IndependenceCare leases 6,500 square feet of office space in Minneapolis, Minnesota; 1,500 square feet in Franklin, Tennessee; and 3,100 square feet in Austin, Texas. RAS leases 4,200 square feet of office space in South Windsor, Connecticut. Marlton leases 6,000 square feet of office space in Voorhees, New Jersey.
Reflects business center services, satellite-based Internet services, cable-based Internet services, document management and telecommunications segments as discontinued operations. Includes Aerzone Corporation as a discontinued operation since its formation on January 24, 2000, and Laptop Lane Limited as a discontinued Operation since its acquisition on April 21, 2000. Includes Intelligent Communications, Inc. as a discontinued operation since its acquisition on February 9, 1999.
(b) All per share data has been restated to show the effect of the Company's one for three reverse split (see Note 2).
The Company is an insurance holding company that currently specializes in medical stop-loss and managed care through its managing general underwriter division (the "MGUs") and an insurance company, Independence American Insurance Company ("Independence American"). Since November 2002, AMIC has been affiliated with Independence Holding Company ("IHC"), which owns 39% of AMIC's stock, and IHC's senior management has provided direction to the Company through a service agreement between the Company and IHC. IHC has also entered into long-term reinsurance treaties to cede medical stop-loss business to Independence American.
While management considers a wide range of factors in its strategic planning, the overriding consideration is underwriting profitability. Management's assessment of trends in healthcare and in the medical stop-loss market play a significant role in determining whether to expand Independence American's reinsurance participation percentage or the number of programs it reinsures. Since Independence American reinsures a portion of all of the business produced by the MGUs, and since the MGUs are also eligible to earn profit sharing commissions based on the profitability of the business they write, the MGUs also emphasize underwriting profitability. In addition, management focuses on controlling operating costs. By sharing employees with IHC and sharing resources among the MGUs and Independence American, AMIC strives to maximize its earnings and utilize its federal net operating loss carryforwards of over $287 million.
The following are highlights in 2003 for Independence American and the MGU subsidiaries:
Beginning in 2004, average percentage of medical stop-loss business ceded from IHC to Independence American has increased to 18.5%.
90.2% of invested assets in bonds and short-term investments, 97% of the bonds have the highest NAIC rating designation (NAIC ratings of 1 and 2 designation).
Acquired 80% interest in Marlton Risk Group, the largest medical stop-loss MGU doing business with Standard Life.
In 2003, our MGUs wrote an aggregate of $135 million of annualized gross premium, and generated pre-tax income of $6.8 million.
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 discontinue 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. The results of operations for the year ended September 30, 2001, have been reclassified for the effects of discontinued operations of Intellicom.
On July 30, 2002, the Company entered into an agreement to acquire First Standard Holdings Corp. ("FSHC") from SSH Corp. and Independence Holding Company ("IHC") for $31,920,000 in cash. As described below, FSHC was the holding company for an insurance company and two managing general underwriters ("MGUs"). Subsequently at the Special Meeting of Stockholders on November 14, 2002, the Company's stockholders approved the stock purchase agreement between the Company, SSH Corp. and IHC (the "Purchase Agreement"), and approved the Company's name change to American Independence Corp. Also on November 14, 2002, the Company consummated the transactions contemplated by the Purchase Agreement and FSHC changed its name to Independence American Holdings Corp. ("IAHC"). Following this acquisition, the Company closed its offices in San Francisco, terminated all but two of its employees, and entered into a services agreement with IHC pursuant to which the Company's operations are directed by IHC's management and employees.
On February 10, 2003, but effective as of January 1, 2003, the Company acquired 80% of the business of an employer medical stop-loss MGU and an affiliated entity (the "Acquired MGUs"). The acquisition was accomplished by the formation of Voorhees Risk Management LLC d.b.a. Marlton Risk Group ("Marlton") into which the Acquired MGUs contributed all of their assets, and the Company contributed $16,000,000 cash for an 80% ownership interest. The Company's cash contribution was then distributed to the Acquired MGUs together with the remaining 20% interest in Marlton, and Marlton assumed all of the liabilities of the Acquired MGUs.
