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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the fiscal year ended SEPTEMBER 30, 2002.
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OR
[ ] Transition Report under Section 13 or 15(d) of the Securities Exchange Act
of 1934.
For the transition period from _____________ to _____________.
Commission File Number: 001-05270
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AMERICAN INDEPENDENCE CORP.
(FORMERLYSOFTNET SYSTEMS, INC.)
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(Exact name of registrant as specified in its charter)
DELAWARE 11-1817252
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
485 MADISON AVENUE, NEW YORK, NEW YORK 10022
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 355-4141
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR
VALUE $0.01 PER SHARE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in the definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the
registrant at OCTOBER 31, 2002, was approximately $38,608,000.
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING ATOCTOBER 31, 2002
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COMMON STOCK, $0.01 PAR VALUE 25,183,701
DOCUMENTS INCORPORATED BY REFERENCE:
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Proxy Statement for Registrant's 2003 Annual Meeting of Stockholders (Part III)
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PART I
ITEM 1. BUSINESS
This Annual Report on Form 10-K contains forward-looking statements that involve
risks and uncertainties. The actual results of American Independence Corp. and
subsidiaries could differ significantly from those set forth herein. Factors
that could cause or contribute to such differences include, but are not limited
to, those discussed in "Factors Affecting the Company's Operating Results" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" as well as those discussed elsewhere in this Annual Report on Form
10-K. Statements contained herein that are not historical facts are
forward-looking statements that are subject to the safe harbor created by the
Private Securities Litigation Reform Act of 1995. Words such as "believes",
"anticipates", "expects", "intends", "estimates", "likelihood", "unlikelihood",
"assessment" and "foreseeable", and other similar expressions are intended to
identify forward-looking statements, but are not the exclusive means of
identifying such statements. A number of important factors could cause our
actual results to differ materially from the statements and those expressed or
implied in any forward-looking statements made by us, or on our behalf. We
undertake no obligation to release publicly the results of any revisions to
these forward-looking statements that may be made to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
On July 30, 2002, SoftNet Systems, Inc., and subsidiaries (collectively referred
to as the "Company") entered into an agreement to acquire First Standard
Holdings Corp. from SSH Corp. and Independence Holding Company ("IHC") for
$31,920,000 in cash. 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 First Standard Holdings Corp. changed its name to
Independence American Holdings Corp. ("IAHC"). IAHC and its wholly-owned
subsidiaries are engaged in the insurance and reinsurance business. The
Company, which was a holding company principally engaged in providing Internet
services, had previously wound down its Internet related businesses and as a
result of the acquisition of IAHC has become an insurance holding company.
Additionally, due to the acquisition of IAHC, the Company has decided to close
its offices in San Francisco, terminate all but one of its employees, and enter
into a services agreement with IHC under which the Company's operations will be
directed by IHC management and employees. The transaction is more fully
described in the Company's Definitive Proxy/Prospectus Statement on Schedule 14A
as filed with the Securities Exchange Commission on September 30, 2002.
In a separate transaction on July 30, 2002, IHC acquired Pacific Century
Cyberworks Limited's ("PCCW") entire interest in the Company consisting of
5,000,000 common stock shares at $3.00 per share for a total value of
$15,000,000. As a result of this transaction, PCCW's appointees Linus W.L.
Cheung and Jeffrey A. Bowden resigned from the Company's Board of Directors, and
Edward Netter, Chairman of IHC, and Roy T.K. Thung, President and Chief
Executive Officer of IHC, were appointed to the Company's Board of Directors.
Additionally, upon closing of the purchase of IAHC, IHC has agreed to make a
cash tender offer at $3.00 per share for at least 3,000,000 outstanding common
stock shares of the Company, subject to certain limitations, by no later than
February 18, 2003.
On May 17, 2002, the Company received a Nasdaq Staff Determination Letter
stating that the Company's common stock was no longer eligible for continued
listing on the Nasdaq National Market as a result of the Company ceasing the
operations of its last business segment, Intellicom, and that the Company
therefore did not meet the requirements for continued listing set forth in
Marketplace Rules 4300 and 4330. Subsequently, the Company requested and was
granted an oral hearing before a Nasdaq Listing Qualifications Panel to appeal
the Nasdaq Staff Determination Letter, which stayed the delisting of the
Company's common stock pending the outcome of the hearing. On July 12, 2002,
the Company appeared before the Nasdaq Listing Qualifications Panel to present
the Company's plan to acquire IAHC, which would allow the Company to comply with
the Marketplace Rules 4300 and 4330. On August 15, 2002, the Nasdaq Listing
Qualifications Panel informed the Company that the Company will remain listed on
Nasdaq, subject to meeting various conditions, including the completion of the
acquisition of IAHC by December 31, 2002. Nasdaq has also informed the Company
that if it does remain listed on Nasdaq, following the acquisition of IAHC, the
Company will be required to meet Nasdaq's initial listing requirements as well
as Nasdaq's continued listing requirements.
-1-
As of September 30, 2002, the Company had substantially completed the wind down
of its Internet services related subsidiaries, ISP Channel, Inc. ("ISP
Channel"), Intelligent Communications, Inc. ("Intellicom"), and Aerzone
Corporation ("Aerzone"), including Laptop Lane Limited ("Laptop Lane"), as a
result of the following:
On December 7, 2000, the Company's Board of Directors approved a plan to
discontinue its ISP Channel operations because of (1) the consolidation in the
cable industry made it difficult for ISP Channel to achieve the economies of
scale necessary to provide such services profitably, and (2) the Company was no
longer able to bear the costs of maintaining the ISP Channel. Subsequently on
December 19, 2000, the Company's Board of Directors approved a plan to
discontinue its Aerzone, including Laptop Lane, business in light of, among
other things, significant long-term capital needs and the difficulty of securing
the necessary financing because of the financial markets. In conjunction with
discontinuing the ISP Channel and Aerzone businesses, the Company's Board of
Directors on December 28, 2000, approved a plan to reduce its corporate
headquarters staff.
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. Subsequently on
April 22, 2002, Intellicom entered into an agreement to sell certain assets to
Native Intellicom, Inc., a wholly-owned subsidiary of the Pinoleville Band of
Pomo Indians, for cash, subject to the termination of Intellicom's lease for its
facility in Livermore, California. On August 1, 2002, Intellicom terminated the
agreement with the Pinoleville Band of Pomo Indians and is negotiating to sell
those assets to another group of Native Americans.
EMPLOYEES
The Company had 9 employees at October 31, 2002.
FACILITIES
The Company's principal executive office is located at 485 Madison Avenue, New
York, New York 10022. The Company is currently in negotiations to sublease its
previous principal executive office located at 650 Townsend Street, Suite 225,
San Francisco, California 94103.
-2-
INDEPENDENCE AMERICAN HOLDINGS CORP.
Prior to its acquisition by the Company, Independence American Holdings Corp., a
Delaware corporation, and it subsidiaries (collectively referred to as "IAHC"),
were an indirect wholly-owned subsidiary of IHC. IAHC is engaged principally in
the health insurance and reinsurance business through its wholly-owned
subsidiaries; Independence American Insurance Company ("Independence American"),
formerly First Standard Insurance Corp.; IndependenceCare Holdings LLC and its
subsidiaries (collectively referred to as "IndependenceCare"); and Risk
Assessment Strategies, Inc. ("RAS").
PRINCIPAL PRODUCT AND SERVICES
Independence American Insurance Company
Independence American, which is domiciled in Delaware, is licensed to write
property and/or casualty insurance in 24 states, and has a B+ (Very Good) rating
from A.M. Best & Company, Inc ("A.M. Best"). An A.M. Best rating is assigned
after an extensive quantitative and qualitative evaluation of a company's
financial condition and operating performance, and is also based upon factors
relevant to policyholders, agents, and intermediaries, and is not directed
toward protection of investors. A.M. Best ratings are not recommendations to
buy, sell or hold securities of IAHC.
Independence American reinsures employer medical stop-loss insurance for
self-insured group medical plans. Self-insured plans permit employers
flexibility in designing employee health coverages at a cost that may be lower
than that available through other health care plans provided by an insurer or
Health Maintenance Organization ("HMO"). Employer medical stop-loss insurance
allows self-insured employers to manage the risk of excessive health insurance
costs under self funded plans by limiting the employer's health care expenses to
a predetermined amount. This stop-loss coverage is available on either a
"specific" or a "specific and aggregate" basis. Specific stop-loss coverage
reimburses employers from large claims incurred by an individual employee or
dependent. When an employee or dependent's covered claims exceed the specific
stop-loss deductible, covered amounts in excess of the deductible are
reimbursable to the employer under the specific stop-loss policy. The specific
stop-loss deductible is selected based on the number of covered employees, the
employer's capacity to assume some of the risk, and the medical claim experience
of the plan. Aggregate stop-loss coverage protects the employer against
fluctuations due to claim frequency. The employer's overall claim liability is
limited to a certain dollar amount, often referred to as the attachment point.
An aggregate stop-loss policy usually provides reimbursement when covered claims
for the plan as a whole exceed the attachment point. Approximately 50% of the
stop-loss policies Independence American reinsures cover specific claims only.
Employer medical stop-loss is a "short-tail" business which means that
substantially all claims will have been paid within eighteen months after
inception of a policy.
Independence American has entered into reinsurance treaties with Standard
Security Life Insurance Company of New York ("Standard Life") and Madison
National Life insurance Company, Inc. ("Madison Life") pursuant to which
Standard Life and Madison Life, respectively, will cede, at treaty renewals, at
least 15% of their employer medical stop-loss business to Independence American.
Standard Life and Madison Life are wholly-owned subsidiaries of IHC. The
reinsurance treaties between Independence American and Standard Life, on the one
hand, and Independence American and Madison Life, on the other hand, terminate
December 31, 2014, unless sooner terminated by Independence American. Standard
Life, which is domiciled in New York, has an A (Excellent) rating from A.M.
Best, and is licensed as an insurance company in all 50 states, the District of
Columbia, the Virgin Islands and Puerto Rico. Madison Life, which is domiciled
in Wisconsin, has an A- (Excellent) rating from A.M. Best, is licensed to sell
insurance products in 46 states, the District of Columbia and the Virgin
Islands, and is an accredited reinsurer in New York. Standard Life and Madison
Life market employer medical stop-loss insurance nationally through a network of
managing general underwriters ("MGUs"), who are non-salaried contractors that
receive administrative fees. Standard Life currently markets this product
through 11 MGUs, including IndependenceCare and RAS. Madison Life currently
markets through 2 MGUs. MGUs are responsible for establishing an employer's
conditions for coverage in accordance with guidelines formulated and approved by
Standard Life and Madison Life, billing and collecting premiums from the
employers, paying commissions to third party administrators ("TPAs") and/or
brokers, and adjudicating claims. Standard Life and Madison Life are
responsible for selecting MGUs, establishing underwriting guidelines,
maintaining approved policy forms and reviewing and medically managing
employers' claims for reimbursement, as well as establishing appropriate
accounting procedures and reserves.
-3-
Managed Care Excess Coverage
Independence American issues and reinsures managed care excess coverages, which
includes provider excess loss insurance and HMO reinsurance.
Provider Excess Loss Insurance and Reinsurance
Independence American issues and reinsures provider excess loss insurance on a
specific loss basis only. This product is marketed to providers, managed care
organizations, including provider hospital organizations, hospital groups,
physician groups and individual practice associations (collectively "MCOs") that
have assumed risk (through capitation by an HMO or otherwise) and desire to
reduce their risk assumption and/or are required to purchase coverage by
contract or regulation.
Independence American is licensed in 24 states and has begun to write provider
excess loss insurance in certain of these states through IndependenceCare and
another MGU that specializes in this product. IndependenceCare and this MGU are
responsible for marketing, underwriting, billing and collecting premiums, and
medically managing, administering and adjudicating claims. Independence
American also reinsures provider excess loss insurance written through
IndependenceCare and this other MGU and issued by Standard Life and other
carriers on a specific loss basis only.
HMO Reinsurance
Independence American reinsures HMO Reinsurance coverage written through
Standard Life and marketed by IndependenceCare. This coverage protects HMO's
against excess losses incurred under an HMO health plan and is marketed to HMO's
who desire to reduce their risk assumption and/or are required to purchase
coverage by contract or regulation.
Managing General Underwriters
IndependenceCare is an MGU for the employer medical stop-loss, provider excess
loss and HMO Reinsurance products of Standard Life and Independence American.
IndependenceCare has agreements with other carriers to write business on its
behalf in the event of marketing conflicts or regulatory requirements. During
the first quarter of 2001, IndependenceCare acquired the business and employees
of two other managed care MGUs and, during the first quarter of 2002, it
acquired the business and employees of a medical stop-loss MGU.
IndependenceCare currently has three operating subsidiaries, IndependenceCare
Underwriting Services - Minneapolis L.L.C., IndependenceCare Underwriting
Services - Tennessee L.L.C. and IndependenceCare Underwriting Services -
Southwest L.L.C. IndependenceCare's experienced staff is responsible for
marketing, underwriting, billing and collecting premiums and medically managing,
administering and adjudicating claims. Final authority for all financial
decisions remains with the carrier.
RAS is an MGU for employer medical stop-loss and group life for Standard Life
and another carrier. RAS, which is based in South Windsor, Connecticut, has
experienced marketing, underwriting and claims personnel.
REINSURANCE INDUSTRY
Reinsurance is an arrangement in which an insurance company, the reinsurer,
agrees to indemnify another insurance company, the ceding company, against all
or a portion of the insurance risks underwritten by the ceding company under one
or more insurance contracts. Reinsurance can provide a ceding company with
several benefits, including a reduction in net liability on individual or
classes of risks, catastrophe protection from large or multiple losses and
assistance in maintaining acceptable financial ratios. Reinsurance also
provides a ceding company with additional underwriting capacity by permitting it
to accept larger risks and write more business than would be possible without an
accompanying increase in capital and surplus. Reinsurance, however, does not
discharge the ceding company from its liability to policyholders.
There are two basic types of reinsurance arrangements: treaty and facultative
reinsurance. In treaty reinsurance, the ceding company is obligated to cede and
the reinsurer is obligated to assume a specified portion of a type of category
of risks insured by the ceding company. Treaty reinsurers do not separately
evaluate each of the individual risks assumed under their treaties and,
consequently, after a review of the ceding company's underwriting practices, are
largely dependent on the original risk underwriting decisions made by the ceding
company. In facultative reinsurance, the ceding company cedes and the reinsurer
assumes all or part of the risk under a single insurance contract. Facultative
reinsurance is negotiated separately for each insurance contract that is
reinsured. Facultative reinsurance normally is purchased by ceding companies
for individual risks not covered by their reinsurance treaties, for amounts in
excess of the dollar limits of their reinsurance treaties and for unusual risks.
-4-
Both treaty and facultative reinsurance can be written on either a pro rata
basis or an excess of loss basis. Under pro rata reinsurance, the ceding
company and the reinsurer share the premiums as well as the losses and expenses
in an agreed proportion. Under excess of loss reinsurance, the reinsurer
indemnifies the ceding company against all or a specified portion of losses and
expenses in excess of a specified dollar amount, known as the ceding company's
retention or reinsurer's attachment point, generally subject to a negotiated
reinsurance contract limit.
Premiums paid by the ceding company to a reinsurer for excess of loss
reinsurance are not directly proportional to the premiums that the ceding
company receives because the reinsurer does not assume a proportionate risk. In
pro rata reinsurance, the reinsurer generally pays the ceding company a ceding
commission. The ceding commission generally is based on the ceding company's
cost of acquiring the business being reinsured (commissions, premium taxes,
assessments and miscellaneous administrative expenses). There is usually no
ceding commission on excess of loss reinsurance.
Reinsurers may purchase reinsurance to cover their own risk exposure.
Reinsurance of a reinsurer's business is called a retrocession. Reinsurance
companies cede risks under retrocessional agreements to other reinsurers, known
as retrocessionaires, for reasons similar to those that cause insurers to
purchase reinsurance: to reduce net liability on individual or classes of risks,
protect against catastrophic losses, stabilize financial ratios and obtain
additional underwriting capacity.
RESERVES AND INVESTMENTS
Independence American's securities portfolio is managed by employees of IHC and
its affiliates, and ultimate investment authority rests with Independence
American's Board of Directors. As a result of the nature of its insurance
liabilities, Independence American endeavors to maintain a significant
percentage of its assets in investment grade securities, cash and cash
equivalents. At December 31, 2001, approximately 100% of the fixed maturities
were investment grade. The internal investment group provides a summary of the
investment portfolio and the performance thereof at the meetings of IAHC's board
of directors.
As required by insurance laws and regulations, Independence American establishes
reserves to meet obligations on policies in-force. These reserves are amounts
which are calculated to be sufficient to meet anticipated future policy
obligations. Premiums and reserves are based upon certain assumptions with
respect to morbidity. Independence American invests its assets, which support
the reserves and other funds in accordance with applicable insurance law, under
the supervision of their respective boards of directors. IAHC manages interest
rate risk seeking to maintain a portfolio with a duration and average life that
falls within the band of the duration and average life of the applicable
liabilities.
Under Delaware insurance law, there are restrictions relating to the percentage
of an insurer's admitted assets that may be invested in a specific issuer or in
the aggregate in a particular type of investment. In addition, there are
qualitative investment restrictions.
COMPETITION AND REGULATION
Independence American competes with many larger insurance and reinsurance
companies and managed care organizations. IndependenceCare and RAS compete with
many other managing general underwriters, insurance companies, HMOs and other
managed care organizations.
IAHC is an insurance holding company; as such, it is subject to regulation and
supervision by the insurance supervisory agencies of Delaware. Independence
American is also subject to regulation and supervision in all jurisdictions in
which it is licensed to transact business. These supervisory agencies have
broad administrative powers with respect to the granting and revocation of
licenses to transact business, the licensing of agents, the approval of policy
forms, the approval of commission rates, the form and content of mandatory
financial statements, reserve requirements and the types and maximum amounts of
investments which may be made. Such regulation is designed primarily for the
benefit of policyholders rather than the stockholders of an insurance company or
holding company.
Certain transactions within the holding company system are also subject to
regulation and supervision by such regulatory agencies. All such transactions
must be fair and equitable. Notice to or prior approval by the insurance
department is required with respect to transactions affecting the ownership or
-5-
control of an insurer and of certain material transactions, including dividend
declarations, between an insurer and any person in its holding company system.
Under Delaware insurance laws, "control" is defined as the possession, directly
or indirectly, of the power to direct or cause the direction of the management
and policies of a person, and is presumed to exist if any person, directly or
indirectly, owns, controls or holds with the power to vote ten percent or more
of the voting securities of any other person. An agreement to acquire control
of an insurer domiciled in Delaware must be approved by the Commissioner of
Insurance of Delaware. In addition, periodic disclosure is required concerning
the operations, management and financial condition of the insurer within the
holding company system. An insurer is also required to file detailed annual
statements with each supervisory agency, and its affairs and financial
conditions are subject to periodic examination.
Risk-based capital requirements are imposed on property and casualty insurance
companies. The risk-based capital ratio is determined by dividing an insurance
company's total adjusted capital, as defined, by its authorized control level
risk-based capital. Companies that do not meet certain minimum standards
require specified corrective action. The risk-based capital ratio for
Independence American exceeds such minimum ratios.
EMPLOYEES
As of October 31, 2002, IAHC has 31 employees.
PROPERTIES
IndependenceCare leases 4,000 square feet of office space in Minneapolis,
Minnesota; 3,800 square feet in Vernon Hills, Illinois; 2,500 square feet in
Franklin, Tennessee; and 1645 square feet in Austin, Texas. RAS leases 4,200
square feet of office space in South Windsor, Connecticut.
LEGAL PROCEEDINGS
There are various lawsuits pending against IAHC in the normal course of its
insurance business. IAHC's management is of the opinion that the ultimate
liabilities arising from such litigation, if any, would not have a material
adverse effect on the financial position of IAHC.
-6-
ITEM 2. PROPERTIES
American Independence Corp., formerly SoftNet Systems, Inc., and subsidiaries
(collectively referred to as the "Company") leases approximately 16,800 square
feet of office space at 650 Townsend Street, San Francisco, California, which
expires on July 31, 2005. The Company is currently in negotiations to
sublease these offices.
IndependenceCare leases 4,000 square feet of office space in Minneapolis,
Minnesota; 3,800 square feet in Vernon Hills, Illinois; 2,500 square feet in
Franklin, Tennessee; and 1645 square feet in Austin, Texas. RAS leases 4,200
square feet of office space in South Windsor, Connecticut.
ITEM 3. LEGAL PROCEEDINGS
On September 26, 2001, Lucent Technologies Inc. ("Lucent") brought an action in
San Francisco Superior Court against American Independence Corp., formerly
SoftNet Systems, Inc., and subsidiaries (collectively referred to as 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, which may increase over time. On December 31, 2001,
the San Francisco Superior Court issued an order to deny Lucent's application
for writ of attachment, finding that Lucent had not shown a substantial
probability that it will prevail on its claim. The Company continues to believe
that Lucent's claims are without merit and will contest these claims vigorously.
On November 9, 2001, Nokia Inc. ("Nokia") commenced an action in San Francisco
Superior Court against the Company and Aerzone Corporation ("Aerzone"), alleging
breach of contract arising out of the Aerzone's proposed operations in certain
airports. Nokia seeks approximately $2.1 million in damages. The Company
believes that Nokia's claims are without merit and intends to contest these
claims vigorously. Additionally, the Company deposited security collateral of
$1,053,000 as required by the performance bond indemnity agreement with the
surety company. In the event that the Company prevails, any balance on the
collateral will be returned by the surety company to the Company.
On October 30, 2001, Global Information Distribution GmbH ("GID") commenced a
demand for arbitration against the Company, alleging breach of contract and
warranties relating to the sale of Micrographic Technology Corporation ("MTC")
to GID on September 30, 1999. GID claims approximately $750,000 in damages.
The Company believes GID's claims are without merit and intends to contest these
claims vigorously.
The Company is also involved in other legal proceedings and claims, which arise
in the ordinary course of its discontinued businesses. The Company believes the
results of the above noted legal proceedings, other pending legal proceedings
and claims are not expected to have a material adverse effect on its results of
operations, financial condition or cash flows.
There are various lawsuits pending against IAHC in the normal course of its
insurance business. IAHC's management is of the opinion that the ultimate
liabilities arising from such litigation, if any, would not have a material
adverse effect on the financial position of IAHC.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
-7-
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Since November 15, 2002, the common stock of American Independence Corp.,
formerly SoftNet Systems, Inc., and subsidiaries (collectively referred to as
the "Company") has been listed and traded on the Nasdaq National Market
("Nasdaq") under the symbol "AMIC". From April 14, 1999 through November 14,
2002, the Company's common stock was traded and listed on Nasdaq under the
symbol "SOFN". Prior to that date, the Company's common stock was traded and
listed on the American Stock Exchange ("AMEX") under the symbol "SOF". The per
share range of high and low sale prices for the Company's common stock as
reported on Nasdaq, as applicable, for each three month period over the two
years ended September 30, 2002, are as follows:
HIGH LOW
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YEAR ENDED SEPTEMBER 30, 2001:
December 31, 2000. . . . . . $6.437500 $1.125000
March 31, 2001 . . . . . . . 2.500000 1.062500
June 30, 2001. . . . . . . . 2.150000 1.156250
September 30, 2001 . . . . . 2.100000 1.380000
YEAR ENDED SEPTEMBER 30, 2002:
December 31, 2001. . . . . . $1.880000 $1.290000
March 31, 2002 . . . . . . . 2.220000 1.710000
June 30, 2002. . . . . . . . 2.290000 1.800000
September 30, 2002 . . . . . 2.550000 1.720000
At October 31, 2002, there were 407 record holders of the Company's common
stock. The closing price for the Company's common stock at October 31, 2002,
was $2.39.
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
$3.00. 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 Rights are designed to inhibit some acquisitions of the Company's common
stock shares that could result in the imposition of limitations on the use of
its Federal net operating loss carryforwards and certain income tax credits.
The Rights are also intended to enable all stockholders to realize the long-term
value of their investment in the Company. The Rights are not being distributed
in response to any specific effort to acquire control of the Company. The
Rights are designed to help protect the tax benefits associated with the
Company's net operating loss carryforwards.
If a person becomes an Acquiring Person, each Right will entitle its holder to
purchase, at the Right's then-current exercise price, a number of the Company's
common shares having a market value at that time of twice the Right's exercise
price. The Rights held by the Acquiring Person will become void and will not be
exercisable to purchase shares at the bargain purchase price. If Company is
acquired in a merger or other business combination transaction which has not
been approved by the Company's Board of Directors, each Right will entitle its
holder to purchase, at the Right's then-current exercise price, a number of the
acquiring company's common shares having a market value at that time of twice
the Right's exercise price.
