CompManagement leases a 70,000 square foot office building in Dublin, Ohio, which is used as its principal office facilities. The lease for the building is for a term of 15 years, which began in 1997, provides for annual rent payments and requires CompManagement to pay all operating expenses for the building. The lease also provides for, among other things, three renewal options of five years each, an option to purchase the building and a right of first offer with respect to the sale of such building. The lease restricts CompManagement's ability to distribute funds and/or assets to Health Power, Inc. or another affiliate unless CompManagement meets certain tangible net worth requirements. CompManagement also leases office space in Akron, Cincinnati, Cleveland, and Toledo, Ohio; Seattle, Washington; Charleston, West Virginia; Lexington, Kentucky; Richmond and Fairfax, Virginia; Atlanta,
Georgia; San Antonio, Austin and Dallas, Texas; and Baltimore, Maryland. These spaces are used as regional offices and service centers for its operations.
There are certain accounting policies that the Company believes are critical to its business and the understanding of its financial statements. The development and selection of these policies have been discussed with the Audit Committee and are discussed below. In addition, the preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the Company's management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements. The Company's accounting policies are disclosed in the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K. The more critical of these policies include revenue recognition, accounting for goodwill and other intangible assets and use of management estimates.
The educational services segment recognizes royalties based on a percentage of 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 been certified for occupancy, which is generally
concurrent with the commencement of operations. Assignment fees are earned for site identification and preparation for the construction of the school, including zoning permits. Assignment fees are recognized upon the closing of the purchase of the property by the franchisees and the funding of their construction loans. Transfer fees are earned upon sale of an existing franchise to either another franchisee or to a separate third party. Real estate services fees are earned for consulting services related to engineering and architectural design services provided to the franchisees during the construction of the school. The real estate services fees are recognized upon the certification of occupancy of the school, which is generally within one to two weeks of the commencement of operations. Forfeited franchise fees are earned if a franchise agreement is terminated. The Company typically collects any termination fee specified in the franchise agreement and recognizes it as income at that time. If the franchisee has an assignment agreement, it will also be terminated and any termination fee specified in the agreement will be recognized as income at that time. All fees received prior to being earned are recorded as unearned revenue.
The methodology used in performing these tests was a discounted cash flow approach to determine fair value. The discount rate used for each reporting unit was determined by assessing the appropriate risk level of the cash flows of the respective reporting units and adjusting the risk-free rate by a factor dependent upon this risk assessment. The terminal value of the respective reporting units was based upon assigning what management believed to be appropriate multiples of earnings before income taxes,
depreciation and amortization for companies of similar size and in the industry in which the each of the units operate.
educational-based childcare centers, which numbered 105 and 95 as of December 31, 2002 and 2001, respectively.
2001 as compared with December 31, 2000 as partially offset by lower sales volumes at the seasonal products segment during 2001.
Revenues increased by $51,282,000 or 122% to $93,186,000 for the year ended December 31, 2001. The Company's employer cost containment and health services segment's revenues increased by $52,333,000 or 4,023% to $53,634,000 for the year ended December 31, 2001 as compared to the year ended December 31, 2000 due to the inclusion of a full year of results for this segment which was acquired on December 21, 2000 and therefore only reflected 10 days of activity for the year ended December 31, 2000. The Company's seasonal products segment revenues decreased by $1,859,000 or 6% to $31,900,000 for the year ended December 31, 2001 as compared to the year ended December 31, 2000, due to impact that the economic slowdown had on the retail market. Educational segment revenues increased by $808,000 or 12% to $7,652,000 for the year ended December 31, 2001 as compared to the year ended December 31, 2000 due to same school revenue increases and the revenue contribution made by the 14 new schools opened during 2001. As an additional performance measure of the increasing success of the educational services segment's concept, the Company monitors the revenues generated by its franchisees. Total education system revenue, or gross revenue of all educational-based child care center franchises, increased by $13,076,000 or 18% to $85,318,000, for the year ended December 31, 2001 as compared to the same period of the prior year. This increase was generated as a result of a 17% increase in the number of educational-based child care centers, which numbered 96 and 82 as of December 31, 2001 and 2000, respectively.
Interest expense increased by $2,384,000 or 69% to $5,826,000 for the year ended December 31, 2001 as compared to the year ended December 31, 2000, primarily due to the acquisition of the employer cost containment and health services segment. Without taking into consideration the acquisition of this segment, interest expense decreased by $651,000 or 19% for the year ended December 31, 2001 as compared to the year ended December 31, 2000, with the major factors being lower interest rates on all of the Company's variable rate debt and reduced average debt levels.