The preparation of consolidated financials statements and related disclosures in conformity with generally accepted accounting principles 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 believes the following critical accounting policies are significantly affected by judgments, assumptions and estimates used in preparation of its consolidated financial statements. For a detailed discussion on the application of these and other accounting policies, see Note 2 to the consolidated financial statements of the Company appearing elsewhere in this annual report on Form 10-K.
The Company accounts for discontinued operations in accordance to Accounting Principles Board Opinion No. 30 ("APB 30"), Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. Under APB 30, the Company accrued estimates of expected liabilities related to discontinued operations through its eventual discharge. The estimated remaining liabilities related to discontinued operations include contract terminations, litigation and loss from operations subsequent to September 30, 2002. The Company reviews the estimated closure costs liability on a quarterly basis to determine changes in the costs of the discontinued operations activities.
The Company accounts for its investments in debt and equity securities under Statement of Financial Accounting Standards No. 115 ("SFAS 115"), Accounting for Certain Investments in Debt and Equity Securities. The Company has classified all of its investments as available-for-sale securities. These investments are carried at fair value based on quoted market prices with unrealized gains and losses reported in accumulated other comprehensive income (loss) in the accompanying consolidated balance sheets. Net realized gains and losses on investments are computed using the specific identification method and are reported in net realized gains, in the accompanying consolidated statements of operations. Declines in value judged to be other-than-temporary are determined based on the specific identification method and are reported in the accompanying consolidated statements of operations as net realized gains.
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 at December 31, 2003.
Insurance benefits, claims and reserves amounted to $23,312,000 related to the premiums earned by Independence American for fiscal 2003.
Income Taxes. The Company had a benefit of income taxes of $2,993,000 for fiscal 2003. This includes a benefit of $4,466,000 due to a reduction of the valuation allowance. In 2003, the Company further reduced the valuation allowance relating to the deferred tax asset, which caused a corresponding increase in such deferred tax asset. 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 management's view that it was appropriate to further reduce the valuation allowance in the fourth quarter of 2003, which resulted in an increase in net income and income from continuing operations.
The Company's tax year end is September 30, and, for the first nine months of 2003, AMIC had a recovery for federal income taxes arising from losses in the fourth quarter of 2002. These losses were fully applied, and the Company began to utilize its NOLs, in the fourth quarter of 2003. As long as AMIC utilizes these NOLs, it will not pay any income taxes, except for federal alternative minimum taxes and state income taxes. In the first nine months of 2003, AMIC did not have any provision for federal income taxes on its income statement due to losses arising in the fourth quarter of 2002. Starting in the fourth quarter of 2003, the Company had a provision for federal income taxes of $920,000 on its income statement, and the utilization of its NOLs reduced the deferred tax asset on its balance sheet. The Company also had a provision for state income taxes of $504,000 for fiscal 2003.
Restructuring Expense. The Company recognized a restructuring charge for the year ended September 30, 2001, related to the downsizing of its corporate headquarters' staff. The charge in the amount of $3,900,000 was recognized as restructuring expense and primarily consisted of termination payments for affected employees. The Company increased the restructuring reserve by $152,000 for fiscal 2003 and $502,000 for the year ended September 30, 2002, respectively, as a result of additional estimated lease termination costs associated with Company's headquarters. At December 31, 2003 and September 30, 2002, a restructuring accrual of $866,000 and $1,446,000, respectively, remained outstanding.
Loss on Equity Investments. The Company recognized a loss on disposition of equity investments of $733,000 for fiscal 2002, consisting of $253,000 related to 1,000,000 SkyNet Global Limited common stock shares and $480,000 related to the 400,000 SkyNet Global Limited preference stock shares.
Results of Operations for the Fiscal Year Ended September 30, 2002, Compared to the Fiscal Year Ended September 30, 2001
Restructuring Expense. The Company recognized a restructuring charge for the year ended September 30, 2001, related to a plan to downsize its corporate headquarter staff. The charge in the amount of $3,900,000 was recognized as restructuring expense and primarily consisted of termination payments for affected employees. The Company increased the restructuring reserve by $502,000 for the year ended September 30, 2002, as a result of additional estimated lease termination costs associated with the Company's headquarters. At September 30, 2002, a restructuring accrual of $1,446,000 remained outstanding.