The Plan will expire on the close of business on the earliest date that (a) a
vote of Company's stockholders does not approve an amendment or an amendment and
restatement of the Company's Certificate of Incorporation proposed by the
Company's Board of Directors providing for limitations on the acquisition of the
Company's common stock in excess of certain percentage amounts, (b) such
restated Certificate of Incorporation is filed with the Secretary of State of
the State of Delaware or (c) the Company's stock purchase agreement with SSH
Corp. and IHC is terminated, subject to the Company's right to extend such date
and the Company's earlier redemption or exchange of such rights or termination
of the Plan.
-8-
Subsequently, as a result of the approval of the Company's amended and restated
Certificate of Incorporation by the Company's stockholders at the Special
Meeting of Stockholders on November 14, 2002, and filing of the restated
Certificate of Incorporation with the Secretary of State of the State of
Delaware, the Plan expired.
Other than restrictions that may be part of various debt instruments, the
Company does not have any legal restriction on paying dividends.
RECENT SALES OF UNREGISTERED SECURITIES
On September 15, 1995, in association with the acquisition of MTC, the Company
assumed $1,800,000 of 6% Convertible Subordinated Secured Debentures due
February 28, 2002. These 6% debentures were subject to redemption at the option
of the Company at face value, provided however, that the Company issued warrants
to purchase common stock shares for the same number of shares as would have been
issued if the debentures were converted. These debentures were convertible into
the Company's common stock at $8.10 per share. These securities were issued in
a non-public offering pursuant to transactions exempt under Section 4(2) of the
Securities Act of 1993, as amended (the "Securities Act"). As of September 30,
1999, the Company issued 140,739 common stock shares pursuant to the conversion
of $1,140,000 of these convertible debentures. Subsequently on November 15,
2000, the remaining principal of $660,000 and accrued interest was paid.
On September 15, 1995, the Company issued $2,856,000 of its 9% Convertible
Subordinated Debentures due September 15, 2000, in conjunction with the
acquisition of MTC. The debentures were issued to the shareholders of MTC as
partial consideration for the acquisition. These 9% debentures had a conversion
price of $6.75. These securities were issued in a non-public offering pursuant
to transactions exempt under Section 4(2) of the Securities Act. As of
September 30, 1999, the Company issued 222,200 common stock shares pursuant to
the conversion of $1,499,000 of these debentures. For the year ended September
30, 2000, the Company issued 1,467 common stock shares pursuant to the
conversion of $63,000 of convertible debt by two separate holders of these
debentures. On September 15, 2000, the Company paid the remaining $1,294,000 of
convertible debt and accrued interest in cash.
On January 2, 1998, the Company issued $1,444,000 principal amount of its 5%
Convertible Subordinated Debentures due September 30, 2002, to Mr. R.C.W.
Mauran, who was at the time of the transaction a beneficial owner of more than
5% of the Company's common stock, in exchange for the assignment to the Company
of certain equipment leases and other consideration, all of which had been
assimilated into the business of Micrographic Technology Corporation. The
debentures were convertible into the Company's common stock at $8.25 per share
after December 31, 1998. These securities were issued in a non-public offering
pursuant to transactions exempt under Section 4(2) of the Securities Act. On
September 30, 2002, the Company paid the principal of $1,444,000 and accrued
interest in cash.
On January 12, 1999, the Company issued $12,000,000 of its 9% Senior
Subordinated Convertible Notes (the "Notes") due January 1, 2001, to a group of
institutional investors. These Notes were convertible into the Company's common
stock with an initial conversion price of $17.00 per share until July 1, 1999,
and, thereafter, at the lower of $17.00 per share (the "Initial Conversion
Price") and the lowest five-day average closing bid price of the Company's
common stock during the 30-day trading period ending one day prior to the
applicable conversion date (the "Conversion Price"). In connection with these
Notes, the Company issued to these investors warrants to purchase an aggregate
of 300,000 shares of the Company's common stock. These warrants have an
exercise price of $17.00 per share and expire in 2003. On April 28, 1999, as a
result of the Company's underwritten secondary public offering (the "Secondary
Offering"), and in conjunction with an anti-dilution provision associated with
the Notes, the Initial Conversion Price was reduced from $17.00 to $16.49 per
share. Furthermore, in order to secure three month lock-up agreements from the
holders of the Notes in conjunction with the Secondary Offering, the Company
entered into a new arrangement with the holders of the Notes to issue all future
interest payments, beginning with the three months ended June 30, 1999, in the
form of convertible notes with substantially the same form and features as the
original Notes. Therefore, the Company issued an additional $549,000 in notes,
representing interest for the six months ended September 30, 1999 (the "Interest
Notes"). The Notes and warrants were issued in a nonpublic offering pursuant
Regulation D under the Securities Act. On October 22, 1999, all of the 9%
Senior Subordinated Convertible Notes, related Interest Notes and accrued
interest were converted into 765,201 common stock shares of the Company.
On February 9, 1999, a wholly owned subsidiary of the Company merged with and
into Intellicom (the "Intellicom Acquisition"). The Intellicom Acquisition was
accounted for under the purchase method, and the results of Intellicom have been
included in the consolidated financial statements since the date of acquisition.
The purchase price of $14,869,000 was comprised of: (i) a cash component of
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$500,000 (the "Cash Consideration"); (ii) a promissory note in the amount of
$1,000,000 bearing interest at 7.5% per annum and due one year after closing
(the "First Promissory Note"); (iii) a promissory note in the amount of
$2,000,000 bearing interest at 8.5% per annum and due two years after closing
(the "Second Promissory Note", together with the First Promissory Note are
defined as "Debt Consideration"); (iv) the issuance of 500,000 shares of the
Company's common stock (adjustable upwards after one year in certain
circumstances), valued at $14.938 per share, for a total value of $7,469,000
(the "Closing Shares"); (v) additional shares of the Company's common stock
issuable upon the first, second and third anniversaries of the closing, valued
at a total of $3,500,000 (the "Anniversary Shares", together with the Closing
Shares are defined as "Equity Consideration"); and (vi) certain direct
acquisition costs totaling $400,000. The Debt Consideration may be partially or
wholly converted into the Company's common stock, under certain circumstances.
The conversion price of the Debt Consideration was based upon the average
closing price of the Company's common stock for the 15 days immediately
preceding the conversion date. In April 1999, the Company paid the First
Promissory Note and related interest in full with a combination of $832,000 in
cash and the remainder, after expenses, with 6,118 common stock shares valued at
$190,000. The Intellicom Acquisition agreement required the Company to issue
$1,500,000 of common stock shares on the first anniversary date of the
Intellicom Acquisition. Accordingly, on February 8, 2000, the Company issued
43,314 common stock shares valued at $1,499,000 and paid $1,000 for fractional
shares to the former Intellicom stockholders. On February 7, 2001, the Company
made an offer to the former Intellicom stockholders to pay a discounted amount
in lieu of the Company's obligation to pay cash and stock for the remaining
consideration, which was to be paid in connection with the Intellicom
acquisition and consisted of (i) a $2,000,000 8.5% promissory note and accrued
interest, (ii) the requirement for the Company to issue $1,500,000 of common
stock shares on the second anniversary date of the Intellicom acquisition, and
(iii) the requirement for the Company to issue $500,000 of common stock shares
on the third anniversary date of the Intellicom acquisition. The parties agreed
to settle the obligation by which the Company paid $2,815,000 (including accrued
interest of $325,000), issued 99,922 common stock shares valued at $199,000, and
recognized a $1,326,000 extraordinary gain on settlements of outstanding
obligations. On February 9, 2002, the Company issued 12,426 common stock shares
to settle the remaining obligations related to the requirement to issue common
stock shares on the third anniversary date of the Intellicom acquisition. Both
the Debt Consideration and the Equity Consideration were issued in a nonpublic
offering pursuant to transactions exempt under Section 4(2) of the Securities
Act.
On February 22, 1999, the Company entered into a license agreement with Inktomi
Corporation ("Inktomi", the "Inktomi Licensing Agreement") allowing the Company
rights to install certain Inktomi caching technology into the Company's
cable-based Internet network infrastructure. Additionally, the Inktomi
Licensing Agreement allowed the Company to purchase up to 500 additional
licenses during the first four years of the agreement. The Inktomi Licensing
Agreement was valued at $4,000,000 for a total of 500 licenses, of which the
first $1,000,000 was paid with 65,843 common stock shares of the Company and the
remaining amount payable in cash in eight quarterly payments of $375,000. For
the years ended September 30, 2001, 2000 and 1999, total payments amounted to
$750,000, $1,500,000 and $750,000, respectively. Prepaid license fees were
$2,602,000 at September 30, 2000. As a result of the Company discontinuing the
operations of ISP Channel, prepaid license fees were written off and reflected
in the loss on disposition of discontinued operations for the year ended
September 30, 2000. Payments for the year ended September 30, 2001, were
charged directly to the net liabilities associated with discontinued operations
of ISP Channel, Inc. of the accompanying consolidated balance sheet. These
common stock shares were issued 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 3,013 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 have an exercise price of $29.875 and expire on
March 22, 2003. These securities were issued in a nonpublic offering pursuant
to transactions exempt under Section 4(2) of the Securities Act.
In conjunction with offering incentives to launch the Company's ISP Channel
cable-based Internet services, the Company issued common stock to cable
affiliates in return for the exclusive rights to provide Internet services to
their customers. During the year ended September 30, 1999, the Company issued
an aggregate of 13,574 common stock shares valued at $337,000 to eight separate
cable affiliates. During the year ended September 30, 2000, the Company issued
35,160 common stock shares valued at $419,000 to two separate cable affiliates.
In addition, on April 12, 1999, the Company issued 660,000 common stock shares
to an investor for $14,990,000 in cash and a modification of the affiliate
agreement between the Company and Teleponce Cable TV, which is controlled by the
investor; the modification of the affiliate agreement was valued at $8,925,000
as a cable affiliate launch incentive. Further, on November 4, 1999, the
Company entered into various definitive agreements with Mediacom LLC
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("Mediacom"). In exchange for signing an agreement to launch the ISP Channel
services, the Company issued a total of 3,500,000 common stock shares to
Mediacom, of which 3,150,000 common stock shares were restricted. The
restrictions were progressively lifted as Mediacom launched ISP Channel's
services in Mediacom's cable television systems. At September 30, 2000, there
were 2,100,000 common stock shares restricted and unvalued. The unrestricted
1,400,000 common stock shares were valued at $26,513,000 as a cable affiliate
launch incentive. As a result of the Company discontinuing the operations of
ISP Channel, the cable affiliate launch incentive, net of amortization, was
written off and reflected in the loss on disposition of discontinued operations
for the year ended September 30, 2000, and in the net assets associated with
discontinued operations at September 30, 1999. On February 16, 2001, the
Company and ISP Channel entered into agreements with Mediacom, to terminate
Mediacom's affiliate relationship with ISP Channel. As part of these agreements
Mediacom released all obligations under the affiliate agreement with ISP Channel
and returned 1,300,000 restricted common stock shares of the Company, and in
exchange received certain equipment, a $3,768,000 payment from the Company, and
the Company removed restrictions on 800,000 common stock shares valued at
$1,500,000 held by Mediacom. Mediacom currently holds a total of 2,200,000
unrestricted common stock shares of the Company. Pursuant to these agreements,
neither the Company nor ISP Channel has any further material obligation to
Mediacom. These common stock shares were issued in a nonpublic offering
pursuant to transactions exempt under Section 4(2) of the Securities Act.
On December 13, 1999, the Company completed a private placement of 5,000,000
common stock shares for net proceeds of $128,121,000 to Pacific Century
Cyberworks Limited ("PCCW"), and entitled PCCW to designate two persons for
election to the Board of Directors. These common stock shares were issued in a
nonpublic offering pursuant to transactions exempt under Section 4(2) of the
Securities Act. On July 30, 2002, Independence Holding Company ("IHC") acquired
PCCW entire interest in the Company consisting of 5,000,000 common stock shares
at $3.00 per share for a total value of $15,000,000. As a result of this
transaction, PCCW's appointees Linus W.L. Cheung and Jeffrey A. Bowden resigned
from the Company's Board of Directors, and Edward Netter, Chairman of IHC, and
Roy T.K. Thung, Chief Executive Officer of IHC, were appointed to the Company's
Board of Directors. Additionally, IHC has agreed to make a cash tender offer at
$3.00 per share for at least 3,000,000 outstanding common stock shares of the
Company, subject to certain limitations.
On April 21, 2000, the Company acquired Laptop Lane Limited ("Laptop Lane"), a
Washington corporation, under the purchase method of accounting, and the results
of Laptop Lane have been included in the consolidated financial statements since
the date of acquisition. Laptop Lane was a provider of business center services
in airports. The Company paid approximately $21,559,000 consisting of (i)
972,266 common stock shares of the Company valued at $15,107,000, net of
adjustment for expenses paid by the Company on behalf of Laptop Lane, exchanged
for all outstanding common stock shares of Laptop Lane, (ii) direct acquisition
costs of approximately $2,300,000, which included a bonus payment to Laptop Lane
employees of $431,000 in lieu of Laptop Lane stock options, and (iii) 250,000
common stock shares of the Company valued at $3,652,000 issued to former Laptop
Lane stockholders in payment for achieving certain criteria. As part of the
acquisition, an additional 333,333 common stock shares of the Company were to be
distributed to former Laptop Lane stockholders if certain performance goals or
other criteria were met. At September 30, 2000, Laptop Lane achieved three of
the four performance goals; as a result, 249,981 common stock shares of the
Company and cash amounting to $3,652,000 were distributed to the former Laptop
Lane stockholders. In October 2000, Laptop Lane achieved the fourth performance
goal requirement, resulting in the distribution of 81,050 common stock shares of
the Company valued at $332,000 to the former Laptop Lane stockholders. These
common stock shares were issued in a nonpublic offering pursuant to transactions
exempt under Section 4(2) of the Securities Act.
As of September 30, 2002, the Company has 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.
The stock options typically vest over the period of contracted service. These
stock options have an exercise price range from $7.375 to $23.8125. In the
aggregate, the stock options have a weighted average exercise price of $13.08.
At September 30, 2002, consultant stock options for 15,000 common stock shares
were vested and outstanding. For the year ended September 30, 2002, no stock
options were issued to consultants. 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.
-11-
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction
with the consolidated financial statements and related notes thereto and
"Management's Discussions and Analysis of Financial Condition and Results of
Operations" included elsewhere in this annual report on Form 10-K. The
consolidated statement of operations data for the years ended and consolidated
balance sheet data as of September 30, 2002, 2001, 2000 and 1999, have been
derived from the American Independence Corp., formerly SoftNet Systems, Inc.,
and subsidiaries (collectively referred to as the "Company") consolidated
financial statements audited by KPMG LLP. The consolidated statements of
operations for the year ended and consolidated balance sheet data as of
September 30, 1998, were derived from the Company's consolidated financial
statements audited by PricewaterhouseCoopers LLP.
YEAR ENDED SEPTEMBER 30,
------------------------------------------------------
2002 2001 2000(b) 1999(c) 1998
--------- --------- ---------- --------- ---------
(In thousands, except per share data)
Consolidated Statement of Operations Data(a):
- ---------------------------------------------
Operating expenses:
Selling and marketing, engineering, and general and
administrative . . . . . . . . . . . . . . . . . . . . $ 7,297 $ 10,016 $ 13,078 $ 7,268 $ 1,866
Depreciation . . . . . . . . . . . . . . . . . . . . . . 189 350 355 175 84
Compensation expense (benefit) related to stock options. 1,466 (807) 14,668 8,173 27
Provision for impaired assets. . . . . . . . . . . . . . 352 - - - -
Restructuring expense. . . . . . . . . . . . . . . . . . 502 3,900 - - -
--------- --------- ---------- --------- ---------
Total operating expenses . . . . . . . . . . . . . . . 9,806 13,459 28,101 15,616 1,977
--------- --------- ---------- --------- ---------
Loss from continuing operations. . . . . . . . . . . . . . (9,806) (13,459) (28,101) (15,616) (1,977)
Other income (expenses):
Interest income. . . . . . . . . . . . . . . . . . . . . 1,802 6,421 11,840 3,617 112
Interest expense . . . . . . . . . . . . . . . . . . . . (72) (107) (526) (4,675) (966)
Gain (loss) on disposition of equity investments, net. . (733) (17,195) 10,157 - -
Equity in net losses of investee companies . . . . . . . - (394) (581) - -
Miscellaneous income (expense) . . . . . . . . . . . . . (21) 216 (396) (1,414) (173)
--------- --------- ---------- --------- ---------
Loss from continuing operations before income taxes. . . . (8,830) (24,518) (7,607) (18,088) (3,004)
Provision for income taxes . . . . . . . . . . . . . . . . - - - - - -
--------- --------- ---------- --------- ---------
Loss from continuing operations. . . . . . . . . . . . . . (8,830) (24,518) (7,607) (18,088) (3,004)
Discontinued operations:
Loss from operations . . . . . . . . . . . . . . . . . . (1,829) (29,557) (85,346) (33,741) (13,998)
Gain (loss) on disposition . . . . . . . . . . . . . . . (4,097) (4,898) (139,400) 1,820 -
Extraordinary item:
Gain on settlements of outstanding obligations . . . . . - 1,326 - - -
--------- --------- ---------- --------- ---------
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . (14,756) (57,647) (232,353) (50,009) (17,002)
Preferred dividends. . . . . . . . . . . . . . . . . . . . - - - (473) (343)
--------- --------- ---------- --------- ---------
Net loss applicable to common shares . . . . . . . . . . . $(14,756) $(57,647) $(232,353) $(50,482) $(17,345)
========= ========= ========== ========= =========
Basic and diluted loss per common share:
Loss from continuing operations. . . . . . . . . . . . . $ (0.35) $ (0.98) $ (0.32) $ (1.46) $ (0.41)
Discontinued operations. . . . . . . . . . . . . . . . . (0.24) (1.38) (9.56) (2.59) (1.89)
Extraordinary item . . . . . . . . . . . . . . . . . . . - 0.05 - - -
Preferred dividends. . . . . . . . . . . . . . . . . . . - - - (0.04) (0.05)
--------- --------- ---------- --------- ---------
Net loss . . . . . . . . . . . . . . . . . . . . . . . . $ (0.59) $ (2.31) $ (9.88) $ (4.09) $ (2.35)
========= ========= ========== ========= =========
Consolidated Balance Sheet Data(a):
- -----------------------------------
Working capital. . . . . . . . . . . . . . . . . . . . . . $ 60,626 $ 70,684 $ 130,067 $133,821 $ 11,817
Total assets . . . . . . . . . . . . . . . . . . . . . . . 70,814 84,500 190,809 193,731 21,810
Long-term liabilities. . . . . . . . . . . . . . . . . . . - - 4,104 20,153 9,048
Redeemable convertible preferred stock . . . . . . . . . . - - - - 18,187
Stockholders' equity (deficit) . . . . . . . . . . . . . . 63,665 76,446 139,914 163,710 (6,171)
______________________________
(a) Reflects business center services, satellite-based Internet services,
cable-based Internet services, document management and telecommunications
segments as discontinued operations.
(b) 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.
(c) Includes Intelligent Communications, Inc. as a discontinued operation since
its acquisition on February 9, 1999.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the financial condition and results of operations of
the American Independence Corp. and subsidiaries (collectively referred to as
the "Company") should be read in conjunction with, and is qualified in its
entirety by reference to, the Consolidated Financial Statements of the Company
and the related Notes thereto appearing elsewhere in this Annual Report on Form
10-K. This discussion contains forward-looking statements that involve risks
and uncertainties. The actual results of the Company could differ significantly
from those set forth herein. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in "Business" and
"Factors Affecting the Company's Operating Results" as well as those discussed
elsewhere in this Annual Report on Form 10-K. Statements contained herein that
are not historical facts are forward-looking statements that are subject to the
safe harbor created by the Private Securities Litigation Reform Act of 1995.
Words such as "believes", "anticipates", "expects", "intends", "estimates",
"likelihood", "unlikelihood", "assessment" and "foreseeable", and other similar
expressions are intended to identify forward-looking statements, but are not the
exclusive means of identifying such statements. A number of important factors
could cause our actual results to differ materially from the statements and
those expressed or implied in any forward-looking statements made by us, or on
our behalf. We undertake no obligation to release publicly the results of any
revisions to these forward-looking statements that may be made to reflect events
or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
OVERVIEW
On July 30, 2002, SoftNet Systems, Inc., and subsidiaries (collectively referred
to as the "Company") entered into an agreement to acquire First Standard
Holdings Corp. from SSH Corp. and Independence Holding Company ("IHC") for
$31,920,000 in cash. 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 First Standard Holdings Corp. changed its name to
Independence American Holdings Corp. ("IAHC"). IAHC and its wholly-owned
subsidiaries are engaged in the insurance and reinsurance business. The
Company, which was a holding company principally engaged in providing Internet
services, had previously wound down its Internet related businesses and as a
result of the acquisition of IAHC has become an insurance holding company.
Additionally, due to the acquisition of IAHC, the Company has decided to close
its offices in San Francisco, terminate all but one of its employees, and enter
into a services agreement with IHC under which the Company's operations will be
directed by IHC management and employees. The transaction is more fully
described in the Company's Definitive Proxy/Prospectus Statement on Schedule 14A
as filed with the Securities Exchange Commission on September 30, 2002.
In a separate transaction on July 30, 2002, IHC acquired Pacific Century
Cyberworks Limited's ("PCCW") entire interest in the Company consisting of
5,000,000 common stock shares at $3.00 per share for a total value of
$15,000,000. As a result of this transaction, PCCW's appointees Linus W.L.
Cheung and Jeffrey A. Bowden resigned from the Company's Board of Directors, and
Edward Netter, Chairman of IHC, and Roy T.K. Thung, President and Chief
Executive Officer of IHC, were appointed to the Company's Board of Directors.
Additionally, upon closing of the purchase of IAHC, IHC has agreed to make a
cash tender offer at $3.00 per share for at least 3,000,000 outstanding common
stock shares of the Company, subject to certain limitations.
On May 17, 2002, the Company received a Nasdaq Staff Determination Letter
stating that the Company's common stock was no longer eligible for continued
listing on the Nasdaq National Market as a result of the Company ceasing the
operations of its last business segment, Intellicom, and that the Company
therefore did not meet the requirements for continued listing set forth in
Marketplace Rules 4300 and 4330. Subsequently, the Company requested and was
granted an oral hearing before a Nasdaq Listing Qualifications Panel to appeal
the Nasdaq Staff Determination Letter, which stayed the delisting of the
Company's common stock pending the outcome of the hearing. On July 12, 2002,
the Company appeared before the Nasdaq Listing Qualifications Panel to present
the Company's plan to acquire IAHC, which would allow the Company to comply with
the Marketplace Rules 4300 and 4330. On August 15, 2002, the Nasdaq Listing
Qualifications Panel informed the Company that the Company will remain listed on
Nasdaq, subject to meeting various conditions, including the completion of the
acquisition of IAHC by December 31, 2002. Nasdaq has also informed the Company
that if it does remain listed on Nasdaq, following the acquisition of IAHC, the
Company will be required to meet Nasdaq's initial listing requirements as well
as Nasdaq's continued listing requirements.
-13-
As of September 30, 2002, the Company had substantially completed the wind down
of its Internet services related subsidiaries, ISP Channel, Inc. ("ISP
Channel"), Intelligent Communications, Inc. ("Intellicom"), and Aerzone
Corporation ("Aerzone"), including Laptop Lane Limited ("Laptop Lane"), as a
result of the following:
On December 7, 2000, the Company's Board of Directors approved a plan to
discontinue its ISP Channel operations because of (1) the consolidation in the
cable industry made it difficult for ISP Channel to achieve the economies of
scale necessary to provide such services profitably, and (2) the Company was no
longer able to bear the costs of maintaining the ISP Channel. Subsequently on
December 19, 2000, the Company's Board of Directors approved a plan to
discontinue its Aerzone, including Laptop Lane, business in light of, among
other things, significant long-term capital needs and the difficulty of securing
the necessary financing because of the financial markets. In conjunction with
discontinuing the ISP Channel and Aerzone businesses, the Company's Board of
Directors on December 28, 2000, approved a plan to reduce its corporate
headquarters staff.
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. Subsequently on
April 22, 2002, Intellicom entered into an agreement to sell certain assets to
Native Intellicom, Inc., a wholly-owned subsidiary of the Pinoleville Band of
Pomo Indians, for cash, subject to the termination of Intellicom's lease for its
facility in Livermore, California. On August 1, 2002, Intellicom terminated the
agreement with the Pinoleville Band of Pomo Indians and is negotiating to sell
those assets to another group of Native Americans.
