The following table sets forth certain information with respect to the principal facilities used in our operations, all of which are leased.
The following historical information of Clark/Bardes should be read in conjunction with information included elsewhere herein, including the financial statements and notes thereto and "
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Tables shown in thousands of dollars, except per share amounts)
Our results for the year ended December 31, 1998, were adversely impacted by a non-recurring operating charge of $4.8 million to reflect a fair value adjustment for put warrants previously issued to some of our former note holders. In addition, we received the benefit of a deferred tax asset of $1.8 million arising from conversion from an S to a C corporation. Had these items not occurred, net income for the twelve months ended December 31, 1998, would have been $3.2 million, or $0.57 per diluted share.
The companies we acquire are typically privately owned and structured as S corporations for federal income tax purposes, where virtually all of the income is passed on to the shareholders. Accordingly, our evaluation focus is on the quality of the management and future earnings and growth potential. Typically, we
also acquire the financial value embedded in a strong book of recurring renewal business to be realized for many years after the acquisition takes place.
On October 6, 1999, we acquired all of the assets of Banking Consultants of America and Financial Institutions Services, Inc. Banking Consultants of America and Financial Institutions Services, Inc. is a strong regional firm in the Memphis, Tennessee area and was acquired as part of our Bank Compensation Strategies division. The purchase price was $1.4 million and approximately $28,000 of expenses. The acquisition was accounted for as a purchase and the entire purchase price was allocated to the inforce revenue acquired in the transaction.
The Wamberg Organization has historically produced our largest volume of revenue -- 17.5% of total revenue in 1998 and 15.2% to August 31, 1999. In light of the relationship between The Wamberg Organization, Wamberg Financial Corporation, W. T. Wamberg and us, our board appointed a special committee of independent, non-employee directors to review the terms of the transaction. After analyzing the matter and considering all relevant issues, the special committee recommended that our board approve the transaction.
The total price of the net assets of The Wamberg Organization and the stock of Wamberg Financial Corporation was $18.0 million and provided for:
- a cash payment to W. T. Wamberg of $50,000 for his shares of Wamberg Financial Corporation;
- the direct payment of $1.5 million for outstanding loans of The Wamberg Organization;
The cash portion of $14.2 million was funded through our existing cash balances.
On December 22, 1999, the airplane was sold to a leasing company for $4.3 million and Wamberg Financial Corporation entered into a ten-year lease for the plane at a rental of $27,924 per month. The net proceeds from the sale were used to repay the note incurred for the original purchase and the net, after-tax proceeds have been reflected as a reduction of the purchase price. Under the terms of the lease, Wamberg Financial Corporation can purchase the plane for 85% of its original cost of $3.7 million after six years or, after ten years, renew the lease, return the plane or purchase the plane at fair value at that time.
For the period prior to the acquisition, The Wamberg Organization and Wamberg Financial Corporation had combined revenue and net income as follows:
The pro forma information below presents our results of operations and those of The Wamberg Organization and Wamberg Financial Corporation as if the acquisition occurred on January 1, 1998, reflecting the purchase method of accounting.
On May 18, 1999, we acquired National Institute for Community Banking (NICB), which, by agreement with its shareholders, was effective January 1, 1999. The acquisition was consummated by merging NICB into us with the NICB shareholders receiving 99,851 shares of our common stock at $16 per share for a total value of $1.6 million. As part of the agreement, the NICB shareholders will receive an additional 384,452 shares of our common stock as consideration if stipulated revenue and income goals during the years 1999 through 2002 are achieved. Acquisition expenses were approximately $130,000. NICB was acquired as an addition to and an expansion of our BCS division.
On April 5, 1999, we purchased the assets and business and assumed certain liabilities of Phynque, Inc., d/b/a Management Compensation Group/HealthCare (MCG) for a purchase price of $35.9 million consisting of the following:
The acquisition of MCG marked our entrance into the not-for-profit healthcare executive benefit and compensation plan business with the creation of our newest major operating division, HealthCare Compensation Strategies.
For the periods prior to the acquisition, MCG had revenue and net income as follows:
The pro forma information below presents our results of operations and that of MCG combined as if the acquisition had occurred on January 1, 1998, reflecting the purchase method of accounting.