Income tax expense increased by $1,960,000 or 172% to $3,100,000 for the year ended December 31, 2001 as compared to the year ended December 31, 2000, due to the pre-tax income effects of adding the employer cost containment and health services segment in December 2000 and an increase in the effective tax rate from 41% for the year ended December 31, 2000 to 47% for the year ended December 31, 2001. This increase in the effective tax rate in 2001 reflected the Company's amortization of goodwill acquired in the December 2000 acquisition, most of which is non-deductible for income tax purposes.
Cash and cash equivalents decreased by $5,150,000 from $11,562,000 at December 31, 2001 to $6,412,000 at December 31, 2002.
The Company's consolidated working capital deficit increased by $10,699,000 from a deficit of $6,566,000 at December 31, 2001 to a deficit of $17,265,000 at December 31, 2002. The most significant contributor to this deficit increase was the $5,150,000 decrease in cash discussed above which was driven mostly by the employer cost containment and health services and seasonal products segments. The seasonal products segment's working capital also decreased due to the reclassification into current debt of $1,960,000 subordinated promissory notes due on May 31, 2003 and of $1,275,000 of the long-term portion of this segment's term debt due to debt covenant violations as discussed in Note 8 to the Consolidated Financial Statements contained in this Report on Form 10-K.
The Company, in aggregate, maintains four revolving lines of credit, with $3,931,000 outstanding and $8,061,000 of additional availability (reflective of borrowing base restrictions) at December 31,
2002. The Company's employer cost containment and health services segment maintains a $7,000,000 revolving line of credit, which had a balance outstanding of $287,000 and $6,713,000 of additional availability at December 31, 2002. The seasonal products segment, in aggregate, maintains two revolving lines of credit, which had combined balances of $3,044,000 outstanding and $948,000 of additional availability (reflective of borrowing base restrictions) at December 31, 2002. The Company's educational services segment maintains a $1,000,000 revolving line of credit, which had a balance of $600,000 outstanding and $400,000 of additional availability at December 31, 2002. Borrowings under the Company's revolving lines of credit are limited to a borrowing base which could restrict availability.
Possible Dreams entered into a loan and security agreement with an effective date of December 31, 2001 and a funded date of January 3, 2002 with LaSalle Business Credit, Inc. that provides for a $12,700,000 revolving line of credit and two separate term loans, Term Loan A for $1,500,000 and Term Loan B for $1,800,000. Amounts drawn on the new line of credit bear interest at the prime rate or LIBOR plus 2.50%. Term Loan A and Term Loan B are payable in monthly installments through December 2004 and January 2004, respectively, with Term Loan A also requiring a balloon principal payment in December 2004 of $1,075,000. Both term loans bear interest at the prime rate plus 1/2% or LIBOR plus 3%. Additionally, Possible Dreams was required by the loan and security agreement to refinance its subordinated note on or before March 17, 2003 or to extend its maturity until a date after March 31, 2005. This refinancing did not occur, causing an event of default at March 17, 2003, and management has not yet extended the maturity of this obligation. Borrowings under the new facility are secured by substantially all of the assets of Possible Dreams. At the time of this financing, there were $213,000 in financing costs which were deferred and will be amortized over the life of the loan.
subordinated debt prior to repayment of the senior term debt and to concurrently increase the revolving facility from $4,500,000 to $5,000,000 effective February 28, 2002.
The Company refinanced its debt at Primrose on April 5, 2002. The terms of the new debt are as follows: $3,200,000 term loan repayable $624,000 per quarter beginning July 15, 2002 bearing interest at an interest rate of prime plus 2.0%, an additional $4,000,000 of non-amortizing term debt with a balloon payment due in September 2003 bearing interest at LIBOR plus 1.0% and a revolving facility of $1,000,000 (of which $681,000 was drawn at closing) bearing interest at LIBOR plus 3.0% or prime plus 0.5% expiring in September 2003. To secure this debt, Primrose pledged all of its assets, Primrose Holdings and the Company guaranteed the debt and the Chairman of the Company issued a personal guarantee for $4,000,000, for which he received a guarantee fee of 8% per annum of the declining average quarterly balance of his guarantee during the remainder of 2002. This fee was approved by both the Audit Committee and the Board of Directors. The guarantee of the Chairman was, however, terminated on December 31, 2002 by amendment to the loan agreement, as discussed below. During the period his guarantee was outstanding, it entitled the Chairman to a subordinated interest in Primrose's assets, and Primrose had agreed to reimburse the Chairman for any amount paid by him on his guarantee. In addition, the Company had agreed to reimburse the Chairman for any amount paid by him on his guarantee in the event Primrose failed to reimburse him.