The Company reports operating expenses in several categories: (i) selling and
marketing; (ii) engineering; and (iii) general and administrative costs. Also
included in operating expenses are depreciation and non-cash compensation
expense related to stock options. Non-cash compensation expense related to
stock options relates primarily to the amortization of deferred stock
compensation resulting from below market value stock options granted between
October 1998 and March 1999.
The results of operations for the years ended September 30, 2001 and 2000, have
been reclassified for the effects of discontinued operations of Intellicom.
-14-
CRITICAL ACCOUNTING POLICIES
The preparation of consolidated financial 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.
Discontinued Operations
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.
Restructuring Expense
The Company recorded restructuring expenses related to an approved plan to
reduce corporate headquarters staff and to relocate its corporate offices in
conjunction with discontinuing the Aerzone, ISP Channel and Intellicom
businesses. These restructuring expenses are based on estimates of the expected
costs associated with employee severance, lease terminations, and facility
relocation. The Company reviews the estimated restructuring costs accrual on a
quarterly basis to determine changes in the costs of the restructuring
activities.
Impairment of Long-lived Assets
The Company evaluates long-lived assets for impairment whenever current events
or changes in circumstances, as defined in Statement of Financial Accounting
Standards No. 121 ("SFAS 121"), Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of, indicate that the carrying
value of an asset may not be recoverable based on expected undiscounted cash
flows attributable to that asset. The amount of any impairment is measured as
the difference between the carrying value and the fair value of the impaired
asset.
Short-term Investments
The Company accounts for its short-term 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.
Short-term investments generally consist of highly liquid securities with
original maturities in excess of three months. The Company has classified its
short-term investments as available-for-sale securities. These short-term
investments are carried at fair value based on quoted market prices with
unrealized gains and losses reported in accumulated other comprehensive loss of
the accompanying consolidated balance sheets. Realized gains and losses on
short-term investments are computed using the specific identification method and
are reported in miscellaneous income (expense), net of the accompanying
consolidated statements of operations. Declines in value judged to be
other-than-temporary is determined based on the specific identification method
and are reported in loss in disposition of equity investments of the
accompanying consolidated statements of operations.
-15-
RESULTS OF OPERATIONS FOR THE YEAR ENDED SEPTEMBER 30, 2002, COMPARED TO THE
YEAR ENDED SEPTEMBER 30, 2001
Selling and Marketing. The Company incurred no selling and marketing expenses
- -----------------------
for the year ended September 30, 2002, compared to $182,000 for the year ended
September 30, 2001, as a result of eliminating the public relations department
associated with the December 28, 2000, corporate restructuring plan.
Engineering. The Company incurred no engineering expenses for the year ended
- -----------
September 30, 2002, compared to $551,000 for the year ended September 30, 2001,
as a result of eliminating the corporate technology department associated with
the December 28, 2000, corporate restructuring plan.
General and Administrative. Consolidated general and administrative expenses
- ----------------------------
decreased $1,986,000, or 21%, to $7,297,000 for the year ended September 30,
2002, compared to $9,283,000 for the year ended September 30, 2001, primarily
due to staff reductions associated with the December 28, 2000, corporate
restructuring plan.
Depreciation. Consolidated depreciation expense decreased $161,000, or 46%, to
- ------------
$189,000 for the year ended September 30, 2002, compared to $350,000 for the
year ended September 30, 2001, primarily due to sales and disposal of property.
Non-Cash Compensation Expense/Benefit Related to Stock Options. The Company
- ------------------------------------------------------------------
recognized a non-cash compensation expense related to stock options of
$1,466,000 for the year ended September 30, 2002, compared to non-cash
compensation benefit related to stock options of $807,000 for the year ended
September 30, 2001. For the year ended September 30, 2002 and 2001, non-cash
compensation expense/benefit related to stock options issued to employees
relates primarily to the amortization of deferred stock compensation resulting
from below market value stock options granted between October 1998 and March
1999.
Non-cash compensation benefits are recognized following the reversal of
previously recognized expenses related to terminated unvested stock options with
a cliff vesting feature. Non-cash compensation expense related to stock options
should continue to decrease as the Company reduces its staff as a result of its
discontinued operations and corporate restructuring.
Provision for Impaired Assets. The Company recognized a charge of $352,000 for
- -------------------------------
the year ended September 30, 2002, as a result of writing off its accounting
software. In light of reduced operations, the Company migrated to an
off-the-shelf accounting software.
Restructuring Expense. The Company recognized a restructuring charge for the
- -----------------------
year ended September 30, 2001, related to a plan to downsize its corporate
headquarters staff. The charge in the amount of $3,900,000 was recognized as
restructuring expense and consisted primarily 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 Company headquarters. At September 30, 2002,
a restructuring accrual of $1,446,000 remained outstanding.
Interest Income. Consolidated interest income decreased $4,619,000, or 72%, to
- ----------------
$1,802,000 for the year ended September 30, 2002, compared to $6,421,000 for the
year ended September 30, 2001, as a result of lower interest rates, and decrease
in cash, cash equivalents, and short-term investments, available-for-sale.
Interest Expense. Consolidated interest expense decreased $35,000, or 33%, to
- -----------------
$72,000 for the year ended September 30, 2002, compared to $107,000 for the year
ended September 30, 2001. This decrease is primarily due to the reduction of
interest expense resulting from the retirement of the 8.5% promissory note to
the former Intellicom stockholders.
Loss on Disposition of Equity Investments. The Company recognized a loss on
- ----------------------------------------------
disposition of equity investments of $733,000 for the year ended September 30,
2002, consisting of $253,000 related to the 1,000,000 SkyNet Global Limited
common stock shares and $480,000 related to the 400,000 SkyNet Global Limited
preference stock shares. For the year ended September 30, 2001, the Company
recognized a charge of $17,195,000, consisting of a $768,000 write down of a
note receivable and related interest associated with the sale of Big Sky Network
Canada, Limited common shares to China Broadband Corporation, and $16,427,000 of
write-downs and realized losses related to various short-term and long-term
equity investments.
-16-
Equity in Net Losses of Investee Companies. The Company recognized equity in
- ----------------------------------------------
net losses of investee companies of $394,000 for the year ended September 30,
2001. The Company did not incur any equity in net losses of investee companies
for the year ended September 30, 2002, as a result of the sale and write offs of
investee companies accounted for under the equity method for the year ended
September 30, 2001.
Miscellaneous Expense, Net. The Company incurred consolidated miscellaneous
- ----------------------------
expense of $21,000 for the year ended September 30, 2002, compared to
consolidated miscellaneous income of $216,000 for the year ended September 30,
2001, primarily resulting from the write off of costs associated with a failed
business acquisition.
Income Taxes. The Company made no provision for income taxes for the year ended
- ------------
September 30, 2002 and 2001, as a result of the Company's continuing losses.
Loss Attributed to Discontinued Operations. The Company recognized a $5,926,000
- -------------------------------------------
loss attributed to discontinued operations for the year ended September 30,
2002, compared to a loss of $34,455,000 for the year ended September 30, 2001.
For the year ended September 30, 2002, the loss attributed to discontinued
operations consisted of a $3,120,000 loss on disposition of Intellicom, a
$1,829,000 loss from operations of Intellicom, a $1,127,000 loss on disposition
of Micrographic Technology Corporation ("MTC"), as a result of a preliminary
arbitration decision related to a dispute with Applications Informatiques
Multimedia and a dispute related to the sale of MTC to Global Information
Distribution GmbH ("GID"), a $900,000 gain on disposition of ISP Channel,
resulting from the lower than anticipated costs of closing ISP Channel, and a
$750,000 loss on disposition of Aerzone, resulting from a superior court
decision related to a breach of contract and other legal matters. For the year
ended September 30, 2001, the loss attributed to discontinued operations
consisted of a $29,557,000 net loss from the operations of Intellicom, a
$10,008,000 gain due to the revision of the loss on disposition of ISP Channel,
resulting from lower than anticipated costs of closing ISP Channel, and a
$14,906,000 loss on disposition of Aerzone, resulting primarily from the
reduction of the estimated sales proceeds of Laptop Lane.
Extraordinary Item-Gain on Settlement of Obligation. The Company recognized a
- ------------------------------------------------------
gain of $1,326,000 for the year ended September 30, 2001, resulting from the
cash payment made in lieu of the Company's obligation to pay off the 8.5%
promissory note and interest, and to settle business acquisition liability to
former Intellicom stockholders with common stock.
Net Loss. The Company had a net loss of $14,756,000, or a net loss per share of
- --------
$0.59, for the year ended September 30, 2002, compared to a net loss of
$57,647,000, or a net loss per share of $2.31, for the year ended September 30,
2001.
RESULTS OF OPERATIONS FOR THE YEAR ENDED SEPTEMBER 30, 2001, COMPARED TO THE
YEAR ENDED SEPTEMBER 30, 2000
Selling and Marketing. The Company's selling and marketing expenses decreased
- ------------------------
$1,572,000, or 90%, to $182,000 for the year ended September 30, 2001, compared
to $1,754,000 for the year ended September 30, 2000, primarily as a result of
eliminating the business development and public relations departments as part of
a corporate restructuring.
Engineering. The Company's engineering expenses increased $15,000, or 3%, to
- ------------
$551,000 for the year ended September 30, 2001, compared to $536,000 for the
year ended September 30, 2000.
General and Administrative. The Company's general and administrative expenses
- ---------------------------
decreased $1,505,000, or 14%, to $9,283,000 for the year ended September 30,
2001, compared to $10,788,000 for the year ended September 30, 2000, primarily
as a result of staff reductions as part of a corporate restructuring.
Depreciation. The Company's depreciation expense decreased $5,000, or 1%, to
- -------------
$350,000 for the year ended September 30, 2001, compared to $355,000 for the
year ended September 30, 2000.
Non-Cash Compensation Expense/Benefit Related to Stock Options. The Company
- -------------------------------------------------------------------
recognized a non-cash compensation benefit related to stock options of $807,000
for the year ended September 30, 2001, compared to non-cash compensation expense
related to stock options of $14,668,000 for the year ended September 30, 2000.
For the year ended September 30, 2001, non-cash compensation benefit related to
stock options consisted of $776,000 related to employee stock options and
$31,000 related to non-employee options, and for the year ended September 30,
2000, non-cash compensation expense related to stock options consisted of
$14,407,000 related to employee stock options and $261,000 related to
non-employee options.
-17-
Non-cash compensation benefits are recognized following the reversal of
previously accrued expenses in respect to stock option terminations as result of
corporate restructuring. Non-cash compensation expense related to stock options
were expected to continue to decrease or generate a benefit, as the Company
continued to reduce its staff due to its discontinued operations and corporate
restructuring.
Restructuring Expense. The Company recognized a restructuring expense of
- -----------------------
$3,900,000 for the year ended September 30, 2001, related to a plan to downsize
its corporate headquarters staff. At September 30, 2001, restructuring reserve
of $1,240,000 remained outstanding for corporate.
Interest Income. The Company's interest income decreased $5,419,000, or 46%, to
- ----------------
$6,421,000 for the year ended September 30, 2001, compared to $11,840,000 for
the year ended September 30, 2000, as a result of lower interest rates, and
decrease in cash, cash equivalents, and short-term investments,
available-for-sale.
Interest Expense. The Company's interest expense decreased $419,000, or 80%, to
- -----------------
$107,000 for the year ended September 30, 2001, compared to $526,000 for the
year ended September 30, 2000. This decrease is primarily due to the reduction
of interest expense resulting from the conversion of the 9% senior subordinated
convertible notes, retirement of the 6% subordinated convertible notes and
retirement of the 8.5% promissory note to the former Intellicom stockholders.
Equity in Net Losses of Investee Companies. The Company recognized equity in
- ----------------------------------------------
net losses of investee companies of $394,000 for the year ended September 30,
2001, compared to equity in net losses of investee companies of $581,000 for the
year ended September 30, 2000.
Gain (Loss) on Disposition of Equity Investments, Net. The Company recognized a
- ------------------------------------------------------
charge of $17,195,000 for the year ended September 30, 2001, consisting of a
$768,000 write down of a note receivable and related interest associated with
the sale of Big Sky Network Canada, Limited common shares to China Broadband
Corporation; and $16,427,000 of write-downs and realized losses related to
various short-term and long-term equity investments. The Company recognized a
gain on disposition of long-term equity investments of $10,157,000 for the year
ended September 30, 2000, primarily due to a $10,194,000 gain on an exchange of
50,000 common stock shares of Big Sky Network Canada, Limited for (i) $2,500,000
in cash, (ii) a promissory note in the amount of $1,700,000 bearing interest at
8% per annum due September 29, 2001, and (iii) 1,133,000 common stock shares
valued at $9,630,000 from China Broadband Corporation on September 29, 2000.
Miscellaneous Income (Expense), Net. The Company's miscellaneous income
- ---------------------------------------
increased $612,000 to $216,000 for the year ended September 30, 2001, compared
to consolidated miscellaneous expense of $396,000 for the year ended September
30, 2000. This increase is primarily due to contract termination costs for the
year ended September 30, 2000.
Income Taxes.
- --------------
The Company made no provision for income taxes for the year ended September 30,
2001 and 2000, as a result of the Company's continuing losses.
Loss Attributed to Discontinued Operations. The Company recognized a
- -----------------------------------------------
$34,455,000 loss attributed to discontinued operations for the year ended
September 30, 2001, compared to $224,746,000 for the year ended September 30,
2000. For the year ended September 30, 2001, the loss attributed to
discontinued operations consisted of a $29,557,000 net loss from the operations
of Intellicom, a $10,008,000 gain due to the revision of the loss on disposition
of ISP Channel, resulting from lower than anticipated costs of closing ISP
Channel, and a $14,906,000 loss on disposition of Aerzone, resulting primarily
from the reduction of the estimated sales proceeds of Laptop Lane. For the year
ended September 30, 2000, the loss attributed to discontinued operations
consisted of a $12,948,000 net loss from the operations of Intellicom, a
$97,200,000 loss on disposition of ISP Channel, a $60,249,000 net loss from the
operations of ISP Channel, a $42,200,000 loss on disposition of Aerzone , and a
$12,150,000 net loss from the operations of Aerzone .
Extraordinary Item - Gain on Settlements of Outstanding Obligations. The
- ---------------------------------------------------------------------------
Company recognized a gain of $1,326,000 for the year ended September 30, 2001,
resulting from the cash payment made in lieu of the Company's obligation to pay
off the 8.5% promissory note and related interest, and to settle the business
acquisition liability to former Intellicom stockholders with common stock.
Net Loss. The Company had a net loss of $57,647,000, or a net loss per share of
- ---------
$2.31, for the year ended September 30, 2001, compared to a net loss of
$232,353,000, or a net loss per share of $9.88, for the year ended September 30,
2000.
-18-
LIQUIDITY AND CAPITAL RESOURCES
Since September 1998, the Company has funded the significant negative cash flows
from its subsidiary operating activities and the associated capital expenditures
through a combination of public and private equity sales, convertible debt
issues and equipment leases. At September 30, 2002, the Company had $62,059,000
in cash, cash equivalents, and short-term investments compared with $75,454,000
at September 30, 2001.
Net cash used in operating activities of continuing operations for the year
ended September 30, 2002, was $7,425,000. This results from a net loss of
$8,830,000 from continuing operations, net increase in operating assets of
$848,000 and a net decrease in operating liabilities of $1,055,000, offset by
several non-cash items including loss on write down of impaired assets of
$352,000, loss on disposition of equity investments of $733,000, provision for
restructuring costs of $502,000, amortization of deferred stock compensation
expense of $1,466,000, and depreciation expense of $189,000. Net cash used in
operating activities of discontinued operations was $4,721,000.
Net cash provided by investing activities of continuing operations for the year
ended September 30, 2002, was $19,841,000, and was primarily provided by
proceeds from maturities and sales of short-term investments, net of purchases.
Net cash used in investing activities of discontinued operations was $2,000.
Net cash used in financing activities of continuing operations for the year
ended September 30, 2002, was $1,444,000, resulting from the payment of the 5%
Convertible Subordinated Debentures due September 30, 2002, to Mr. R.C.W.
Mauran. Net cash used in financing activities of discontinued operations was
$60,000.
The Company believes it has sufficient cash to meet its presently anticipated
business requirements over the next twelve months including the funding of
operating losses, discontinued operations, working capital requirements, and
capital investments. The Company expects significant reductions in cash usages
from its discontinued operating activities for the year ending September 30,
2003.
Acquisition and Discontinued Operations of Intellicom. On February 9, 1999, a
- ---------------------------------------------------------
wholly owned subsidiary of the Company merged with and into Intellicom (the
"Intellicom Acquisition"). The Intellicom Acquisition was accounted for under
the purchase method, and the results of Intellicom have been included in the
consolidated financial statements since the date of acquisition. The purchase
price of $14,869,000 was comprised of: (i) a cash component of $500,000 (the
"Cash Consideration"); (ii) a promissory note in the amount of $1,000,000
bearing interest at 7.5% per annum and due one year after closing (the "First
Promissory Note"); (iii) a promissory note in the amount of $2,000,000 bearing
interest at 8.5% per annum and due two years after closing (the "Second
Promissory Note", together with the First Promissory Note are defined as the
"Debt Consideration"); (iv) the issuance of 500,000 shares of the Company's
common stock (adjustable upwards after one year in certain circumstances),
valued at $14.938 per share, for a total value of $7,469,000 (the "Closing
Shares"); (v) additional shares of the Company's common stock issuable upon the
first, second and third anniversaries of the closing, valued at a total of
$3,500,000 (the "Anniversary Shares", together with the Closing Shares are
defined as the "Equity Consideration"); and (vi) certain direct acquisition
costs totaling $400,000. The Debt Consideration may be partially or wholly
converted into the Company's common stock, under certain circumstances. The
conversion price of the Debt Consideration was based upon the average closing
price of the Company's common stock for the 15 days immediately preceding the
conversion date.
In April 1999, the Company paid the First Promissory Note and related interest
in full with a combination $832,000 in cash and the remainder, after expenses,
with 6,118 common stock shares valued at $190,000. The Intellicom Acquisition
agreement required the Company to issue $1,500,000 of common stock shares on the
first anniversary date of the Intellicom Acquisition. Accordingly, on February
8, 2000, the Company issued 43,314 common stock shares valued at $1,499,000 and
paid $1,000 for fractional shares to the former Intellicom stockholders. On
February 7, 2001, the Company made an offer to the former Intellicom
stockholders to pay a discounted amount in lieu of the Company's obligation to
pay cash and stock for the remaining consideration, which was to be paid in
connection with the Intellicom acquisition and consisted of (i) a $2,000,000
8.5% promissory note and accrued interest, (ii) the requirement for the Company
to issue $1,500,000 of common stock shares on the second anniversary date of the
Intellicom acquisition, and (iii) the requirement for the Company to issue
$500,000 of common stock shares on the third anniversary date of the Intellicom
acquisition. The parties agreed to settle the obligation by which the Company
paid $2,815,000 (including accrued interest of $325,000), issued 99,922 common
stock shares valued at $199,000, and recognized a $1,326,000 extraordinary gain
on settlements of outstanding obligations. On February 9, 2002, the Company
issued 12,426 common stock shares to settle the remaining obligations related to
the requirement to issue common stock shares on the third anniversary date of
the Intellicom acquisition.
-19-
Additionally, the Intellicom Acquisition agreement included a demonstration
bonus ("Demonstration Bonus") of $1,000,000 payable in cash or shares of the
Company's common stock at the Company's option by the first anniversary date of
the Intellicom Acquisition if certain conditions were met. On February 8, 2000,
the opportunity to earn the Demonstration Bonus had expired, and accordingly,
the Demonstration Bonus was not paid or included in the purchase price of
Intellicom.
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. Subsequently on
April 22, 2002, Intellicom entered into an agreement to sell certain assets to
Native Intellicom, Inc., a wholly-owned subsidiary of the Pinoleville Band of
Pomo Indians, for cash, subject to the termination of Intellicom's lease for its
facility in Livermore, California. On August 1, 2002 Intellicom terminated the
agreement with the Pinoleville Band of Pomo Indians and is negotiating to a sell
those assets to another group of Native Americans. The operating results of
Intellicom have been segregated from continuing operations and are reported as a
loss from discontinued operations on the accompanying consolidated statements of
operations. Although it is difficult to predict the final results, the loss on
disposition from discontinued operations includes management's estimates of
costs to wind down the business, costs to settle its outstanding liabilities,
and the proceeds from the sale of assets. The actual results could differ
materially from these estimates. The assets and liabilities of such operations
are reflected in net liabilities associated with discontinued operations of the
accompanying consolidated balance sheets at September 30, 2002 and 2001. The
Company recorded an estimated loss on disposition of Intellicom of $3,120,000
for the year ended September 30, 2002. The estimated loss on disposition
reserve of Intellicom is reflected in net liabilities associated with
discontinued operations of the accompanying consolidated balance sheets at
September 30, 2002, and the corresponding charge is reflected in loss on
disposition of discontinued operations of the accompanying consolidated
statements of operations for the years ended September 30, 2002.
Formation of Aerzone, Acquisition of Laptop Lane, and Discontinued Operations of
- --------------------------------------------------------------------------------
Aerzone. On January 24, 2000, the Company founded Aerzone (formerly SoftNet
- --------
Zone, Inc.), a Delaware corporation, to provide high-speed Internet access to
global business travelers. As part of the Aerzone business, the Company
acquired Laptop Lane, a Washington corporation, on April 21, 2000. The
acquisition was accounted for under the purchase method, and the results of
Laptop Lane have been included in the consolidated financial statements since
the date of acquisition. Laptop Lane is a leading provider of business center
services in airports. The Company paid approximately $21,559,000 consisting of
(i) 972,266 common stock shares of the Company valued at $15,107,000, net of
adjustment for expenses paid by the Company on behalf of Laptop Lane, exchanged
for all outstanding common stock shares of Laptop Lane, (ii) direct acquisition
costs of approximately $2,300,000, which included a bonus payment to Laptop Lane
employees of $431,000 in lieu of Laptop Lane stock options, and (iii) 250,000
common stock shares of the Company valued at $3,652,000 issued to former Laptop
Lane stockholders in payment for achieving certain criteria. As part of the
acquisition, an additional 333,333 common stock shares of the Company were to be
distributed to former Laptop Lane stockholders if certain performance goals or
other criteria were met. As of September 30, 2000, Laptop Lane achieved three
of the four performance goals; as a result, 249,981 common stock shares of the
Company and cash amounting to $3,652,000 were distributed to the former Laptop
Lane stockholders. In October 2000, Laptop Lane achieved the fourth performance
goal requirement, resulting in the distribution of 81,050 common stock shares of
the Company valued at $332,000 to the former Laptop Lane stockholders.
Additionally, in connection with the acquisition, the Company provided
$6,000,000 in working capital to Laptop Lane, under a secured promissory note.
On December 19, 2000, the Company decided to discontinue the Aerzone business in
light of significant long-term capital needs and the difficulty of securing the
necessary financing because of the current state of the financial markets. The
operating results of Aerzone have been segregated from continuing operations and
are reported as loss from discontinued operations of the accompanying
consolidated statement of operations. The loss from discontinued operations
includes management's estimates of the remaining costs to wind down the business
and costs to settle its outstanding liabilities. The assets and liabilities of
such operations are reflected in net liabilities associated with discontinued
operations of the accompanying consolidated balance sheets at September 30, 2002
and 2001. For the year ended September 30, 2000, the Company recorded an
estimated loss on disposition reserve of Aerzone of $42,200,000. For the year
ended September 30, 2001, the Company increased the estimated loss on
-20-
disposition reserve of Aerzone by $14,906,000, primarily as a result of the
Company reducing the estimated proceeds from the sale of Laptop Lane and
increasing estimated discontinued operating costs. For the year ended September
30, 2002, the Company increased the estimated loss on disposition of Aerzone by
$750,000, as a result of a superior court decision related to a breach of
contract and other legal matters. The estimated loss on disposition reserve of
Aerzone is reflected in net liabilities associated with discontinued operations
of the accompanying consolidated balance sheets at September 30, 2002 and 2001,
and the corresponding charge is reflected in loss on disposition of discontinued
operations of the accompanying consolidated statements of operations for the
years ended September 30, 2002, 2001 and 2000.
