The Company leases approximately 16,800 square feet of office space at 650 Townsend Street, San Francisco, California, which expires on July 31, 2005. Substantially all of this space has been sublet for the remaining term of the lease.
The following is a summary of selected consolidated financial data of the Company for each of the last five years. The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and related notes thereto and "Management's Discussions and Analysis of Financial Condition and Results of Operations" included elsewhere in this annual report on Form 10-K.
The following is a summary of the results of operations for the Company (in thousands):
Statutory Capital and Surplus as determined under statutory accounting principles of over $27.2 million; this is an increase of $4.8 million or 21.3% from the previous year.
Premiums increased to $37.8 million in the year ended December 31, 2003 from $6.9 million in the year ended 2002.
In a separate transaction on July 30, 2002, IHC acquired Pacific Century Cyberworks Limited's ("PCCW") entire interest in the Company consisting of 1,666,666 shares of common stock at $9.00 per share for a total value of $15,000,000. As a result of this transaction, PCCW's two appointees resigned from the Company's Board of Directors, and Edward Netter, Chairman of IHC, and Roy T.K. Thung, President and Chief Executive Officer of IHC, were appointed to the Company's Board of Directors. On April 22, 2003, a wholly-owned subsidiary of IHC completed its tender for one million shares of the common stock of the Company at $9.00 per share for a total value of $9,000.000. On December 22, 2003, IHC purchased an aggregate of 613,401 shares in the market and private transactions. As a result of these transactions, IHC and its subsidiary own 39% of the Company.
As of December 31, 2003, the Company had substantially completed the wind down of its Internet services related subsidiaries, ISP Channel, Intellicom, and Aerzone, including Laptop Lane Limited ("Laptop Lane"), as a result of the following:
On December 7, 2000, the Company's Board of Directors approved a plan to discontinue its ISP Channel operations because of (1) the consolidation in the cable industry made it difficult for ISP Channel to achieve the economies of scale necessary to provide such services profitably, and (2) the Company was no longer able to bear the costs of maintaining the ISP Channel. On March 29, 2002, the Company and its wholly-owned subsidiary, Intellicom, entered into an agreement to sell its operating business and certain assets to Loral Cyberstar, Inc. Following the sale of its operating business and certain assets to Loral Cyberstar, Inc., the Company's Board of Directors unanimously agreed to cease the operations of Intellicom on April 3, 2002.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the period in which those temporary difference become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Management believes that although sufficient uncertainty exists regarding the future realization of deferred tax assets, the valuation allowance has been adjusted to account for the expected utilization of net operating losses against future taxable income. 	The Company has net operating loss carryforwards for federal income tax purposes available to reduce future income subject to income taxes. The net operating loss carryforwards expire between 2009 and 2023.
In accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, goodwill and intangible assets with indefinite lives resulting from business combinations will not be amortized but instead will be tested for impairment at least annually (more frequently if certain indicators are present). In the event that the management of the Company determines that the value of goodwill or intangible assets with indefinite lives has become impaired, the Company will incur an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made.
Premiums from short-duration contracts will be recognized as revenue over the period of the contracts in proportion to the amount of insurance protection provided. The Company records MGU fee income as policy premium payments are earned. MGUs are compensated in two ways. They earn fee income based on the volume of business produced, and collect profit-sharing commissions if such business exceeds certain profitability benchmarks. Profit-sharing commissions are accounted for beginning in the period in which the Company believes they are reasonably estimable. While profit-sharing commissions are a function of an MGU attaining certain profitability thresholds and could greatly vary from quarter to quarter, AMIC's MGUs price their business to an anticipated profit margin in excess of such thresholds.
Results of Operations for the Fiscal Year Ended December 31, 2003, Compared to the Fiscal Year Ended September 30, 2002
Due to the acquisition of the insurance operations of IAHC, certain line items only appear in the fiscal 2003 and in the quarter ended December 31, 2002 Consolidated Statement of Operations.
Premiums Earned. The Company earned $37,817,000 of premiums on insurance business of Independence American for fiscal 2003.
Amortization and Depreciation. Amortization and depreciation expense increased $1,822,000 to $2,011,000 for fiscal 2003, compared to $189,000 for fiscal 2002. The expense for fiscal 2003 mainly relates to the amortization of the intangible assets for the value of broker/TPA relationships of the MGUs. These intangible assets were acquired as part of the acquisitions of IAHC and Marlton.
Net Income/Loss. The Company had net income of $12,671,000, or $1.50 per share, diluted, for fiscal 2003, compared to a net loss of $14,756,000, or a net loss per share of $1.76, diluted, for the year ended September 30, 2002.
Selling, General and Administrative. Selling, general and administrative expenses decreased $2,698,000 to $7,318,000 for the year ended September 30, 2002, compared to $10,016,000 for the year ended September 30, 2001, primarily due to staff reductions associated with the December 28, 2000 corporate restructuring plan.