On February 7, 2000, we signed a letter of intent to acquire substantially all the assets and assume certain liabilities of a group of privately held companies, engaged in the sale of executive benefit and compensation plans to medium and large corporations.
- 308,428 shares of our common stock with an agreed upon value of $4.9 million
- contingent payments of $15 million based on achieving predetermined levels of earnings before interest, taxes depreciation and amortization for the years 2000 through 2004.
The acquisition will be accounted for as a purchase with the purchase price allocated first to the net present value of future cash flow from renewal revenue and the remainder, if any, to goodwill.
On June 7, 1999, we sold 1,000,000 shares of our common stock at $17 per share to Conning Insurance Capital Limited Partnership V, L. P. (Conning) in a private placement. As part of the private placement, we granted Conning registration rights, which they may use to have their shares of our common stock registered along with any shares we may be registering with the SEC, after December 31, 2002.
Our revenue is usually long term and recurring, is typically paid annually and extends for a period of ten years or more after the sale. Commissions paid by insurance companies vary by policy and by program and usually represent a percentage of the premium or the cash surrender value of the insurance policies underlying our program.
- First Year Commission Revenue. First year revenue is recognized at the time the application is substantially completed, the client is contractually committed to purchase the insurance policies, and the premiums are paid by the client to the insurance company.
- Other Revenue. Other revenue consists of several sources of revenue associated with our operations including consulting and administrative fees.
Our operating results can fluctuate considerably, especially when compared on a consecutive quarterly basis, and we can experience large increases in revenue in the fourth quarter. In addition, operating results can be affected by a number of other factors, including:
CBH continues to experience significant growth in first year revenue from both its existing businesses and from acquisitions.
Our renewal revenue grows through acquisition, and through new business that generates recurring revenues after the year of sale. As the acquired divisions and first year revenue continue to grow, renewal revenue will grow as well. The rate of growth of our renewal revenue is influenced by our acquisition activity and new business product mix. For example, as we discussed previously, we made certain large-bank sales with products that generate a higher percentage of first-year commission than our historical products used in the large-bank market. This results in a lower growth in renewal revenue in the subsequent year than would have been achieved with the sale of our historical products. Our renewal revenue grew at a 40.0% rate for the year, which is broken down as follows:
In addition, the gross profit on the ten-year projected inforce renewal revenue improved substantially from the prior year, as shown in the table below.
* This projected revenue is not adjusted for mortality, lapse, or other factors that may impair realization. We cannot assure you that commissions revenue under these policies will be received. These projected gross revenues are based on the beliefs and assumptions of management and are not necessarily indicative of the revenue that may actually be achieved in the future.
The overall increase is general and administrative expense may be analyzed as follows:
Each operating unit contributed positively to our operating income before the non-recurring item. Comparing our divisions;
The relative contribution between existing businesses and acquisitions to operating income is as follows:
Amortization of intangibles: Amortization expense increased $3.1 million for the year ended December 31, 1999.
- first is the net present value of the realizable cash flow based on forecasts we receive from the target and their carriers. These projects can extend over thirty years and are valued at their present value. The annual amortization is the net decrease in the remaining present value of the renewal premiums in the revenue stream; and,
- the remaining excess purchase price is allocated to goodwill. At present, goodwill is amortized over twenty-five to forty years. The Financial Accounting Standards Board has announced its intention to issue a new standard calling for, among other things, that goodwill be amortized over a period not to exceed twenty years. While we do not anticipate retroactive application of this proposed new standard, we intend to fully comply our policy with the standard as it is eventually issued.
In addition to the net present value of inforce revenues and goodwill, intangibles also include the value of non-competition agreements negotiated with selling shareholders. These are amortized over their terms on a straight line basis.
Net interest costs increased $618,000 or 23.8% for the full year 1999 compared with 1998. The entire additional expense resulted primarily from a net increase in borrowings of $13.7 million.
- the cash cost of the MCG/HealthCare acquisition -- $17.8 million was accomplished through bank borrowings and we issued an $8.7 million promissory note
- we borrowed $2.0 million for small acquisitions and working capital.
With increased borrowings as a result of our acquisition program, these costs may be expected to increase in subsequent quarters.