Net Loss. The Company had a net loss of $14,756,000, or a net loss per share of $1.76, for the year ended September 30, 2002, compared to a net loss of $57,647,000, or a net loss per share of $7.35, for the year ended September 30, 2001.
Insurance Benefits, Claims and Reserves. Insurance benefits, claims and reserves amounted to $989,000 related to the premium earned by Independence American for the six weeks ended December 31, 2002.
Amortization and Depreciation. Amortization and depreciation expense increased $175,000 to $240,000 for the quarter ended December 31, 2002, compared to $65,000 for the quarter ended December 31, 2001. The expense for December 31, 2002 relates to the amortization of the intangible asset for the value of third party administrators of the MGUs. This asset was part of the purchase accounting adjustments for the acquisition of IAHC.
Income Taxes. The Company made no provision for federal income taxes for the quarter ended December 31, 2002 and 2001, as a result of the Company's continuing losses. For the quarter ended December 31, 2003, the Company recorded a $1,000 provision for state and local taxes attributed to IAHC.
Loss on Disposition. Loss on disposition increased $885,000 to $1,475,000 for the quarter ended December 31, 2002, compared to $590,000 for the quarter ended December 31, 2001. The loss is primarily attributable to an arbitration award on MTC, a settlement on Aerzone, and additional reserves on Intellicom related to the lease obligations of the Livermore facility.
Net Loss. The Company had a net loss of $7,052,000, or a net loss per share of $0.84, for the quarter ended December 31, 2002, compared to a net loss of $2,780,000, or a net loss per share of $0.33, for the three months ended December 31, 2001. There was no gain or loss from discontinued operations for the quarter ended December 31, 2001.
The nature and quality of insurance company investments must comply with all applicable statutes and regulations which have been promulgated primarily for the protection of policyholders. Of the aggregate carrying value of the Company's investment assets, approximately 99% was invested in investment grade fixed income securities, resale agreements, policy loans and cash and cash equivalents at December 31, 2003. Also at such date, approximately 97% of the Company's fixed maturities were investment grade. These investments carry less default risk and, therefore, lower interest rates than other types of fixed maturity investments. At December 31, 2003, approximately 3% of the carrying value of fixed maturities was invested in diversified non-investment grade fixed income securities. Investments in such securities have different risks than investment grade securities, including greater risk of loss upon default, and thinner trading markets. The Company does not have any non-performing fixed maturities.
The Company has expected contractual obligations relating to non-cancelable leases of the following at December 31, 2003:
Independence American, which is domiciled in Delaware, is licensed to write property and/or casualty insurance in 24 states. Currently, Independence American reinsures medical stop-loss produced by IHC and other carriers. Independence American has entered into reinsurance treaties with Standard Life and Madison Life which run through December 31, 2014, under which Independence American receives at least 15% of their medical stop-loss business. Standard Life and Madison Life have increased the amount ceded to Independence American under several programs in 2004.
Independence American is already IHC's largest reinsurer, and will become even larger in 2004. Independence American, which has been licensed in New York for many years, is also filing policies in order to write a short-term statutory disability benefit product ("DBL") in New York.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). This interpretation requires that certain disclosures be made by a guarantor in its financial statements about its obligations under guarantees, effective for financial statements for periods ending after December 15, 2002. FIN 45 also requires the recognition, at fair value, of a liability by a guarantor at the inception of certain guarantees issued or modified after December 31, 2003. The disclosure and recognition requirements did not have a material impact on the Company's consolidated financial statements.
The risks and uncertainties described below are not the only ones that the Company faces. Additional risks and uncertainties not presently known to the Company or that the Company currently deems immaterial may also impair the Company's business operations. If any of the following risks actually occur, the Company's business, financial condition or results of operations could be materially adversely affected. In such case, the trading price of the Company's common stock could decline.
The Company's operations are being directed by IHC management and employees, which may result in potential conflicts of interest between IHC and the Company. For example, a conflict may arise if IHC were to engage in activities or pursue corporation opportunities that overlap with the Company's business. Because IHC's management will also constitute the Company's management, these individuals will have fiduciary duties to both companies, which could result in conflicts of interest, including the Company foregoing opportunities or taking actions that disproportionately benefit IHC. IHC will also have at least two representatives on the Company's Board of Directors who will have similar conflicts of interest. In addition, the Company is relying upon the management and expertise of officers of IHC who also serve as officers of the Company.
