Effective September 1, 1998, Clark/Bardes acquired substantially all the assets and the business of Schoenke, based in Germantown, Maryland, for a purchase price of $17.0 million in cash and seller-financed notes, plus acquisition related expenses of $98,000. For the period beginning September 1, 1998 to December 31, 1998, the assets acquired from Schoenke generated total revenue of $3.5 million, which represented 4.7% of Clark/Bardes' total revenue for the year ended December 31, 1998.
Effective September 1, 1997, Clark/Bardes acquired substantially all the assets and the business of BCS, a Minnesota based company, for a total purchase price equal to $24.0 million, plus acquisition related expenses of $383,000. BCS generated total revenue of $29.4 million, which represented 39.3% of Clark/Bardes' total revenue for the year ended December 31, 1998.
In addition, the proposed terms contemplate the issuance of options, under employment agreements, to acquire approximately 361,600 shares of Common Stock, at market prices at the time of closing, to certain retained employees of the target companies upon the attainment of stipulated levels of revenue.
These non-binding discussions and the consummation of either acquisition are subject to Clark Bardes' ongoing review of the target companies, the execution of definitive purchase agreements, and the satisfaction of certain conditions, including the approvals of Clark/Bardes' board of directors, the boards of directors of the target companies and the consent of Clark/Bardes lenders, among others. Accordingly, Clark/Bardes can give no assurance that the acquisitions will be completed and, if so, on the terms described above.
In July 1998, Clark/Bardes entered into consulting agreements with four new principals. These principals have assisted Clark/Bardes in building the Clark/Bardes Healthcare Compensation Group. This new division is focused on executive compensation and benefit plans for large and medium-sized non-profit healthcare facilities. All payments under the compensation consulting agreements have been made and expensed as of December 31, 1998.
In September 1998, Clark/Bardes entered into an arrangement with Robert Miller, who formerly led the Minneapolis/St. Paul Financial Institutions Practice for McGladrey & Pullen, LLP, a public accounting firm. Mr. Miller will head Clark/Bardes' newest division, Bank Compensation Consulting, a division of Bank Compensation Strategies. This division will focus on providing comprehensive compensation consulting services exclusively to the banking industry. The Bank Compensation Consulting division was officially "launched" in January 1999.
Clark/Bardes derives its revenue primarily from (i) commissions paid by the insurance companies that underwrite the policies underlying Clark/Bardes' programs and (ii) fees paid by clients in connection with program design and the administrative services provided by Clark/Bardes. Such revenue is usually long term and recurring and is typically paid annually to extend over a period of ten years or more after a sale. Commissions paid by insurance companies vary by policy and by program and are usually based on a
percentage of premium paid or a percentage of the cash surrender value of the insurance policies underlying the program. Commissions paid by insurance companies accounted for approximately 89.7% of Clark/Bardes' total revenue for the year ended December 31, 1998. Fees are paid by clients in consideration for the design and administration of employee benefit plans and the insurance products underlying such plans. The scope of these services and fees payable are negotiated on a client-by-client basis. Fees accounted for approximately 10.3% of Clark/Bardes' total revenue for the year ended December 31, 1998.
Generally, Clark/Bardes recognizes its revenue at the time the insurance premium is paid by the client to the insurance company or the renewal premium is due to the insurance company. Clark/Bardes retains approximately 35% of the gross revenue, with the producer receiving the balance.
- First Year Revenue. First year revenue is recognized at the time the client is contractually committed to purchase the insurance policies and the premiums are paid by the client to the insurance company. First year revenue accounted for approximately 49.3% of Clark/Bardes' total revenue for the year ended December 31, 1998.
Commission and fee expense comprises the portion of the total revenue paid to the producer after deducting the cost of servicing policies and other direct expenses related to sales. Commission and fee expense as a percentage of total revenue was approximately 61.7% for the year ended December 31, 1998.