Discontinued Operations of ISP Channel. On December 7, 2000, the Company's
- -------------------------------------------
Board of Directors approved a plan to discontinue providing cable-based Internet
services through its ISP Channel subsidiary by December 31, 2000, because of (1)
consolidation in the cable television industry made it difficult for ISP Channel
to achieve the economies of scale necessary to provide such services profitably,
and (2) the Company was no longer able to bear the costs of maintaining the ISP
Channel. The operating results of ISP Channel have been segregated from
continuing operations and are reported as loss from discontinued operations of
the accompanying consolidated statements of operations. The loss from
discontinued operations includes management's estimates of the remaining costs
to wind down the business, costs to settle its outstanding liabilities, and the
proceeds from the sale of assets. The assets and liabilities of such operations
are reflected in net liabilities associated with discontinued operations of the
accompanying consolidated balance sheets at September 30, 2002 and 2001. For
the year ended September 30, 2000, the Company recorded an estimated loss on
disposition reserve of ISP Channel of $97,200,000. For the year ended September
30, 2001, the Company decreased the estimated loss on disposition reserve of ISP
Channel by $10,008,000, primarily as a result of the Company experiencing better
than previously estimated contract settlements. For the year ended September
30, 2002, the Company reduced the estimated loss on disposition reserve of ISP
Channel by $900,000, primarily as a result of the Company experiencing better
than previously estimated contract settlements. The estimated loss on
disposition reserve of ISP Channel is reflected in net liabilities of
discontinued operations of the accompanying consolidated balance sheets at
September 30, 2002 and 2001, and the corresponding benefit and charge is
reflected in loss on disposition of discontinued operations of the accompanying
consolidated statements of operations for the years ended September 30, 2002,
2001 and 2000.
Discontinued Operations of Micrographic Technology Corporation ("MTC")
As a result of a preliminary arbitration decision related to a dispute with
Applications Informatiques Multimedia and a dispute related to the sale of MTC
to Global Information Distribution GmbH ("GID"), the Company recorded a
$1,127,000 estimated loss on disposition reserve of MTC for the year ended
September 30, 2002. MTC was previously owned by the Company, and was sold to
GID on September 30, 1999. The estimated loss on disposition reserve of MTC is
reflected in net liabilities associated with discontinued operations of the
accompanying consolidated balance sheet at September 30, 2002, and the
corresponding charge is reflected in loss on disposition of discontinued
operations of the accompanying consolidated statement of operations for the year
ended September 30, 2002.
-21-
FACTORS AFFECTING THE COMPANY'S OPERATING RESULTS
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, and you may lose all or part of your investment.
COMPANY RISKS
IHC WILL EXERCISE SIGNIFICANT INFLUENCE OVER THE COMPANY'S BUSINESS AND AFFAIRS,
WHICH MAY RESULT IN POTENTIAL CONFLICTS OF INTEREST BETWEEN IHC AND THE COMPANY
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
corporate 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.
These conflicts could harm the Company's business.
THE OCCURRENCE OF VARIOUS EVENTS MAY ADVERSELY AFFECT THE COMPANY'S ABILITY TO
UTILIZE FULLY ITS TAX NET OPERATING LOSS CARRYFORWARDS
One of the potential benefits of the Company's acquisition of IAHC is the
Company's expectation that the Company's U.S. federal tax net operating loss
carryforwards of approximately $264 million may be used against any subsequent
profits from IAHC'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
IAHC profits would not be realized and the Company could potentially have a
higher tax liability in the future than it would otherwise have had.
AS A RESULT OF THE COMPANY'S ACQUISITION OF IAHC, THE COMPANY WILL OPERATE IN
THE INSURANCE AND REINSURANCE INDUSTRY, AN INDUSTRY IN WHICH THE COMPANY HAS NOT
PREVIOUSLY OPERATED
The Company has not previously operated in the insurance and reinsurance
industry. As such, the Company is faced with risks that are new to the Company
and which may adversely affect the Company. The Company is relying upon the
management and expertise of officers of IHC who will serve as officers of the
Company post-closing. The Company cannot assure you of the effect this will
have on the Company's future operating results or stock price. These risks
include the following:
IAHC's Results May Fluctuate as a Result of Factors Generally Affecting the
Insurance and Reinsurance Industry
The results of companies in the insurance and reinsurance industry
historically have been subject to significant fluctuations and
uncertainties. Factors that affect the industry in general could also cause
IAHC's results to fluctuate. The industry's and IAHC's financial condition
and results of operations may be affected significantly by:
- Fluctuations in interest rates, inflationary pressures and other
changes in the investment environment, which affect returns on
invested capital and may impact the ultimate payout of loss
amounts;
- Rising levels of actual costs that are not known by companies at
the time they price their products;
- Events like the September l1, 2001 attacks, which affected the
insurance and reinsurance markets generally;
- Changes in reserves resulting from different types of claims that
may arise and the development of judicial interpretations
relating to the scope of insurers' liability; and
- The overall level of economic activity and the competitive
environment in the industry.
-22-
Decrease in Rates for Accident and Health Reinsurance and Insurance Could
Reduce IAHC's Net Income
IAHC primarily writes accident and health insurance and reinsurance. Rates
for accident and health insurance and reinsurance are influenced primarily
by factors that are outside of IAHC's control and historically have been
highly cyclical. Any significant decrease in the rates for accident and
health insurance or reinsurance could reduce IAHC's net income.
If the Rating Agencies Downgrade IAHC's Insurance Company, IAHC's Results
of Operations and Competitive Position in the Industry May Suffer
Ratings have become an increasingly important factor in establishing the
competitive position of insurance companies. IAHC's insurance subsidiary
Independence American Insurance Company ("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 IAHC cannot assure you of the continued retention of this rating.
If A.M. Best Company, Inc. reduces Independence American's ratings from its
current levels, IAHC's business would be adversely affected.
IAHC's Loss Reserves are Based on an Estimate of Its Future Liability, and
if Actual Claims Prove to be Greater Than IAHC's Reserves, Its Results of
Operations and Financial Condition May Be Adversely Affected
IAHC maintains loss reserves to cover IAHC's estimated liability for unpaid
losses and loss adjustment expenses, including legal and other fees as well
as a portion of IAHC's general expenses, for reported and unreported claims
incurred as of the end of each accounting period. Because setting reserves
is inherently uncertain, IAHC cannot assure you that current reserves will
prove adequate in light of subsequent events. If IAHC's reserves are
insufficient to cover its actual losses and loss adjustment expenses, IAHC
would have to augment its reserves and incur a charge to its earnings, and
these charges could be material. Reserves do not represent an exact
calculation of liability. Rather, reserves represent an estimate of what
IAHC expects the ultimate settlement and administration of claims will
cost. These estimates, which generally involve actuarial projections, are
based on IAHC's assessment of facts and circumstances then known, as well
as estimates of future trends in claims severity, frequency, judicial
theories of liability and other factors. These variables are affected by
both internal and external events, such as changes in claims handling
procedures, inflation, judicial trends and legislative changes. Many of
these items are not directly quantifiable in advance. Additionally, there
may be a significant reporting lag between the occurrence of the insured
event and the time it is reported to IAHC. The inherent uncertainties of
estimating reserves are greater for certain types of liabilities,
particularly those in which the various considerations affecting the type
of claim are subject to change and in which long periods of time may elapse
before a definitive determination of liability is made. Reserve estimates
are continually refined in a regular and ongoing process as experience
develops and further claims are reported and settled. Adjustments to
reserves are reflected in the results of the periods in which such
estimates are changed.
IAHC's Inability to Assess Underwriting Risk Accurately Could Reduce Its
Net Income
IAHC's success is dependent on its ability to assess accurately the risks
associated with the businesses on which the risk is retained. If IAHC fails
to assess accurately the risks it retains, IAHC may fail to establish the
appropriate premium rates and IAHC's reserves may be inadequate to cover
its losses, requiring augmentation of IAHC's reserves, which in turn could
reduce IAHC's net income.
If IAHC is Unsuccessful in Competing Against Larger or More
Well-Established Competitors, IAHC's Results of Operations and Financial
Condition Will Be Adversely Affected
IAHC's industry is highly competitive and has experienced severe price
competition from time to time over the last several years. IAHC faces
competition from domestic and international insurance and reinsurance
companies, underwriting agencies, and from diversified financial services
companies that are significantly larger than IAHC. Some of these
competitors have greater financial, marketing and other resources than
IAHC, have been operating longer than IAHC and have established long-term
and continuing business relationships throughout the industry, which can be
a significant competitive advantage. In addition to competition in the
operation of IAHC's business, IAHC faces competition from a variety of
sources in attracting and retaining qualified employees. IAHC cannot assure
you that it will maintain its current competitive position in the markets
in which it operates, or that it will be able to expand its operations into
new markets and compete effectively in the future. If IAHC fails to do so,
its business could be materially adversely affected.
-23-
If IAHC Fails to Comply With Extensive State and Federal Regulations, IAHC
Will Be Subject to Penalties, Which May Include Fines and Suspension and
Which May Adversely Affect IAHC's Results of Operations and Financial
Condition.
IAHC is subject to extensive governmental regulation and supervision. Most
insurance regulations are designed to protect the interests of
policyholders rather than stockholders and other investors. This
regulation, generally administered by a department of insurance in each
state in which IAHC does business, relates to, among other things:
- Approval of policy forms and premium rates;
- Standards of solvency, including risk-based capital measurements,
which are a measure developed by the National Association of
Insurance Commissioners and used by state insurance regulators to
identify insurance companies that potentially are inadequately
capitalized;
- Licensing of insurers and their agents;
- Restrictions on the nature, quality and concentration of
investments;
- Restrictions on the ability of Independence American's insurance
company to pay dividends to IAHC;
- Restrictions on transactions between insurance companies and
their affiliates;
- Restrictions on the size of risks insurable under a single
policy;
- Requiring deposits for the benefit of policyholders;
- Requiring certain methods of accounting;
- Periodic examinations of Independence American's operations and
finances;
- Prescribing the form and content of records of financial
condition required to be filed; and
- Requiring reserves for unearned premium, losses and other
purposes.
State insurance departments also conduct periodic examinations of the
affairs of insurance companies and require the filing of annual and other
reports relating to the financial condition of insurance companies, holding
company issues and other matters.
Recently adopted federal financial services modernization legislation is
expected to lead to additional federal regulation of the insurance industry
in the coming years. IAHC'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 of
regulations. In some instances, IAHC 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 IAHC 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 IAHC from carrying on some or all of its
activities or otherwise penalize it. That type of action could have a
material adverse effect on IAHC's 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 IAHC's
business.
Certain Proposed Federal and State Legislation May, if Adopted, Adversely
Affect IAHC's Reinsurance of Medical Stop-Loss.
Individuals who obtain health coverage through self-insured plans cannot
currently sue their employer in state court for punitive or compensatory
damages, but can seek legal recourse in federal court where an employer can
be ordered to cover a wrongfully-denied benefit. In the continuing debate
over health care reform, certain federal and state legislation has been
proposed which could have the effect of making plan sponsors,
administrators, or certain other parties liable for punitive damages in
state court. While IAHC cannot predict whether any of these proposals will
be adopted or what, if any, impact enactment of any of these would have on
its reinsurance of medical stop-loss, the number of employers offering
health benefits or choosing self-insured plans could be reduced, plans
could increase the portion paid by employees (thereby reducing
participation), pricing and coverage options could be affected, and
Independence American could be faced with greater liability exposures,
although this would be somewhat mitigated since Independence American would
not be the issuing carrier.
-24-
Decreases in the Fair Market Value of Fixed Income Securities May Greatly
Reduce the Value of IAHC's Investment Portfolio, and as a Result, IAHC's
Financial Condition May Suffer
At September 30, 2002, $5,463,000 of IAHC's $11,203,000 investment
portfolio was invested in fixed income securities. The fair market value of
these fixed income securities and the investment income from these fixed
income securities fluctuate depending on general economic and market
conditions. With respect to IAHC's investments in fixed income securities,
the fair market value of these investments generally increases or decreases
in an inverse relationship with fluctuations in interest rates, while net
investment income realized by IAHC from future investments in fixed income
securities will generally increase or decrease with interest rates. In
addition, actual net investment income and/or cash flows from investments
that carry prepayment risk, such as mortgage-backed and other asset-backed
securities, may differ from those anticipated at the time of investment as
a result of interest rate fluctuations. An investment has prepayment risk
when there is a risk that the timing of cash flows that result from the
repayment of principal might occur earlier than anticipated because of
declining interest rates or later than anticipated because of rising
interest rates. Historically, the impact of market fluctuations has
affected IAHC's financial statements. Because all of IAHC's fixed income
securities are classified as available for sale, changes in the fair market
value of IAHC's securities are reflected in IAHC's other comprehensive
income. Similar treatment is not available for liabilities. Therefore,
interest rate fluctuations and economic conditions could adversely affect
IAHC's stockholders' equity, total comprehensive income and/or cash flows.
Regulatory Restrictions Limit IAHC's Ability to Obtain Dividends from
Independence American
One of IAHC's principal assets is the shares of capital stock of
Independence American. IAHC 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 IAHC's other sources of funds prove to be inadequate, IAHC
may not be able to receive dividends from Independence American at times
and in amounts necessary to meet its obligations.
IAHC is Dependent on Key Personnel
IAHC's success has been, and will continue to be, dependent on its ability
to retain the services of its existing key executive officers, who are also
executive officers of IHC, and to attract and retain additional qualified
personnel in the future. The loss of the services of any of its key
executive officers or the inability to hire and retain other highly
qualified personnel in the future could adversely affect IAHC's ability to
conduct its business.
New Laws and Regulations Addressing Privacy and Electronic Transaction
Issues Create Uncertainty and Risk for Insurers
In recent years, the United States Congress passed the Gramm-Leach-Bliley
Act and the Health Insurance Portability and Accountability Act. These acts
afford protection for "nonpublic personal information" relating to
consumers, and require certain transactions to be conducted on an
electronic basis. Federal regulators have implemented several requirements
of these acts. Additionally, virtually all state legislatures or regulatory
bodies have adopted, or are considering the adoption of, additional laws
and regulations to address privacy and electronic transaction issues. These
new laws create uncertainty and risks for insurers, which need to
accurately describe their privacy practices and develop appropriate
procedures to manage, protect and transmit certain types of customer data.
While IAHC has implemented a process to monitor and achieve compliance with
these laws, the associated costs and potential risks and liabilities are
difficult or impossible to quantify. IAHC is unable to predict the precise
nature and content of future laws and regulations, or the effects that they
may have on the business, operations, operating results or financial
condition of IAHC. Potential areas of exposure facing the industry as a
whole include failure to accurately or adequately describe privacy
practices or to protect customer information from unauthorized disclosure.
THE COMPANY'S ACQUISITION OF IAHC MAY ADVERSELY AFFECT THE COMPANY'S FINANCIAL
CONDITION
The acquisition of IAHC may have potential negative effects on the Company's
reported results of operations from acquisition-related charges and amortization
of other intangible assets. As a result of the IAHC acquisition, the Company
may record additional intangible assets, which may adversely affect the
Company's earnings and profitability for the foreseeable future. If the amount
-25-
of such recorded intangible assets is increased or if the Company has future
losses and is unable to demonstrate the Company's ability to recover the amount
of intangible assets recorded during such time periods, the intangible asset can
be written down or the period of amortization could be shortened, which may
further increase annual amortization charges. In such event, the Company's
business and financial condition could be materially adversely affected.
IF THE COMPANY IS UNABLE TO SUCCESSFULLY INTEGRATE ANY FUTURE ACQUISITIONS INTO
THE COMPANY'S OPERATIONS, THEN THE COMPANY'S RESULTS AND FINANCIAL CONDITION MAY
BE ADVERSELY AFFECTED
Following its acquisition of IAHC, the Company expects to acquire other managing
general underwriter businesses. The Company cannot predict if or when any
prospective acquisitions will occur or the likelihood that they will be
completed on favorable terms. Acquiring a business involves many risks,
including:
- Diversion of resources and management time;
- Dilution to existing stockholders if the Company uses equity
securities to finance acquisitions;
- Incurrence of unforeseen obligations or liabilities;
- Inability of management to maintain uniform standards, controls,
procedures and policies;
- Difficulty assimilating the acquired operations and personnel;
- Risks of entering markets in which the Company has little or no direct
prior experience; and
- Impairment of relationships with employees as a result of changes in
management.
The Company cannot assure you that it will make any acquisitions or that it will
be able to obtain additional financing for such acquisitions, if necessary. If
any acquisitions are made, the Company cannot assure you that it will be able to
successfully integrate the acquired business into its operations or that the
acquired business will perform as expected.
THE COMPANY'S EQUITY INVESTMENTS IN OTHER COMPANIES MAY NOT YIELD ANY RETURNS
Although the Company does not intend to do so in the future, the Company has
made equity investments in Internet-related companies. In most instances, these
investments are in the form of unregistered securities of private companies.
These companies typically are in an early stage of development and may be
expected to incur substantial losses. The Company's investments in these
companies may not yield any returns. Furthermore, if these companies are not
successful, the Company could incur and has incurred charges related to the
write-down or write-off of these investments. For example, the Company wrote
down equity investments by $733,000 for the year ended September 30, 2002. The
Company also records and continues to record a share of the net losses in these
companies, up to its cost basis. The Company may make additional investments in
the future. Losses or charges resulting from these investments could harm the
Company's operating results.
THE COMPANY'S STOCK PRICE IS VOLATILE
The volatility of the Company's stock price may make it difficult for holders of
the common stock to transfer their shares at the prices they want. The market
price for the Company's common stock has been volatile in the past, and several
factors could cause the price to fluctuate substantially in the future. These
factors include:
- Announcements of developments related to the Company's business;
- Fluctuations in the Company's results of operations;
- Sales of substantial amounts of the Company's securities in the
marketplace;
- General conditions in the Company's industries or the worldwide
economy;
- An outbreak of war or hostilities;
- A shortfall in earnings compared to securities analysts' expectations;
- Changes in analysts' recommendations or projections; and
- Changes in the Company's relationships with the Company's suppliers.
The market price of the Company's common stock may fluctuate significantly in
the future, and these fluctuations may be unrelated to the Company's
performance. General market price declines or market volatility in the future
could adversely affect the price of the Company's common stock, and thus, the
current market price may not be indicative of future market prices.
-26-
PROSPECTIVE ANTI-TAKEOVER PROVISIONS COULD NEGATIVELY IMPACT THE COMPANY'S
STOCKHOLDERS
The Company is a Delaware corporation. The Delaware General Corporation Law
contains certain provisions that may discourage or delay a change in control of
the Company, make a change in control of the Company more difficult or prevent
the removal of incumbent directors. In addition, the Company's certificate of
incorporation and bylaws contain certain provisions that have the same or a
similar effect. These provisions may have a negative impact on the price of the
Company's common stock and may discourage third-party bidders from making a bid
for the Company or may reduce any premiums paid to stockholders for their common
stock.
THE COMPANY HAS A HISTORY OF LOSSES AND MAY FACE UNEXPECTED LIABILITIES IN
WINDING DOWN THE BUSINESSES OF INTELLICOM, ISP CHANNEL AND AERZONE
The Company has sustained substantial losses over the last five fiscal years.
For the year ended September 30, 2002, the Company had a net loss of
$14,756,000. At September 30, 2002, the Company had an accumulated deficit of
$405,003,000. While the Company expects the process of winding down Intellicom
to be substantially completed by December 31, 2002, the Company cannot assure
you that it will be able to do so. The Company expects to incur significant
costs related to terminating contracts, reducing the workforce and recovering
and disposing of deployed assets. While the businesses of ISP Channel,
Intellicom, and Aerzone have been substantially wound down, the Company also
cannot assure you that all claims and issues have been resolved. In addition,
the Company is currently involved in litigation, and may in the future be
involved in additional litigation, with respect to the winding down of these
former businesses. The Company cannot assure you of the outcome of any such
litigation.
-27-
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
The Company's exposure to market risk for changes in interest rates relates
primarily to the increase or decrease in the amount of interest income the
Company can earn on its investment portfolio, and on the increase or decrease in
the amount of interest expense the Company must pay with respect to its various
outstanding debt instruments. The risk associated with fluctuating interest
expense is limited, however, to the exposure related to those debt instruments
and credit facilities, which are tied to market rates. The Company does not use
derivative financial instruments or engage in hedging activities in its
investment portfolio. The Company ensures the safety and preservation of its
invested principal funds by limiting default risks, market risk and reinvestment
risk. The Company mitigates default risk by investing in safe and high-credit
quality securities.
The Company had short-term investments of $40,910,000 at September 30, 2002.
Except for investments in common and preferred stock, these short-term
investments consist of highly liquid investments with original maturities at the
date of purchase of between three and twenty-three months. These investments
are subject to interest rate risk and will fall in value if market interest
rates increase. The Company believes a hypothetical increase in market interest
rates by 10% from levels at September 30, 2002, would cause the fair value of
these short-term investments to fall by an immaterial amount. Since the Company
is not required to sell these investments before maturity, it has the ability to
avoid realizing losses on these investments due to a sudden change in market
interest rates. On the other hand, declines in the interest rates over time
will reduce its interest income.
Interest rate increases, however, will increase interest expense associated with
future borrowing by the Company, if any. The Company does not hedge against
interest rate fluctuations.
CURRENCY EXCHANGE RISK
The Company has historically had very low exposure to changes in foreign
currency exchange rates, and as such, has not used derivative financial
instruments to manage foreign currency fluctuation risk.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting No. 145 ("SFAS 145"), Rescission of SFAS No.
4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections. This
statement rescinds Statement of Financial Accounting No. 4, Reporting Gains and
Losses from Extinguishment of Debt, Statement of Financial Accounting No. 64,
Extinguishment of Debt made to satisfy Sinking-Fund Requirements, and Statement
of Financial Accounting No. 44, Accounting for Intangible Assets of Motor
Carriers. This statement also amends Statement of Financial Accounting No. 13,
Accounting for Leases, to eliminate an inconsistency between the accounting for
sale-leaseback transactions and the accounting for certain lease modifications
that have economic effects that are similar to sale-leaseback transactions.
SFAS 145 is effective for fiscal years beginning after, transactions entered
into after and financial statements issued on or subsequent to May 15, 2002.
The adoption of SFAS 145 had no impact on financial statements of the Company.
In June 2002, the FASB issued Statement of Financial Accounting No. 146 ("SFAS
146"), Accounting for Exit or Disposal Activities. SFAS 146 addresses the
recognition, measurement, and reporting of costs that are associated with exit
and disposal activities, including costs related to terminating a contract that
is not a capital lease and termination benefits that employees who are
involuntarily terminated receive under the terms of a one-time benefit
arrangement that is not an ongoing benefit arrangement or an individual
deferred-compensation contract. SFAS 146 supersedes Emerging Issues Task Force
Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring), and requires liabilities associated with exit and disposal
activities to be expensed as incurred. SFAS 146 is effective for exit or
disposal activities that we initiate after December 31, 2002.
-28-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
AMERICAN INDEPENDENCE CORP. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2002
PAGE
-----
Report of Independent Auditors KPMG LLP. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Consolidated Balance Sheets as of September 30, 2002 and 2001. . . . . . . . . . . . . . . . . . . . . 31
Consolidated Statements of Operations for the three years ended September 30, 2002 . . . . . . . . . . 32
Consolidated Statements of Stockholders' Equity (Deficit) for the three years ended September 30, 2002 33
Consolidated Statements of Cash Flows for the three years ended September 30, 2002 . . . . . . . . . . 34
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35-54
-29-
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
American Independence Corp. (formerly SoftNet Systems, Inc.):
We have audited the accompanying consolidated balance sheets of American
Independence Corp. (formerly SoftNet Systems, Inc.) and Subsidiaries as of
September 30, 2002 and 2001, and the related consolidated statements of
operations, stockholders' equity (deficit) and cash flows for each of the years
in the three-year period ended September 30, 2002. In connection with our
audits of the consolidated financial statements, we have also audited the
financial statement schedule as listed in the index appearing under Item
15(a)(2). These consolidated financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
American Independence Corp. (formerly SoftNet Systems, Inc.) and Subsidiaries as
of September 30, 2002 and 2001, and the results of their operations and cash
flows for each of the years in the three-year period ended September 30, 2002,
in conformity with accounting principles generally accepted in the United States
of America. Also, in our opinion, the related financial statement schedule,
when considered in relation to the consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
/s/ KPMG LLP
San Francisco, California
October 25, 2002, except as to note 19,
which is as of November 19, 2002
-30-
AMERICAN INDEPENDENCE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
SEPTEMBER 30,
---------------------
2002 2001
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 21,149 $ 14,960
Short-term investments, available-for-sale . . . . . . . . . . . . . . . . . . . . . . 40,910 60,494
Account receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,092 2,018
Deferred acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,834 -
Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 790 1,266
---------- ----------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67,775 78,738
Restricted cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800 800
Property and equipment, net of accumulated depreciation of $384 and $375, respectively . 70 691
Account receivable, non current portion. . . . . . . . . . . . . . . . . . . . . . . . . - 1,566
Long-term equity investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,004 1,484
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,165 1,221
---------- ----------
$ 70,814 $ 84,500
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 24 $ 273
Accrued compensation and related expenses. . . . . . . . . . . . . . . . . . . . . . . 147 478
Net liabilities associated with discontinued operations. . . . . . . . . . . . . . . . 3,850 2,757
Restructuring accrual. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,446 1,240
Other accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,682 1,862
Current portion of long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . - 1,444
---------- ----------
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,149 8,054
---------- ----------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.10 par value, 3,970,000 shares designated, no shares issued and
outstanding. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - -
Common stock, $0.01 par value, 100,000,000 shares authorized;27,474,201 and
27,461,775 shares issued; 25,183,701 and 25,171,275 shares outstanding, respectively 275 275
Additional-paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 477,615 477,680
Deferred stock compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (79) (1,645)
Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . (6) (480)
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (405,003) (390,247)
Treasury stock, at cost, 2,290,500 and 2,290,500 shares, respectively. . . . . . . . . (9,137) (9,137)
---------- ----------
Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63,665 76,446
---------- ----------
$ 70,814 $ 84,500
========== ==========
See accompanying notes to consolidated financial statements.