The Company has U.S. federal tax net operating loss carryforwards of approximately $287 million, which may be used against any profits from the Company's business. However, events outside of the control of the Company or IHC, such as certain acquisitions and dispositions of the Company's common stock, may limit the use of all or a portion of the Company's tax net operating loss carryforwards. If such events were to occur, the Company's expectation of using its tax net operating loss carryforwards against potential profits would not be realized and the Company could potentially have a higher tax liability in the future than it would otherwise have had.
Decrease in Rates for Accident and Health Reinsurance and Insurance Could Reduce Net Income
If the Rating Agencies Downgrade Independence American, the Company's Results of Operations and Competitive Position in the Industry May Suffer
Ratings are an important factor in establishing the competitive position of insurance companies. Independence American is rated B+ (Very Good) by A.M. Best Company, Inc., whose ratings reflect its opinions of an insurance company's financial strength, operating performance, strategic position, and ability to meet its obligations to policyholders, and are not evaluations directed to investors. The rating of Independence American is subject to periodic review by A.M. Best Company, Inc., and the Company is not assured of the continued retention of this rating. If A.M. Best Company, Inc. reduces Independence American's ratings from its current levels, the Company's business would be adversely affected.
The Company's success is dependent on its ability to assess accurately the risks associated with the businesses on which the risk is retained. If the Company fails to assess accurately the risks it retains, it may fail to establish the appropriate premium rates and its reserves may be inadequate to cover its losses, requiring augmentation of the Company reserves, and a reduction in future profit commissions which in turn could reduce net income.
If the Company Fails to Comply with Extensive State and Federal Regulations, It Will Be Subject to Penalties, Which May Include Fines and Suspension and Which May Adversely Affect its Results of Operations and Financial Condition.
Recently adopted federal financial services modernization legislation is expected to lead to additional federal regulation of the insurance industry in the coming years. The Company's business depends on compliance with applicable laws and regulations and its ability to maintain valid licenses and approvals for its operations. Regulatory authorities have broad discretion to grant, renew, or revoke licenses and approvals. Regulatory authorities may deny or revoke licenses for various reasons, including the violation or regulations. In some instances, the Company follows practices based on its interpretations of regulations, or those that it believes to be generally followed by the industry, which may be different from the requirements or interpretations of regulatory authorities. If the Company does not have the requisite licenses and approvals and does not comply with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend it from carrying on some or all of its activities or otherwise penalize it. That type of action could have a material adverse effect on its business. Also, changes in the level of regulation of the insurance industry (whether federal, state or foreign), or changes in laws or regulations themselves or interpretations by regulatory authorities, could have a material adverse effect on the Company's business.
Regulatory Restrictions Limit the Company's Ability to Obtain Dividends from Independence American
One of the Company's principal assets through its ownership of IAHC, is the shares of capital stock of Independence American. The Company may rely on dividends from Independence American to meet its obligations for paying principal and interest on outstanding debt obligations, dividends to stockholders and corporate expenses. The payment of dividends by Independence American is subject to regulatory restrictions and will depend on the surplus and future earnings of Independence American, as well as the regulatory restrictions. As a result, should the Company's other sources of funds prove to be inadequate. The Company may not be able to receive dividends from Independence American at times and in amounts necessary to meet its obligations.
Consolidated Statements of Stockholders' Equity for the fiscal years ended December 31, 2003,
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2003 and September 30, 2002, and the results of their operations and their cash flows for the year ended December 31, 2003, the three months ended December 31, 2002 and the years ended September 30, 2002 and 2001, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
As discussed in Notes 2 and 12 to the consolidated financial statements, the Company adopted certain provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," in the three months ended December 31, 2002.