Amortization and Deprecation. Amortization and depreciation decreased $161,000 to $189,000 for the year ended September 30, 2002, compared to $350,000 for the year ended September 30, 2001, primarily due to sales and disposal of property.
Non-Cash Compensation Expense (Benefit) Related to Stock Options. The Company recognized a non-cash compensation expense related to stock options of $1,466,000 for the year ended September 30, 2002, compared to non-cash compensation benefit related to stock options of $807,000 for the year ended September 30, 2001. For the year ended September 30, 2002 and 2001, non-cash compensation expense/benefit related to stock options issued to employees primarily relates to the amortization of deferred stock compensation resulting from below market value stock options granted between October 1998 and March 1999, accounted for under APB 25.
Equity in Net Losses of Investee Companies. The Company recognized equity in net losses of investee companies of $394,000 for the year ended September 30, 2001. The Company did not incur any equity in net losses of investee companies for the year ended September 30, 2002, as a result of the sale and write offs of investee companies accounted for under the equity method for the year ended September 30, 2001.
Income Taxes. The Company made no provision for income taxes for the year ended September 30, 2002 and 2001, as a result of the Company's continuing losses.
Premiums Earned. The Company earned $1,636,000 of premiums on insurance business of Independence American for the six weeks ended December 31, 2002.
Net cash provided by operating activities of continuing operations for the fiscal year ended December 31, 2003 was $14,713,000. This results from net income of $12,671,000, a gain of $110,000 from discontinued operations and a net decrease in the remaining assets and liabilities of $2,152,000 which includes several non-cash items including stock compensation expense of $141,000, realized gains of $330,000 and amortization and depreciation expense of $2,011,000. Net cash used in operating activities of discontinued operations was $2,960,000.
Net cash used by investing activities of continuing operations for the fiscal year ended December 31, 2003 was $17,106,000. This use of cash results from the acquisition of Marlton for $16,102,000, and net cash used of $1,002,000 from purchases of all other investments, net of purchases.
The Company believes it has sufficient cash to meet its presently anticipated business requirements over the next twelve months including the funding of discontinued operations, working capital requirements, and capital investments.
The Company normally generates cash flow from (i) operations; (ii) the receipt of scheduled principal payments on its portfolio of fixed income securities; and (iii) earnings on investments. Such cash flow is partially used to finance liabilities for insurance policy benefits. These liabilities represent long-term and short-term obligations that are calculated using certain assumed interest rates.
The Company reviews its investments regularly and monitors its investments continually for impairments. The Company's gross unrealized losses on fixed maturities totaled $401,000 at December 31, 2003. Substantially all of these securities were investment grade. The remaining unrealized losses have been evaluated in accordance with the Company's policy and were determined to be temporary in nature at December 31, 2003. The Company holds all securities as available-for-sale and accordingly marks all of its securities to market through accumulated other comprehensive income (loss).
The following summarizes the estimated pre-tax change in fair value (based upon hypothetical parallel shifts in the U.S. Treasury yield curve) of the fixed income portfolio assuming immediate changes in interest rates at specified levels at December 31, 2003:
In the Company's analysis of the asset-liability model, a 100 to 200 basis point change in interest rates on the Company's liabilities would not be expected to have a material adverse effect on the Company. With respect to its investments, the Company employs (from time to time as warranted) investment strategies to mitigate interest rate and other market exposures.
Total investments decreased $2,652,000 to $38,258,000 at December 31, 2003 from $40,910,000 at September 30, 2002, largely due to the use of cash to acquire Marlton, particularly offset by the growth in business 2003. The $17,858,000 increase in insurance policy benefits reflects growth in the business. The $6,463,000 increase in total stockholders' equity is mainly due to net income generated in the three months ended December 31, 2002 and during fiscal 2003.
The Company had net receivables from reinsurers of $4,299,000 at December 31, 2003. Substantially all of the business ceded to such reinsurers is of short duration. All of such receivables are either due from highly rated companies or are adequately secured. No allowance for doubtful accounts was deemed necessary at December 31, 2003.
Due to its strong capital ratio and excellent asset quality and credit-worthiness, the Company remains well positioned to increase or diversify its current activities. It is anticipated that future acquisitions or other expansion of operations will be funded internally from existing capital and surplus and parent company liquidity. In the event additional funds are required, it is expected that they would be borrowed or raised in the public or private capital markets to the extent determined to be necessary or desirable
Under certain circumstances set forth in the Limited Liability Company Agreement of Marlton, the Company has the right and/or obligation to purchase some or all of the minority interests in Marlton.
In accordance with SFAS No. 115, the Company may carry its portfolio of fixed income securities either as held to maturity (carried at amortized cost), as trading securities (carried at fair value) or as available-for-sale (carried at fair value). The Company has chosen to carry all of its debt securities as available-for-sale. The Company experienced a change in net unrealized loss of $ 60,000, reflecting net unrealized loss of $66,000 at December 31, 2003 from net unrealized losses of $6,000 at September 30, 2002. From time to time, as warranted, the Company employs investment strategies to mitigate interest rate and other market exposures.