-31-
AMERICAN INDEPENDENCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
YEAR ENDED SEPTEMBER 30,
--------------------------------
2002 2001 2000
--------- --------- ----------
Operating expenses:
Selling and marketing. . . . . . . . . . . . . . . . . . . . . . . . . $ - $ 182 $ 1,754
Engineering. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 551 536
General and administrative, exclusive of non-cash compensation expense
(benefit) of $1,466, $(807) and $14,668, respectively. . . . . . . . 7,297 9,283 10,788
Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189 350 355
Non-cash compensation expense (benefit) related to stock options . . . 1,466 (807) 14,668
Provision for impaired assets. . . . . . . . . . . . . . . . . . . . . 352 - -
Restructuring expense. . . . . . . . . . . . . . . . . . . . . . . . . 502 3,900 -
--------- --------- ----------
Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . 9,806 13,459 28,101
--------- --------- ----------
Loss from continuing operations before other income (expense), income
taxes, discontinued operations and extraordinary item. . . . . . . . . (9,806) (13,459) (28,101)
Other income (expense):
Interest income. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,802 6,421 11,840
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . (72) (107) (526)
Gain (loss) on disposition of equity investments, net. . . . . . . . . (733) (17,195) 10,157
Equity in net losses of investee companies . . . . . . . . . . . . . . - (394) (581)
Miscellaneous income (expense), net. . . . . . . . . . . . . . . . . . (21) 216 (396)
--------- --------- ----------
Loss from continuing operations before income taxes, discontinued
operations and extraordinary item. . . . . . . . . . . . . . . . . . . (8,830) (24,518) (7,607)
Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . - - -
--------- --------- ----------
Loss from continuing operations before discontinued operations and
extraordinary item . . . . . . . . . . . . . . . . . . . . . . . . . . (8,830) (24,518) (7,607)
Discontinued operations:
Loss from operations . . . . . . . . . . . . . . . . . . . . . . . . . (1,829) (29,557) (85,346)
Gain (loss) on disposition . . . . . . . . . . . . . . . . . . . . . . (4,097) (4,898) (139,400)
Extraordinary item:
Gain on settlements of outstanding obligations . . . . . . . . . . . . - 1,326 -
--------- --------- ----------
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(14,756) $(57,647) $(232,353)
========= ========= ==========
Basic and diluted loss per common share:
Loss from continuing operations. . . . . . . . . . . . . . . . . . . . $ (0.35) $ (0.98) $ (0.32)
Discontinued operations. . . . . . . . . . . . . . . . . . . . . . . . (0.24) (1.38) (9.56)
Extraordinary item . . . . . . . . . . . . . . . . . . . . . . . . . . - 0.05 -
--------- --------- ----------
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.59) $ (2.31) $ (9.88)
========= ========= ==========
Shares used to compute basic and diluted loss per common share . . . . . 25,179 25,024 23,518
========= ========= ==========
See accompanying notes to consolidated financial statements
-32-
AMERICAN INDEPENDENCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(In thousands, except share data)
ACCUMULATED
OTHER
COMMON STOCK ADDITIONAL DEFERRED COMPREHEN-
-------------------- PAID STOCK SIVE ACCUMULATED
SHARES AMOUNT IN CAPITAL COMPENSATION LOSS DEFICIT
----------- ------- ------------ -------------- ------ ----------
BALANCE, SEPTEMBER 30, 1999. . . . . . . . . . . . . . . . 17,225,523 $ 172 $ 327,445 $ (63,346) $(315) $(100,247)
Common stock shares issued in connection with:
Non-public offering, net of selling costs. . . . . . . 5,000,000 50 128,071 - - -
Acquisition of Laptop Lane Limited . . . . . . . . . . 1,205,337 12 18,398 - - -
Acquisition of Intelligent Communications, Inc.
(Anniversary Shares). . . . . . . . . . . . . . . . 43,314 - 1,499 - - -
Repayment of long-term debt. . . . . . . . . . . . . . 76,764 1 1,861 - - -
Cable incentive program, Mediacom LLC. . . . . . . . . 3,500,000 - - - - -
Value assigned to cable incentive program,
Mediacom LLC. . . . . . . . . . . . . . . . . . . . - 14 26,499 - - -
Cable incentive program, other . . . . . . . . . . . . 35,160 - 419 - - -
Conversion of convertible subordinated notes . . . . . 766,668 8 9,941 - - -
Exercise of warrants . . . . . . . . . . . . . . . . . 200,000 2 1,536 - - -
Exercise of options. . . . . . . . . . . . . . . . . . 455,592 5 3,666 - - -
Employee stock purchase plan . . . . . . . . . . . . . 15,116 - 145 - - -
Value assigned to beneficial conversion feature of debt. - - 34 - - -
Common stock repurchased . . . . . . . . . . . . . . . . - - - - - -
Reversal of deferred stock compensation charge due
to employee termination . . . . . . . . . . . . . . . - - (15,712) 15,712 - -
Amortization of deferred stock compensation. . . . . . . - - - 19,057 - -
Unrealized losses on securities. . . . . . . . . . . . . - - - - (385) -
Foreign currency translation adjustment. . . . . . . . . - - - - 4 -
Net loss . . . . . . . . . . . . . . . . . . . . . . . . - - - - - (232,353)
----------- ------- ------------ -------------- ------ ----------
BALANCE, SEPTEMBER 30, 2000. . . . . . . . . . . . . . . . 28,523,474 264 503,802 (28,577) (696) (332,600)
Common stock shares issued in connection with:
Acquisition of Laptop Lane Limited
(Performance Shares). . . . . . . . . . . . . . . . 81,050 1 331 - -
Acquisition of Intelligent Communications, Inc.:
Anniversary Shares . . . . . . . . . . . . . . . . . 46,047 - 92 - - -
Repayment of long-term debt. . . . . . . . . . . . . 53,875 1 106 - - -
Affiliate agreement termination settlement,
Mediacom LLC (Returned Shares) . . . . . . . . . . . (2,100,000) - - - - -
Affiliate agreement termination settlement,
Mediacom LLC . . . . . . . . . . . . . . . . . . . . 800,000 8 1,492 - - -
Cable incentive program. . . . . . . . . . . . . . . . 560 - - - -
Employee stock purchase plan . . . . . . . . . . . . . 56,769 1 99 - - -
Common stock repurchased . . . . . . . . . . . . . . . . - - - - - -
Reversal of deferred stock compensation charge
due to employee termination. . . . . . . . . . . . . . - - (28,242) 28,242 - -
Amortization of deferred stock compensation. . . . . . . - - - (1,310) - -
Unrealized gains on securities . . . . . . . . . . . . . - - - - 236 -
Foreign currency translation adjustment. . . . . . . . . - - - - (20) -
Net loss . . . . . . . . . . . . . . . . . . . . . . . . - - - - - (57,647)
----------- ------- ------------ -------------- ------ ----------
BALANCE, SEPTEMBER 30, 2001. . . . . . . . . . . . . . . . 27,461,775 275 477,680 (1,645) (480) (390,247)
Common stock shares issued in connection with:
Acquisition of Intelligent Communications, Inc.:
Anniversary Shares . . . . . . . . . . . . . . . . . 12,426 - - - - -
Reversal of deferred stock compensation charge
due to employee termination. . . . . . . . . . . . . . - - (65) 65 - -
Amortization of deferred stock compensation. . . . . . . - - - 1,501 - -
Unrealized gains on securities . . . . . . . . . . . . . - - - - 458 -
Foreign currency translation adjustment. . . . . . . . . - - - - 16 -
Net loss . . . . . . . . . . . . . . . . . . . . . . . . - - - - - (14,756)
----------- ------- ------------ -------------- ------ ----------
BALANCE, SEPTEMBER 30, 2002. . . . . . . . . . . . . . . . 27,474,201 $ 275 $ 477,615 $ (79) $ (6) $(405,003)
=========== ======= ============ ============== ====== ==========
TREASURY STOCK TOTAL
------------------- STOCKHOLDERS' COMPREHENSIVE
SHARES AMOUNT EQUITY (DEFICIT) LOSS
--------- -------- ----------------- ----------
BALANCE, SEPTEMBER 30, 1999. . . . . . . . . . . . . . . . - $ - $ 163,709
Common stock shares issued in connection with:
Non-public offering, net of selling costs. . . . . . . - - 128,121
Acquisition of Laptop Lane Limited . . . . . . . . . . - - 18,410
Acquisition of Intelligent Communications, Inc.
(Anniversary Shares). . . . . . . . . . . . . . . . - - 1,499
Repayment of long-term debt. . . . . . . . . . . . . . - - 1,862
Cable incentive program, Mediacom LLC. . . . . . . . . - - -
Value assigned to cable incentive program,
Mediacom LLC. . . . . . . . . . . . . . . . . . . . - - 26,513
Cable incentive program, other . . . . . . . . . . . . - - 419
Conversion of convertible subordinated notes . . . . . - - 9,949
Exercise of warrants . . . . . . . . . . . . . . . . . - - 1,538
Exercise of options. . . . . . . . . . . . . . . . . . - - 3,671
Employee stock purchase plan . . . . . . . . . . . . . - - 145
Value assigned to beneficial conversion feature of debt. - - 34
Common stock repurchased . . . . . . . . . . . . . . . . 409,500 (2,279) (2,279)
Reversal of deferred stock compensation charge due
to employee termination . . . . . . . . . . . . . . . - - -
Amortization of deferred stock compensation. . . . . . . - - 19,057
Unrealized losses on securities. . . . . . . . . . . . . - - (385) $ (385)
Foreign currency translation adjustment. . . . . . . . . - - 4 4
Net loss . . . . . . . . . . . . . . . . . . . . . . . . - - (232,353) (232,353)
--------- -------- ----------------- ----------
BALANCE, SEPTEMBER 30, 2000. . . . . . . . . . . . . . . . 409,500 (2,279) 139,914 $(232,734)
==========
Common stock shares issued in connection with:
Acquisition of Laptop Lane Limited
(Performance Shares). . . . . . . . . . . . . . . . - - 332
Acquisition of Intelligent Communications, Inc.:
Anniversary Shares . . . . . . . . . . . . . . . . . - - 92
Repayment of long-term debt. . . . . . . . . . . . . - - 107
Affiliate agreement termination settlement,
Mediacom LLC (Returned Shares) . . . . . . . . . . . - - -
Affiliate agreement termination settlement,
Mediacom LLC . . . . . . . . . . . . . . . . . . . . - - 1,500
Cable incentive program. . . . . . . . . . . . . . . . - - -
Employee stock purchase plan . . . . . . . . . . . . . - - 100
Common stock repurchased . . . . . . . . . . . . . . . . 1,881,000 (6,858) (6,858)
Reversal of deferred stock compensation charge
due to employee termination . . . . . . . . . . . . . - - -
Amortization of deferred stock compensation. . . . . . . - - (1,310)
Unrealized gains on securities . . . . . . . . . . . . . - - 236 $ 236
Foreign currency translation adjustment. . . . . . . . . - - (20) (20)
Net loss . . . . . . . . . . . . . . . . . . . . . . . . - - (57,647) (57,647)
--------- -------- ----------------- ----------
BALANCE, SEPTEMBER 30, 2001. . . . . . . . . . . . . . . . 2,290,500 (9,137) 76,446 $ (57,431)
==========
Common stock shares issued in connection with:
Acquisition of Intelligent Communications, Inc.:
Anniversary Shares . . . . . . . . . . . . . . . . . - - -
Reversal of deferred stock compensation charge
due to employee termination. . . . . . . . . . . . . . - - -
Amortization of deferred stock compensation. . . . . . . - - (1,501)
Unrealized gains on securities . . . . . . . . . . . . . - - 458 $ 458
Foreign currency translation adjustment. . . . . . . . . - - 16 16
Net loss . . . . . . . . . . . . . . . . . . . . . . . . - - (14,756) (14,756)
--------- -------- ----------------- ----------
BALANCE, SEPTEMBER 30, 2002. . . . . . . . . . . . . . . . 2,290,500 $(9,137) $ 63,665 $ (14,282)
========= ======== ================= ==========
See accompanying notes to consolidated financial statements.
-33-
AMERICAN INDEPENDENCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
YEAR ENDED SEPTEMBER 30,
--------------------------------
2002 2001 2000
--------- --------- ----------
Cash flows from operating activities:
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(14,756) $(57,647) $(232,353)
Adjustments to reconcile net loss to net cash used in operating activities:
Loss from discontinued operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,829 29,557 85,346
(Gain) loss on disposition of discontinued operations. . . . . . . . . . . . . . . . . . 4,097 4,898 139,400
Extraordinary item - gain on settlements of outstanding obligations. . . . . . . . . . . - (1,326) -
Gain on write off of obligation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . - (161) -
Provision for impaired assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 352 - -
Provision for restructuring costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . 502 3,900 -
Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189 350 355
Amortization of deferred stock compensation expense (benefit). . . . . . . . . . . . . . 1,466 (807) 14,668
Amortization of deferred debt issuance costs . . . . . . . . . . . . . . . . . . . . . . - - 59
Loss on disposition of property and equipment. . . . . . . . . . . . . . . . . . . . . . 72 45 -
Equity in net losses of investee companies . . . . . . . . . . . . . . . . . . . . . . . - 394 581
(Gain) loss on disposition of equity investment, net . . . . . . . . . . . . . . . . . . 733 17,195 (10,157)
Gain on disposition of other short-term investment . . . . . . . . . . . . . . . . . . . (6) (2) -
Interest paid with additional convertible notes. . . . . . . . . . . . . . . . . . . . . - - 69
Changes in operating assets and liabilities (net of effect of acquisitions and
discontinued operations):
Decrease (increase) in accounts receivable, net. . . . . . . . . . . . . . . . . . . . . 1,492 1,668 (5,252)
Increase in other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,358) (595) (158)
Decrease (increase) in other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . 18 (1,007) 56
Increase (decrease) in accounts payable and accrued expenses . . . . . . . . . . . . . . (1,055) (8,235) 1,181
--------- --------- ----------
Net cash used in operating activities of continuing operations . . . . . . . . . . . . . . . (7,425) (11,773) (6,205)
Net cash used in operating activities of discontinued operations . . . . . . . . . . . . . . (4,721) (70,845) (64,523)
--------- --------- ----------
Net cash used in operating activities. . . . . . . . . . . . . . . . . . . . . . . . . . . . (12,146) (82,618) (70,728)
--------- --------- ----------
Cash flows from investing activities:
Proceeds from maturities and sales (payment for purchases) of short-term investments, net. 19,795 57,092 (65,377)
Proceeds from sale of property and equipment . . . . . . . . . . . . . . . . . . . . . . . 8 5 -
Payment received on note receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 1,000 1,000
Proceeds from sale of equity investments . . . . . . . . . . . . . . . . . . . . . . . . . - 250 2,500
Payment for purchase of Laptop Lane Limited, net of cash acquired. . . . . . . . . . . . . - - (1,867)
Payments for purchase of equity investments. . . . . . . . . . . . . . . . . . . . . . . . - (766) (11,683)
Payment for purchase of property and equipment . . . . . . . . . . . . . . . . . . . . . . - (676) (446)
Disbursement for promissory notes issued . . . . . . . . . . . . . . . . . . . . . . . . . - - (6,600)
--------- --------- ----------
Net cash provided by (used in) investing activities of continuing operations . . . . . . . . 19,841 56,905 (82,473)
Net cash provided by (used in) investing activities of discontinued operations . . . . . . . (2) 10,351 (19,870)
--------- --------- ----------
Net cash provided by (used in) investing activities. . . . . . . . . . . . . . . . . . . . . 19,839 67,256 (102,343)
--------- --------- ----------
Cash flows from financing activities:
Proceeds from sale of common stock, net of selling costs . . . . . . . . . . . . . . . . . - - 128,121
Proceeds from exercise of warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - 1,538
Proceeds from exercise of options. . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - 3,671
Proceeds from purchase of common stock by employee stock purchase plan . . . . . . . . . . - 100 145
Payment for long-term debt and liability related to anniversary issuance of common stock
to former Intelligent Communications, Inc. stockholders. . . . . . . . . . . . . . . . . - (2,490) (1)
Payment for purchase of treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . - (6,858) (2,279)
Principal payments of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,444) (660) (1,294)
--------- --------- ----------
Net cash provided by (used in) financing activities of continuing operations . . . . . . . . (1,444) (9,908) 129,901
Net cash used in financing activities of discontinued operations . . . . . . . . . . . . . . (60) (4,481) (1,598)
--------- --------- ----------
Net cash provided by (used in) financing activities. . . . . . . . . . . . . . . . . . . . . (1,504) (14,389) 128,303
Foreign exchange effect on cash and cash equivalents . . . . . . . . . . . . . . . . . . . . - (20) -
--------- --------- ----------
Net increase (decrease) in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . 6,189 (29,771) (44,768)
Cash and cash equivalents, beginning of period . . . . . . . . . . . . . . . . . . . . . . . 14,960 44,731 89,499
--------- --------- ----------
Cash and cash equivalents, end of period . . . . . . . . . . . . . . . . . . . . . . . . . . $ 21,149 $ 14,960 $ 44,731
========= ========= ==========
See accompanying notes to consolidated financial statements.
-34-
AMERICAN INDEPENDENCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
American Independence Corp. ("AIC"), formerly SoftNet Systems, Inc., and
subsidiaries (collectively referred to as the ''Company'') was previously a
holding company principally engaged in providing Internet services. As a
result of the Company's Board of Directors' decisions, the Company
discontinued the businesses of ISP Channel, Inc. ("ISP Channel"),
Intelligent Communications, Inc. ("Intellicom") and Aerzone Corporation
("Aerzone"), including Laptop Lane Limited ("Laptop Lane"), and reduced its
corporate headquarters staff. As of September 30, 2002, the wind down of
ISP Channel, Intellicom and Aerzone, including Laptop Lane, were
substantially complete. Upon the closing of the transactions contemplated
by the Company's agreement dated July 30, 2002, to acquire Independence
American Holdings Corporation ("IAHC") from SSH Corp. and Independence
Holding Company ("IHC") for $31,920,000 in cash, AIC will become an
insurance holding company. Four previously reported business segments,
business center services, satellite-based Internet services, cable-based
Internet services and document management, have ceased operations or have
been sold, and accordingly are reported as discontinued operations (see
Note 3).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of AIC and its
wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
Restatements and Reclassifications
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.
Use of Estimates and Assumptions
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles 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.
Segment Information
The Company adopted Statement of Financial Accounting Standards No. 131
("SFAS 131"), Disclosures about Segments of an Enterprise and Related
Information. SFAS 131 establishes standards for companies to report
information about its operating segments on the same basis a company uses
internally for evaluating segment performance and deciding how to allocate
resources to segments. As a result of the April 3, 2002, decision by the
Company's Board of Directors to cease the operations of Intellicom, the
Company discontinued its last business segment. Accordingly, no segment
information is disclosed in the accompanying notes to these consolidated
financial statements.
Comprehensive Income
The Company adopted Statement of Financial Accounting Standards No. 130
("SFAS 130"), Reporting Comprehensive Income. SFAS 130 establishes
standards for reporting and displaying comprehensive income (loss), and its
components in the consolidated financial statements. Comprehensive income
(loss) is defined by Statement of Financial Accounting Concepts No. 6,
Elements of Financial Statements, as the change in equity of a business
enterprise during a period from transactions and other events and
circumstances from nonowner sources. As required by SFAS 130, all
transactions, including foreign currency translation adjustments and
unrealized losses on investments, are included in accumulated other
comprehensive loss of the accompanying consolidated statements of
stockholders' equity (deficit) and consolidated balance sheets.
Impairment of Long-lived Assets
The Company evaluates long-lived assets for impairment whenever current
events or changes in circumstances, as defined in Statement of Financial
Accounting Standards No. 121 ("SFAS 121"), Accounting for the Impairment of
-35-
Long-Lived Assets and for Long-Lived Assets to be Disposed of, indicate
that the carrying value of an asset may not be recoverable based on
expected undiscounted cash flows attributable to that asset. The amount of
any impairment is measured as the difference between the carrying value and
the fair value of the impaired asset.
Fair Value of Financial Instruments
The carrying amount of the Company's financial instruments, which include
cash and cash equivalents, short-term investments, trade receivables,
accounts payable, accrued liabilities and long-term debt, approximates
their fair values.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of trade receivables, cash
and cash equivalents, and short-term investments. The Company's account
receivable is comprised of one customer at September 30, 2002 and 2001, and
was $2,092,000 and $3,584,000, respectively. The Company does not invest in
derivative instruments or engage in hedging activities.
Cash, cash equivalents and short-term investments are managed by recognized
financial institutions, which follow the Company's investment policy. Such
investment policy limits the amount of credit exposure in any one issue and
the maturity date of the investment securities that typically comprise
investment grade short-term debt instruments.
Cash, Cash Equivalents and Restricted Cash
Cash and cash equivalents consist of cash and highly liquid securities with
maturities of three months or less from date of purchase. Restricted cash
consists of time deposit pledged as collateral on a letter of credit
relating to a certain operating lease.
Short-term Investments
The Company accounts for its short-term 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.
Short-term investments generally consist of highly liquid securities with
original maturities in excess of three months. The Company has classified
its short-term investments as available-for-sale securities. These
short-term investments are carried at fair value based on quoted market
prices with unrealized gains and losses reported in accumulated other
comprehensive loss of the accompanying consolidated balance sheets.
Realized gains and losses on short-term investments are computed using the
specific identification method and are reported in miscellaneous income
(expense), net of the accompanying consolidated statements of operations.
Declines in value judged to be other-than-temporary is determined based on
the specific identification method and are reported in provision for
impaired assets of the accompanying consolidated statement of operations.
Property and Equipment
Property and equipment, including leasehold improvements, are recorded at
cost. When property and equipment is retired or otherwise disposed of, the
cost and related accumulated depreciation are removed from the accounts and
the resulting gain or loss is included in miscellaneous income (expense),
net of the accompanying consolidated statements of operations. Depreciation
is computed on a straight-line basis over the shorter of the estimated
useful lives of between three to seven years or the life of the lease.
Internal Use Software Costs
The Company capitalizes the costs of computer software developed or
obtained for internal use in accordance with Statement of Position No. 98-1
("SOP 98-1"), Accounting for Costs of Computer Software Developed or
Obtained for Internal Use. Capitalized computer software costs consist of
purchased software licenses and implementation costs. Costs capitalized at
September 30, 2001, of $446,000 are included in other equipment (see Note
7). These capitalized software costs are being depreciated on a
straight-line basis over five years. In March 2002, the Company migrated to
an off-the-shelf accounting software, and accordingly wrote off the
remaining capitalized accounting software costs net book value of $352,000,
which is included in the provision for impaired assets in the accompanying
consolidated statement of operations for the year ended September 30, 2002.
Depreciation expense was $42,000 and $52,000 for the years ended September
30, 2002 and 2001, respectively. No depreciation expense for internal use
software was charged for the year ended September 30, 2000.
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Income Taxes
The Company accounts for income taxes under the asset and liability method
in accordance with Statement of Financial Accounting Standards No. 109
("SFAS 109"), Accounting for Income Taxes. Deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial carrying amounts of existing assets and
liabilities and their respective tax bases, and operating loss and tax
credit carryforwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the enactment date.
Valuation allowances are established when necessary to reduce deferred tax
assets where it is more likely than not that the deferred tax asset will
not be realized (see Note 16).
Stock-Based Compensation
The Company accounts for employee stock-based compensation using the
intrinsic value method, as prescribed by Accounting Principles Board
Opinion No. 25 ("APB 25"), Accounting for Stock Issued to Employees. As
such, deferred compensation is recorded only if the exercise price of the
stock option is below the current market price of the Company's common
stock on the date of grant. Deferred compensation expense for employee
stock options is amortized on a straight-line basis over the vesting term
of the stock option, which typically is four years.