On December 31, 2002, the terms of the note dated April 5, 2002 were amended as follows: The due date is now December 31, 2004. Principal payments on the entire term debt consist of four quarterly payments during 2003 of $600,000 and four quarterly payments during 2004 of $732,000 with the remaining balance due and payable on December 31, 2004. Interest is payable quarterly. The term debt bears interest at the Eurodollar rate plus 3.00% or the prime rate plus 0.50%. The applicable rate for the revolving portion of the agreement bears interest at the Eurodollar rate plus 2.75% or at the prime rate.
for the full amount payable of $2,352,000. The note accrues interest at the rate of 10% per annum and is due and payable in full on April 30, 2003.
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" later in this Item 7. of this Report on Form 10-K. The Company introduced a number of new products in its target markets in 2001 and 2002 and plans to introduce additional products in 2003 which could possibly 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. Except as indicated above with regard to uncertainties relative to Possible Dreams' ability to continue as a going concern, the Company believes that cash flows from operating activities, 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 12 months, although there can be no assurance in this regard. The Company is continually evaluating financing alternatives as a means of improving its liquidity and continually evaluating strategic alternatives in order to maximize stockholder value and enhance stockholder liquidity.
The Company adopted the new rules on accounting for goodwill and other intangible assets effective January 1, 2002. During 2002, the Company completed the transitional test for impairment of goodwill using the two-step process prescribed in SFAS 142. The first step was a screen for potential impairment which indicated that goodwill in the seasonal products segment was impaired as of January 1, 2002. The performance of the second step of the impairment test measured the amount of the impairment to be $3,402,000 (net of tax benefit of $2,420,000) which the Company has reflected as the cumulative effect of a change in accounting principle as of January 1, 2002 in accordance with the prescribed guidance in SFAS 142. The Company also performed the first annual required impairment tests of goodwill at December 31, 2002. The results of these tests were that no further impairment was present. The Company has also ceased amortization of goodwill effective January 1, 2002 upon its adoption of SFAS 142. Amortization expense of goodwill included in the results shown for the years ended December 31, 2001 and 2000 was $3,158,000 and $1,424,000, respectively.
In December 2002, the Financial Accounting Standards Board issued Statement No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. SFAS 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for SFAS 123's fair value method of accounting for stock-based employee compensation. SFAS 148 also amends the
This filing 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 management's 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: future legislative changes which could impact the laws governing workers' compensation insurance in Ohio and the other states in which the Company's employer cost containment and health services segment operates, the level of orders that are received and shipped by the Company in any given quarter, the rescheduling and cancellation of orders by customers, the availability and cost of materials and the impact that prolonged longshoremen labor strikes would have on the availability and cost of imported materials and products, 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 manufacturing facilities of the Company's suppliers, interest rate and foreign exchange fluctuations, political stability in the Pacific Rim, the Company's ability to attract qualified franchisees or access to financing for these franchisees and the Company's consideration of, decisions relative to and the outcome of any such decisions regarding strategic alternatives with respect to maximizing stockholder value and enhancing stockholder liquidity.
(2)The second quarter of 2002 net income includes a net gain on the early extinguishment of debt associated with this Primrose refinancing of $808 relating to the repurchase of warrants net of the write-off of original issue discount and deferred financing costs associated with the original debt.
Consolidated Statements of Income-For the years ended December 31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows-For the years ended December 31, 2002, 2001 and 2000
All schedules, except for Schedule I, for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions, are inapplicable and therefore have been omitted or the information has been included within the financial statements.
We have audited the accompanying consolidated balance sheets of Security Capital Corporation and subsidiaries (the "Company") as of December 31, 2002 and 2001 and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Security Capital Corporation and subsidiaries at December 31, 2002 and 2001 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Exposure to and the risk of losses on receivables is dependent on each customer's financial position. The Company performs ongoing credit evaluations of its customers' financial condition, and
receivables are generally not collateralized. The Company maintains an allowance for doubtful accounts which management believes is adequate to cover potential credit losses. In determining the appropriate level of this allowance, the Company uses customer credit evaluations, collection history and other pertinent information.
Prepaid catalog costs consist of the cost to produce, print and distribute catalogs. These costs are considered direct-response advertising and, as such, are capitalized as incurred, included in other current assets on the Consolidated Balance Sheets and amortized over a period which is generally less than one year. At December 31, 2002 and 2001, these prepaid catalog costs were $349 and 362, respectively. Other advertising costs which are expensed when incurred were $290, $314 and $338 for 2002, 2001 and 2000, respectively.
Property and equipment are carried at cost, less accumulated depreciation. 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 three to 27 years. Leasehold improvements are amortized over the shorter of the useful life or the lease term.
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and Other Intangible Assets (SFAS 142), effective for fiscal years beginning after December 15, 2001. SFAS 141 required that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001. SFAS 142 prohibits the amortization of goodwill and assets with indefinite lives. SFAS 142 requires that these assets be reviewed for impairment at least annually. Intangible assets with definite lives continue to be amortized over their estimated useful lives.