Independence American is also positioning itself to be an issuing carrier of medical stop-loss. Currently, it has approved employer medical stop-loss policies in 15 states and approved provider excess loss policies in 13 states. Independence American anticipates writing more provider business in 2004. Independence American is actively seeking more licenses and product approvals, and has also positioned itself to be an issuing carrier of employer medical stop loss at the appropriate time (through the AMIC MGUs and otherwise) to augment its reinsurance operations.
In May 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" which requires an issuer of mandatory redeemable financial instruments to classify such instruments as a liability and to measure such liability at its present value, using the rate implicit at the inception of the contract. In addition, all future dividends paid to holders of those instruments are to be reflected as interest cost. As originally issued, SFAS No. 150 was effective for all 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 for financial instruments that were in existence prior to May 31, 2003. However, the effective date of the statement's provisions related to the classification and measurement of certain mandatory non-controlling interests has been deferred indefinitely by the FASB, pending further Board action. Upon adoption of SFAS No. 150, transition is achieved by reporting the difference (if any) between the measurement of the liability upon adoption and the previous carrying value as the cumulative effect of a change in accounting principle. The adoption of SFAS No. 150 did not have any effect on the Company's consolidated financial statements
In December 2003, the FASB issued FASB Interpretation No. 46 (revised), Consolidation of Variable Interest Entities ("FIN 46R"), which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and, accordingly, should consolidate the variable interest entity ("VIE"). FIN 46R replaces FASB Interpretation No. 46 that was issued in January 2003. The Company is required to apply FIN 46R to special-purpose entities as of December 31, 2003 and to other VIEs no later than as of March 31, 2004. For any VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the assets, liabilities and non-controlling interest of the VIE initially would be measured at their carrying amounts, and any difference between the net amount added to the balance sheet and any previously recognized interest would be recorded as a cumulative effect of an accounting change. The adoption of FIN 46R as of December 31, 2003 did not have a material impact on the Company. The Company held no interests in VIEs that were required to be consolidated under FIN 46R as of December 31, 2003.
From time to time, information provided by the Company, including but not limited to statements in this report, or other statements made by or on behalf of the Company, may contain "forward-looking" information within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements involve a number of risks, uncertainties and contingencies, many of which are beyond the Company's control, which may cause actual results, performance or achievements to differ materially from those anticipated. Set forth below are important factors that could cause the Company's results, performance or achievements to differ materially from those in any forward-looking statements made by or on behalf of the Company. FACTORS AFFECTING THE COMPANY'S OPERATING RESULTS
The Occurrence of Various Events May Adversely Affect the Company's Ability to Utilize Fully Its Tax Net Operating Loss Carryforwards.
Results May Fluctuate as a Result of Factors Generally Affecting the Insurance and Reinsurance Industry
Events like the September 11, 2001 attacks, which affected the insurance and reinsurance markets generally;
Independence American, the Company's insurance subsidiary, primarily reinsures accident and health insurance. Rates for accident and health insurance and reinsurance are influenced primarily by factors that are outside of Independence American's control and historically have been highly cyclical. Any significant decrease in the rates for accident and health insurance or reinsurance could reduce the Company's net income.
The Company's Loss Reserves are Based on an Estimate of Its Future Liability, and if Actual Claims Prove to be Greater Than Reserves, the Company's Results of Operations and Financial Condition May be Adversely Affected.
The Company maintains loss reserves to cover its estimated liability for unpaid losses and loss adjustment expenses, including legal and other fees as well as a portion of its general expenses, for reported and unreported claims incurred as of the end of each accounting period. Because setting reserves is inherently uncertain, the Company cannot assure that current reserves will prove adequate in light of subsequent events. If the Company reserves are insufficient to cover its actual losses and loss adjustment expenses, it would have to augment its reserves and incur a charge to its earnings, and these charges could be material. Reserves do not represent an exact calculation of liability. Rather, reserves represent an estimate of what the Company expects the ultimate settlement and administration of claims will cost. These estimates, which generally involve actuarial projections, are based on the Company's assessment of facts and circumstances then known, as well as estimates of future trends in claims severity, frequency, judicial theories of liability and other factors. These variables are affected by both internal and external events, such as changes in claims handling procedures, inflation, judicial trends and legislative changes. Many of these items are not directly quantifiable in advance. Additionally, there may be a significant reporting lag between the occurrence of the insured event and the time it is reported. The inherent uncertainties of estimating reserves are greater for certain types of liabilities, particularly those in which the various considerations affecting the type of claim are subject to change and in which long periods of time may elapse before a definitive determination of liability is made. Reserve estimates are continually refined in a regular and ongoing process as experience develops and further claims are reported and settled. Adjustments to reserves are reflected in the results of the periods in which such estimates are changed.
