o commissions paid by the insurance companies issuing the policies underlying our clients' benefit programs; o program design and administrative service fees paid by our clients; o executive compensation and benefit and related consulting fees; and o fees for legislative liaison and related advisory services.
Our first year commission revenue is frequently subject to chargeback, which means that insurance companies retain the right to recover commissions paid in the event policies prematurely terminate. The chargeback schedules differ by product and usually apply to first year commission only. A typical chargeback schedule, based on a percent of first year commission, is as follows: Year 1 100% Years 2 and 3 50% Year 4 25% Years 5 and beyond 0%
While the commission revenue is subject to chargeback, our experience has indicated that less than 1% of revenue recognized has ever been refunded to insurance companies pursuant to such chargeback provisions. Given the homogenous nature of such cases and historical information about chargebacks, we believe we are able to accurately estimate the revenue earned. We currently maintain a chargeback allowance, which is monitored on a quarterly basis for adequacy.
Consulting fee revenue. Consulting fee revenue consists of fees of Human Capital Practice, Pearl Meyer and Federal Policy Group for the services we perform in advising our clients on their executive compensation programs and related consulting services, retirement, benefit, actuarial, pension savings plan design and management, people strategy, compensation surveys, institutional registered investment advisory services and fees from legislative and regulatory policy matters. These fees are generally based on a rate per hour arrangement and are earned when the service is rendered. Some of our consulting clients pay a retainer at the beginning of a project. These revenues are recognized ratably over the term of the engagement. Consulting revenue generated by the Executive Benefits Practice, Banking Practice and Healthcare Group are included in the first year revenue line on our consolidated income statement.
During the fourth quarter of 2002, we completed an analysis of the services provided and timing thereof under our administrative services agreements at our Executive Benefits Practice. As a result of this analysis, we determined that because of changes in the timing of the services being provided, revenue under these agreements should have been recognized on the straight-line during 2002. Historically, these fees were recognized 75% in the renewal month and 25% ratably over the remainder of the annual service agreement.
As a result, the first three quarters of the year ended December 31, 2002, have been restated from the amounts previously reported to recognize administrative service fees on a straight-line basis.
In accordance with Emerging Issues Task Force ("EITF") Issue No. 01-14, Income Statement Characterization of Reimbursements Received for "Out-of-Pocket" Expenses Incurred, reimbursements received for out-of-pocket expenses incurred are characterized as revenues and are shown as a separate component of total revenue. Similarly, related reimbursable expenses are also shown separately within operating expenses. EITF Issue No. 01-14 was effective as of January 1, 2002 and all periods presented have been reclassified to reflect the adoption of this accounting literature. The net result of the above is an increase in revenue and operating expense of approximately $5.0 million, $4.8 million and $2.0 million for the years ended December 31, 2002, 2001, and 2000, respectively. These reclassifications had no effect on our operating income.
We are required to assess potential impairments of long-lived assets in accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, Accounting for Impairment of Long-Lived Assets, if events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
SFAS No. 123, Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair value based method of accounting for stock based employee compensation plans. We have elected to remain on the current method of accounting as described above for employees. However, we account for stock options granted to non-employees under the provisions of SFAS No. 123.
Revenue. Total revenue for the year ended December 31, 2002 was $278.6 million compared to $236.9 million for the year ended December 31, 2001. The Banking Practice experienced strong revenue growth of 26.3% between December 31, 2001 and December 31, 2002 as a result of the closing of numerous cases in the community banking sector and the acquisition of LongMiller in November 2002. The increase of approximately $3.0 million of first year commission and fee revenue and approximately $14.0 million of renewal revenue is attributable to the acquisition of LongMiller. Revenue growth was also strong in the Healthcare Group which benefited from increased first year commission and fee revenue. Revenue was positively impacted by approximately $9.5 million with the February 2002 acquisition of Federal Policy Group, which provides tax and legislative consulting services. New business revenue includes $3.2 million received pursuant to an Administrative Services Agreement and Bonus Forfeiture Agreement with an insurance carrier with which a significant amount of in-force insurance is in place (see Administrative Services Agreement and Bonus Forfeiture Agreement below). Our Executive Benefits Practice experienced a decline in revenue from $94.2 million in 2001 to $85.6 million in 2002 as a result of the current economic conditions and proposed legislation related to the structure of deferred compensation plans that has caused clients to delay implementing new deferred compensation plans. These circumstances may continue in future periods and adversely affect our ability to generate future revenue in EBP.