Deferred financing costs are amortized over the term of the related debt (ranging from four to six years) and the expense is reflected in interest expense in the Consolidated Statements of Income.
Financial instruments, other than the interest rate swap discussed below, consist of current assets (except inventories), current liabilities, notes payable, long-term debt and other long-term obligations. Current assets and current liabilities are carried at cost, which approximates fair value due to the short-term nature of these items. Notes payable, the additional payment obligations and long-term debt bear interest at current market rates or at fixed rates which approximate current market rates and, accordingly, their carrying values approximate fair value.
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 137 and SFAS No. 138 on January 1, 2001. The Company uses financial instruments to manage its exposures to movements in interest rates. The use of the financial instruments modifies the exposure of these risks from variable to fixed with the intent to reduce the risk or cost to the Company. The Company does not use derivatives for trading purposes and is not a party to leveraged derivatives. The fair value of derivatives is recorded in the consolidated balance sheets in other long-term obligations. At December 31, 2002 and 2001, this liability was $907 and $529, respectively. The Company assesses changes in the fair value of
their derivative instruments and records any changes in fair market value in the consolidated statements of income as such instruments are not being accounted for as hedges. These gains and losses on derivative instruments are reflected in the consolidated statements of income in other income (expense).
The Company reviews long-lived assets, including its definite-lived intangible assets, for impairment using the three-step approach prescribed in SFAS 144. Under this three-step approach, the Company needs to: (a) consider whether indicators of impairment of long-lived assets are present, (b) if indicators of impairment are present, determine whether the sum of undiscounted cash flows attributable to the assets in question is less than the assets' carrying amount, and (c) if the sum of the undiscounted cash flows is less than the assets' carrying value, recognize an impairment loss based on the excess of the carrying amount of the assets over their respective fair values. As of December 31, 2002, the Company has determined that there is no need to recognize any impairment losses on its long-lived assets.
The Company measures compensation cost for stock options issued to employees using the intrinsic value method of accounting for stock-based compensation under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). Under APB 25, when the exercise price of the Company's stock options equals the market value of the underlying stock on the date of the grant, no compensation expense is recognized. The Company has adopted the disclosure only provisions of SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123) as amended by Statement No. 148, Accounting for Stock-Based Compensation-Transitions and Disclosure, an amendment to FASB Statement No. 123 (SFAS 148).SFAS 148 provides for two additional transition approaches for companies which adopt SFAS 123, which the Company has not. More importantly for the Company, SFAS 148 requires more prominent disclosure of pro forma net income and earnings per share.
Pro forma information regarding income available to common stockholders and earnings per share as required by SFAS 123 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 2002, 2001 and 2000: risk-free interest rate of 4.90%, 4.00% and 5.16%, respectively;
dividend yield of 0%, 0% and 0%, respectively; volatility factor of the expected market price of the Company's common stock of .207, .238 and .320, respectively; and a weighted-average expected life of the options of 7.5, 8.5 and 9.5 years, respectively.
In connection with the financing of the acquisition, the Company borrowed funds under bank credit agreements (see Notes 7 and 8). Under terms of the bank credit agreements, the borrowings are secured by a pledge of all assets of the WC Holdings subsidiary businesses, and by the capital stock of WC Holdings held by the Company. The costs associated with such financing were recorded as
deferred financing costs and are being amortized over the life of the related debt agreements (see Note 1).
On April 1, 2001, the Company's subsidiary, Health Power, Inc., acquired 100% of the outstanding common stock of Trigon Administrators, Inc. (Trigon), a third party administrator in Virginia, Maryland, and North Carolina. The results of operations of Trigon for the nine months ended December 31, 2001 have been included in the financial statements. The acquisition has been accounted for as a purchase, with the purchase price of $5,495 allocated as follows based on estimated fair values at the date of acquisition:
On October 1, 2002, WC Holdings acquired all of the outstanding stock of Barron Risk Management, Inc. ("Barron"), a Texas corporation, which is a subsidiary of UICI, a Delaware Corporation. Barron is a third party administrator ("TPA") that offers various services for the administration of self-insured property and casualty programs and is one of the largest administrators of workers' compensation programs in the region. It markets and sells its services in Texas and the surrounding states. This acquisition was accounted for under the purchase method of accounting for business combinations. The Company paid approximately $1,750 in cash, to purchase 100% of Barron's book of business. The acquisition has been accounted for as a purchase, with the purchase price in excess of the fair value of tangible assets of $1,000 allocated to health care membership client lists.
