, CPI provides certain advisory services and management services related to investments, general administration, corporate development, strategic planning, stockholder relations, financial matters and general business policy. Fees paid by the Company to CPI are based upon the greater of either a fixed dollar amount or 5% of earnings before income taxes, depreciation and amortization, as defined. Subsequent to the acquisition of WC Holdings, the minimum annual fixed dollar amount is $1,095. Fees paid to CPI are generally subordinate to the rights of the lenders to the Company. In addition, the Company has agreed to pay fees to CPI for acquisition opportunities presented to the Company by CPI at a usual and customary rates for investment banking fees for transactions of similar size and complexity. The agreement is renewable annually. Fees incurred by the Company to CPI were $1,153, $1,092 and $500 in the years ended December 31, 2000, 1999 and 1998, respectively.
2001 and 2002, respectively. The Company also has operating leases at other subsidiaries which contain renewal options and escalation clauses.
The Company had rents expense of $563, $362, and $131 for 2000, 1999, and 1998, respectively.
Total assets at the holding company net of investments in and amounts due from subsidiaries was approximately $735 which includes approximately $200 of current assets at December 31, 2000. In addition the redeemable convertible preferred stock discussed in Note 9 is a holding company obligation.
Following the 2000 acquisition of WC Holdings and the 1999 acquisition of Primrose, the Company has three segments. The seasonal products segment consists of the Company's activities principally in the design, importing and manufacturing of Halloween and Christmas products, the educational segment consists of Primrose, and the employer cost containment-related service segment consists of WC Holdings who, through its subsidiary Health Power, provides services to corporations and their employees primarily relating to industrial health and safety, industrial medical care and workers' compensation insurance. Management evaluates performance of its segments based upon adjusted EBITDA, defined for the purposes of the segment disclosures as earnings before interest, taxes, depreciation, amortization, minority interest expense, management fees and non-recurring charges or gains. EBITDA is used to evaluate performance because the Company feels that it is the true measurement of its ability to generate cash flow and is a widely-accepted financial indicator of value and ability to incur and service debt. EBITDA is not a substitute for operating income or cash flow from operating activities in accordance with accounting principles generally accepted in the United States. The accounting policies of the segments are the same as those described in Note 1.