The following historical information should be read in conjunction with information included elsewhere herein, including the consolidated financial statements and notes thereto and "
A significant portion of our growth has been acquisition related. Business-owned life insurance programs have tax advantages associated with products that are attractive to our clients. A portion of our product offering is interest rate sensitive. Changes in tax and legislative laws can have an affect on our business, as seen over the last several years with our Executive Benefits Practice. We have been expanding our compensation consulting practices to diversify our product offerings. The largest component of our general and administrative expense is salary and other benefit related costs.
Consulting fee revenue. Consulting fee revenue consists of fees charged by Human Capital Practice, Pearl Meyer & Partners, 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 or a fixed monthly fee and are earned when the service is rendered. 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.
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.
We record revenue on a gross basis when we are the primary obligors in the arrangement or when we bear the credit risk in the arrangement. We record revenue on a net basis when another party is the primary obligor in the arrangement or when another party bears the credit risk.
Intangible assets represent the excess of the costs of acquired businesses over the fair values of the tangible net assets associated with an acquisition. Intangible assets consist of the net present value of future cash flows from policies inforce at the acquisition date, non-compete agreements with the former owners, other identifiable intangibles, and goodwill. Non-compete agreements are amortized over the period of the agreements and other identifiable intangibles are amortized over their useful lives.
The net present value of inforce revenue is typically amortized between 20 and 30 years (the expected average policy duration). The determination of the amortization schedule involves making certain assumptions related to persistency, expenses, and discount rates that are used in the calculation of the carrying value of inforce revenue. If any of these assumptions change or actual experience differs materially from the assumptions used, it could affect the carrying value of the inforce revenue.
Financial Statement Overview. Our revenue for the year ended December 31, 2003 was $325.9 million, compared to $278.6 million for the year ended December 31, 2002, an increase of 17.0%. Our net income for 2003 was $12.7 million, compared to $17.3 million (net of the effect of a change in accounting principle of $523 thousand, net of tax, from the adoption of SFAS No. 142) for the year ended December 31, 2002, a decrease of 26.8% over 2002. Diluted earnings per share for 2003 were $0.68, compared to $0.99 for 2002. The diluted weighted average number of shares outstanding increased to 18.7 million for the year ended December 31, 2003, compared to 17.5 million for the year ended December 31, 2002.
Revenue. Total revenue for the year ended December 31, 2003 was $325.9 million compared to $278.6 million for the year ended December 31, 2002. First year revenue (which includes consulting and reimbursable expense revenue) increased $3.3 million, or 2.0%, in 2003 compared to 2002. Renewal and other recurring revenues were $158.5 million in 2003, up $44.1 million, or 38.5%, from 2002, reflecting a full year of renewals from the November 2002 LongMiller acquisition. First year commission revenue for 2003 included $3.5 million related to agreements with two of our insurance carriers in which we received additional payments and revenue based on the cash value of our existing inforce revenue with these carriers. The length of one of the contracts is five and one half years and the other contract is one year. The contracts automatically renew at the end of each term unless notice is given by one of the parties. These agreements generated $775 thousand per quarter starting in the fourth quarter of 2003 for the Banking Practice and increasing to $1.1 million per quarter starting in the third quarter of 2004, of which, $875 thousand is for the Banking Practice and $200 thousand is for the Executive Benefits Practice. First year commission revenue in 2002 included $3.1 million related to an agreement with another insurance carrier, which was executed in 2002. Under the thirty-year agreement, renewal revenues have also been affected each quarter since execution of the agreement with approximately $2.5 million of revenue reflected in the year ended December 31, 2003. The expected revenue streams are based on our existing inforce business with these carriers, and would be negatively impacted by potential future surrenders of the inforce business or non-renewal of the agreements and positively impacted by asset growth of our business with these carriers.
Income taxes. Income taxes for the year ended December 31, 2003 were $8.1 million, at an effective tax rate of 38.9%, compared to $12.4 million at an effective tax rate of 41.0% for the year ended December 31, 2002. The effective tax rate for the year ended December 31, 2003 reflects $283 thousand of net state tax refunds relating to prior years. The decrease in the effective tax rate is primarily related to the true up of the estimated 2002 state tax liability. We expect a normalized effective income tax rate of approximately 40% in future periods.
Commission expense. Commission and fee expense was $90.0 million, or 32.3% of total revenue, for the year ended December 31, 2002, versus $84.0 million, or 35.5% of total revenue, for the year ended December 31, 2001. This reduction in the percentage of commission expense as a percentage of revenue reflects an increased proportion of revenue from fee-based consulting activity in 2002 as well as an increase in the percentage of revenue generated from employee consultants. We expect the acquisition of LongMiller to result in a greater percentage of commission expense as a percentage of revenue in the future. Fee-based consulting activity accounted for 11.6% of 2002 revenue compared to 8.3% of 2001 revenue. Included in commission expense is $474 thousand of non-cash expense recognized in 2002 from performance-based stock options issued to non-employee producers. Such expenses may be incurred in the future if certain non-employee producers achieve specified targets.