On October 31, 2002, Pumpkin Masters Holdings, Inc. executed its call provisions under the original Asset Purchase Agreement dated June 27, 1997 pursuant to which Pumpkin Masters Holdings, Inc. was granted the right to call all 200 shares of minority interest in Pumpkin Masters Holdings, Inc. at a pre-negotiated formula price based on a multiple of Pumpkin Ltd.'s EBITDA, as defined, less outstanding debt. Pumpkin Masters Holdings, Inc. consummated this transaction on December 31, 2002 by issuing a note for the full amount payable of $2,352. The note accrues interest at the rate of 10% per annum and is due and payable in full on April 30, 2003. This note was paid in full on March 5, 2003. This transaction has been accounted for as a purchase, with the purchase price in excess of the fair value of tangible assets of $944 preliminarily allocated to goodwill.
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:
Concurrent with a February 28, 2002 amendment to WC Holdings' senior term debt with Bank One to allow prepayment of the subordinated debt prior to repayment of the senior term debt, the revolving facility was increased from $4,500 to $5,000. In August 2002, the Company's subsidiary, Health Power, further amended its existing loan agreement to increase the available revolving credit facility from $5,000 to $7,000 and the extension of the expiration of the facility to December 2003. It was previously December 2002.
Health Power, Inc., therefore, had a $7,000 line of credit at December 31, 2002 ($4,500 at December 31, 2001) under which $287 and $0 were borrowed at December 31, 2002 and 2001, respectively, at an interest rate of LIBOR plus 175 basis points (3.75% and 4.25% at December 31, 2002 and 2001, respectively).
On June 13, 2001, Pumpkin entered into a three-year loan agreement with LaSalle Business Credit, Inc. The total credit facility is $10,000, consisting of a maximum term loan amount of $2,500 and a revolving loan commitment of $7,500. The amount Pumpkin is allowed to draw on the revolver is limited by a borrowing base defined by specific accounts receivable and inventory levels. The agreement also provides for seasonal overdrafts from April 1 through July 31 of each year during the peak of the inventory build-up period. On June 14, 2001, Pumpkin used the new financing facilities to retire all amounts owing to Banc of America Commercial Finance Corporation ($3,247, including $900 to repurchase the full amount of outstanding warrants) and to pay the closing costs of the refinancing ($100). On November 7, 2002, the terms of the Pumpkin loan agreement were amended to allow a one
Pumpkin, therefore, had a $7,500 line of credit at December 31, 2002, under which borrowing capacity is limited to a defined borrowing base. Interest is calculated at the prime rate or LIBOR plus 2.5% (4.25% at December 31, 2002). There were no borrowings outstanding at the current balance sheet date. Borrowing capacity under the revolving facilities was $291 at December 31, 2002. This agreement expires in 2004.
In addition, because of covenant violations on Possible Dreams discussed more fully later in this footnote, all of the 2004 payments on their term debt, which aggregated $1,288, are included in the 2004 maturities of $10,407 shown above but are classified as current portion of long-term debt on the Consolidated Balance Sheet at December 31, 2002.
Pumpkin recorded a contingent earnout obligation to its former owners that was earned on December 31, 2000. The amount recorded was determined based upon the average EBITDA, as defined, during the four-year period ended December 31, 2000. The former owners are entitled to an earnout amount of $1,812, which is included in long-term debt. The earnout obligation is subordinated to Pumpkin's term note and revolving loan and is due in 2004.
During October and early November 2002, the Company's subsidiary, Pumpkin, prepaid all of its term debt then outstanding ($833) under the June 2001 loan agreement with LaSalle Business Credit, Inc. This amount was to be fully repaid by June 2003 under the terms of the loan agreement. There was no prepayment penalty. The prepayment was financed by cash generated from operations.
December 31, 2002, the Chairman's guarantee and the reserve account requirements were removed as discussed below.
On December 31, 2002, the terms of the Primrose note dated April 5, 2002 were amended as follows: The due date is now December 31, 2004. Principal payments on the entire term debt consist of four quarterly payments during 2003 of $600 and four quarterly payments during 2004 of $732 with the remaining balance due and payable on December 31, 2004. Interest is payable quarterly. The term debt bears interest at the Eurodollar rate plus 3.00% or the prime rate plus .50% (approximately 4.38% for December 2002). The applicable rate for the revolving portion of the agreement bears interest at the Eurodollar rate plus 2.75% or at the prime rate. The individual guarantee by the Chairman of Security Capital was terminated as of December 31, 2002.