Inability to Assess Underwriting Risk Accurately Could Reduce Its Net Income
The Company's industry is highly competitive and has experienced severe price competition from time to time over the last several years. The Company faces competition from domestic and international insurance and reinsurance companies, underwriting agencies, and from diversified financial services companies that are significantly larger than the Company. Some of these competitors have greater financial, marketing and other resources, have been operating longer than the Company and have established long-term and continuing business relationships through the industry, which can be a significant competitive advantage. In addition to competition in the operation of its business, the Company faces competition from a variety of sources in attracting and retaining qualified employees. The Company cannot assure that it will maintain its current competitive position in the markets in which it operates, or that it will be able to expand its operations into new markets and compete effectively in the future. If the Company fails to do so, its business could be materially adversely affected.
Prescribing the form and content of records of financial condition required to be filed; and
Certain Proposed Federal and State Legislation May, if Adopted, Adversely Affect the Company's Reinsurance of Medical Stop-Loss.
At December 31, 2003, $31.0 million of the Company's $38.3 million investment portfolio was invested in fixed income securities. The fair market value of these fixed income securities and the investment income from these fixed income securities fluctuate depending on general economic and market conditions. With respect to the Company's investments in fixed income securities, the fair market value of these investments generally increases or decreases in an inverse relationship with fluctuations in interest rates, while net investment income realized by the Company from future investments in fixed income securities will generally increase or decrease with interest rates. In addition, actual net investment income and/or cash flows from investments that carry prepayment risk, such as mortgage-backed and other asset-backed securities, may differ from those anticipated at the time of investment as a result of interest rate fluctuations. An investment has prepayment risk when there is a risk that the timing of cash flows that result from the repayment of principal might occur earlier than anticipated because of declining interest rates or later than anticipated because of rising interest rates. Historically, the impact of market fluctuations has affected the Company's financial statements. Because all of the Company's fixed income securities are classified as available for sale, changes in the fair market value of the Company's securities are reflected in the Company's other comprehensive income. Similar treatment is not available for liabilities. Therefore, interest rate fluctuations and economic conditions could aversely affect the Company's stockholders' equity, total comprehensive income (loss) and/or cash flows.
The Company is a Delaware corporation. The Delaware General Corporation Law contains certain provisions that may discourage or delay a change in control of the Company, make a change in control the Company more difficult or prevent the removal of incumbent directors. In addition, the Company's certificate of incorporation and bylaws contain certain provisions that have the same or a similar effect. These provisions may have a negative impact on the price of the Company's common stock and may discourage third-party bidders from making a bid for the Company or may reduce any premiums paid to stockholders for their common stock.
Consolidated Balance Sheets as of December 31, 2003 and September 30, 2002
Consolidated Statements of Operations for the fiscal years ended December 31, 2003,
September 30, 2002 and 2001, and for the three months ended December 31, 2002
We have audited the accompanying consolidated balance sheets of American Independence Corp. (formerly SoftNet Systems, Inc.) and subsidiaries ("the Company") as of December 31, 2003 and September 30, 2002, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for the year ended December 31, 2003, for the three months ended December 31, 2002 and for the years ended September 30, 2002 and 2001. In connection with our audits of the financial statements, we have also audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
Prior to November 14, 2002, the Company (then known as SoftNet Systems, Inc.) was a holding company principally engaged in providing Internet services. As of September 30, 2002, the Company had discontinued the businesses of ISP Channel, Inc. ("ISP Channel"), Intelligent Communications, Inc. ("Intellicom") and Aerzone Corporation ("Aerzone"), including Laptop Lane Limited ("Laptop Lane"), and reduced its corporate headquarters staff. Four previously reported business segments, business center services, satellite-based Internet services, cable-based Internet services and document management, have ceased operations or have been sold, and accordingly are reported as discontinued operations (see Note 3).
Independence Holdings Company ("IHC"), an insurance holding company, held 39% of AMIC's outstanding common stock at December 31, 2003.
The consolidated financial statements include the accounts of AMIC and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
On February 13, 2003, the shareholders of the Company voted in favor of a one-for-three reverse stock split. The purpose of the reverse stock split was to increase the Company's stock price to over $5.00 per share in order to avoid a delisting of the Company's common stock from the Nasdaq National Market. Although currently listed on the NASDAQ National Market, the Company was required to comply with NASDAQ's initial listing requirements because of the discontinuation of its prior business and acquisition of its current insurance operations. The effect of the reverse split has been reflected in all periods in the accompanying consolidated financial statements and notes thereto.
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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 the revenues and expenses during the reporting period. Actual results could differ from those estimates.