Clark/Bardes has experienced and expects to continue to experience significant fluctuations in its results of operations, in particular when such results are compared on a consecutive quarterly basis. Management believes these quarterly fluctuations are attributable primarily to revenue variations since operating expenses remain relatively constant throughout the year. Historically, Clark/Bardes recognizes a significant increase in both first year and renewal revenue in the fourth quarter due to the seasonality of program implementation. In general, results of operations may fluctuate as a result of a number of factors, including the introduction of new or enhanced programs and services by Clark/Bardes or its competitors, client acceptance or rejection of new programs and services, program development expenses, timing of significant sales, demand for Clark/Bardes' administrative services, competitive, legislative and regulatory conditions in the insurance-financed employee benefit industry and general economic conditions.
The following table sets forth, with respect to Clark/Bardes for the periods indicated, the percentage of total revenues represented by certain revenue, expense and income items:
Amortization. Amortization expense equaled $433,687 for the three month period ended December 31, 1998, reflecting the full-period amortization of intangible assets capitalized as a result of the BCS and Schoenke acquisition and two months of amortization for the Wiedemann acquisition. Amortization expense was $159,913 for the three month period ended December 31, 1997, which reflects the BCS acquisition only.
Total Revenue. Total revenue increased to $49.5 million for the year ended December 31, 1997 compared to $33.2 million for the year ended December 31, 1996, representing an increase of 48.8%. $8.5 million of total revenue for the year ended December 31, 1997 was associated with the assets acquired from BCS in September 1997. The remaining increase was due to a growth in renewal revenue to $25.4 million ($24.1 million excluding BCS) in 1997 from $23.6 million in 1996, and was also attributable to an increase in first year sales. The increase in total revenue was accomplished despite a decrease in the renewal revenue on Leveraged COLI business to $6.1 million for the year ended December 31, 1997 from $9.7 million for the year ended December 31, 1996.
Commission and Fee Expense. Commission and fee expense increased to $32.4 million for the year ended December 31, 1997 compared to $21.0 million for the year ended December 31, 1996, representing an increase of 54.1%. Commission and fee expense as a percentage of total revenue increased to 65.6% for the year ended December 31, 1997 as compared to 63.3% for the year ended December 31, 1996. Of the $11.4 million increase in commission and fee expense, $6.0 million was attributable to the BCS acquisition.
General and Administrative Expense. General and administrative expense increased to $11.5 million for the year ended December 31, 1997 compared to $8.6 million for the year ended December 31, 1996, representing an increase of 34.5%. General and administrative expense as a percent of total revenue was 23.3% for the year ended December 31, 1997 compared to 25.7% for the year ended December 31, 1996. The improvement in general and administrative expense as a percentage of total revenue was a result of the BCS acquisition.
Income from Operations. Income from operations increased to $5.2 million for the year ended December 31, 1997 compared to $3.6 million for the year ended December 31, 1996, representing an increase of 43.3%. The increase was attributable primarily to the income from BCS. Operating Margin decreased slightly to 10.5% for the year ended December 31, 1997 from 10.9% for the year ended December 31, 1996. This decrease in operating margin was due to amortization expense of $295,000 incurred as a result of the BCS acquisition.
Other Expense -- Net. Other income and expense for the year ended December 31, 1997 was $923,000 compared to other income of $121,000 for the year ended December 31, 1996. The amount for the year ended December 31, 1997 included interest expense of $1.1 million. There was no interest expense for the year ended December 31, 1996. The increase in interest expense was attributable to the incurrence of debt associated with the repurchase of shares of common stock of the Clark/Bardes throughout the year and the BCS acquisition in September 1997.
Net Income. Net income increased to $4.2 million for the year ended December 31, 1997 compared to $3.6 million for the year ended December 31, 1996, representing an increase of 19.1%, reflecting the factors
Credit Facilities. As of December 31, 1998, Clark/Bardes owed an aggregate of $29.1 million under outstanding debt obligations. Of this amount, $4.3 million is due within the next twelve months. Since January 1, 1998, cash flow from operations was more than sufficient to cover scheduled principal and interest payments on existing indebtedness as well as Clark/Bardes' working capital requirements.