The Company accounts for non-employee stock-based compensation using the
fair value method, as required by Statement of Financial Accounting
Standard No. 123 ("SFAS 123"), Accounting for Stock-Based Compensation. As
such, deferred compensation is recorded for all non-employee stock options
as of the date of grant. Deferred compensation expense for non-employee
stock options is amortized on an accelerated basis, as prescribed by
Financial Interpretation No. 28 ("FIN 28"), Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans, over
the contractual life of the stock option.
Earnings (Loss) Per Common Share
The Company calculates earnings (loss) per common share in accordance with
Statement of Financial Accounting Standard No. 128 ("SFAS 128"), Earnings
Per Share. SFAS 128 requires the presentation of basic earnings per share
and diluted earnings per share for companies with potentially dilutive
securities, such as stock warrants and stock options. Accordingly, basic
earnings (loss) per common share is computed using the weighted average
number of common stock shares outstanding during the period. Diluted
earnings (loss) per common share is computed using the weighted average
number of common stock shares and common stock equivalent shares
outstanding during the period. Common stock equivalents consist of
convertible preferred stock (using the "as if converted" method), stock
options and stock warrants (using the "treasury stock" method). Common
stock equivalent shares are excluded from the computation if the effect is
antidilutive. As a result of the antidilutive effect, common stock
equivalent shares have been excluded from the computation of diluted
earnings per share for all periods presented.
Recent Accounting Pronouncements
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting No. 145 ("SFAS 145"), Rescission of SFAS
No. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections.
This statement rescinds Statement of Financial Accounting No. 4, Reporting
Gains and Losses from Extinguishment of Debt, Statement of Financial
Accounting No. 64, Extinguishment of Debt made to satisfy Sinking-Fund
Requirements, and Statement of Financial Accounting No. 44, Accounting for
Intangible Assets of Motor Carriers. This statement also amends Statement
of Financial Accounting No. 13, Accounting for Leases, to eliminate an
inconsistency between the accounting for sale-leaseback transactions and
the accounting for certain lease modifications that have economic effects
that are similar to sale-leaseback transactions. SFAS 145 is effective for
fiscal years beginning after, transactions entered into after and financial
statements issued on or subsequent to May 15, 2002. The adoption of SFAS
145 had no impact on financial statements of the Company.
In June 2002, the FASB issued Statement of Financial Accounting No. 146
("SFAS 146"), Accounting for Exit or Disposal Activities. SFAS 146
addresses the recognition, measurement, and reporting of costs that are
associated with exit and disposal activities, including costs related to
terminating a contract that is not a capital lease and termination benefits
that employees who are involuntarily terminated receive under the terms of
a one-time benefit arrangement that is not an ongoing benefit arrangement
or an individual deferred-compensation contract. SFAS 146 supersedes
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Emerging Issues Task Force Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring), and requires
liabilities associated with exit and disposal activities to be expensed as
incurred. SFAS 146 is effective for exit or disposal activities initiated
after December 31, 2002.
3. ACQUISITIONS AND DISCONTINUED OPERATIONS
Acquisition of First Independence American Corporation ("IAHC")
On July 30, 2002, the Company entered into an agreement to acquire IAHC,
formerly First Standard Holdings Corp. from SSH Corp. and IHC for
$31,920,000 in cash. IAHC and its wholly-owned subsidiaries are engaged in
the insurance and reinsurance business. Upon closing of the transaction,
the Company will become an insurance holding company, close its offices in
San Francisco, terminate all but one of its employees, and enter into a
services agreement with IHC under which the Company's operations will be
directed by IHC management and employees. Consummation of this acquisition
is subject to satisfaction of certain conditions, including approval by
insurance regulators and the Company's stockholders. The Company
anticipates the Company's stockholders will approve the transaction at the
Special Meeting of Stockholders on November 14, 2002.
In a separate transaction, IHC acquired Pacific Century Cyberworks
Limited's ("PCCW") entire interest in the Company consisting of 5,000,000
common stock shares at $3.00 per share for a total value of $15,000,000. As
a result of this transaction, PCCW's appointees Linus W.L. Cheung and
Jeffrey A. Bowden resigned from the Company's Board of Directors, and
Edward Netter, Chairman of IHC, and Roy T.K. Thung, Chief Executive Officer
of IHC, were appointed to the Company's Board of Directors. Additionally,
upon closing of the transaction, IHC has agreed to make a cash tender offer
at $3.00 per share for at least 3,000,000 outstanding common stock shares
of the Company, subject to certain limitations.
Acquisition and Discontinued Operations of Intellicom
On February 9, 1999, a wholly owned subsidiary of the Company merged with
and into Intellicom (the "Intellicom Acquisition"). The Intellicom
Acquisition was accounted for under the purchase method, and the results of
Intellicom have been included in the consolidated financial statements
since the date of acquisition. The purchase price of $14,869,000 was
comprised of: (i) a cash component of $500,000 (the "Cash Consideration");
(ii) a promissory note in the amount of $1,000,000 bearing interest at 7.5%
per annum and due one year after closing (the "First Promissory Note");
(iii) a promissory note in the amount of $2,000,000 bearing interest at
8.5% per annum and due two years after closing (the "Second Promissory
Note", together with the First Promissory Note, are defined as the "Debt
Consideration"); (iv) the issuance of 500,000 shares of the Company's
common stock (adjustable upwards after one year in certain circumstances),
valued at $14.938 per share, for a total value of $7,469,000 (the "Closing
Shares"); (v) additional shares of the Company's common stock issuable upon
the first, second and third anniversaries of the closing, valued at a total
of $3,500,000 (the "Anniversary Shares", together with the Closing Shares,
are defined as the "Equity Consideration"); and (vi) certain direct
acquisition costs totaling $400,000. The Debt Consideration may be
partially or wholly converted into the Company's common stock, under
certain circumstances. The conversion price of the Debt Consideration was
based upon the average closing price of the Company's common stock for the
15 days immediately preceding the conversion date.
In April 1999, the Company paid the First Promissory Note and related
interest in full with a combination of $832,000 in cash and the remainder,
after expenses, with 6,118 common stock shares valued at $190,000. The
Intellicom Acquisition agreement required the Company to issue $1,500,000
of common stock shares on the first anniversary date of the Intellicom
Acquisition. Accordingly, on February 8, 2000, the Company issued 43,314
common stock shares valued at $1,499,000 and paid $1,000 for fractional
shares to the former Intellicom stockholders. On February 7, 2001, the
Company made an offer to the former Intellicom stockholders to pay a
discounted amount in lieu of the Company's obligation to pay cash and stock
for the remaining consideration, which was to be paid in connection with
the Intellicom acquisition and consisted of (i) a $2,000,000 8.5%
promissory note and accrued interest, (ii) the requirement for the Company
to issue $1,500,000 of common stock shares on the second anniversary date
of the Intellicom acquisition, and (iii) the requirement for the Company to
issue $500,000 of common stock shares on the third anniversary date of the
Intellicom acquisition. The parties agreed to settle the obligation by
which the Company paid $2,815,000 (including accrued interest of $325,000),
issued 99,922 common stock shares valued at $199,000, and recognized a
$1,326,000 extraordinary gain on settlements of outstanding obligations. On
February 9, 2002, the Company issued 12,426 common stock shares to settle
the remaining obligations related to the requirement to issue common stock
shares on the third anniversary date of the Intellicom acquisition.
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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.
On April 22, 2002, Intellicom entered into an agreement to sell certain
assets to Native Intellicom, Inc., a wholly-owned subsidiary of the
Pinoleville Band of Pomo Indians, for cash, subject to the termination of
Intellicom's lease for its facility in Livermore, California. On August 1,
2002 Intellicom terminated the agreement with the Pinoleville Band of Pomo
Indians and is negotiating to a sell those assets to another group of
Native Americans. The operating results of Intellicom have been segregated
from continuing operations and are reported as a loss from discontinued
operations of the accompanying consolidated statements of operations.
Although it is difficult to predict the final results, the loss on
disposition from discontinued operations includes management's estimates of
costs to wind down the business, costs to settle its outstanding
liabilities, and the proceeds from the sale of assets. The actual results
could differ materially from these estimates. The Company recorded an
estimated loss on disposition of Intellicom of $3,120,000 for the year
ended September 30, 2002. The assets and liabilities of such operations are
reflected in net liabilities associated with discontinued operations of the
accompanying consolidated balance sheets at September 30, 2002 and 2001.
Through September 30, 2002, $2,274,000, primarily consisting of loss on
sale of assets, net loss subsequent to March 31, 2002, severance payments
and contract termination settlements, has been applied to this reserve. The
remaining $846,000 will be utilized primarily for contract terminations.
In an effort to reduce Intellicom losses, the Company initiated an overall
cost cutting program and organizational restructuring during May 2001. As a
result of the organizational restructuring, the Company established a
$1,290,000 restructuring reserve, which consists of severance costs for
affected employees and shut down costs for certain offices, and is
reflected in net liabilities associated with discontinued operations of the
accompanying consolidated balance sheets at September 30, 2002 and 2001.
Through September 30, 2002, $1,290,000 of severance payments, and write
offs of leasehold improvements and office furniture related to the various
offices have been applied to this reserve.
Acquisition of Laptop Lane, Formation of Aerzone and Discontinued
Operations of Aerzone
On January 24, 2000, the Company founded Aerzone (formerly SoftNet Zone,
Inc.), a Delaware corporation, to provide high-speed Internet access to
global business travelers. As part of the Aerzone business, the Company
acquired Laptop Lane, a Washington corporation, on April 21, 2000. The
acquisition was accounted for under the purchase method, and the results of
Laptop Lane have been included in the consolidated financial statements
since the date of acquisition. The Company paid approximately $21,559,000
consisting of (i) 972,266 common stock shares of the Company valued at
$15,107,000, net of adjustment for expenses paid by the Company on behalf
of Laptop Lane, exchanged for all outstanding common stock shares of Laptop
Lane, (ii) direct acquisition costs of approximately $2,300,000, which
included a bonus payment to Laptop Lane employees of $431,000 in lieu of
Laptop Lane stock options, and (iii) 250,000 common stock shares of the
Company valued at $3,652,000 issued to former Laptop Lane stockholders in
payment for achieving certain criteria. As part of the acquisition, an
additional 333,333 common stock shares of the Company were to be
distributed to former Laptop Lane stockholders if certain performance goals
or other criteria were met. As of September 30, 2000, Laptop Lane achieved
three of the four performance goals; as a result, 249,981 common stock
shares of the Company and cash amounting to $3,652,000 were distributed to
the former Laptop Lane stockholders. In October 2000, Laptop Lane achieved
the fourth performance goal requirement, resulting in the distribution of
81,050 common stock shares of the Company valued at $332,000 to the former
Laptop Lane stockholders. Additionally, in connection with the acquisition,
the Company provided $6,000,000 in working capital to Laptop Lane, under a
secured promissory note, which was included as part of the purchase price
consideration.
On December 19, 2000, the Company decided to discontinue the Aerzone
business in light of significant long-term capital needs and the difficulty
of securing the necessary financing because of the current state of the
financial markets. The operating results of Aerzone have been segregated
from continuing operations and are reported as loss from discontinued
operations of the accompanying consolidated statement of operations. The
loss from discontinued operations includes management's estimates of the
remaining costs to wind down the business and costs to settle its
outstanding liabilities. The assets and liabilities of such operations are
reflected as net liabilities associated with discontinued operations of the
accompanying consolidated balance sheets at September 30, 2002 and 2001.
For the year ended September 30, 2000, the Company recorded an estimated
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loss on disposition reserve of Aerzone of $42,200,000. For the year ended
September 30, 2001, the Company increased the estimated loss on disposition
reserve of Aerzone by $14,906,000, primarily as a result of the Company
reducing the estimated proceeds from the sale of Laptop Lane and increasing
estimated discontinued operating costs. For the year ended September 30,
2002, the Company increased the estimated loss on disposition of Aerzone by
$750,000, as a result of a superior court decision related to a breach of
contract and other legal matters. The estimated loss on disposition reserve
of Aerzone is reflected in net liabilities associated with discontinued
operations of the accompanying consolidated balance sheets at September 30,
2002 and 2001, and the corresponding charge is reflected in loss on
disposition of discontinued operations of the accompanying consolidated
statements of operations for the years ended September 30, 2002, 2001 and
2000. Through September 30, 2002, $56,091,000, primarily consisting of
intangibles write off, loss on sale of assets, net loss subsequent to
September 30, 2000, severance payments and contract termination
settlements, has been applied to this reserve. The remaining $1,765,000
will be utilized primarily for contract terminations and legal fees.
Following the sale of certain assets on August 16, 2001, Laptop Lane ceased
operations and made an assignment for the benefit of creditors of its
remaining assets.
Discontinued Operations of ISP Channel
On December 7, 2000, the Company's Board of Directors approved a plan to
discontinue providing cable-based Internet services through its ISP Channel
subsidiary by December 31, 2000, because of (1) consolidation in the cable
television industry made it difficult for ISP Channel to achieve the
economies of scale necessary to provide such services profitably, and (2)
the Company was no longer able to bear the costs of maintaining the ISP
Channel. The operating results of ISP Channel have been segregated from
continuing operations and are reported as loss from discontinued operations
of the accompanying consolidated statements of operations. The loss from
discontinued operations includes management's estimates of the remaining
costs to wind down the business, costs to settle its outstanding
liabilities, and the proceeds from the sale of assets. The assets and
liabilities of such operations are reflected as net liabilities associated
with discontinued operations of the accompanying consolidated balance
sheets at September 30, 2002 and 2001. For the year ended September 30,
2000, the Company recorded as estimated loss on disposition reserve of ISP
Channel of $97,200,000. For the year ended September 30, 2001, the Company
decreased the estimated loss on disposition reserve of ISP Channel by
$10,008,000, primarily as a result of the Company experiencing better than
previously estimated contract settlements. For the year ended September 30,
2002, the Company reduced the estimated loss on disposition reserve of ISP
Channel by $900,000, primarily as a result of the Company experiencing
better than previously estimated contract settlements. The estimated loss
on disposition reserve of ISP Channel is reflected in net liabilities of
discontinued operations of the accompanying consolidated balance sheets at
September 30, 2002 and 2001, and the corresponding benefit and charge are
reflected in loss on disposition of discontinued operations of the
accompanying consolidated statements of operations for the years ended
September 30, 2002, 2001 and 2000. Through September 30, 2002, $85,978,000,
primarily consisting of intangibles write off, loss on sale of assets, net
loss subsequent to September 30, 2000, severance payments and contract
termination settlements, has been applied to this reserve. The remaining
$314,000 will be utilized primarily for contract terminations.
Discontinued Operations of Micrographic Technology Corporation ("MTC")
As a result of a preliminary arbitration decision related to a dispute with
Applications Informatiques Multimedia and a dispute related to the sale of
MTC to Global Information Distribution GmbH ("GID"), the Company recorded a
$1,127,000 estimated loss on disposition reserve of MTC for the year ended
September 30, 2002. MTC was previously owned by the Company, and was sold
to GID on September 30, 1999. The estimated loss on disposition reserve of
MTC is reflected in net liabilities associated with discontinued operations
of the accompanying consolidated balance sheet at September 30, 2002, and
the corresponding charge is reflected in loss on disposition of
discontinued operations of the accompanying consolidated statement of
operations for the year ended September 30, 2002. Through September 30,
2002, $202,000 of legal fees has been applied to this reserve. The
remaining $925,000 will be utilized primarily for the arbitration decision
related to a dispute with Applications Informatiques Multimedia and related
legal fees.
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Discontinued Operations Summary
The operating results of discontinued operations are as follows (in
thousands):
YEAR ENDED SEPTEMBER 30,
------------------------------
2002 2001 2000
-------- --------- ---------
Revenues . . . . . . . . . $ 1,463 $ 4,177 $ 18,129
======== ========= =========
Loss before income taxes . $(1,829) $(29,557) $(85,346)
Provision for income taxes - - -
-------- --------- ---------
Net loss . . . . . . . . . $(1,829) $(29,557) $(85,346)
======== ========= =========
The net liabilities associated with discontinued operations are as follows
(in thousands):
SEPTEMBER 30,
------------------
2002 2001
-------- --------
Current assets:
Short-term investments, available-for-sale. . . . . . $ - $ 20
Accounts receivable, net. . . . . . . . . . . . . . . - 91
Inventory, net. . . . . . . . . . . . . . . . . . . . - 537
Other current assets. . . . . . . . . . . . . . . . . 2 90
-------- --------
Total current assets. . . . . . . . . . . . . . . . . . 2 738
Property, plant and equipment, net. . . . . . . . . . . - 1,644
Restricted cash . . . . . . . . . . . . . . . . . . . . - 639
Other assets. . . . . . . . . . . . . . . . . . . . . . 55 51
-------- --------
Total assets. . . . . . . . . . . . . . . . . . . . . . $ 57 $ 3,072
======== ========
Current liabilities:
Accounts payable. . . . . . . . . . . . . . . . . . . $ 1 $ 423
Estimated closure costs . . . . . . . . . . . . . . . 3,610 3,703
Restructuring accrual . . . . . . . . . . . . . . . . - 512
Laptop Lane Limited acquisition reserve . . . . . . . - 27
Other accrued expenses. . . . . . . . . . . . . . . . 296 1,164
-------- --------
Total liabilities . . . . . . . . . . . . . . . . . . . $ 3,907 $ 5,829
======== ========
Net liabilities associated with discontinued operations $ 3,850 $ 2,757
======== ========
4. RESTRUCTURING EXPENSE
On December 28, 2000, the Company's Board of Directors approved a plan to
reduce its corporate headquarters staff in conjunction with discontinuing
the Aerzone and ISP Channel businesses. As a result of this plan, the
Company established a $3,900,000 restructuring reserve, which consists
primarily of severance costs for affected employees. Subsequently, for the
year ended September 30, 2002, the Company increased the restructuring
reserve by $502,000 for additional estimated lease termination costs
associated with Company headquarters. The restructuring reserve is
reflected as restructuring accrual of the accompanying consolidated balance
sheets at September 30, 2002 and 2001. Through September 30, 2002,
$2,956,000 of severance payments has been applied to this reserve. The
remaining $1,446,000 will be utilized primarily for lease termination costs
associated with Company headquarters.
5. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Short-term investments, available-for-sale are carried at fair value based
on quoted market prices. Net unrealized holding losses amounted to $6,000
and $464,000, and are based on the market value of securities at September
30, 2002 and 2001, respectively. Net unrealized holding losses are
reflected in accumulated other comprehensive loss of the accompanying
consolidated balance sheets at September 30, 2002 and 2001.
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Short-term investments, available-for-sale at September 30, 2002, consist
of $40,900,000 of debt securities that mature between one to five years,
and $10,000 of common stock. Cash, cash equivalents and short-term
investments, available-for-sale consist of the following at September 30,
2002 (in thousands):
UNREALIZED UNREALIZED
COST GAIN LOSS MARKET
------- ----------- ------------ -------
Cash and cash equivalents:
Cash. . . . . . . . . . . . . . . . . . . $ 1,317 $ - $ - $ 1,317
Money market funds. . . . . . . . . . . . 19,832 - - 19,832
------- ----------- ------------ -------
$21,149 $ - $ - $21,149
======= =========== ============ =======
Short-term investments, available-for-sale:
Market auction securities . . . . . . . . $40,900 $ - $ - $40,900
Common stock. . . . . . . . . . . . . . . 16 - (6) 10
------- ----------- ------------ -------
$40,916 $ - $ (6) $40,910
======= =========== ============ =======
Short-term investments, available-for-sale at September 30, 2001, consist
of $3,799,000 of debt securities that mature between three months to one
year, $56,597,000 of debt securities that mature between one to five years,
and $98,000 of common stock. Cash, cash equivalents and short-term
investments, available-for-sale consist of the following at September 30,
2001 (in thousands):
UNREALIZED UNREALIZED
COST GAIN LOSS MARKET
------- ----------- ------------ -------
Cash and cash equivalents:
Cash. . . . . . . . . . . . . . . . . . . $ 5,198 $ - $ - $ 5,198
Banker's acceptance . . . . . . . . . . . 412 - - 412
Corporate debt securities . . . . . . . . 1,004 - - 1,004
Money market funds. . . . . . . . . . . . 8,346 - - 8,346
------- ----------- ------------ -------
$14,960 $ - $ - $14,960
======= =========== ============ =======
Short-term investments, available-for-sale:
Market auction securities . . . . . . . . $53,099 $ - $ (2) $53,097
Foreign debt securities . . . . . . . . . 798 1 - 799
Corporate debt securities . . . . . . . . 6,793 (293) 6,500
Common stock. . . . . . . . . . . . . . . 268 - (170) 98
------- ----------- ------------ -------
$60,958 $ 1 $ (465) $60,494
======= =========== ============ =======
6. EQUITY INVESTMENTS
On February 12, 1999, substantially all of the assets of the
telecommunications segment, Kansas Communications, Inc. ("KCI"), were sold
to Convergent Communications Services, Inc. ("Convergent") for an aggregate
sale price of approximately $6,300,000, including 30,000 shares of
Convergent's parent company common stock with an agreed value of
approximately $300,000 ($10.00 per share) (the "Convergent Shares"),
subject to adjustment in certain events. Subsequently, a purchase price
adjustment provided the Company with additional Convergent Shares with an
agreed value of $198,000 for a total investment in Convergent Shares of
$498,000. As a result of Convergent's inability to secure funding for its
cash shortfall and subsequent filing on April 19, 2001, for protection
under Chapter 11 of the U.S. Bankruptcy Code, the Company recognized
an-other-than temporary decline of $498,000 for the year ended September
30, 2001. The other-than-temporary decline is reflected in the loss on
disposition of equity investments, net of the accompanying consolidated
statement of operations for the year ended September 30, 2001.
On August 18, 1999, the Company acquired 106,250 series A convertible
preferred stock shares of YourDay.com, Inc. ("YourDay"), a Delaware
corporation, for $250,000. YourDay was a leading online calendar and
scheduling system that integrates Palm Pilots, telephones and the Internet
anywhere in the world. Subsequently, on February 23, 2000, YourDay merged
with deltathree.com, Inc. ("Deltathree"), a Delaware corporation. The
merger called for each YourDay series A convertible preferred stock share
be converted into .0469 Deltathree series A common stock share. The Company
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received 4,983 Deltathree series A common stock shares in the exchange, and
accounted for the exchange at fair value, which resulted in a loss of
$37,000 included in gain on disposition of long-term equity investments of
the accompanying consolidated statements of operations. Deltathree is a
global provider of IP telephony services and other enhanced Web-based
communications to individuals and businesses worldwide. Deltathree is
listed and traded on the Nasdaq National Market under the symbol "DDDC". As
a result of problems facing Deltathree in attempting to raise additional
financing to cover projected cash shortfalls, the Company recognized an
other-than-temporary decline of $207,000 for the year ended September 30,
2001. The other-than-temporary decline is reflected in the loss on
disposition of equity investments, net of the accompanying consolidated
statement of operations for the year ended September 30, 2001.
On February 23, 2000, the Company entered into an agreement to provide
management consulting advice on strategy, operations, marketing, technology
and content, and training related to high speed Internet services through
cable television networks to Big Sky Network Canada, Ltd. ("Big Sky"), a
British Virgin Islands international business company. As part of the
agreement, the Company acquired 10,000 Big Sky common stock shares for
$500,000. On April 24, 2000, the Company acquired an additional 40,000 Big
Sky common stock shares for $2,000,000. Additionally, the Company incurred
$1,136,000 of expenses on behalf of Big Sky for a total investment of
$3,636,000. Big Sky was a company that formed cooperative joint venture
relationships with government-approved partners to offer high capacity,
high speed Internet access and services in major urban markets throughout
the People's Republic of China. Subsequently, on September 29, 2000, the
Company sold its 50,000 Big Sky common stock shares for $13,830,000 to the
other owner of Big Sky, China Broadband Corporation ("China Broadband"), a
Nevada corporation, which resulted in a gain of $10,194,000 included in
gain on disposition of long-term equity investments of the accompanying
consolidated statements of operations. Proceeds from the sale consisted of
(i) $2,500,000 in cash, (ii) a promissory note in the amount of $1,700,000
bearing interest at 8% per annum due September 29, 2001, and (iii)
1,133,000 China Broadband common stock shares valued at $9,630,000. China
Broadband is the leading cable broadband provider in China. China Broadband
is listed and traded on the Nasdaq Over-the-Counter Bulletin Board under
the symbol "CBBD". On July 13, 2001, the Company sold its interest in China
Broadband Corporation, consisting of 1,133,000 common stock shares and
$1,700,000 promissory note and accrued interest, to Canaccord International
Limited for $1,000,000. For this transaction, the Company recognized loss
of $9,630,000 related to the 1,133,000 China Broadband common stock shares,
and a loss of $768,000 related to the $1,700,000 promissory note and
accrued interest. The loss related to the 1,133,000 China Broadband common
stock shares, and the loss related to the promissory note and accrued
interest are reflected in the loss on disposition of equity investments,
net of the accompanying consolidated statement of operations for the year
ended September 30, 2001.