Other income. During 2002, we received $269,000 rental income from a tenant. During 2001, we received $191,000 of life insurance proceeds as the result of the death of one of our employees, and rental income from a tenant of $256,000.
Interest expense - net. Net interest expense for the year December 31, 2002 was $3.7 million compared to $7.2 million in 2001. In 2001, we recorded interest expense of approximately $2.0 million as a result of the interest rate swap settlements associated with the pay off of our outstanding bank debt with the proceeds from our secondary equity offering. As a result, we had minimal debt outstanding during the first half of 2002. With the November 2002 acquisition of LongMiller, we borrowed approximately $87.5 million on our line of credit and issued $305 million of non-recourse insurance revenue asset-backed notes. For 2003, interest expense is expected to increase significantly with the incurrence of this additional indebtedness.
Income taxes. Income taxes for the year ended December 31, 2002 were $12.4 million at an effective tax rate of 41.0% compared to $8.7 million at an effective tax rate of 35.3% for the year ended December 31, 2001. The 2001 effective tax rate was affected by the filing of an amended tax return during the third quarter 2001 which reduced the overall tax rate.
Net income. Net income, after an impairment charge of $523,000 net of taxes from the adoption of SFAS No. 142, for the year ended December 31, 2002 was $17.3 million, or $0.99 per diluted common share versus net income of $16.0 million or $1.18 per diluted share for the same period last year. The diluted weighted average number of shares outstanding increased to 17.5 million shares for the year ended December 31, 2002 from 13.6 million shares for the year ended December 31, 2001.
Commission expense. Commission expense increased 65.3% from $50.8 million in 2000 to $84.0 million in 2001, and was negatively impacted by a larger percentage of sales in 2001 that were generated by independent consultants who typically are paid higher commissions. However, this was partially offset by the larger percentage of total sales in 2001 generated by Pearl Meyer and Human Capital Practice which has no commission expense.
Net income. Net income of $16.0 million in 2001 represented a $4.6 million, or a 39.9% increase over 2000. On a diluted per share basis, earnings were $1.18, an increase of 12.4% over 2000.
On November 26, 2002, we acquired Long, Miller & Associates, LLC ("LongMiller"). LongMiller, located in Greensboro, North Carolina, specializes in bank-owned life insurance portfolio services. For the nine months ended September 30, 2002 and the year ended December 31, 2001, LongMiller had revenues of $47.1 million and $65.8 million, respectively, and operating income of $31.1 million and $41.8 million, respectively. This acquisition enhances our capabilities by coupling LongMiller's product offerings and personnel with our current Banking Practice's extensive distribution channel. We financed this acquisition, with a purchase price of approximately $403.5 million and transaction costs of approximately $736,000, through the issuance of $305 million of non-recourse debt secured by commission and related payments from in-force policies sold by LongMiller, a draw-down of approximately $87.5 million on our existing credit facility and the issuance of $20 million of our common stock at $16.71 per share. The results of LongMiller are included in our Banking Practice results from date of acquisition.
The unaudited pro forma information below presents our results as if the acquisition of LongMiller had occurred on January 1, 2001.
More detailed financial information relating to LongMiller and pro forma financial information relating to our results if the acquisition had been completed on January 1, 2001, are contained in our Current Report on Form 8-K filed with the SEC on January 29, 2003.