As Clark/Bardes' business grows, its working capital and capital expenditures will also continue to increase. Management believes that net cash flows from operations will be sufficient to finance Clark/Bardes' required debt payments, working capital needs and capital expenditures for the next twelve months. There can be no assurance, however, that the net cash flows from operations will be sufficient to meet Clark/Bardes' anticipated requirements or that Clark/Bardes will not require additional debt or equity financing within this time frame.
In February 1997, the FASB issued SFAS No. 128, "Earnings per Share." SFAS No. 128 specifies the computation, presentation and disclosure requirements for earnings per share for entities with publicly-held common stock. SFAS No. 128 is effective for financial statements for both interim and annual periods ending after December 15, 1997 and has been adopted by Clark/Bardes and is presented in the accompanying financial statements.
As of January 1, 1998, Clark/Bardes adopted SFAS No. 130 "Reporting Comprehensive Income." SFAS No. 130 establishes new rules for the reporting and display of comprehensive income and its components. The adoption of this Statement had no impact on Clark/Bardes' net income or shareholders' equity. Clark/Bardes has no other comprehensive income as defined by SFAS No. 130 as of December 31, 1997 or December 31, 1998.
In February 1999, the Clinton administration proposed eliminating the "employee, officer and director" exception to the interest disallowance rule as a part of its budget proposal. If enacted, such proposal would significantly reduce the attractiveness of business-owned life insurance to companies that traditionally have high debt/equity ratios. Banks, due to the depositor/debtor relationship with their depositors, would in particular be negatively affected by the administration's proposal. To the extent that any tax law amendment is made retroactive, banks and other clients of Clark/Bardes may lose the economic advantages of maintaining the policies underlying their benefit plans. This could result in significant surrenders of policies from which Clark/Bardes currently derives commission and fee revenue. Although management believes that the Clinton administration's proposal, which is being considered in the current session of Congress, does not have widespread support in Congress, Clark/Bardes is unable to predict the extent to which these or other amendments to existing laws will be adopted or the effect that any such amendments will have on Clark/ Bardes' business.
No assurances can be given that the administration's proposal or other adverse tax proposals will not be enacted in the future or that adverse interpretations of existing laws will not occur in the future. If the Internal Revenue Code were to be amended to eliminate or reduce the tax-deferred status of the insurance programs marketed by Clark/Bardes, or if adverse interpretations of existing laws occur in the future, the market demand for such programs would be materially adversely affected.
Companies purchase business-owned life insurance policies primarily to offset the costs of employee benefit liabilities. These policies usually show high persistency rates, in part because the policies contain early penalties and the tax laws typically impose unfavorable tax consequences to the corporate policyholders if the policies are terminated early. The high persistency rates are also due to the purpose of the underlying life insurance policies that are not typically used to fund benefits for specific individuals, but rather to offset the purchaser's employee benefit costs on an aggregate basis. Therefore, each policy is usually held to maturity (i.e., the death of the individual insured covered by such policy), regardless of whether the insured remains employed by the plan sponsor. High persistency rates are advantageous since Clark/Bardes receives a substantial portion of its revenue in the form of renewal commissions and fees. If the business purchaser chooses to let a policy lapse, Clark/Bardes does not receive any renewal commissions and fees for insurance policy servicing after the policy lapses. Although Clark/Bardes has historically experienced high persistency rates, there can be no assurance that these high persistency rates will continue in the future.
Clark/Bardes' performance is substantially dependent on the performance of its executive officers and key employees. Clark/Bardes is dependent on the ability to retain and motivate high quality personnel, especially its management, producers and program development teams. The loss of the services of any of its key employees, particularly W.T. Wamberg, Chairman of the Board of Directors, Melvin G. Todd, President and Chief Executive Officer, and Richard C. Chapman, Executive Vice President, could have a material
adverse effect on Clark/Bardes' business, financial condition and operating results. There can be no assurance that Clark/Bardes will be successful in retaining its key personnel.