General and administrative expense. General and administrative expense for the year ended December 31, 2002 was $140.6 million, or 50.5% of total revenue, compared to $102.9 million, or 43.4% of total revenue, for the year ended December 31, 2001. The increase is attributed to the expanded staffing of sales consultants and support services company-wide and expenses associated with recent acquisitions. General and administrative expenses in 2002 include $13.3 million of general and administrative expense, which includes approximately $825 thousand of severance costs associated with not pursuing the International Employment Solutions practice, for Human Capital Practice since May 2002. In addition, general and administrative expense includes $550 thousand of severance costs related to reorganization initiatives in the Healthcare Group that occurred in second quarter 2002.
Amortization. Amortization expense for the year ended December 31, 2002 was $9.2 million, compared to $11.6 million in the prior year period. The reduction in amortization expense resulted from the January 2002 adoption of SFAS No. 142, which eliminated the amortization of goodwill, offset by amortization related to identifiable intangibles through acquisitions in 2002. For the year ended December 31, 2001, amortization expense included $4.0 million pre-tax attributed to goodwill amortization. The acquisition of LongMiller added approximately $14.0 million of amortization expense in 2003, as a result of a full year's of amortization of the net present value of inforce revenue and non-compete agreements. We acquired approximately $400 million of inforce revenue with our November 2002 acquisition of LongMiller and the 2002 results include one month of amortization related to this intangible asset.
Interest expense. Interest expense for the year ended December 31, 2002 was $4.1 million compared to $7.7 million in 2001. In 2001, we recorded interest expense of approximately $2.0 million as a result of 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.
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 federal tax return during the third quarter 2001 which reduced the overall tax rate.
Our acquisition criteria focuses on the quality of the management, future earnings and the strategic fit with our company, as well as the 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 line of credit, which we frequently use for acquisitions. 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 frequently privately owned and structured as subchapter S corporations and the acquisitions are usually effected through a purchase of assets with the income taxed directly to the stockholders.
In the fourth quarter of 2003, we reorganized our executive compensation consulting practices. As part of the reorganization, some of the operations and employees of the Human Capital Practice were transferred to the Pearl Meyer & Partners practice. In addition, four partners and six staff members were terminated which resulted in exiting certain activities of the practice and creating unused leased office space in numerous cities. We recorded a charge of $7.5 million in the fourth quarter of 2003 relating to the reorganization of which $7.1 million remains on the consolidated balance sheet as of December 31, 2003.
During the third quarter of 2003, we completed agreements with two of our insurance carriers, which will generate additional revenue on our existing blocks of business with these carriers. The length of one of the contracts is five and one half years and the other contract is one year. The contracts automatically renew at the end of each term unless notice is given by one of the parties. The agreements resulted in revenue of $2.7 million in the third quarter 2003, and $775 thousand in the fourth quarter 2003, and provide for additional payments upon certain conditions and measurement dates. The future payment amounts are based on the cash value (or fair value) of our existing inforce business with these carriers at specified dates of measurement and are projected at approximately $3.7 million per year. Future payment amounts would be negatively impacted by potential future surrenders of the inforce business or non-renewal of the agreements and positively impacted by asset growth of these contracts.
In recent years, the Internal Revenue Service ("IRS") has undertaken a major enforcement initiative to disallow the interest deductions on certain leveraged business-owned life insurance programs sold during or prior to 1995. The IRS has prevailed on the cases it has litigated to date related to this initiative and recently made a temporary (now expired) public settlement offer to address ongoing cases. While we stopped selling leveraged business-owned life insurance programs after 1995 and we do not expect any material adverse impact on our revenue from this enforcement initiative, it is impossible to determine the impact of this initiative on a client's decision to continue or surrender an existing leveraged business-owned life insurance program.
There have been several recent proposals in various states (e.g., Georgia, Texas, and Washington) 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. California has recently enacted legislation prohibiting the purchase of business-owned life insurance on the lives of employees not exempt from wage and hour laws (a group of employees not typically insured under the arrangements we market). 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 broadly 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.
The acquisitions of Comiskey Kaufman, Inc. (acquired April 2002) and Lyons Compensation and Benefits, LLC (acquired August 2001) contributed approximately $4.7 million to the year ended December 31, 2002, revenue and $200 thousand of operating income. 2002 renewal revenue increased due to higher than anticipated premium payments on inforce business and additional renewals from 2001 new business. General and administrative expense increased for the year ended December 31, 2002 over 2001 due to the acquisitions mentioned above and additional hirings. Amortization expense decreased in 2002 when compared to 2001 primarily due to the elimination of goodwill amortization as of January 1, 2002. Goodwill amortization for Executive Benefits Practice in 2001 was approximately $759 thousand.