At December 31, 2002, Possible Dreams was not in compliance with its minimum EBITDA (as defined), minimum fixed charge coverage ratio and maximum leverage ratio covenants. No waiver was pursued because of foreseeable covenant violations within the next four quarters. Consequently, all Possible Dreams' term debt was classified as a current liability. However, discussions with the lender have taken place, and resolutions are being considered. Management strongly believes that the loan will not be called. Remedies upon an event of default under the agreement include a right to the lender to take possession of any or all of the collateral as defined under the agreement. These conditions raise substantial doubt about the Possible Dreams' ability to continue as a going concern. The accompanying financial statements have been prepared assuming that Possible Dreams will continue as a going concern and, accordingly, do not include any adjustments that may result from the outcome of this uncertainty. The Report of the Possible Dreams' Independent Auditors expresses substantial doubt about Possible Dreams ability to continue as a going concern. As of December 31, 2002, the Company's investment in Possible Dreams was a negative $577. The debt at Possible Dreams is neither cross-collateralized nor guaranteed by the Company or any other subsidiary of the Company. Accordingly,
Management expects to be in compliance with the covenants on all other debt for the foreseeable future. Borrowings under the bank credit agreements are secured by a pledge of substantially all of the Company's assets as well as a pledge of the Company's share ownerships in the subsidiaries.
As of December 31, 2002 and 2001, the unrealized derivative loss was $907 and $529, respectively, which were determined by quoted market prices. The maturity date of the derivative instrument is December 22, 2005, but is cancelable at the lender's option after December 2003. At December 31, 2002 and 2001, the notional principal amount of this agreement was $8,500.
WC Holdings leases computer equipment under an agreement which is classified as a capital lease. At December 31, 2002, property and equipment included the equipment under this capital lease with a carrying value of $48. The amortization of the cost of this equipment is included in depreciation expense.
The Company has issued and outstanding 500,000 shares of zero coupon, redeemable convertible preferred stock that have a stated liquidation value of $10 per share. Such preferred shares are convertible into Class A common stock on a 1:1 basis. The preferred shares are redeemable at the option of the Company at their liquidation value upon the earlier of (1) the date Primrose's earnings before interest, income taxes, depreciation and amortization (EBITDA) as defined, exceeds $8,500 on a latest twelve month basis on or after April, 2002, or (2) on April 6, 2006. EBITDA for Primrose was $4,217 for the year ended December 31, 2002.
The Company has 2,500,000 shares of authorized preferred shares, $.01 par value, of which 2,000,000 shares remain issuable at December 31, 2002 and 2001.
During 2000, the Company retired all of the 318,575 shares then held in its treasury, returning them to their status of authorized and unissued shares of common stock and Class A common stock. During 2001, the Company acquired 7,722 shares of Class A common stock when a director who resigned for personal reasons (directly related to and required by his employment by the U.S. government) decided to exercise his vested stock options utilizing 7,722 of his previously-owned shares in lieu of cash to pay the option price due to the Company with regard to the 16,000 options he was exercising.
Pursuant to the provisions of the 2000 Long Term Incentive Plan (which allows for the grant of up to 966,000 shares), on July 13, 2000, the Company granted options to acquire 549,000 shares of its Class A common stock at the then market value, which was $6.125 per share. Of the 549,000 options granted, 48,000 vest over a two-year period with one-third vesting immediately upon grant and the remaining two-thirds vesting equally on each of the first and second anniversaries of the grant, while the remaining 501,000 vest over a five-year period in equal 20% amounts beginning on the first anniversary of the grant and annually thereafter. Additional grants, also pursuant to the provisions of the 2000 Long Term Incentive Plan, were made during the year ended December 31, 2001 as follows: On May 16, 2001, the Company granted options to acquire 24,000 shares of its Class A common stock at an exercise price per share equal to market value, which was $10.31. These 24,000 options vest over a two-year period with one-third vesting immediately upon grant and the remaining two-thirds vesting equally on each of the first and second anniversaries of the grant. On July 19, 2001, the Company granted options to acquire 237,000 shares of its Class A common stock at an exercise price per share equal to market value, which was $10.85. These 237,000 options granted vest over a five-year period in equal 20% amounts beginning on the first anniversary of the grant and annually thereafter. On September 7, 2001, the Company granted options to acquire 24,000 shares of its Class A common stock at an exercise price per share equal to market value, which was $12.69. These 24,000 options vest over a two-year period with one-third vesting immediately upon grant and the remaining two-thirds vesting equally on each of the first and second anniversaries of the grant. On February 1, 2002, the Company granted options to a director to acquire 24,000 shares of its Class A common stock at an exercise price per share equal to market value, which was $9.65. These 24,000 options vest over a two-year period,
As mentioned above, pursuant to the provisions of the 2000 Long-Term Incentive Plan, a director who resigned for personal reasons (directly related to and required by his employment by the U.S. government) decided to exercise 16,000 vested options to purchase the Company's Class A common stock in October 2001. This resulted in a net increase in shares of Class A common stock outstanding of 8,278 when he used 7,722 previously-owned shares in lieu of cash to pay the option price due to the Company. These options would have otherwise expired 90 days after the August 17th termination of his directorship (November 15, 2001). The remaining 8,000 options held by this former director were not vested and were cancelled on August 17, 2001 pursuant to the provisions of his stock option grant certificate as issued under the 2000 Long Term Incentive Plan.