Since the acquisition of Independence American Holding Corp. ("IAHC") on November 14, 2002, American Independence Corp. ("AMIC") has been a holding company engaged in the insurance and reinsurance business through its wholly-owned insurance company, Independence American Insurance Company ("Independence American") and its managing general underwriter subsidiaries: IndependenceCare Holdings L.L.C. and its subsidiaries (collectively referred to as "IndependenceCare"); Risk Assessment Strategies, Inc. ("RAS") and Voorhees Risk Management LLC d.b.a. Marlton Risk Group ("Marlton"). IndependenceCare, RAS and Marlton are collectively referred to as the "MGU Subsidiaries".
The Company has changed its fiscal year end from September 30 to December 31. As a result, the Company filed a Form 10-QT for the quarter ended December 31, 2002 representing the transitional reporting period. This report on Form 10-K for the twelve months ended December 31, 2003 represents the first four fiscal quarters of the new fiscal year ending December 31, 2003. Accordingly, the information for the twelve months ended September 30, 2002 and 2001 (as restated for discontinued operations) is included herein for comparative purposes. The Company's tax year remains unchanged at September 30.
The consolidated financial statements and related notes to the consolidated financial statements have been restated for the effects of the discontinued operations of Intellicom (see Note 3). Certain reclassifications have been made to prior years' consolidated financial statements in order to conform to the current year presentation.
The carrying amount of the Company's financial instruments, which include cash and cash equivalents, short-term investments, receivables, accounts payable and accrued liabilities approximates their fair values.
Investments in fixed income securities, redeemable preferred stock, equity securities, and derivatives (options and options on future contracts) are valued as follows: securities which may or may not be held to maturity ("available-for-sale") are carried at fair value; unrealized gains or losses, net of deferred income taxes, are credited or charged, as appropriate, directly to accumulated other comprehensive income (loss) (a component of stockholders' equity); realized gains and losses on sales of available-for-sale securities, and unrealized losses considered to be other than temporary, are credited or charged to the Consolidated Statements of Operations.
Fixed assets are stated at cost net of accumulated depreciation. Improvements are capitalized while repair and maintenance costs are charged to operations as incurred. Depreciation of property and equipment has been provided on the straight-line method over the estimated useful lives of the respective assets (3 years for computer equipment and 10 years for furniture and fixtures). Amortization of leasehold improvements has been provided on the straight-line method over the shorter of the lease term or the estimated useful life of the asset.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). This interpretation requires that certain disclosures be made by a guarantor in its financial statements about its obligations under guarantees, effective for financial statements for periods ending after December 15, 2002. FIN 45 also requires the recognition, at fair value, of a liability by a guarantor at the inception of certain guarantees issued or modified after December 31, 2003. The disclosure and recognition requirements did not have any impact 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 any 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.
Additional information regarding the background of the 2002 transactions can be found in the Company's proxy statement for the special meeting filed with the Securities and Exchange Commission under cover of a Schedule 14A on November 14, 2002.
On November 14, 2002, the Company acquired IAHC from IHC for $31,920,000 in cash, which is accounted for using the purchase method. The total purchase price of approximately $35,755,000 consists of the $31,920,000 cash paid to IHC, and $3,835,000 of direct transaction costs. Direct transaction costs include fees to Bear, Stearns & Co. Inc. of $1,880,000.
Under the purchase method of accounting, the total estimated purchase price is allocated to IAHC's net tangible and intangible assets based on their estimated fair values as of the date of the completion of the acquisition. Based on an independent valuation, the estimated purchase price is allocated as follows (in thousands):
Of the total purchase price, $31,461,000 has been allocated to net tangible assets acquired and $1,900,000 has been allocated to amortizable intangible assets acquired. The depreciation and amortization related to the fair value adjustment to net tangible assets and the amortization related to the amortizable intangible assets are reflected in the consolidated statements of operations. The intangible assets are being written off over the five years following the acquisition based on the respective discounted cash flows.
On February 10, 2003, but effective as of January 1, 2003, the Company acquired 80% of the business of an employer medical stop-loss MGU and an affiliated entity (the "Acquired MGUs"). The acquisition was accomplished by the formation of Voorhees Risk Management LLC d.b.a. Marlton Risk Group ("Marlton") into which the Acquired MGUs contributed all of their assets, and the Company contributed $16,000,000 cash for an 80% ownership interest. The Company's cash contribution was then distributed to the Acquired MGUs together with the remaining 20% interest in Marlton, and Marlton assumed all of the liabilities of the Acquired MGUs. 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. The total purchase price of approximately $16,102,000 consists of $16,000,000 of cash and $102,000 of estimated direct transaction costs.