On February 25, 2002, we acquired the Federal Policy Group of PricewaterhouseCoopers LLP. Based in Washington, D.C., Federal Policy Group is a consulting practice representing Fortune 500 companies, trade associations and other businesses before the government on legislative and regulatory policy matters. This acquisition allows us to continue to expand our service offerings to the corporate market. The purchase price was $11.0 million before acquisition costs, consisting of a cash payment at closing of $5.0 million and $6.0 million of contingent payments over the next four years based upon attainment of established performance criteria. If earned, the contingent payments will consist of 70% cash and 30% our common stock. As of September 30, 2002, Federal Policy Group attained its 2002 performance criteria. Accordingly, $1.5 million has been included in accrued liabilities and goodwill on the December 31, 2002 balance sheet. The results of the Federal Policy Group are included in the consolidated results from date of acquisition. With the acquisition of Federal Policy Group, it became our sixth operating segment.
Our evaluation focus is on the quality of the management and future earnings and growth potential of the target company. In several of our acquisitions, we also acquire the financial value embedded in a book of recurring renewal business that is expected to be realized for many years after the acquisition takes place. Up until now, our future renewal revenue stream has been the source of collateral for our acquisition line of credit. As we acquire more businesses that do not have this attribute, this may limit our future borrowing availability. We typically structure a majority of the purchase price in cash. We acquire little in the way of tangible assets, thus creating a substantial amount of intangible assets on our balance sheet. The companies we acquire are typically privately owned and structured as subchapter S corporations with the income taxed directly to the shareholders and the acquisitions are usually effected through a purchase of assets.
On May 16, 2002, we announced the formation of our Human Capital Practice. The new practice includes our existing Rewards and Performance Group and ten former partners ("partners") and 74 support staff from the Human Capital Practice of Arthur Andersen LLP ("Andersen"). Prior to hiring, the partners and Andersen mutually terminated their partnership interest and association with each other free of all restrictive provisions under the Andersen Partnership Agreement and under any agreements relating to the employment with Andersen. We believe any successor liability is mitigated by hiring each new employee in a conventional employer/employee relationship.
On September 25, 2002, we entered into an Administrative Services Agreement and Bonus Forfeiture Agreement with an affiliate of AUSA Holding, Inc., one of our principal stockholders and insurance carrier. During 2002, we received $2.5 million for services rendered prior to and through September 30, 2002 and recognized a total of $3.2 million in 2002, pursuant to this
There have been several recent proposals in various states (e.g., Georgia, Texas, Washington, and California) to change the insurable interest and other state laws governing the ability of an employer to purchase or hold life insurance on the lives of employees. Significant segments of the life insurance industry are engaged in an ongoing, intensive effort to prevent the enactment of state law changes that would have an adverse impact on business-owned life insurance. If one or more states were to adopt proposals limiting the ability of employers to purchase or hold life insurance on the lives of employees, the market for these policies would be reduced and a number of existing policies could be surrendered or exchanged, with a resulting reduction in our revenues from these arrangements.
On January 7, 2003, we entered into two interest rate swaps with a total notional value of $50 million to hedge $50 million of term debt. The terms of these interest rate swaps are as follows:
We lease 16,266 square feet of office space owned by our Chairman and Chief Executive Officer, W. Thomas Wamberg, for approximately $400,000, under a lease expiring on February 21, 2009.
During 2003, we paid Randy Pohlman, a member of our Board of Directors, $40,000 as a referral fee. This amount was accrued in our financial statements as of December 31, 2002.
In 2001, Mr. Wamberg and Richard Chapman, Executive Vice-President of Clark/Bardes, Inc. and President of the Banking Practice, have collectively invested $1 million in a company of which George Dalton, a member of our Board of Directors, is founder and majority shareholder.
On February 25, 2002, we acquired the Federal Policy Group of PricewaterhouseCoopers LLP. The purchase price was $11.0 million before acquisition costs of approximately $28,000, consisting of a cash payment at closing of $5.0 million and $6.0 million of contingent payments over the next four years based upon attainment of established performance criteria.