On April 3, 2001, the Company exercised its call provision relating to common shares of Primrose owned by a then resigning officer. The Company repurchased 100 shares, or 0.3%, of Primrose from this officer for $50 per share, increasing its direct ownership to 98.46%. The amount paid by Primrose for these shares was reflected as additional cost of the acquisition of Primrose.
WC Holdings-Options to acquire 1,281 shares of common stock of Health Power, an 80%-owned subsidiary of WC Holdings, at approximately $694 per share, the fair value at the date of the grant, were granted to subsidiary employees during the first quarter of 2001. All such options vest over a five-year period with the exception of one grant of 360 options which vests over an eight-year period but is subject to certain acceleration provisions. Options to acquire 100 shares of Health Power at approximately $1,626 per share, the fair value at the date of grant, were granted during the first quarter of 2002. These options vest over an eight-year period, but are subject to certain acceleration provisions. The options may be settled in either Health Power stock or in Security Capital stock, or the Company, but not the holders, has the right to settle the options in cash. If all such outstanding options had been vested and exercised at December 31, 2002, the Company's ownership share of Health Power would have been 73%.
Possible Dreams-Options to acquire 175 shares of common stock of Possible Dreams at approximately $1,900 per share were granted in 1996, which were cancelled on July 12, 1999. Options to acquire 87.5 shares at $1,905 per share (fair value at date of grant) and 87.5 shares at $3,810 per share of Possible Dreams stock were granted on July 12, 1999. Such options vest over five years and expire in 2009. In addition, warrants to purchase 250 shares of Possible Dreams Class B common shares were issued in 1996 and remain outstanding at December 31, 2002. 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, 2002, the Company's ownership share of Possible Dreams would have been 78.75%.
Concurrent with the refinancing of Primrose's debt on April 5, 2002, the Company repurchased warrants formerly held by a lender to acquire shares of Primrose and recognized a gain on this repurchase of $1,554. At December 31, 2002, warrants to acquire shares of Possible Dreams 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 Consolidated Statements of Income. At December 31, 2002, the estimated fair value of the Possible Dreams warrants is $0. Therefore, no liability has been recorded. Warrant income (expense), classified as other income (expense) was $2,052, $74 and $(559) for the years ended December 31, 2002, 2001 and 2000, respectively (see Note 15). The warrant income for the year ended December 31, 2002 included the income recognized on the Primrose warrant repurchase, and the warrant income for the year ended December 31, 2001 included $176 in income recognized when Pumpkin's warrants were repurchased for less than their recorded value as part of Pumpkin's debt refinancing discussed in Note 8. Long-term warrant liabilities, included in other long-term obligations, were $0 and $1,334 at December 31, 2002 and 2001, respectively. Current warrant liabilities included in accrued expenses and other liabilities were $0 and $718 at December 31, 2002 and 2001, respectively.
Options to purchase Class A common stock of Security Capital granted under the 2000 Long-Term Incentive Plan are exercisable at the market price at the date of grant and, subject to termination of the grantee's employment or directorship, expire10 years from the date of grant and are not transferable other than upon death.
A summary of the Company's stock option activity and related information for the years ended December 31, 2002, 2001 and 2000 is as follows:
Pro forma information regarding net income and earnings per share as required by SFAS 148 has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. See Note 2.
The provision (benefit) for income taxes for the years ended December 31, 2002, 2001, and 2000 is as follows:
For the years ended December 31, 2001 and 2000, 500,000 shares of zero coupon redeemable convertible preferred stock, which were convertible into 500,000 common shares, were excluded from the computation of diluted earnings per share (EPS) because their inclusion as converted had an anti-dilutive effect on EPS. In addition, certain subsidiary options were excluded from the computation of diluted EPS for the years ended December 31, 2001 and 2000 because their inclusion would have had an antidilutive effect on consolidated EPS. For the year ended December 31, 2002, Security Capital options to purchase 309,000 shares of Class A common stock at exercise prices ranging from $9.65 to $12.69 were not included in the computation of dilutive EPS because the options' exercise prices were greater than the average market price of the Class A common stock. For the year ended December 31, 2001, options to purchase 285,000 shares of Class A common stock at exercise prices ranging from $10.31 to $12.69 were not included in the computation of dilutive EPS because the options' exercise price was greater than the average market price of the Class A common stock.