Interest Expense -- Net. Interest expense for the year ended December 31, 1998 was $2.6 million compared to $921,000 for the year ended December 31, 1997. The amount for the year ended December 31, 1998 included interest income of $566,000 and interest expense of $3.2 million as compared to interest income of $189,000 and interest expense of $1.1 million for the year ended December 31, 1997. Interest income was higher in 1998 due to larger cash balances resulting primarily from the Clark/Bardes initial public offering. Interest expense was higher primarily due to a full year of outstanding debt associated with the BCS acquisition for the year ended December 31, 1998, compared to four months of outstanding debt in for the year ended December 31, 1997.
Net Income/Loss. Actual net loss was $411,000 for the year ended December 31, 1998. Excluding the non-recurring operating expense and income tax benefit, net income is estimated at $2.5 million for the year. Net income was $4.2 million for the year ended December 31, 1997, which reflects $60,000 of income tax expense.
We continue to generate strong cash flow from operations. As a financial company with strong operating cash flow, we have little need to retain substantial cash balances. We use the net cash from operating activities to fund capital expenditures and small acquisitions. We expect that large future acquisitions will be financed primarily through externally available funds. However, we can offer no assurance that such funds will be available and, if so, on terms acceptable to us.
Our cash flow from operations for the twelve months ended December 31, 1999, improved significantly over that of the comparable twelve month period in 1998. The components were:
Acquisitions accounted for $38.6 million of the $43.4 million used in investing activities. The balance was comprised of $5.1 million for purchase of equipment and various assets such as deferred debt expenses.
Our primary market risk exposure is to changes in interest rates as a result of our line of credit and long-term debt. At December 31, 1999, we had total outstanding indebtedness of $42.7 million, or approximately 30.9% of total market capitalization. Our interest rate risk objective is to limit the impact of interest rate fluctuations on earnings and cash flows and to lower overall borrowing costs. To achieve this objective, we manage our exposure to fluctuations in interest rates for borrowings through the use of fixed rate debt instruments to the extent that reasonably favorable rates are obtainable with such arrangements and enter into derivative financial instruments such as interest rate swaps to mitigate interest rate risk and to effectively lock the interest rate on a portion of our variable debt.
We do not enter into derivative or interest rate transactions for speculative purposes. Approximately 22.7% of our outstanding debt was subject to fixed rates with a weighted average of 9.5% at December 31, 1999. An additional 69.9% of our outstanding debt at December 31, 1999, was effectively locked at an interest rate of 5.53% plus a spread based on our leverage ratio, through an interest rate swap agreement for a notional amount of $30.0 million. We regularly review interest rate exposure on outstanding borrowings in an effort to minimize the risk of interest rate fluctuations.
The following table provides information about our debt obligations that are sensitive to changes in interest rates. The table presents principal cash flows and related weighted average interest rates by expected maturity dates totaling $42.7 million.
The table incorporates only those exposures that exist as of December 31, 1999, and does not consider exposures or positions that could arise after that date. In addition, because firm commitments are not represented in the table above, the information presented therein has limited predictive value. As a result, our ultimate realized gain or loss with respect to interest rate fluctuations would depend on the exposures that arise during the future period, prevailing interest rates, and our hedging strategies at that time. There is inherent rollover risk for borrowings as they mature and are renewed at current market rates. The extent of this risk is not quantifiable or predictable because of the variability of future interest rates and our financing requirements.
In late 1999, we completed our remediation and testing of systems for year 2000 compliance. As a result of past planning and implementation efforts, we experienced no significant disruptions in mission critical information technology and non-information technology systems, and we believe those systems successfully responded to the year 2000 date change. We expensed approximately $400,000 during 1999 in connection with remediating our systems. We are not aware of any material problems resulting from year 2000 issues, either with products, internal systems, or the products and services of third parties. We will continue to monitor
mission critical computer applications and those of our suppliers and vendors throughout the year 2000 to ensure that any latent year 2000 matters that may arise are addressed promptly.
The risks described below are not the only risks we face. Any of the following risks could have a material adverse effect on our business, financial condition and operating results. Additional risks and uncertainties of which we are unaware or currently believe are immaterial may also impair our business operations. You should carefully consider these risks in reviewing this Form 10-K, and these risks qualify, in their entirety, each forward looking statement herein.