Clark/Bardes designs and markets employee benefit programs typically financed by policies underwritten by insurance companies. The commissions payable for the sale of the insurance policies underlying Clark/ Bardes' programs are usually long term and recurring in nature, typically paid annually and extending over a period of ten years or more after the sale. Since Clark/Bardes derives a substantial portion of its total revenue from renewal revenue, any financial difficulties encountered by, or the insolvency of, an insurance company from whom renewal revenue is due could cause Clark/Bardes to realize less than the full amount of the renewal revenue to which it is entitled. Clark/Bardes' inability to collect renewal revenue could have a material adverse effect on its business, financial condition and results of operations.
Since November 1997, Clark/Bardes has completed three acquisitions, is actively considering two more acquisitions and has a number of potential acquisitions under consideration at any point in time. Future acquisitions may require substantial financial expenditures which will need to be financed through cash from operations as well as future debt and equity offerings by Clark/Bardes. An acquisition may not produce the revenue, earnings or business that Clark/Bardes anticipated and which is paid for. Furthermore, there can be no assurance that a business acquired in the future will even achieve acceptable levels of revenue and profitability. Accordingly, acquisition efforts may not succeed, and the time capital and management and other resources spent on an acquisition that fails to meet Clark/Bardes' expectations could cause Clark/Bardes' business, results of operations and financial condition to be materially affected. In addition, acquisitions involve numerous other risks, including: (i) the diversion of management's time and attention to the negotiation of the acquisition and to the assimilation of the businesses acquired, (ii) the need to modify financial and other systems and add management resources, (iii) the potential liabilities of the acquired businesses, (iv) unforeseen difficulties in the acquired operations, and (v) the possible adverse short-term effects on Clark/Bardes' business, financial condition and results of operations.
All of these amounts having been determined by the excess of the purchase price (including acquisition costs) over the net tangible assets acquired. The amounts allocated to inforce revenue is determined using the discounted cash flow of inforce revenues adjusted for expected persistency, mortality and associated costs. The balance of the excess purchase price over the net tangible assets is allocated to goodwill. The inforce revenue is amortized over a period of anticipated benefit normally thirty years. There are a number of factors determining the persistency of such inforce business all of which are beyond Clark/Bardes' control and there can be no assurance that the values so allocated will ultimately be realized.
Clark/Bardes has adopted SFAS No. 121 "Accounting for Impairment of Long Lived Assets and Long Lived Assets To Be Disposed Of." Under SFAS No. 121 Clark/Bardes will periodically (at least annually) review the components of this asset and make the appropriate adjustment if it becomes apparent that the residual present value is less than its amortized carrying amount. In 1998, the FASB announced a study of the
CLARK/BARDES' INABILITY TO GROW AND EXPAND PRODUCTS AND SERVICES COULD ADVERSELY IMPACT FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Clark/Bardes' growth strategy relies in part on its ability to increase its share of the insurance-financed employee benefit market. Clark/Bardes intends to increase its market share by (i) growing its client base in existing product lines through superior sales, marketing, technology and administration, (ii) developing new related products and services and (iii) acquiring competitors and related businesses. There can be no assurance that Clark/Bardes will have the financial, managerial, administrative, marketing or other resources necessary to achieve these growth and acquisition objectives and to overcome difficulties associated with growth. If Clark/Bardes were to encounter difficulties in implementing the growth, development or expansion of its products and services, such difficulties could have a material adverse effect on Clark/Bardes' business, financial condition and results of operations.
In addition, the success of Clark/Bardes depends in large part on its ability to attract and retain highly skilled managerial, sales and marketing personnel. Clark/Bardes also believes it will need to hire additional technical personnel to further enhance and develop its programs and services. Competition for such personnel is intense, and should Clark/Bardes be unable to hire the necessary personnel, the development and sale of new or enhanced programs and services would likely be delayed or prevented. There can be no assurance that Clark/Bardes will be able to attract, integrate and retain such highly skilled personnel. If any component of the inforce revenue base should become unrealizable or the accounting regulatory bodies impose shorter amortization periods, Clark/Bardes' financial positions and future operating results could be materially adversely affected.