agreement was terminated, and a new agreement was entered into whereby the Company now is required to pay CPI compensation at the rate of $1,250 per annum, subject to adjustment upon the occurrence of any material unforeseen event, and which agreement would be terminable by either CPI or the Company as of any December 31 upon not less that 60 days' prior written notice to the other. The advisory fees calculated under the terms of the original agreement and under the terms of the new agreement for the respective periods to which each apply are considered by management to be reasonable estimates of the allocation of salaries and other allocable costs of CPI with respect to the resources it provides to the Company in providing the aforementioned advisory services and management services. In addition, the Company has agreed to pay fees to CPI for acquisition opportunities presented to the Company by CPI at usual and customary rates for investment banking fees for transactions of similar size and complexity. Fees incurred by the Company to CPI were $1,273, $1,191 and $1,153 in the years ended December 31, 2002, 2001 and 2000, respectively, and are included in selling, general, and administrative expenses in the Consolidated Statements of Income. Amounts due to CPI were $39, $266 and $188 at December 31, 2002, 2001 and 2000, respectively. Fees paid to CPI are generally subordinate to the rights of the lenders to the Company.
A director who joined the Board during 2001 was a senior counsel, from October 2001 until August 2002 and a partner prior to October 2001, in a law firm which the Company engages on a regular basis to perform legal services. Total amounts paid to the law firm were $198, $111 and $64 for the years ended December 31, 2002, 2001 and 2000, respectively.
The Company rents showrooms, office space and certain equipment under operating lease agreements. The Company through its subsidiary, WC Holdings, Inc., leases a 70,000 square foot office building in Dublin, Ohio that is used as this subsidiary's principal office facilities. The lease for the building is for a term of 15 years, which began in 1997, provides for annual rent payments and requires the Company to pay all operating expenses for the building. The lease also provides for three renewal options of five years each, an option to purchase the building between the fourth and fifth years of the lease term at a price determined under a formula based on the rentable and unimproved square footage of the building, and a right of first offer to purchase the building before the landlord enters into a contract to sell the building to a third party. The lease restricts WC Holdings' subsidiary, CompManagement, Inc., from paying a dividend, or otherwise distributing funds or assets outside the
Future minimum rental commitments at December 31, 2002 for each of the following years are as follows:
The Company had rent expense of $4,041, $3,670 and $563 for 2002, 2001 and 2000, respectively.
The purchase agreement for the Company's 1997 acquisition of Pumpkin provided for additional payments contingent upon Pumpkin's future EBITDA. Under the terms of this agreement during each of the years ended December 31, 2002, 2001 and 2000, Pumpkin made additional payments of $160 each and has recorded an amount of $1,812 included in long-term debt on the Consolidated Balance Sheets at December 31, 2002 and December 31, 2001, which is payable in 2004.
The application of the non-amortization provisions of SFAS 142 increased net income (net of income tax of $1,119 and of minority interest of $345) in the year ended December 31, 2002 by approximately $1,359 ($0.21 per share basic and $0.19 per share diluted).
Holding company information is contained in Schedule I of this Report on Form 10-K. Security Capital (the holding company) has guaranteed the debt of Primrose as discussed in Note 8.
depreciation, amortization, minority interest expense, management fees, cumulative effect of change in accounting principle and certain items. Segment income (as defined) is used to evaluate performance because the Company believes this segment income (as defined) is a financial indicator of value and ability to incur and service debt and, adjusted for capital expenditures, is a simple measure of the Company's ability to generate operating cash flow. It is also one method by which we evaluate and value potential acquisition candidates and by which we value our current subsidiaries. Segment income (as defined) is not a substitute for operating income or cash flows from operating activities determined 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. There are no intersegment sales.
Of the total $2,084 in 2002 capital expenditures, $1,895 related to employer cost containment and health services segment and was primarily for computer system upgrades throughout all of this segment's locations and capital additions to support its new City of Baltimore account and its operations which were acquired from Trigon Administrators operations in 2001.
Possible Dreams purchased approximately 78%, 82% and 76% of its supplies from two companies during 2002, 2001 and 2000, respectively. The loss of either supplier could have an adverse effect on future operating results and financial condition of Possible Dreams.
Approximately 45%, 43% and 35% of Pumpkin's gross sales during 2002, 2001 and 2000, respectively, were to its three largest customers. Pumpkin purchased approximately 53%, 47% and 50% of its supplies from two companies during 2002, 2001 and 2000, respectively. The loss of any of its three largest customers or either of its two largest suppliers could have an adverse effect on Pumpkin's future operating results and financial condition.
WC Holdings, Inc. and its subsidiaries earned 79% and 84% of their revenues in the State of Ohio during 2002 and 2001, respectively.