On September 25, 2002, we entered into an Administrative Services Agreement and Bonus Forfeiture Agreement with an affiliate of AUSA Holding, Inc., one of our principal stockholders. During 2002, we received $2.5 million for services rendered prior to and through September 30, 2002 and recognized a total of $3.2 million in 2002, pursuant to this agreement. Under the terms of this agreement, we expect to continue to receive approximately $2.5 million annually from the carrier for a period of 30 years, depending upon certain conditions. Of this annual amount, $2.0 million is included in the cash flows securitizing the asset-backed notes issued to finance the acquisition of LongMiller, and we will not have access to this cash for general corporate purposes until the securitization notes are fully paid. This revenue, net of amounts provided for chargebacks, are being recognized on a monthly basis beginning in October 2002. The amounts received are subject to chargeback (reimbursement of a portion of amounts received) if any policies under this agreement are surrendered or exchanged. Any chargeback amounts would be deducted from the next scheduled payment.
Our operating results can fluctuate considerably, especially when compared on a consecutive quarterly basis. We can experience large increases in revenue in the first and fourth quarter and operating results may be affected by a number of other factors, including new or enhanced programs and services by us or our competitors and client acceptance or rejection of these programs, program development expenses, competitive, legislative and regulatory changes and general economic conditions. Many of these factors are beyond our control. Sales cycles often take between twelve to eighteen months, with a significant amount of revenue that can come from a few large cases. Our revenue is thus difficult to forecast, and we believe that comparing our consecutive quarterly results of operations is not necessarily meaningful, nor does it indicate what results we will achieve for any subsequent period.
During the fourth quarter of 2002, we completed an analysis of the services provided and timing thereof under our administrative services agreements at our Executive Benefits Practice. As a result of this analysis, we determined that because
As a result, the first three quarters of the year ended December 31, 2002, have been restated from the amounts previously reported to recognize administrative service fees on a straight-line basis and record CBFS revenue in the appropriate period.
Executive Benefits Practice ("EBP") revenue decreased from December 31, 2001 as a result of current economic and legislative conditions which caused clients to delay implementation of new deferred compensation plans. We may continue to experience revenue declines in future periods due to the economy and legislation.
Revenue was $94.2 million for 2001 compared to $47.2 million for 2000. This increase of $47.0 million is primarily attributed to a full year of results in 2001 for Compensation Resource Group (full twelve months in 2001 versus four months in 2000) and strong first quarter 2001 sales. Commission expense as a percentage of revenue increased to 50.6% in 2001 from 43.3% in 2000 due to more sales being generated by senior consultants who are generally paid a higher commission expense. General and administrative expenses increased 83.1% over 2000 primarily due to a full year of expenses in 2001 for Compensation Resource Group. Operating income as a percentage of revenue declined to 12.2% in 2001 from 18.9% in 2000 as a result of the higher commission expense mentioned above and a full year of amortization expense of the goodwill and in-force revenue from the acquisition of Compensation Resource Group.
Total first year commission revenue increased 15.0% to $64.2 million and total revenue increased 26.3% to $116.0 million for the year ended December 31, 2002 compared to the prior year. These increases reflect significant sales growth in the community bank market, and include only limited contribution from the large bank market, which has been more adversely affected by the economy. Approximately $14 million of the increase to renewal revenue is attributable to the acquisition of LongMiller which was completed November 26, 2002. Commission expense for the year ended December 31, 2002 was $45.3 million, or 39.1% of revenue, compared to $33.4 million or 36.3% of revenue in the same period in 2001. Commission expense as a percentage of revenue increased due to the mix of business between independent and employee consultants. General and administrative expenses for the year ended December 31, 2002 were $30.8 million, or 26.6% of revenue, compared to $25.5 million or 27.7% of revenue for the comparable period in 2001, due to the acquisitions of Hilgenberg and LongMiller, and investments in staffing of sales consultants and support staff to service increased sales volumes.
Revenue increased 28.2% in 2001 compared to 2000 primarily due to strong first year sales in the community banking sector. Reduction in the commission expense as percentage of revenue from 38.3% in 2000 to 36.3% in 2001 relates to more sales being generated by employee consultants who have a lower commission structure than independent consultants. General and administrative expense as a percentage of revenue was 27.7% in 2001 and 31.1% in 2000. This has improved as a result of consolidation of the majority of the banking business in Minneapolis, thereby centralizing several administrative functions.
The Healthcare Group acquired Partners First in March 2001 and MSA in July 2001. MSA contributed $4.1 million of revenue and $1.2 million of operating income to the consolidated results of the Healthcare Group in 2001.