The amortized cost and fair value of fixed maturities at December 31, 2003, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The average life of mortgage backed securities is affected by prepayments on the underlying loans and, therefore, is materially shorter than the original stated maturity.
The following table summarizes, for all securities in an unrealized loss position at December 31, 2003, the aggregate fair value and gross unrealized loss by length of time, those securities have continuously been in an unrealized loss position (in thousands):
Substantially all of the unrealized losses at December 31, 2003 relate to investment grade securities and are attributable to changes in market interest rates subsequent to purchase. There were no individual securities with unrealized losses that were significant dollar amounts at December 31, 2003. A total of 39 securities were in a continuous unrealized loss position for less than 12 months and 1 security 12 months or longer. For fixed maturities, there are no securities for which the Company currently believes it is not probable that it will collect all amounts due according to the contractual terms of the investment. Because the Company has the ability and intent to hold securities with unrealized losses until a market price recovery (which, for fixed maturities, may be until maturity) the Company did not consider these investments to be other-than-temporarily impaired at December 31, 2003.
At December 31, 2003 and September 30, 2002, the Company had no derivative instruments.
During fiscal years ended September 30, 2002 and 2001, the Company recorded $733,000 and $17,195,000, respectively of losses on equity investments with declines in fair value that the Company considered to be other than temporary.
There were no realized gains for the years ended September 30, 2002 and 2001.
In prior periods, the Company had various equity investments. At December 31, 2003, the Company had written off or sold all investments held under the equity method of accounting. The Company wrote off $0, $1,000,000, $733,000 and $17,195,000 in the twelve months ending December 31, 2003, the transition period ending December 31, 2002 and the twelve months ending September 30, 2002 and 2001, respectively. Such losses are shown as loss on equity investments in the Consolidated Statements of Operations.
In the twelve months ended September 30, 2002, the Company wrote off its 1,000,000 common stock shares and 400,000 preference stock shares of SkyNet Global Limited ("SkyNet) for $253,000 and $480,000, respectively. SkyNet is a provider of business center services in airports
In the twelve months ended September 30, 2001 the Company recorded losses from the write off or sale of:
30,000 shares of Convergent Communications Services, Inc. ("Convergent") common stock recording a loss of approximately $498,000 as a result of Convergent's inability to secure funding for its cash shortfall and subsequent filing for protection under Chapter 11 of the U.S. Bankruptcy Code, as an other-than-temporary decline;
4,983 Deltathree.Com Inc. ("Deltathree") series A common stock shares recording a loss of $207,000 as an other-than-temporary decline;
267,501 SenseNet, Inc. common stock shares with a carrying value of $250,000. SenseNet was a privately held company that provides intranet business applications that focus on increasing productivity and profitability;
3,000,000 series A convertible preferred stock shares of Freewire Networks, Inc. ("Freewire") with a carrying value of $2,622,000. Freewire was a privately held company developing wireless broadband services at sporting venues. For the year ended September 30, 2001, the Company also recognized equity losses of $415,000 which is reflected in equity in loss on equity investments in the accompanying consolidated statement of operations;
5,300 Interactive Cable Communications Incorporated ("ICC") common stock shares sold to ICC for $250,000 resulting in a loss of $3,180,000. ICC was engaged in the business of providing data transferring services including high-speed cable-based Internet services. For the year ended September 30, 2001, the Company also recognized equity income of $21,000 which is reflected in equity in loss on equity investments in the accompanying consolidated statement of operations.
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. Principally due to the Company's guaranty of Intellicom's lease for its facility in Livermore, California, the Company has a remaining reserve for discontinued operations of Intellicom of $1,119,000 for this liability at December 31, 2003.
On December 28, 2000, the Company's Board of Directors approved a plan to reduce its corporate headquarters staff. At December 31, 2003, the Company had a remaining reserve of $866,000 relating to the restructuring. The additional estimated reserve of $690,000 was necessary due to the final sub-let agreement as compared to original expectations. This reserve primarily relates to the leasehold obligations of the former corporate headquarters in San Francisco, California; the Company maintains an $800,000 security deposit with respect to this liability which is included in restricted cash.