On August 18, 1999, the Company acquired 83,330 series A convertible
preferred stock shares of YourStuff.com, Inc. ("YourStuff"), a Delaware
corporation, for $250,000. YourStuff provides a secure Web-based central
file repository. Subsequently, on October 30, 2000, YourStuff merged with
SenseNet, Inc. ("SenseNet"), a Delaware corporation. The Company received
267,501 SenseNet common stock shares in the exchange, and accounted for the
exchange at cost. SenseNet is a privately held company that provides
intranet business applications that focus on increasing productivity and
profitability. As a result of problems facing SenseNet in attempting to
raise needed follow-on financing to cover projected cash shortfalls under
current stock market conditions, the Company wrote off the investment of
$250,000 related to the 267,501 SenseNet common stock shares for the year
ended September 30, 2001. The write off is reflected in the loss on
disposition of equity investments, net of the accompanying consolidated
statement of operations for the year ended September 30, 2001.
On January 14, 2000, the Company acquired 337,496 series B preferred stock
shares of Dotcast.com, a California corporation, for $1,000,000.
Dotcast.com is a privately held company developing a national high-speed
digital network for the distribution of digital entertainment, interactive
services and multimedia communications. The investment in Dotcast.com is
classified as a long-term equity investment of the accompanying
consolidated balance sheets at September 30, 2002 and 2001.
On October 12, 1999, the Company entered into a memorandum of understanding
with PCCW to form a joint venture, Pacific Century SoftNet, to market
cable-based Internet products and services to cable operators throughout
Asia. For the year ended September 30, 2000, the Company contributed
$230,000 to this joint venture and recognized equity losses of $191,000,
which is reflected in equity in net losses of investee companies of the
accompanying consolidated statement of operations. As a result of PCCW and
the Company mutually ending the joint venture, the Company wrote off the
remaining investment of $39,000 for the year ended September 30, 2001. The
write off is reflected in the loss on disposition of equity investments,
net of the accompanying consolidated statement of operations for the year
ended September 30, 2001.
-43-
On March 24, 2000, the Company entered into an agreement to provide
management consulting advice on strategy, operations, marketing, technology
and content, and training related to high speed Internet services through
cable television networks to Interactive Cable Communications Incorporated
("ICC"). As part of this agreement, the Company acquired 5,300 ICC common
stock shares for $3,800,000, and formed a joint venture with Marubeni
Corporation ("Marubeni"), a Japan corporation. 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 and
2000, the Company recognized equity income of $21,000 and equity losses of
$390,000, respectively, and is reflected in equity in net losses of
investee companies of the accompanying consolidated statements of
operations. On July 17, 2001, the Company sold its 5,300 ICC common stock
shares to Marubeni for $250,000. For this transaction, the Company
recognized a loss of $3,180,000 related to the 5,300 ICC common stock
shares. The loss is reflected in the loss on disposition of equity
investments, net of the accompanying consolidated statement of operations
for the year ended September 30, 2001.
On September 15, 2000, the Company entered into a stock purchase agreement
to acquire 3,000,000 series A convertible preferred stock shares of
Freewire Networks, Inc. ("Freewire"), a Delaware corporation, for
$3,000,000. Freewire was a privately held company developing wireless
broadband services at sporting venues using IEEE 802.11 technology. The
Company held Freewire in a corporate joint venture with Lucent Technologies
Inc. ("Lucent") and Freewire's founding management stockholders. Under
certain circumstances, Lucent had the option to require the Company to
purchase Lucent's shares. For the year ended September 30, 2001, the
Company recognized equity losses of $415,000 that is reflected in equity in
net losses of investee companies of the accompanying consolidated statement
of operations. As a result of problems facing Freewire in attempting to
raise needed follow-on financing to cover projected cash shortfalls under
current stock market conditions, the Company wrote off $2,622,000 related
to the 3,000,000 Freewire series A convertible preferred stock shares for
the year ended September 30, 2001. The write off is reflected in the loss
on disposition of equity investments, net of the accompanying consolidated
statement of operations for the year ended September 30, 2001. On September
26, 2001, Lucent brought action against the Company, alleging that the
Company breached a contract by failing to purchase Lucent's shares in
Freewire Networks, Inc. and claiming damages of approximately $3.5 million,
which may increase over time. On December 31, 2001, the San Francisco
Superior Court issued an order to deny Lucent's application for writ of
attachment, finding that Lucent had not shown a substantial probability
that it will prevail on its claim. The Company continues to believe that
Lucent's claims are without merit and will be contested vigorously.
In November 2000, the Company acquired 1,000,000 common stock shares and
400,000 preference stock shares of SkyNet Global Limited ("SkyNet"), an
Australian corporation, for $262,000 and $484,000, respectively. SkyNet is
a provider of business center services in airports. SkyNet's common stock
is listed and traded on the Australian Stock Exchange under the symbol
"SKG.AX". The Company recognized a loss of $253,000 related to the
1,000,000 SkyNet Global Limited common stock shares and $480,000 related to
the 400,000 SkyNet Global Limited preference stock shares for the year
ended September 30, 2002. The loss is reflected in loss on disposition of
equity investments, net of the accompanying consolidated statements of
operations for the year ended September 30, 2002. The common stock
investment in SkyNet is an available-for-sale security, and accordingly, is
classified as a short-term investment of the accompanying consolidated
balance sheets at September 30, 2002 and 2001. The preference stock
investment of SkyNet is classified as a long-term equity investment of the
accompanying consolidated balance sheets at September 30, 2002 and 2001.
7. PROPERTY AND EQUIPMENT, NET
Property and equipment consist of the following (in thousands):
SEPTEMBER 30,
--------------------
2002 2001
--------- ---------
Furniture and fixtures. . . . . $ - $ 39
Equipment . . . . . . . . . . . 454 1027
--------- ---------
Property and equipment, gross . 454 1,066
Less allowance for depreciation (384) (375)
--------- ---------
Property and equipment, net . . $ 70 $ 691
========= =========
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8. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
SEPTEMBER 30,
-------------------
2002 2001
--------- --------
5% Convertible Subordinated Debentures, due September 30, 2002, interest payable
annually, convertible into the Company's common stock at $8.25 per share after
December 31, 1998. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ - $ 1,444
--------- --------
Total long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 1,444
Less current portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - (1,444)
--------- --------
Long-term debt, net of current portion . . . . . . . . . . . . . . . . . . . . . $ - $ -
========= ========
On January 2, 1998, the Company issued $1,444,000 principal amount of its
5% Convertible Subordinated Debentures due September 30, 2002, to Mr.
R.C.W. Mauran, who was at the time of the transaction a beneficial owner of
more than 5% of the Company's common stock, in exchange for the assignment
to the Company of certain equipment leases and other consideration, all of
which had been assimilated into the business of Micrographic Technology
Corporation. The debentures were convertible into the Company's common
stock at $8.25 per share after December 31, 1998. On September 30, 2002,
the Company paid the principal of $1,444,000 and accrued interest in cash.
9. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company has operating leases for office space and certain other office
equipment. These operating leases provide for minimum rents and generally
include options to renew for additional periods. The Company is currently
in negotiations to sublease its principal executive offices.
Future minimum lease payments under non-cancelable operating leases as of
September 30, 2002, are as follows (in thousands):
YEAR ENDING SEPTEMBER 30:
2003. . . . . . . . . . $ 529
2004. . . . . . . . . . 534
2005. . . . . . . . . . 445
------
$1,508
======
The Company's rent expense from continuing operations for the years ended
September 30, 2002, 2001 and 2000, were $430,000, $499,000 and $649,000,
respectively.
Legal Proceedings
On September 26, 2001, Lucent brought action in San Francisco Superior
Court against the Company, alleging that the Company breached a contract by
failing to purchase Lucent's shares in Freewire and claiming damages of
approximately $3.5 million, which may increase over time. On December 31,
2001, the San Francisco Superior Court issued an order to deny Lucent's
application for writ of attachment, finding that Lucent had not shown a
substantial probability that it will prevail on its claim. The Company
continues to believe that Lucent's claims are without merit and will be
contested vigorously.
On November 9, 2001, Nokia, Inc. ("Nokia") commenced an action in San
Francisco Superior Court against the Company and Aerzone, alleging breach
of contract arising out of the Aerzone's proposed operations in certain
airports. Nokia seeks approximately $2.1 million in damages. The Company
believes that Nokia's claims are without merit and intends to contest these
claims vigorously. Additionally, the Company deposited security collateral
of $1,053,000 as required by the performance bond indemnity agreement with
the surety company. In the event that the Company prevails, any balance on
the collateral will be returned by the surety company to the Company. The
security collateral is reflected in other assets of the accompanying
consolidated balance sheets at September 30, 2002, and September 30, 2001.
-45-
On October 30, 2001, GID commenced a demand for arbitration against the
Company, alleging breach of contract and warranties relating to the sale of
MTC to GID on September 30, 1999. GID claims approximately $750,000 in
damages. The Company believes GID's claims are without merit and intends to
contest these claims vigorously.
The Company is also involved in other legal proceedings and claims, which
arise in the ordinary course of its discontinued businesses. The Company
believes the results of the above noted legal proceedings, other pending
legal proceedings and claims are not expected to have a material adverse
effect on its results of operations, financial condition or cash flows.
10. COMMON STOCK
Common Stock
On January 12, 1999, the Company issued $12,000,000 of its 9% Senior
Subordinated Convertible Notes (the "Notes") due January 1, 2001, to a
group of institutional investors. These Notes were convertible into the
Company's common stock with an initial conversion price of $17.00 per share
until July 1, 1999, and, thereafter, at the lower of $17.00 per share (the
"Initial Conversion Price") and the lowest five-day average closing bid
price of the Company's common stock during the 30-day trading period ending
one day prior to the applicable conversion date (the "Conversion Price").
In connection with these Notes, the Company issued to these investors
warrants to purchase an aggregate of 300,000 shares of the Company's common
stock. These warrants have an exercise price of $17.00 per share and expire
in 2003. On April 28, 1999, as a result of the Company's underwritten
secondary public offering (the "Secondary Offering"), and in conjunction
with an anti-dilution provision associated with the Notes, the Initial
Conversion Price was reduced from $17.00 to $16.49 per share. Furthermore,
in order to secure three month lock-up agreements from the holders of the
Notes in conjunction with the Secondary Offering, the Company entered into
a new arrangement with the holders of the Notes to issue all future
interest payments, beginning with the three months ended June 30, 1999, in
the form of convertible notes with substantially the same form and features
as the original Notes. Therefore, the Company issued an additional $549,000
in notes, representing interest for the six months ended September 30, 1999
(the "Interest Notes"). On October 22, 1999, all of the Notes, related
Interest Notes and accrued interest were converted into 765,201 shares of
the Company's common stock.
On September 15, 1995, the Company issued $2,856,000 of its 9% Convertible
Subordinated Debentures due September 15, 2000, in conjunction with the
acquisition of MTC. The debentures were issued to the shareholders of MTC
as partial consideration for the acquisition. These 9% debentures had a
conversion price of $6.75. As of September 30, 1999, the Company issued
222,200 common stock shares pursuant to the conversion of $1,499,000 of
these debentures. For the year ended September 30, 2000, the Company issued
1,467 common stock shares pursuant to the conversion of $63,000 of
convertible debt by two separate holders of these debentures. On September
15, 2000, the Company paid the remaining $1,294,000 of convertible debt and
accrued interest in cash.
On September 15, 1995, in association with the acquisition of MTC, the
Company assumed $1,800,000 of 6% Convertible Subordinated Secured
Debentures due February 28, 2002. These 6% debentures were subject to
redemption at the option of the Company at face value, provided however,
that the Company issued warrants to common stock shares purchase for the
same number of shares as would have been issued if the debentures were
converted. These Debentures were convertible into the Company's common
stock at $8.25 per share after December 31, 1998. As of September 30, 1999,
the Company issued 140,739 common stock shares pursuant to the conversion
of $1,140,000 of these convertible debentures. Subsequently, on November
15, 2000, the remaining principal of $660,000 and accrued interest was
paid.
On December 13, 1999, the Company completed a private placement of
5,000,000 common stock shares for net proceeds of $128,121,000 to PCCW, and
entitled PCCW to designate two persons for election to the Board of
Directors. On July 30, 2002, IHC acquired PCCW's entire interest in the
Company consisting of 5,000,000 common stock shares at $3.00 per share for
a total value of $15,000,000. As a result of this transaction, PCCW
appointees Linus W.L. Cheung and Jeffrey A. Bowden resigned from the
Company's Board of Directors, and Edward Netter, Chairman of IHC, and Roy
T.K. Thung, Chief Executive Officer of IHC, were appointed to the Company's
Board of Directors. Additionally, upon closing of the acquisition of IAHC,
IHC has agreed to make a cash tender offer at $3.00 per share for at least
3,000,000 outstanding common stock shares of the Company, subject to
certain limitations (see Note 3).
-46-
In conjunction with offering incentives to launch the Company's ISP Channel
cable-based Internet services, the Company issued common stock to cable
affiliates in return for the exclusive rights to provide Internet services
to their customers. For the year ended September 30, 2000, the Company
issued 35,160 common stock shares valued at $419,000 to two separate cable
affiliates. Further, on November 4, 1999, the Company entered into various
definitive agreements with Mediacom LLC ("Mediacom"). In exchange for
signing an agreement to launch the ISP Channel services, the Company issued
a total of 3,500,000 common stock shares to Mediacom, of which 3,150,000
common stock shares were restricted. The restrictions were progressively
lifted as Mediacom launched ISP Channel's services in Mediacom's cable
television systems. At September 30, 2000, there were 2,100,000 common
stock shares restricted and unvalued. The unrestricted 1,400,000 common
stock shares were valued at $26,513,000 as cable affiliate launch
incentive. As a result of the Company discontinuing the operations of ISP
Channel, the cable affiliate launch incentive, net of amortization, was
written off and reflected in the loss on disposition of discontinued
operations for the year ended September 30, 2000. On February 16, 2001, the
Company and ISP Channel entered into agreements with Mediacom, to terminate
Mediacom's affiliate relationship with ISP Channel. As part of these
agreements Mediacom released all obligations under the affiliate agreement
with ISP Channel and returned 1,300,000 restricted common stock shares of
the Company, and in exchange received certain equipment, a $3,768,000
payment from the Company, and the Company removed restrictions on 800,000
common stock shares valued at $1,500,000 held by Mediacom. Mediacom
currently holds a total of 2,200,000 unrestricted common stock shares of
the Company. Pursuant to these agreements, neither the Company nor ISP
Channel has any further material obligation to Mediacom.
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 $3.00. 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 Rights are designed to inhibit some acquisitions of the Company's
common stock shares that could result in the imposition of limitations on
the use of its Federal net operating loss carryforwards and certain income
tax credits. The Rights are also intended to enable all stockholders to
realize the long-term value of their investment in the Company. The Rights
are not being distributed in response to any specific effort to acquire
control of the Company. The Rights are designed to help protect the tax
benefits associated with the Company's net operating loss carryforwards.
If a person becomes an Acquiring Person, each Right will entitle its holder
to purchase, at the Right's then-current exercise price, a number of the
Company's common shares having a market value at that time of twice the
Right's exercise price. The Rights held by the Acquiring Person will become
void and will not be exercisable to purchase shares at the bargain purchase
price. If Company is acquired in a merger or other business combination
transaction which has not been approved by the Company's Board of
Directors, each Right will entitle its holder to purchase, at the Right's
then-current exercise price, a number of the acquiring company's common
shares having a market value at that time of twice the Right's exercise
price.
The Plan will expire on the close of business on the earliest date that (a)
a vote of Company's stockholders does not approve an amendment or an
amendment and restatement of the Company's Certificate of Incorporation
proposed by the Company's Board of Directors providing for limitations on
the acquisition of the Company's common stock in excess of certain
percentage amounts, (b) such restated Certificate of Incorporation is filed
with the Secretary of State of the State of Delaware or (c) the Company's
stock purchase agreement with SSH Corp. and IHC is terminated, subject to
the Company's right to extend such date and the Company's earlier
redemption or exchange of such rights or termination of the Plan.
On May 17, 2002, the Company received a Nasdaq Staff Determination Letter
stating that the Company's common stock was no longer eligible for
continued listing on the Nasdaq National Market as a result of the Company
ceasing the operations of its last business segment, Intellicom, and that
the Company therefore did not meet the requirements for continued listing
set forth in Marketplace Rules 4300 and 4330. Subsequently, the Company
requested and was granted an oral hearing before a Nasdaq Listing
Qualifications Panel to appeal the Nasdaq Staff Determination Letter, which
stayed the delisting of the Company's common stock pending the outcome of
-47-
the hearing. On July 12, 2002, the Company appeared before the Nasdaq
Listing Qualifications Panel to present the Company's plan to acquire IAHC,
which would allow the Company to comply with the Marketplace Rules 4300 and
4330. On August 15, 2002, the Nasdaq Listing Qualifications Panel informed
the Company that the Company will remain listed on Nasdaq National Market,
subject to meeting various conditions, including the completion of the
acquisition of IAHC by December 31, 2002. The Nasdaq Listing Qualifications
Panel has also informed the Company that if it does remain listed on the
Nasdaq National Market, following the acquisition of IAHC, the Company will
be required to meet Nasdaq's initial listing requirements as well as
Nasdaq's continued listing requirements.
11. TREASURY STOCK
On August 15, 2000, the Company's Board of Directors authorized the
repurchase of up to 2,600,000 common stock shares of the Company. The
Company's repurchases of common stock shares are recorded at cost as
treasury stock and result in a reduction of stockholders' equity. For the
years ended September 30, 2001 and 2000, the Company repurchased 1,881,000
common stock shares for $6,858,000 and 409,500 common stock shares for
$2,279,000, respectively.
12. 2000 EMPLOYEE STOCK PURCHASE PLAN ("ESPP")
On February 22, 2000, the Company adopted ESPP, which provides for eligible
Company employees to purchase common stock shares through payroll
deductions during six-month offering periods. Initial enrollment for ESPP
began on March 13, 2000, for the first offering period of April 1, 2000, to
June 30, 2000. Each subsequent offering period will begin July 1 or January
1 and end December 31 or June 30, respectively. On February 2, 2001, the
Company's Board of Directors agreed to suspend ESPP indefinitely beginning
July 1, 2001.
Substantially all employees are eligible for ESPP if they are employed for
twenty (20) or more hours per week on the first day of the offering period.
Eligible employees may elect to contribute up to 15% of their base
compensation.
ESPP provides 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 years ended September
30, 2001 and 2000, the Company issued 56,769 common stock shares for a
total value of $100,000 and 15,116 common stock shares for a total value of
$145,000, respectively.
13. STOCK OPTIONS AND WARRANTS
1998 Stock Incentive Plan ("1998 Plan")
Effective October 1, 1998, the Company implemented the 1998 Plan, which the
Company's stockholders approved on April 13, 1999. Concurrent with such
stockholder approval, all outstanding stock options under the Company's
1995 Long-Term Incentive Plan (the "Incentive Plan") were incorporated into
the 1998 Plan, and no further stock option grants or stock issuances were
made under the Incentive Plan. The incorporated stock options continued to
be governed by their existing terms. However, the Administrator of the 1998
Plan could elect to extend one or more features of the 1998 Plan to the
incorporated stock options. As of September 30, 2002, the 1998 Plan
Administrator has not elected to extend any of the features of the 1998
Plan to the incorporated stock options. Each stock option under the
Incentive Plan was granted at an exercise price not less than the fair
market value of the Company's common stock on the grant date, and vested
equally over a three year period on the yearly anniversary date of the
grant. The 1998 Plan provides for the grants of non-statutory and incentive
stock options, stock appreciation rights, restricted stock awards,
performance shares, and other awards to officers, employees and other
individuals. Under the terms of the 1998 Plan, stock options have a maximum
term of ten years from the date of grant, and have various vesting criteria
depending on the grant with most grants vesting 25% on the first year
anniversary date of the grant and ratably over the next 36 months. In
addition, the number of common stock shares reserved for issuance under the
1998 Plan will automatically increase on the first trading day of each
calendar year, beginning in calendar year 2000, by an amount equal to four
percent of the total number of common stock shares outstanding on the last
trading day of the preceding calendar year, but in no event will any such
annual increase exceed 2,000,000 shares, subject to adjustment for
subsequent stock splits, stock dividends and similar transactions. At
September 30, 2002, a total of 6,473,738 common stock shares are reserved
for issuance under the 1998 Plan. At September 30, 2002, stock options for
894,228 common stock shares were outstanding, stock options for 758,394
common stock shares were vested, and 5,579,510 common stock shares remained
available for future stock option grants and other awards.
-48-
1999 Supplemental Stock Incentive Plan ("1999 Plan")
The Company's 1999 Plan is an equity incentive program for employees and
consultants, who are neither officers nor directors of the Company. Awards
under the 1999 Plan may, in general, be made in the form of non-statutory
stock option grants, stock appreciation rights, restricted stock awards or
performance shares. Each stock option is granted at an exercise price not
less than the fair market value of the Company's common stock on the grant
date, and generally vests over a four year period. A total of 750,000
common stock shares are reserved for issuance under the 1999 Plan. At
September 30, 2002, stock options for 10,000 common stock shares were
outstanding, stock options for 7,083 common stock shares were vested, and
740,000 common stock shares remained available for future stock option
grants and other awards.
Micrographic Technology Corporation Employee Stock Option Plan ("MTC Plan")
The Company's former MTC Plan was an equity incentive program, which was
established for the employees of MTC. The Company sold MTC on September 30,
1999 (See Note 3). A total of 40,000 common stock shares were reserved for
issuance under the MTC Plan. All stock options granted under the MTC Plan
are designed to qualify as incentive stock options under the federal tax
laws. Each stock option grant vests equally over a three year period on the
yearly anniversary date of the grant. For the year ended September 30,
2002, stock options for 1,693 common stock shares were canceled. At
September 30, 2002, no stock options for common stock shares were
outstanding and fully vested, and no common stock shares remained available
for future stock options grants.
Non-Plan Consultant and Employee Stock Options
The Company granted stock options on terms not available under the 1998
Plan or the 1999 Plan to certain consultants as partial consideration for
services rendered and to certain employees. As of September 30, 2002, the
Company has granted to consultants non-plan stock options to purchase an
aggregate of 107,500 common stock shares, and employees non-plan stock
options to purchase an aggregate of 54,500 common stock shares. The stock
options typically vest over the period of contracted service. The exercise
price of the stock options range from $7.375 to $40.8125. At September 30,
2002, non-plan stock options for 15,000 common stock shares were vested and
outstanding.
Common Stock Warrants
On December 31, 1997, the Company issued to RGC International Investors,
LDC ("RGC"), 5,000 Series A Preferred Stock shares and warrants to purchase
150,000 common stock shares (the "Series A Warrants") for an aggregate
purchase price of $5,000,000; $435,000 of the purchase price has been
allocated to the value of the Series A Warrants. The conversion price of
the Series A Preferred Stock was equal to the lower of $8.28 per share and
the lowest consecutive two-day average closing price of the common stock
during the 20-day trading period immediately prior to such conversion. The
sale was arranged by Shoreline Pacific Institutional Finance ("SPIF"), the
Institutional Division of Financial West Group, which received a fee of
$250,000 plus warrants to purchase 20,000 common stock shares, which are
exercisable at $6.625 and expire on December 31, 2000. For the year ended
September 30, 1998, RGC received 100.78 Series A Preferred Stock shares as
dividends paid in kind.
On May 28, 1998, the Company issued to RGC and Shoreline Associates I, LLC
("Shoreline"), 9,000 and 1,000 Series B Preferred Stock shares,
respectively, and warrants to purchase 180,000 and 20,000 common stock
shares (the "Series B Warrants"), respectively, for an aggregate purchase
price of $10,000,000; $900,000 of the purchase price has been allocated to
the value of the Series B Warrants. Prior to February 28, 1999, the
conversion price of the Series B Preferred Stock was equal to $13.20 per
share. Thereafter, the conversion price of the Series B Preferred Stock was
equal to the lower of $13.20 per share and the lowest five-day average
closing price of the common stock during the 20-day trading period
immediately prior to such conversion. The sale was arranged by SPIF, which
received a fee of $500,000 plus warrants to purchase 50,000 common stock
shares, which are exercisable at $11.00 and expire on May 28, 2002. As of
September 30, 1999, RGC and Shoreline received 226.40 and 25.16 Series B
Preferred Stock shares, respectively, as dividends paid in kind.