The Company evaluates long-lived assets for impairment annually or whenever current events or changes in circumstances, that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset. The amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. Fair Value of Financial Instruments
Financial instruments sold, but not yet purchased, represent obligations to replace borrowed securities that have been sold. Such transactions occur in anticipation of declines in the fair value of the securities. The Company's risk is an increase in the fair value of the securities sold in excess of the consideration received, but that risk is mitigated as a result of relationships to certain securities owned. Unrealized gains or losses on open transactions are credited or charged, as appropriate, to the Consolidated Statements of Operations. While the transaction is open, the Company will also incur an expense for any accrued dividends or interest payable to the lender of the securities. When the transaction is closed, the Company realizes a gain or loss in an amount equal to the difference between the price at which the securities were sold and the cost of replacing the borrowed securities. Gains or losses on sales of securities are determined on the basis of specific identification. The Company enters into derivative financial instruments, such as put and call option contracts and options on interest rate futures contracts, to minimize losses on portions of the Company's fixed income portfolio in a rapidly changing interest rate environment. Equity index options are entered into to offset price fluctuations in the equity markets. These derivative financial instruments are all readily marketable and are carried on the Consolidated Balance Sheets at their current fair value with changes in unrealized gains or losses, credited or charged, as appropriate, directly to the Consolidated Statements of Operations. All realized gains and losses are reflected currently in the Consolidated Statements of Operations. Fair value is determined by quoted market prices, where available, or by independent pricing services.
The Company reviews its investment securities regularly and determines whether other than temporary impairments have occurred. If a decline in fair value is judged by management to be other than temporary, a loss is recognized by a charge to the Consolidated Statement of Operations, establishing a new cost basis for the security. The factors considered by management in its regularly review include, but are not limited to: the length of time and extent to which the fair value has been less than cost; the financial condition and near-term prospects of the issuer; adverse changes in ratings announced by one or more rating agencies; whether the issuer of a debt security has remained current on principal and interest payments; whether the decline in fair value appears to be issuer specific or, alternatively, a reflection of general market or industry conditions; and the Company's intent and ability to hold the security for a period of time sufficient to allow for a recovery in fair value. For securities within the scope of Emerging Issues Task Force Issue 99-20, such as purchased interest-only securities, an impairment loss is recognized when there has been a decrease in expected cash flows combined with a decline in the security's fair value below cost.
Premiums from short-duration contracts will be recognized as revenue over the period of the contracts in proportion to the amount of insurance protection provided. The Company records MGU fee income as policy premium payments are earned. MGUs are compensated in two ways. They earn fee income based on the volume of business produced, and collect profit-sharing commissions if such business exceeds certain profitability benchmarks. Profit-sharing commissions are accounted for beginning in the period in which the Company believes they are reasonably estimable. Profit-sharing commissions are a function of an MGU attaining certain profitability thresholds and could greatly vary from quarter to quarter.
Liabilities for insurance policy benefits on short-term medical coverages were computed using completion factors and expected loss ratios derived from actual historical premium and claim data. These methods are widely used in the health insurance industry to estimate the liabilities for insurance policy benefits. Inherent in these calculations are management and actuarial judgments and estimates (within industry standards) which could significantly impact the ending reserve liabilities and, consequently, operating results. Actual results may differ, and these estimates are subject to interpretation and change. Management believes that the Company's method of estimating the liabilities for insurance policy benefits provides an adequate level of reserves.
Amounts paid for or recoverable under reinsurance contracts are included in total assets or total liabilities as due from reinsurers or due to reinsurers.
At December 31, 2003 and September 30, 2002, the Company had goodwill of $23,668,000 and $0, respectively. The Company completed its annual impairment testing of goodwill in 2003 and an impairment charge was not required. At December 31, 2003 and September 30, 2002, the Company had other intangible assets of $2,747,000 and $0, respectively, which are amortizable over the expected useful lives of the asset.
The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial carrying amounts of existing assets and liabilities and their respective tax basis, and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets where it is more likely than not that the deferred tax asset will not be realized (see Note15).
Effective October 1, 2002, the Company adopted certain provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation"("SFAS 123"). SFAS 123 established a fair-value-based method of accounting for stock-based compensation plans. Pursuant to the transition provisions of SFAS 123, the Company will apply the fair value method of accounting to all option grants issued on or after October 1, 2002. The fair value method will not be applied to stock option awards granted prior to October 1, 2002. Such awards will continue to be accounted for under the intrinsic value method pursuant to APB 25, except to the extent those prior years' awards are modified subsequent to October 1, 2002.
Basic earnings (loss) per common share is computed using the weighted average number of common stock shares outstanding during the period. Diluted earnings (loss) per common share is computed using the weighted average number of common stock shares and common stock equivalent shares outstanding during the period. Common stock equivalents consist of convertible preferred stock (using the "as if converted" method), stock options and stock warrants (using the "treasury stock" method). Common Stock equivalent shares are excluded from the computation if the effect is anti-dilutive. As a result of the anti-dilutive effect, common stock equivalent shares have been excluded from the computation of diluted earnings per share for periods presented with a net loss.