The balance of restructuring reserve as of December 31, 2003 and September 30, 2002, and activity during that period is as follows (in thousands):
Fixed maturities with a carrying value of $3,642,000 are on deposit with various state insurance departments at December 31, 2003.
The Company's rent expense from continuing operations for fiscal years 2003, 2002, and 2001 and for the quarter ended December 31, 2002 were $882,000, $430,000, $499,000 and $135,000, respectively.
On September 26, 2001, Lucent Technologies Inc. ("Lucent") brought an action in San Francisco Superior Court against American Independence Corp. and subsidiaries (the "Company"), alleging that the Company breached a contract by failing to purchase Lucent's shares in Freewire Networks, Inc. ("Freewire") and claiming damages of approximately $3.5 million, increasing over time. The Company settled this claim in March, 2003 within applicable reserved amounts.
On July 30, 2002, the Company's Board of Directors approved a shareholder rights plan (the "Plan"). Pursuant to the Plan's approval, the Company's Board of Directors declared a dividend distribution of one Preferred Share Purchase Right (the "Rights") on each outstanding common stock share. The dividend distribution of the Rights will be payable to common stock stockholders of record on August 14, 2002. The Rights distribution is not taxable to stockholders. Subject to limited exceptions, the Rights will be exercisable if a person or group acquires or announces a tender offer for 4.99% or more of the Company's common stock. Under certain circumstances, each Right will entitle shareholders to buy one one-hundredth of a share of newly created Series A Junior Participating Preferred Stock of the Company at an exercise price of $9.00. The Company's Board of Directors will be entitled to redeem the rights at $0.01 per right at any time before a person has acquired 4.99% or more of the outstanding common stock. The Plan expired pursuant to its terms upon the Company's filing of its Amended and Restated Certificate of Incorporation with the Secretary of State of the State of Delaware on November 14, 2002. This Amended and Restated Certificate of Incorporation provided for limitations on the acquisition of the Company's common stock in excess of certain percentage amounts.
ESPP provided for the purchase of common stock at the lower of 85% of the fair market value of the common stock shares on the first day of the offering period or 85% of the fair market value of the common stock shares on the last day of the offering period. A total of 1,325,000 common stock shares were reserved for issuance under ESPP. For the year ended September 30, 2001, the Company issued 56,769 common stock shares for a total value of $100,000.
The Company granted stock options to seven separate consultants to purchase an aggregate of 180,500 common stock shares. The stock options were granted as partial consideration for services rendered, and had exercise prices ranging from $7.375 to $23.8125. Of the 180,500 options issued, 116,194 were exercised, and at December 31, 2003, the remaining 62,306 consultant stock options had expired unexercised. These stock options for common stock shares were granted in a nonpublic offering pursuant to transactions exempt under Section 4(2) of the Securities Act.
On March 22, 1999, the Company issued warrants to purchase 1,004 common stock shares to an institutional lender in connection with a $3,000,000 credit facility. The credit facility was used to fund certain capital equipment acquisitions. The warrants had an exercise price of $89.63 and expired on March 22, 2003. The fair value of the warrants on the issuance date was estimated using the Black-Scholes option pricing model with the following assumptions: volatility of 108% risk free interest rate of 4.78%, no dividend yield, and an expected contractual life of four years.
The following table summarizes the outstanding options and warrants to purchase common stock shares for fiscal years 2003, 2002, 2001 and the three months ended December 31, 2002:
The following table summarizes information regarding stock options outstanding at December 31, 2003:
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure". As permitted by SFAS No. 148, the Company has elected to prospectively account for all stock option grants issued on or after October 1, 2002, under the fair value based method. As part of the election to prospectively account for all stock option grants under the fair value based method, the Company is permitted to continue accounting for all stock option grants issued before October 1, 2002, under the intrinsic value method. Under the fair value based method, stock compensation costs for stock option grants is measured at the grant date based on the value of the award, and such cost is recognized as an expense over vesting period of the stock option grant. Under the intrinsic value method, compensation expense is recognized for stock options issued with an exercise price less than the stock's fair value on the date of grant and such expense is recognized over the vesting period.