Many of the compensation and benefit programs we design and implement for our clients are funded by specifically designed life insurance products. The life insurance products underlying the compensation and benefit programs we sell currently offer a number of tax advantages, such as:
- the cash value of the policies grows on a tax deferred basis until withdrawal;
If any changes in federal tax laws reduce or eliminate these advantages, many policies could be surrendered. As a result, we could lose a substantial amount of renewal income.
In 2000, as part of its budget proposal, the administration sought to eliminate the "employee, officer and director" exception to the interest disallowance rule. This is the same proposal that was introduced in 1999 and 1998. To date, the proposal has not obtained congressional support, however, if enacted, this proposal would significantly affect the Clark/Bardes and Bank Compensation Strategies divisions because it would reduce the attractiveness of business-owned life insurance to companies that traditionally have high debt/ equity ratios, such as banks.
The policies we sell in the healthcare market are often individually owned and, as a result, could be adversely impacted by a tax law change affecting life insurance generally. We believe that Congress is unlikely to make a change that reduces the tax benefits of insurance owned by individuals.
During 1999, one of the carriers we use, General American Life Insurance Company experienced financial difficulties as a result of being unable to meet withdrawal requests under certain guaranteed investment contracts General American had issued. General American represented approximately 6.0% of total revenue in 1998 and 4.8% of total revenue in 1999. Upon learning of these matters, we ceased selling programs financed by insurance policies underwritten by General American. Since that time, General American's insurance business has been sold to MetLife, its financial ratings upgraded and we expect to continue to use General American and its acquirer, MetLife as carriers.
CHANGES IN THE MARKET AND THE ECONOMY COULD HELP DEVELOPMENT OF COMPETING PROGRAMS AND PRODUCTS.
- The Todd Organization (not affiliated with Melvin G. Todd, president of Clark/Bardes division).
The competitors of our Bank Compensation Strategies division include The Benefit Marketing Group, The Todd Organization, and individual insurance agents in the communities where the community banks are located. Additionally, the community banking industry is constantly consolidating, which may reduce the number of potential bank clients for Bank Compensation Strategies. The primary competition for our
HealthCare Compensation Strategies division is Hewitt Associates, Towers, Perrin; Mercer Consulting Group and Hay Group Inc.
Our performance depends largely on the performance of our executive officers and key employees. It is important to us to keep and motivate high quality personnel, especially our management, producers and program development teams. The loss of the services of any of our key employees particularly W. T. Wamberg, chairman of our board of directors and chief executive officer, Melvin G. Todd, president of Clark/ Bardes division, Richard C. Chapman, president of Bank Compensation Strategies, and Donald C. Wegmiller, president of HealthCare Compensation Strategies, could have a material adverse effect on our business, financial condition and operating results. We cannot assure you that we will be successful in retaining our key personnel.
Intangible assets arising from our purchased businesses consisted of the following at December 31:
We have adopted Statement of Financial Accounting Standard No. 121 "Accounting for Impairment of Long Lived Assets and Long Lived Assets To Be Disposed Of." At least annually, we review the components of our intangible assets and make the appropriate adjustment if it becomes apparent that the undiscounted cash flow is less than its unamortized carrying amount. No growth rates are used in the projection of renewal revenue and, in the opinion of management, projections are consistent in all respects. The Financial Accounting Standards Board has determined that amortization of goodwill should be a maximum period of twenty years. We presently amortize the present value of inforce revenue over thirty years and goodwill for periods of twenty to forty years but intend to fully comply with any new standards promulgated at the time of any future acquisitions. If any component of the inforce revenue base should become unrealizable or the accounting regulatory bodies impose shorter amortization periods, this could have a material adverse effect on our business, financial condition and operating results. We cannot assure you that a component of the inforce revenue base will not become unrealizable or that accounting regulatory bodies will not impose shorter amortization periods.
FLUCTUATIONS IN OUR REVENUES MAKE OUR OPERATING RESULTS DIFFICULT TO ANALYZE AND FORECAST.
DELAWARE LAW AND OUR CHARTER DOCUMENTS COULD PREVENT AN UNSOLICITED TAKEOVER.