In May 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" which requires an issuer of mandatorily redeemable financial instruments to classify such instruments as a liability and to measure such liability at its present value, using the rate implicit at the inception of the contract. In addition, all future dividends paid to holders of those instruments are to be reflected as interest cost. As originally issued, SFAS No. 150 was effective for all 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 for financial instruments that were in existence prior to May 31, 2003. However, the effective date of the statement's provisions related to the classification and measurement of certain mandatory non-controlling interests has been deferred indefinitely by the FASB, pending further Board action. Upon adoption of SFAS No. 150, transition is achieved by reporting the difference (if any) between the measurement of the liability upon adoption and the previous carrying value as the cumulative effect of a change in accounting principle. The adoption of SFAS No. 150 did not have any effect on the Company's consolidated financial statements
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The provisions of SFAS No. 149 are to be applied prospectively. Provisions that relate to Statement 133 implementation issues that have been effective for fiscal quarters than began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. The adoption of SFAS No. 149 did not have an impact on the Company's consolidated financial statements.
In a separate transaction, on July 30, 2002, IHC acquired Pacific Century Cyberworks Limited's ("PCCW") entire interest in the Company consisting of 1,666,666 shares of common stock at $9.00 per share for a total value of $15,000,000. As a result of this transaction, PCCW's two appointees resigned from the Company's Board of Directors, and Edward Netter, Chairman of IHC, and Roy T.K. Thung, President and Chief Executive Officer of IHC, were appointed to the Company's Board of Directors. On April 22, 2003, a wholly-owned subsidiary of IHC completed its tender for one million shares of the common stock of the Company at $9.00 per share for a total value of $9,000.000. In December, 2003, IHC purchased an aggregate of 613,401 shares in the market and private transactions at $11.12 per share for a total value of $ 6,821,000. As a result of these transactions, IHC and its subsidiary own 3,280,067 shares, or 39% of the Company.
Of the total purchase price, approximately $12,395,000 has been allocated to goodwill and intangible assets with indefinite lives. Goodwill represents the excess of the purchase price of an acquired business over the fair value of the underlying net tangible and intangible assets. Intangible assets with indefinite lives consist of the estimated fair value allocated to the licenses of Independence American Insurance Company.
Gross gains of $1,449,000 and gross losses of $1,119,000 were realized on sales of available-for-sale securities for the year ended December 31, 2003. During 2003, the Company did not record any losses on securities with declines in fair value that the Company considered to be other than temporary.
Gross gains of $12,000 and no gross losses were realized on sales of available-for-sale securities for the quarter ended December 31, 2002. During this period, the Company recorded $1,000,000 of losses on equity investments with declines in fair value that the Company considered to be other than temporary.
Net realized gains on investments for fiscal years 2003 and the quarter ended December 31, 2002 are as follows:
In the transition period ending December 31, 2002, the Company wrote off its investment in 337,496 series B preferred stock shares of Dotcast.com for $1,000,000 as an other-than-temporary decline. Dotcast.com is a privately held company developing a national high-speed digital network for the distribution of digital entertainment, interactive services and multimedia communications.
1,133,000 common stock shares and $1,700,000 promissory note and accrued interest in China Broadband Corporation ("China Broadband") sold to China Broadband for $1,000,000 resulting in a loss of $9,630,000 related to the 1,133,000 China Broadband common stock shares, and a loss of $768,000 related to the $1,700,000 promissory note and accrued interest;
$39,000 carrying value of its joint venture in Pacific Century SoftNet; and
Until April 2002, the Company (then known as SoftNet Systems, Inc.) was an Internet service provider. Due to difficult and deteriorating conditions in that market, the Company discontinued this business. In December 2000, the Company's board of directors approved a plan to discontinue the operations of its subsidiary, ISP Channel, Inc., which had provided cable-based Internet access and related services, and the operations of another subsidiary, Aerzone Corporation, which provided Internet and related services at airports. In April 2002, the Company, ceased operations of its remaining operating subsidiary, Intelligent Communications, Inc., following the disposition of its key assets. In connection with the Company's exit from the Internet provider business, it undertook a process of consideration of strategic alternatives for the Company.
Prior to becoming an insurance holding company as a result of the acquisition of IAHC on November 14, 2002, the Company was a holding company principally engaged in providing Internet services through the following discontinued operations, Intelligent Communications, Inc. ("Intellicom"), Aerzone, ISP Channel, KCI, and MTC. The operating results of these discontinued operations have been segregated from continuing operations and are reported as a gain or loss from discontinued operations on the consolidated statements of operations. Although it is difficult to predict the final results, the gain or loss on disposition from discontinued operations includes management's estimates of costs to wind down the business and costs to settle its outstanding liabilities. The actual results could differ from these estimates. The net liabilities associated with discontinued operations are reflected in net liabilities associated with discontinued operations in the accompanying consolidated balance sheets.