Had the Company applied the fair value based method of accounting for stock-based compensation awards issued prior to October 1, 2002, the Company's net income (loss) and income (loss) per share would have been the pro forma amounts as follows (in thousands except per share data):
As a result of the Company not granting stock options for the year ended September 30, 2002, no calculation of fair value of each stock option on the date of grant using the Black-Scholes option-pricing model was preformed. The fair value of each stock option grant on the date of grant was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions for the years ended December 31, 2003 and September 30, 2001 and for the three - months ended December 31, 2002:
From October 1, 1998 to April 12, 1999, the Company, pursuant to the 1998 Plan, granted 1,618,550 incentive and non-qualified common stock options with a weighted average exercise price of $12.74 per share to certain employees. As a result of the adoption of the 1998 Plan, and in accordance with APB 25, the Company recorded a non-cash deferred stock compensation charge of $77,361,000 related to the issuance of these stock options. Deferred stock compensation is amortized on a straight-line basis over the remaining vesting period of such stock options to compensation related to stock options. For the year ended December 31, 2003, the three months ended December 31, 2002, and the years ended September 30, 2002 and 2001, the Company recognized compensation expense (benefit) related to these stock options of 17,000; $62,000; $1,501,000, which includes $35,000 allocated to the discontinue operations of Intellicom; and $(1,279,000), which includes $(472,000) allocated to the discontinued operations of ISP Channel and Intellicom, respectively. 	Also, in accordance with SFAS 123 the Company recognized deferred compensation charges of approximately $1,890,000 with respect to the 140,500 stock options granted to certain consultants. These deferred compensation charges were amortized, on an accelerated basis over the vesting period of such options, in accordance with Financial Accounting Standards Board Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. No compensation expense related to these stock options was recognized for the year ended December 31, 2003, the three months ended December 31, 2002 and the year ended September 30, 2002. For the year ended September 30, 2001, the Company recognized compensation benefit related to these stock options of $31,000.
On February 6, 2001, the Company engaged (212) Ventures, Inc. for business and financial advisory services. For the year ended September 30, 2001, the Company paid (212) Ventures, Inc. $100,000 for such services. Edward A. Bennett, a Director of the Company, is a principal of (212) Ventures, Inc.
For the years ended September 30, 2002, and 2001, the Company paid to Bear, Stearns & Co., Inc. $1,337,000 and $350,000 respectively, for investment banking services. Robert C. Harris, Jr., a Director of the Company, is a senior managing director of Bear, Stearns & Co., Inc.
At December 31, 2003, the balance sheet contains a net deferred tax asset of $15,990,000, net of a valuation allowance of $89,664,000. Substantially all of the net deferred tax asset relates to Federal net operating loss carryforwards. The realizability of this net asset is dependent upon the Company's generation of approximately $45,685,000 in future taxable income. However, events may limit the use of all or a portion of these Federal net operating loss carryforwards, which may result in a higher tax liability for the Company in the future. The net deferred tax asset, including the valuation allowance, at December 31, 2003 is subject to future adjustment based upon changes in management's evaluation of the realizability of the deferred tax asset.
The difference between the Company's actual tax expense (benefit) recorded and the amounts computed by applying the U.S. Federal income tax rate of 35% to pre-tax loss for the three months ended December 31, 2002 and the years ended September 30, 2002 and 2001 are due primarily to the valuation allowance on the Company's net operating losses.
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 differences 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 it is more likely than not that the Company will realize the benefits of these net deferred tax assets recorded at December 31, 2003.
At December 31, 2003, the Company had net operating loss carryforwards for Federal income tax purposes of approximately $287,400,000 available to reduce future income subject to income taxes.
Independence American reinsures a portion of its provider excess loss business in order to limit the assumption of disproportionate risks. Amounts not retained are ceded to other companies on an automatic basis. Independence American is contingently liable with respect to reinsurance in the unlikely event that the assuming reinsurers are unable to meet their obligations. The ceding of reinsurance does not discharge the primary liability of the original insurer to the insured. At December 31, 2003, Independence American cedes to two highly rated reinsurers.