The results prior to May 16, 2002 only included the operating results of our Rewards and Performance Group. The former Rewards and Performance Group has a significant concentration of information technology clients and has been adversely affected by weakness in this sector of the economy.
Federal Policy Group was acquired on February 25, 2002. Federal Policy Group is a consulting practice representing Fortune 500 companies, trade associations, and other businesses before Congress, the Treasury Department, and other federal agencies on legislative and regulatory policy matters. Revenue for the year ended December 31, 2002 was $9.5 million with operating income of $4.1 million or 43.0% of revenue. Federal Policy Group continues to experience strong demand for its services as a result of increased legislative activity.
As an active acquirer, our operating results are significantly influenced by the contributions of our acquired businesses. For reporting purposes, we consider the operating results from any business not appearing in four complete quarters as being from acquisitions. After that, they become part of existing business. Non-material acquisitions are not included in the acquisition column. An analysis of our operating results, separating acquisitions from existing business is as follows:
In 2002, approximately 9.5% of gross revenue and 46.3% of operating income were from significant acquisitions (identified parenthetically above) while 3.8% of gross revenue and 8.5% of operating income were from acquisitions in 2001. We do not attribute a great deal of significance to these statistics because an acquisition's contribution to operating performance in any given period is considerably dependent on the timing of the transaction and whether it is considered an acquisition for definition purposes. In addition, the statistics only breakout acquisitions that are considered material to our financial results. Finally, the resources of our existing businesses that are dedicated to our acquisition program could have had an impact on the performance of the existing business had the acquisitions not been made.
In addition to our tangible balance sheet assets and liabilities, we have an on-going non-securitized renewal revenue stream, estimated to be $738.1 million over the next ten years. This on-going renewal revenue stream reflects current conditions and is not necessarily indicative of the revenue that may actually be achieved in the future and we cannot assure you that commissions under these policies will be received. See "Estimated Future Gross Renewal Revenue" below.
The following table represents the estimated gross renewal revenue associated with our in-force business-owned life insurance policies as of December 31, 2002. The projected gross revenue is not adjusted for mortality, lapse or other factors that may impair realization. We cannot assure you that commissions 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 10-year in-force revenues net of commission expense are $516.9 million for the year ended December 31, 2002 as compared to $416.7 at December 31, 2001.
The 10-year in-force revenue net of commission expense are $395.5 million for the year ended December 31, 2002.
As of December 31, 2002, there was restricted cash of approximately $14.1 million which will be used to pay down the asset-backed notes issued to finance the acquisition of LongMiller. This cash is not available for general corporate purposes, but is solely to service securitization indebtedness incurred to finance the acquisition of LongMiller.
The restrictive covenants under the new loan agreement provide for the maintenance of a minimum ratio of fixed charges, a maximum allowable leverage ratio, a minimum amount of net worth (stockholders' equity), and a maximum ratio of debt to capitalization. We were in compliance with all our restrictive covenants as of December 31, 2002. Our restrictive covenants may limit our borrowing ability under our credit line.
The following table provides information about our debt obligations. The table presents principal cash flows and related interest rates by expected maturity dates totaling $418.1 million.
The interest rate on the outstanding term debt and revolver is variable based on current prime or LIBOR rates. The asset-backed notes were issued in November 2002; therefore the carrying value does not differ significantly from its fair value.
In accordance with Emerging Issue Task Force ("EITF") Issue No. 01-14, Income Statement Characterization of Reimbursements Received for "Out-of-Pocket" Expenses Incurred, reimbursements received for out-of-pocket expenses incurred are characterized as revenues and are shown as a separate component of total revenue. Similarly, related reimbursable expenses are also shown separately within operating expenses. EITF Issue No. 01-14 was effective as of January 1, 2002 and all periods presented have been reclassified to reflect the adoption of this accounting pronouncement. The net result of the above is an increase in revenue and operating expense of $5.0 million, $4.8 million and $2.0 million for the years ended December 31, 2002, 2001, and 2000, respectively. These reclassifications had no effect on our operating income.