On January 24, 2000, the Company founded Aerzone (formerly SoftNet Zone, Inc.) to provide high-speed Internet access to global business travelers. As part of the Aerzone business, the Company acquired Laptop Lane, on April 21, 2000. On December 19, 2000, the Company decided to discontinue the Aerzone business in light of significant long-term capital needs and the difficulty of securing the necessary financing because of the current state of the financial markets. The Company has a remaining reserve for discontinued operations of Aerzone of $27,000 at December 31, 2003.
On December 7, 2000, the Company's Board of Directors approved a plan to discontinue providing cable-based Internet services through its ISP Channel subsidiary by December 31, 2000, because consolidation in the cable television industry made it difficult for ISP Channel to achieve the economies of scale necessary to provide such services profitably, and the Company was no longer able to bear the costs of maintaining the ISP Channel. The Company has a remaining reserve of $153,000 at December 31, 2003 relating to the discontinued operations of ISP Channel.
As a result of an arbitration decision related to the sale of MTC to Global Information Distribution GmbH ("GID"), which was sold on December 31, 1999 the Company has a remaining reserve of $49,000 relating to the loss on disposition of MTC at December 31, 2003.
As a result of the February 12, 1999 sale of the assets of the telecommunications segment, KCI, to Convergent Communications Services, Inc. ("Convergent Communications"), the Company has a remaining reserve of $20,000 relating to the loss on disposition of KCI at December 31, 2003. The loss primarily relates to additional state taxes for periods prior to the sale of KCI to Convergent Communications.
Net liabilities associated with discontinued operations at December 31, 2003 and September 30, 2002 are as follows (in thousands):
The Company has operating leases for office space and certain other office equipment. These operating leases provide for minimum rents and generally include options to renew for additional periods. The Company has subleased its principal executive offices.
Future minimum lease payments under non-cancelable operating leases as of December 31, 2003, are as follows (in thousands):
On November 9, 2001, Nokia Inc. ("Nokia") commenced an action in San Francisco Superior Court against the Company and Aerzone Corporation ("Aerzone"), alleging breach of contract arising out of Aerzone's proposed operations in certain airports. The Company settled this claim in April, 2003 within applicable reserved amounts.
On October 30, 2001, Global Information Distribution GmbH ("GID") commenced a demand for arbitration against the Company, alleging breach of contract and warranties relating to the sale of Micrographic Technology Corporation ("MTC") to GID on September 30, 1999. On January 16, 2003, the arbitrator awarded GID $512,000 as the balance of uncollected accounts receivable as of August 31, 2002 net of specific reserves. GID's claims for interest, collection costs, related expenses and attorneys' fees were settled in full in April, 2003 within applicable reserved amounts.
The Company is also involved in certain legal proceedings and claims, which arise in the ordinary course of its businesses. The Company has established reserves that it believes are sufficient given information presently available related to its outstanding legal proceedings and claims. The Company believes the results of the other pending legal proceedings and claims are not expected to have a material adverse effect on its results of operations, financial condition or cash flows.
In a separate transaction, on July 30, 2002, IHC acquired Pacific Century Cyberworks Limited's ("PCCW") entire interest in the Company consisting of 1,666,666 shares of common stock at $9.00 per share for a total value of $15,000,000. As a result of this transaction, PCCW's two appointees resigned from the Company's Board of Directors, and Edward Netter, Chairman of IHC, and Roy T.K. Thung, President and Chief Executive Officer of IHC, were appointed to the Company's Board of Directors. On April 22, 2003, a wholly-owned subsidiary of IHC completed its tender for one million shares of the common stock of the Company at $9.00 per share for a total value of $9,000.000. On December 22, 2003, IHC purchased an aggregate of 613,401 shares in the market and private transactions at $11.12 per share for a total value of $6,827,000. As a result of these transactions, IHC and its subsidiary own 39% of the Company.
On February 22, 2000, the Company adopted ESPP, which provides for eligible Company employees to purchase common stock shares through payroll deductions. On February 2, 2001, the Company's Board of Directors agreed to suspend ESPP indefinitely beginning July 1, 2001.
Effective October 1, 1998, the Company implemented the 1998 Plan, which the Company's stockholders approved on April 13, 1999. The 1998 Plan provides for the grants of non-statutory and incentive stock options, stock appreciation rights, restricted stock awards, performance shares, and other awards to officers, employee and other individuals. Under the terms of the 1998 Plan, stock options have a maximum term of ten years from the date of grant, and have various vesting criteria depending on the grant with most grants vesting 25% on the first year anniversary date of the grant and ratably over the next 36 months. In addition, the number of common stock shares reserved for issuance under the 1998 Plan will automatically increase on the first trading day of each calendar year, beginning in calendar year 2000, by an amount equal to four percent of the total number of common stock shares outstanding on the last trading day of the preceding calendar year, but in no event will any such annual increase exceed 666,666 shares, subject to adjustment for subsequent stock splits, stock dividends and similar transactions. At December 31, 2003, a total of 2,493,695 common stock shares are reserved for issuance under the 1998 Plan. At December 31, 2003, stock options for 454,933 common stock shares were outstanding, stock options for 383,757 common stock shares were vested, and 2,042,096 common stock shares remained available for future stock options grants and other awards.