Healthcare Group revenues were slightly (4.8)% lower for the year ended December 31, 2003, compared to the prior year. Healthcare's 2002 performance was strong and the current Healthcare environment has been challenging especially for revenues in the areas of labor services, rank and file compensation, and physician services. For the year ended December 31, 2003, commission and general and administrative expenses include approximately $435 thousand and $335 thousand, respectively, for costs associated with a severance agreement. General and administrative expense for the year ended December 31, 2002, included one time charges of $729 thousand for write off of leasehold improvements from a previous office space and severance associated with the downsizing of existing staff levels.
Total revenue increased 37.7% for the year ended December 31, 2002 compared to 2001. Revenue was favorably impacted by the acquisition of Management Science Associates ("MSA"), as it was included for the full year 2002, compared to six months for 2001, and continued focus on marketing efforts of the managing directors. Consulting fees included in first year revenues also increased considerably during the period. Revenue from increased fees for providing recordkeeping services (included in renewal commission and related fees) contributed $632 thousand to revenue for the year ended December 31, 2002. Reimbursable expenses revenue increased from the year ended December 31, 2001, as MSA is included for the entire year of 2002 compared to six months for 2001. Commission expense as a percent of revenue decreased to 10.7% of revenue for the year ended December 31, 2002, as compared to 10.9% of revenue in the year ended December 31, 2001, reflecting the increase in administration and recordkeeping fees, in which no commissions are paid to consultants. General and administrative expenses increased 15.1% over 2001, primarily due to a full year of expenses in 2002 for MSA. Severance expense of approximately $550 thousand was incurred during the year associated with the downsizing of existing staff levels of the Healthcare Group. Operating income for the year ended December 31, 2002 was $4.8 million, the highest in any period since acquiring the Healthcare Group, which is a result of the factors discussed above.
operations of the Human Capital Practice to Pearl Meyer & Partners. As a result, all years presented have been reclassified to reflect this transfer. The Human Capital Practice results continue to be negatively affected by the economic climate for consulting services and the inability of the former Andersen employees to retain their Andersen client base or to develop and sell into new relationships.
legislative and regulatory matters. Results for the year ended December 31, 2003 included approximately $1.6 million of revenue and approximately $538 thousand of operating income related to the four new employees hired during the second quarter of 2003. Federal Policy Group experienced strong demand for its services and benefited from a $2.8 million success fee recorded and collected during the first quarter of 2003. Revenue for the year ended December 31, 2002 (10 months activity) was $9.5 million, generating operating income of $4.1 million, or 43.0% of revenue.
Our cash flow from operating activities for the twelve months ended December 31, 2003, 2002, and 2001 were as follows:
The non-cash expenses mentioned above include depreciation of equipment and leasehold improvements, amortization of intangibles, charges for performance-based stock options issued to non-employee producers, and deferred tax expense. Cash provided by changes in operating assets and liabilities included a reduction of accounts receivable $(18.0 million) primarily as a result of lower fourth quarter 2003 revenues than fourth quarter 2002 and improved collection efforts, and an increase in non current liabilities $(6.8 million) primarily as a result of the fourth quarter 2003 Human Capital Practice restructuring charge.
Non-securitized Gross Inforce Revenues. The following table represents the estimated gross inforce revenue associated with business-owned life insurance policies owned by our clients as of December 31, 2003, not including estimated securitized inforce revenues, which are set forth in a separate table.
The 10-year inforce revenues net of commission expense are $612.6 million for the year ended December 31, 2003, as compared to $ 516.9 at December 31, 2002.
The following table represents the estimated gross renewal revenue associated with our securitized inforce bank-owned life insurance policies as of December 31, 2003. These revenue streams are restricted for the specific purpose of paying off our asset-backed notes, which were issued in connection with the acquisition of LongMiller in November 2002.
During the year ended December 31, 2003, $9.2 million was used for acquisitions and $4.4 million was used for purchases of equipment.
On May 23, 2003, we received proceeds of approximately $14.5 million from our participation in a pooled trust preferred transaction, in which we issued $15.0 million aggregate principal amount of long-term subordinated debt securities with a floating rate based on three month LIBOR plus a spread of 420 basis points (5.37% as of December 31, 2003). We used the net proceeds to pay down the term portion of our credit facility. The pooled trust preferred debt is payable in one payment due in 30 years with interest paid quarterly.
In November 2003, we amended and restated our December 28, 1999 Credit Agreement, revising the amount available under the credit facility to $80.0 million. In December 2003, a new participant bank was added to the facility increasing the facility amount to $90 million. At December 31, 2002, we converted $50 million of the outstanding balance under the revolving credit facility to term debt. The term debt is being paid quarterly over five years under the facility agreement. We had $59.1 million available under our credit line at December 31, 2003. Our restrictive covenants may limit our borrowing ability under our credit line.
The restrictive covenants under the credit 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 restrictive covenants as of December 31, 2003.
We do not have any material off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures, or capital resources. Set forth below is a summary presentation of our contractual obligations as of December 31, 2003, which are expected to become due and payable during the periods specified.
We expect to make significant cash outlays in future years for interest, taxes and deferred compensation arrangements. However, due to their variable nature, no amounts for these items have been included in the table above.