On August 31, 1998, the Company issued to RGC 7,500 Series C Preferred
Stock shares and warrants to purchase 93,750 common stock shares (the
"Series C Warrants") for an aggregate purchase price of $7,500,000;
$277,000 of the purchase price has been allocated to the value of the
Series C Warrants. Prior to May 31, 1999, the conversion price of the
Series C Preferred Stock was equal to $9.00 per share. Thereafter, the
conversion price of the Series C Preferred Stock was equal to the lower of
$9.00 per share and the lowest five-day average closing price of the common
stock during the 30-day-trading period immediately prior to such
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conversion. The sale was arranged by SPIF, which received a fee of $375,000
plus warrants to purchase 26,250 common stock shares, which are exercisable
at $7.50 and expire on August 31, 2002. As of September 30, 1999, RGC
received 125.39 Series C Preferred Stock shares as dividends paid in kind.
As of September 30, 1999, all of the Preferred Stock, including dividends
paid-in-kind and accrued interest, were converted into an aggregate of
2,404,464 common stock shares of the Company. Additionally, all warrants to
purchase common stock shares related to the issuance of the Preferred Stock
were exercised as of September 30, 2000.
On March 22, 1999, the Company issued warrants to purchase 3,013 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 have an exercise price of $29.875 and
expire 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.
Options and Warrants Outstanding
The following table summarizes the outstanding options and warrants to
purchase common stock shares for the three years ended September 30, 2002:
OUTSTANDING
OUTSTANDING OPTIONS OUTSTANDING WARRANTS OPTIONS AND WARRANTS
---------------------------- -------------------------- ----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE Shares EXERCISE PRICE
----------- --------------- --------- --------------- ----------- ---------------
BALANCE, SEPTEMBER 30, 1999 3,392,903 $ 14.43 503,013 $ 13.38 3,895,916 $ 14.29
Granted . . . . . . . . . 4,981,000 20.73 - - 4,981,000 20.73
Exercised . . . . . . . . (455,592) 8.06 (200,000) 7.69 (655,592) 7.95
Canceled. . . . . . . . . (1,445,361) 21.08 - - (1,445,361) 21.08
----------- --------- -----------
BALANCE, SEPTEMBER 30, 2000 6,472,950 18.24 303,013 17.13 6,775,963 18.19
Granted . . . . . . . . . 743,600 3.30 - - 743,600 3.30
Exercised . . . . . . . . - - - - - -
Canceled. . . . . . . . . (5,735,435) 17.84 - - (5,735,435) 17.84
----------- --------- -----------
BALANCE, SEPTEMBER 30, 2001 1,481,115 12.29 303,013 17.13 1,784,128 13.11
Granted . . . . . . . . . - - - - - -
Exercised . . . . . . . . - - - - - -
Canceled. . . . . . . . . (561,887) 16.81 - - (561,887) 16.81
----------- --------- -----------
BALANCE, SEPTEMBER 30, 2002 919,228 $ 9.53 303,013 $ 17.13. 1,222,241 $ 11.41
=========== ========= ===========
The following table summarizes information regarding stock options
outstanding at September 30, 2002:
OUTSTANDING OPTIONS VESTED OPTIONS
------------------- --------------
WEIGHTED
AVERAGE
REMAINING WEIGHTED WEIGHTED
CONTRACTUAL AVERAGE AVERAGE
RANGE OF EXERCISE PRICE SHARES LIFE (YEARS) EXERCISE PRICE SHARES EXERCISE PRICE
- ------------------------ ------- ------------ --------------- ---------------
$ 0.01 to $10.00 589,098 7.22 $ 3.48 515,506 $ 3.58
10.01 to 20.00 148,880 6.73 13.30 126,327 12.83
20.01 to 30.00 161,250 7.09 24.63 125,103 24.60
30.01 to 45.00 20,000 7.24 37.81 13,541 37.50
------- -------
$ 0.01 to $45.00 919,228 7.09 $ 9.53 780,477 $ 9.03
======= =======
Stock Option Compensation on a Pro Forma Basis
As allowed by SFAS 123, the Company continues to apply the provisions of
APB 25, in accounting for its stock based employee compensation
arrangements and discloses the pro forma net loss and loss per share
information as if the fair value method suggested in SFAS 123 had been
applied.
Had compensation cost for the Company's stock-based compensation
arrangements for employees been determined based on the fair value at grant
date of the awards for the years ended September 30, 2002, 2001 and 2000,
-50-
consistent with the provisions of SFAS 123, the Company's net loss and loss
per share would have been the pro forma amounts as follows (in thousands,
except per share data):
YEAR ENDED SEPTEMBER 30,
--------------------------------
2002 2001 2000
--------- --------- ----------
Net loss applicable to common shares:
As reported. . . . . . . . . . . . . . $(14,756) $(50,647) $(232,353)
========= ========= ==========
Pro forma. . . . . . . . . . . . . . . $(13,315) $(49,063) $(233,893)
========= ========= ==========
Basic and diluted loss per common share:
As reported. . . . . . . . . . . . . . $ (0.59) $ (2.31) $ (9.88)
========= ========= ==========
Pro forma. . . . . . . . . . . . . . . $ (0.53) $ (1.96) $ (9.95)
========= ========= ==========
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 September 30,
2001 and 2000:
YEAR ENDED SEPTEMBER 30,
--------------------------
2001 2000
------------ ------------
Volatility. . . . . . . . . 110.59% 96.72%
Risk-free interest rate . . 5.25% 5.88%
Dividend yield. . . . . . . - -
Expected lives in years . . 2.24 4.00
Weighted average fair value $ 1.94 $ 14.53
14. DEFERRED COMPENSATION
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 (see Note 13), 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 years ended September 30, 2002, 2001 and
2000, the Company recognized compensation expense (benefit) related to
these stock options of $1,501,000, which includes $35,000 allocated to the
discontinued operations of Intellicom; $(1,279,000), which includes
$(472,000) allocated to the discontinued operations of ISP Channel and
Intellicom; and $18,711,000, which includes $4,043,000 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
September 30, 2002. For the years ended September 30, 2001 and 2000, the
Company recognized compensation expense (benefit) related to these stock
options of $(31,000) and $261,000, respectively.
15. RELATED PARTY TRANSACTIONS
On November 4, 1999, the Company entered into various definitive agreements
with Mediacom LLC ("Mediacom"). In exchange for signing an agreement to
launch the ISP Channel services, the Company issued a total of 3,500,000
common stock shares to Mediacom, of which 3,150,000 shares were restricted.
The restrictions were progressively lifted as Mediacom launched ISP
Channel's services in Mediacom's cable television systems. At September 30,
2000, there were 2,100,000 shares restricted and unvalued. The unrestricted
1,400,000 shares were valued at $26,513,000 as cable affiliate launch
incentive. As a result of the Company discontinuing the operations of ISP
Channel, the cable affiliate launch incentive, net of amortization, was
written off and reflected in the loss on disposition of discontinued
operations for the year ended September 30, 2000. On February 16, 2001, the
Company and ISP Channel entered into agreements with Mediacom, to terminate
-51-
Mediacom's affiliate relationship with ISP Channel. As part of these
agreements Mediacom released all obligations under the affiliate agreement
with ISP Channel and returned 1,300,000 restricted common stock shares of
the Company, and in exchange received certain equipment, a $3,768,000
payment from the Company, and the Company removed restrictions on 800,000
common stock shares valued at $1,500,000 held by Mediacom. Mediacom
currently holds a total of 2,200,000 unrestricted common stock shares of
the Company. Pursuant to these agreements, neither the Company nor ISP
Channel has any further material obligation to Mediacom.
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.
On February 2, 2001, the Company's Board of Directors appointed Ronald I.
Simon, a Director of the Company, to acting Chief Executive Officer and
Chief Financial Officer at $2,500 per day or $10,000 per week beginning
February 5, 2001. Mr. Simon was paid $170,000 for serving as acting Chief
Executive Officer and Chief Financial Officer from February 5, 2001, to
June 1, 2001.
For the years ended September 30, 2002, 2001 and 2000, the Company paid to
Bear, Stearns & Co., Inc. $1,337,000, $350,000 and $522,000, respectively,
for investment banking services. Robert C. Harris, Jr., a Director of the
Company, is a senior managing director of Bear, Stearns & Co., Inc.
16. INCOME TAXES
The Company has not recorded provisions or benefits for U.S. federal, state
or local income taxes for the years ended September 30, 2002, 2001 and
2000, as a result of the Company's net operating losses, and differences
from the amounts computed by applying the U.S. federal income tax rate of
35% to pretax loss due primarily to the valuation allowance on deferred tax
assets.
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets are as follows (in thousands):
SEPTEMBER 30,
--------------------
2002 2001
--------- ---------
Inventory and other operating reserves $ 27 $ 3,096
Restructuring accrual. . . . . . . . . 581 762
Net liabilities associated with
discontinued operations. . . . . . . 1,547 -
Investments. . . . . . . . . . . . . . 294 -
Accounts receivable. . . . . . . . . . - 50
Unpaid accruals. . . . . . . . . . . . 109 349
Deferred revenue . . . . . . . . . . . - 44
Property and equipment . . . . . . . . 141 35
Other. . . . . . . . . . . . . . . . . 18 79
Net operating loss carryforwards . . . 93,699 87,530
--------- ---------
Total gross deferred tax asset . . . . 96,416 91,945
Valuation allowance. . . . . . . . . . (96,416) (91,945)
--------- ---------
Total deferred tax assets. . . . . . . - -
--------- ---------
Deferred tax liabilities . . . . . . . - -
--------- ---------
Net deferred tax asset . . . . . . . . $ - $ -
========= =========
The valuation allowance for deferred tax assets at September 30, 2002 and
2001, was $96,416,000 and $91,945,000, respectively. The change in
valuation allowance for the years ended September 30, 2002 and 2001, was
$4,471,000 and $42,863,000, respectively. 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 periods 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
sufficient uncertainty exists regarding the future realization of deferred
tax assets and, accordingly, a full valuation allowance has been provided.
-52-
The Company has net operating loss carryforwards for federal and state
income tax purposes of approximately $263,636,000 and $27,582,000,
respectively, available to reduce future income subject to income taxes.
The federal net operating loss carryforwards expire in fiscal years 2005 to
2022. The state net operating loss carryforwards expire in fiscal years
2005 to 2014.
At September 30, 2002, $15,774,000 of the net operating loss related to
stock option exercises; the related tax benefits will be charged to equity
when utilized for tax purposes.
U.S. federal and California tax laws impose substantial restrictions on the
utilization of net operating loss and credit carryforwards in the event of
an "ownership change" for tax purposes, as defined in Section 382 of the
Internal Revenue Code. For tax purposes, an ownership change occurred
during 1999 and, as a result, utilization of the net operating losses will
be subject to an annual limitation in future years.
17. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information for the years ended September 30, 2002,
2001 and 2000, is as follows (in thousands):
YEAR ENDED SEPTEMBER 30,
-------------------------------
2002 2001 2000
--------- --------- ---------
Cash paid during the year for:
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 144 $ 355 $ 301
Income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - -
Non-cash investing and financing activities:
Exchange of equity investments:
China Broadband Corporation common stock received . . . . . . . . . . . . . - - 9,630
Promissory note received from China Broadband Corporation . . . . . . . . . - - 1,700
deltathree.com, Inc. series A common stock received . . . . . . . . . . . . - - 213
Value assigned to debt conversion feature . . . . . . . . . . . . . . . . . . - - 34
Common stock issued for-
Acquisition of Intelligent Communications, Inc. . . . . . . . . . . . . . . - 199 1,499
Acquisition of Laptop Lane Limited. . . . . . . . . . . . . . . . . . . . . - 332 20,272
Conversion of subordinated notes. . . . . . . . . . . . . . . . . . . . . . - - 9,949
Payment of affiliate contract termination fees with Mediacom LLC. . . . . . - 1,500 -
Cable affiliate launch incentives . . . . . . . . . . . . . . . . . . . . . - - 26,932
Decrease in additional-paid-in capital associated with common stock options (65) (28,242) (15,712)
Unrealized gain (loss) on short-term investments. . . . . . . . . . . . . . 458 236 (385)
-53-
18. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly supplemental consolidated financial information for
the years ended September 30, 2002 and 2001, are as follows (in thousands,
except per share data):
THREE MONTHS ENDED
--------------------------------------------------------
DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
-------------- ----------- ---------- ---------------
FOR THE YEAR ENDED SEPTEMBER 30, 2002:
Loss from continuing operations . . . . . . . . . $ (1,262) $ (3,308) $ (1,323) $ (2,937)
Net loss. . . . . . . . . . . . . . . . . . . . . (2,780) (6,609) (1,393) (3,974)
Basic and diluted loss per common share . . . . . $ (0.11) $ (0.26) $ (0.05) $ (0.16)
Shares used to compute basic and diluted loss per
common share. . . . . . . . . . . . . . . . . . 25,171 25,178 25,183 25,184
FOR THE YEAR ENDED SEPTEMBER 30, 2001:
Loss from continuing operations . . . . . . . . . $ (4,619) $ (13,384) $ (4,768) $ (1,747)
Net loss. . . . . . . . . . . . . . . . . . . . . (9,054) (33,063) (12,781) (2,749)
Basic and diluted loss per common share . . . . . $ (0.36) $ (1.34) $ (0.51) $ (0.11)
Shares used to compute basic and diluted loss per
common share. . . . . . . . . . . . . . . . . . 24,997 24,762 25,157 25,171
19. SUBSEQUENT EVENTS
At the Special Meeting of Stockholders on November 14, 2002, the Company's
stockholders approved the stock purchase agreement dated as of July 30,
2002, to acquire First Standard Holdings Corp. from SSH Corp. and IHC for
$31,920,000 in cash, and approved the Company's name change to American
Independence Corp. Also on November 14, 2002, the Company consummated the
transacations comtemplated by the Purchase Agreement and First Standard
Holdings Corp. changed its name to Independence American Holdings Corp.
The acquisition of IAHC may result in a change in management's belief that
sufficient uncertainty exists regarding the future realization of deferred
tax assets, as one of the potential benefits of the acquisition of IAHC is
that the Company's federal tax net operating loss carryforwards may be
utilized against any subsequent profits from IAHC's business.
-54-
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable
-55-
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information required by this Item is hereby incorporated by reference to the
registrant's Proxy Statement for the 2003 Annual Meeting of Stockholders under
the captions "Election of Directors", "Executive Officers" and "Compliance with
Section 16(a) of the Securities Exchange Act of 1934.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is hereby incorporated by reference to the
registrant's Proxy Statement for the 2003 Annual Meeting of Stockholders under
the captions "Executive Compensation" and "Board of Directors".
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is hereby incorporated by reference to the
registrant's Proxy Statement for the 2003 Annual Meeting of Stockholders under
the captions "Security Ownership of Certain Beneficial Owners and Management".
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is hereby incorporated by reference to the
registrant's Proxy Statement for the 2003 Annual Meeting of Stockholders under
the captions "Certain Relationships and Related Transactions".
ITEM 14. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Based on their evaluation as of a date within 90 days of the filing date of this
Annual Report on Form 10-K, American Independence Corp., formerly SoftNet
Systems, Inc., and subsidiaries (collectively referred to as the ''Company'')
principal executive officer and principal financial officer have concluded that
the Company's disclosure of controls and procedures (as defined in Rules
13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the "Exchange
Act") are effective to ensure that information required to be disclosed by the
Company in reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission rules and forms.
Changes in Internal Controls
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date of
their evaluation. There were no significant deficiencies or material
weaknesses, and therefore there were no corrective action taken.
-56-
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) FINANCIAL STATEMENTS AND EXHIBITS:
PAGE
-----
(1) FINANCIAL STATEMENTS. The following consolidated financial
statements of the registrant and its subsidiaries are
included in Part II Item 8:
Report of Independent Auditors KPMG LLP. . . . . . . . . . . . . 30
Consolidated Balance Sheets as of September 30, 2002 and 2001. . 31
Consolidated Statements of Operations for the three years
ended September 30, 2002. . . . . . . . . . . . . . . . . . . 32
Consolidated Statements of Shareholders' Equity (Deficit)
for the three years ended September 30, 2002 . . . . . . . . . 33
Consolidated Statements of Cash Flows for the three years
ended September 30, 2002 . . . . . . . . . . . . . . . . . . . 34
Notes to Consolidated Financial Statements . . . . . . . . . . . 35-54
(2) FINANCIAL STATEMENT SCHEDULE. The following schedule for the
three years ended September 30, 2002, is submitted herewith:
Schedule II - Valuation and Qualifying Accounts. . . . . . . . . 61
All other schedules are omitted due to the required information
is not applicable or is shown in the financial statements or
notes thereto.
(3) EXHIBITS. See Index to Exhibits included in this Annual Report on
Form 10-K on page 60.
(b) REPORTS ON FORM 8-K:
The Registrant filed a Current Report on Form 8-K on July 31, 2002,
under Item 5, announcing the adoption of a Preferred Share Purchase
Rights Plan effective July 30, 2002.
The Registrant filed a Current Report on Form 8-K on July 31, 2002,
under Item 5, announcing the Company's agreement to purchase First
Standard Holdings Corporation from Independence Holding Company for
$31.92 million in cash, and Independence Holding Company's purchase of
all the Company's common stock owned by an affiliate of Pacific
Century Cyberworks Limited.
The Registrant filed a Current Report on Form 8-K on August 14, 2002,
under Item 9, submitting the principal executive and financial officer
certification under oath pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, 18 U.S.C. Section 1350 for the Company's Quarterly Report
on Form 10-Q for the quarterly period ended June 30, 2002.
The Registrant filed a Current Report on Form 8-K on August 22, 2002,
under Item 5, announcing Nasdaq's Listing Qualifications Panel
determination to continue the listing of the Company's securities
subject to the Company meeting certain conditions.
The Registrant filed a Current Report on Form 8-K on September 9,
2002, under Item 5, announcing the Company's filing of an amendment to
its preliminary proxy statement on Schedule 14A, containing
Management's Discussion and Analysis of the Financial Condition and
Results of Operations and consolidated financial statements of the
Company restated to reflect the results of operations of the Company's
subsidiary, Intelligent Communications, Inc., as a discontinued
operation.
-57-
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
American Independence Corp.
/s/ Edward A. Bennett Date: November 19, 2002
- ---------------------------------------------- -----------------
Edward A. Bennett
Acting Non Executive Chairman of the Board of
Directors
/s/ George L. Hernandez Date: November 19, 2002
- ---------------------------------------------- -----------------
George L. Hernandez
Acting Chief Operating Office; Vice President,
Finance and Administration; and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
/s/ Edward A. Bennett Date: November 19, 2002
- ---------------------------------------------- -----------------
Edward A. Bennett
Acting Non Executive Chairman
of the Board of Directors
/s/ Edward Netter Date: November 19, 2002
- ---------------------------------------------- -----------------
Edward Netter
Director
/s/ Robert C. Harris, Jr. Date: November 19, 2002
- ---------------------------------------------- -----------------
Robert C. Harris, Jr.
Director
/s/ Ronald I. Simon Date: November 19, 2002
- ---------------------------------------------- -----------------
Ronald I. Simon
Director
/s/ Roy T.K. Thung Date: November 19, 2002
- ---------------------------------------------- -----------------
Roy T.K. Thung
Director
-58-
CERTIFICATIONOF PRINCIPAL EXECUTIVE AND FINANCIAL OFFICER
---------------------------------------------------------
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
---------------------------------------------------------
I, George L. Hernandez, Acting Chief Operating Officer; Vice President, Finance
and Administration; and Secretary of American Independence Corp., certify that:
1. I have reviewed this annual report on Form 10-K of American Independence
Corp.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ George L. Hernandez Date: November 19, 2002
- ---------------------------------------------- -----------------
George L. Hernandez
Acting Chief Operating Office; Vice President,
Finance and Administration; and Secretary
-59-
AMERICAN INDEPENDENCE CORP. AND SUBSIDIARIES
INDEX TO EXHIBITS
ITEM 15(A)(3)
EXHIBIT
NO. DESCRIPTION OF DOCUMENT
- -------- -----------------------
2.1 Stock Purchase Agreement, dated as of July 30, 2002, between
Registrant, SSH Corporation and Independence Holding Company.
Incorporated by reference to exhibit 10.1 of the Registrant's Current
Report on Form 8-K dated July 31, 2002.
3.1 Second Amended and Restated Certificate of Incorporation of the
Registrant.
3.2 Amended By-Laws of the Registrant.
4.1 Registration Rights Agreement, dated as of July 30, 2002, between
Registrant and Madison Investors Corporation. Incorporated by
reference to exhibit 4.1 of the Registrant's Current Report on Form
8-K dated July 31, 2002.
4.2 Stock Agreement, dated as of July 30, 2002, between Registrant,
Independence Holding Company and Madison Investors Corporation.
Incorporated by reference to exhibit 10.2 of the Registrant's Current
Report on Form 8-K dated July 31, 2002.
4.3 Rights Agreement, dated as of July 30, 2002, between Registrant and
Mellon Investor Services LLC which includes the form of Certificate of
Designations of the Series A Junior Participating Preferred Stock of
Registrant as Exhibit A, the form of Right Certificate as Exhibit B
and the Summary of Rights to Purchase Preferred Shares as Exhibit C.
Incorporated by reference to exhibit 4.1 of the Registrant's Current
Report on Form 8-K dated July 31, 2002.
10.1 Registrant 1995 Long Term Incentive Plan Incorporated by reference to
exhibit 10.3 of the Registrant's Annual Report on Form 10-KSB for the
fiscal year ended September 30, 1995.
10.2 Registrant 1998 Stock Incentive Plan. Incorporated by reference to
exhibit 99.1 of the Registrant's Registration Statement on Form S-8
dated May 10, 1999.
10.3 Registrant 1999 Supplemental Stock Incentive Plan. Incorporated by
reference to exhibit 99.1 of the Registrant's Registration Statement
on Form S-8 dated June 8, 1999.
10.4 Stock Purchase Agreement by and between Registrant and various former
owners of Intelligent Communications, Inc. dated February 7, 2001.
Incorporated by reference to exhibit 10.17 of the Registrant's Annual
Report on Form 10-K for the fiscal year ended September 30, 2001.
10.5 Financial Advisory Services Agreement between Registrant and Bear,
Stearns & Co., Inc. dated May 23, 2001. Incorporated by reference to
exhibit 10.19 of the Registrant's Annual Report on Form 10-K for the
fiscal year ended September 30, 2001.
10.6 Retention Agreement by and between Registrant and Steven M. Harris
dated January 3, 2001. Incorporated by reference to exhibit 10.1 of
the Registrant's Quarterly Report on Form 10-Q for the quarterly
period ended December 31, 2000.
10.7 Letter Agreement by and between Registrant and George L. Hernandez
dated January 9, 2001 as amended February 16, 2001. Incorporated by
reference to exhibit 10.23 of the Registrant's Annual Report on Form
10-K for the fiscal year ended September 30, 2001.
23.1 Consent of KPMG LLP
99.1 Certification of Principal Executive and Financial Officer Pursuant to
18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
-60-
AMERICAN INDEPENDENCE CORP. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
CHARGED TO
BALANCE AT CHARGED TO OTHER
BEGINNINGOF COSTS AND ACCOUNTS DEDUCTIONS BALANCE AT
DESCRIPTION PERIOD EXPENSES DESCRIBE DESCRIBE END OF PERIOD
- --------------------------------------- ------------ ----------- ----------- ------------ --------------
VALUATION ALLOWANCE ON DEFERRED TAX ASSET:
Year ended September 30, 2002 . . . . $ 91,945 $ 4,471 $ - $ - $ 96,416
Year ended September 30, 2001 . . . . $ 49,082 $ 42,863 $ - $ - $ 91,945
Year ended September 30, 2000 . . . . 22,465 26,617 $ - - 49,082
NET LIABILITIES ASSOCIATED WITH DISCONTINUED OPERATIONS:
Year ended September 30, 2002 . . . . $ 2,757 $ 4,097 $ - $ 3,004 (b) $ 3,850
Year ended September 30, 2001 . . . . $ 36,427 $ 4,898 $ - $ 38,568 (b) $ 2,757
Year ended September 30, 2000 . . . . - 139,400 - 102,973 (a) 36,427
RESTRUCTURING RESERVE
Year ended September 30, 2002 . . . . $ 1,240 $ 502 $ - $ 296 (b) $ 1,446
Year ended September 30, 2001 . . . . $ - $ 3,900 $ - $ 2,660 (b) $ 1,240
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(a) Amounts written off.
(b) Amounts written off and payments applied, net of receipts.
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