On November 14, 2002, the Company adopted certain provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation"("SFAS 123"). SFAS 123 established a fair-value-based method of accounting for stock-based compensation plans. Pursuant to the transition provisions of SFAS 123, the Company will apply the fair value method of accounting to all option grants issued on or after October 1, 2002. The fair value method will not be applied to stock option awards granted prior to October 1, 2002. Such awards will continue to be accounted for under the intrinsic value method pursuant to APB 25, except to the extent those prior years' awards are modified subsequent to October 1, 2002. The Company recorded an expense of approximately $123,000 and $ 570,000 for the year ended December 31, 2003 and the three months ended December 31, 2002, respectively, related to the issuance of approximately 58,000 and 355,000 options issued under the fair value based method. The remaining $18,000 and $62,000 of non-cash compensation expense relates to options issued under the intrinsic value method pursuant to APB 25.
On February 2, 2001, the Company's Board of Directors appointed Ronald I. Simon, a Director of the Company, as acting Chief Executive Officer and Chief Financial Officer at $2,500 per day or $10,000 per week beginning February 5, 2001. Mr. Simon was paid $170,000 for serving as acting Chief Executive Officer and Chief Financial Officer from February 5, 2001 to June 1, 2001.
For the twelve months ended December 31, 2003 and the three months ended December 31, 2002 the Company paid $175,000 and $19,000, respectively, under a service agreement with INHO dated November 15, 2002.
The Company had a benefit for income taxes of $2,993,000 for the 2003 calendar year. Included in this amount is a benefit of $4,466,000 for a reduction of the valuation allowance, an income tax provision of $969,000 from the utilization of the Company's prior tax year Federal net operating loss carryforwards (NOLs) and a $504,000 state income tax provision. In addition, a $1,000 state income tax provision was recorded in the quarter ended December 31, 2002. The valuation allowance relates to the possibility that AMIC might not be able to fully utilize its prior tax year federal net operating loss carryforwards ("NOLs"). AMIC periodically reviews the valuation allowance to determine the reasonableness of the amount, and previously reduced it in connection with the Company's acquisitions in 2002 and 2003. Based upon AMIC's profitability in 2003 and projected continuing profitable results, it was appropriate to further reduce the valuation allowance in 2003. In the future, AMIC will continue to evaluate the valuation allowance as it analyzes the impact of the development of its business on its ability to fully utilize its NOLs.
The Company and its subsidiaries file a consolidated Federal income tax return on a September 30 fiscal year. The provision (benefit) for income taxes for the periods ended December 31, 2003, December 31, 2002, September 30, 2002 and September 30, 2001 is as follows (in thousands):
Taxes computed at the Federal statutory rate of 35% for the year ended December 31, 2003, are reconciled to the Company's actual income tax expense (benefit) as follows (in thousands):
The tax effect of temporary differences that give rise to significant portions of the net deferred tax assets are as follows (in thousands):
During the year ended December 31, 2003, the Company reduced its valuation allowance by $12,548,000. The reduction includes $5,760,000 recorded in the Marlton purchase transaction, a $4,466,000 reduction based on management's periodic evaluation of the valuation allowance, and a $2,322,000 reduction from the utilization of net operating losses. During the three months ended December 31, 2002, the Company increased its valuation allowance by $12,412,000 for net operating losses and other deferred tax assets. This increase was partially offset by a $6,616,000 decrease in the valuation allowance for the net deferred tax asset recorded in the IAHC purchase transaction. As of September 30, 2002, a valuation allowance was provided for all unused net operating loss carryforwards and other deferred tax assets.
The Federal net operating loss carryforwards expire as follows (in thousands):
At December 31, 2003, the Company also had net operating loss carryforwards of approximately $29,349,000 for state income tax purposes (primarily in the state of California). Management believes that it is more likely than not that the state tax benefit of these net operating loss carryforwards will not be realized.
The liability for insurance policy benefits as of the acquisition date of IAHC on November 14, 2002 was $3,025,000 net of reinsurance recoverables of $3,484,000
The effect of reinsurance on benefits to policyholders and premiums earned is as follows:
As a result of the Company's Board of Directors decision to discontinue the last of its former business segments in April 2002, segment information for all periods prior to the acquisition of IAHC has been restated. Management has reclassified its segment information to show its direct insurance operation separately from its MGU operations, which is how management currently reviews its operations. Segment information is as follows (in thousands):
The components of total comprehensive income include net income and certain amounts reported directly in equity, such as the after-tax unrealized gains and losses on investment securities available-for-sale. The components of comprehensive income for fiscal years ended, 2003, 2002 and 2001 and for the quarter ended December 31, 2002 are as follows (in thousands):
The quarterly results of operations are summarized below (in thousands, except per share data):