The marketing, design and administration of insurance-financed employee benefit programs is highly competitive. Clark/Bardes and its producers compete with a large number of insurance agents, life insurance brokers, third party administrators, producer groups and insurance companies, a number of whom have greater financial resources and can offer alternative programs. Clark/Bardes' direct competitors include Compensation Resource Group, Harris Crouch Long Scott and Miller, Management Compensation Group, Newport Group, TBG Financial and The Todd Organization. Furthermore, competition exists for producers and other marketers of life insurance products who have demonstrated sales ability. National banks, with their existing depositor bases for financial service products, may pose increasing competition in the future to companies who sell life insurance products, including Clark/Bardes. Recent United States Supreme Court decisions have expanded the authority of national banks to sell life insurance products.
approximately fourteen life insurance companies to underwrite substantially all of the business-owned life insurance policies underlying Clark/Bardes' programs of which nine insurance companies, General American, Great-West, Life Investors, Nationwide, Transamerica, The Mutual Group, Alexander Hamilton, Jefferson Pilot and West Coast Life, accounted for approximately 76.4% of Clark/Bardes' first year commission revenue for the year ended December 31, 1998. There is no assurance that these relationships will continue in the future or that Clark/Bardes will be able to develop relationships with other insurance companies.
ERRORS AND OMISSIONS IN THE SERVICES IT PROVIDES MAY SUBJECT CLARK/BARDES TO DAMAGES
Clark/Bardes markets, designs and administers sophisticated financial products. Certain of Clark/Bardes' employees provide financial, actuarial and other professional services in connection with marketing, designing and administering these programs. Clark/Bardes' clients rely upon the services and interpretations rendered by its employees. To the extent any services or interpretations provided by Clark/Bardes' employees prove to be inaccurate, Clark/Bardes may be liable for the damages, and such liability, to the extent not covered by existing insurance, could have a material adverse effect on Clark/Bardes' business, financial condition and results of operations.
PROTECTION OF PROPRIETARY PROGRAMS AND SERVICES MAY BE INADEQUATE TO PREVENT LEAKS OR THEIR USE BY OTHERS
Clark/Bardes regards certain of its programs and services as proprietary and relies primarily on a combination of intellectual property laws, confidentiality agreements and contractual provisions to protect its proprietary rights. Trade secret and copyright laws afford limited protection. Despite Clark/Bardes' efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the programs or services marketed by Clark/Bardes or to obtain and use information that Clark/Bardes regards as proprietary. There can be no assurance that the obligation to maintain the confidentiality of Clark/Bardes' proprietary information will prevent disclosure of such information or that the proprietary programs marketed by Clark/ Bardes will not be independently developed by competitors.
The insurance-financed employee benefit market is subject to extensive regulation by state governments. Clark/Bardes products are sold in all 50 states through licenses held by Clark/Bardes or by its producers. In addition, Clark/Bardes markets its insurance-financed employee benefit programs in the states of Ohio, Pennsylvania and Texas through entities licensed in those states for which Clark/Bardes provides almost all services by means of administrative service agreements. In general, state insurance laws establish supervisory agencies with broad administrative and supervisory powers related to such matters as granting and revoking licenses, approving individuals and entities to whom commissions can be paid, licensing insurance agents, transacting business, approving policy forms and regulating premium rates for some lines of business. Licensing laws applicable to insurance marketing activities and the receipt of commissions vary by jurisdiction and are subject to interpretation as to the application of such requirements to specific activities or transactions. While Clark/Bardes has not encountered regulatory problems in the past, no assurance can be given that Clark/Bardes would be deemed to be in compliance with all applicable licensing requirements of each jurisdiction in which Clark/Bardes operates or that additional licenses would not be required of Clark/Bardes or that Clark/Bardes or its producers will not encounter regulatory problems in the future, including any potential sanctions or penalties for operating in a jurisdiction without all required licenses.
FLUCTUATIONS IN OPERATING RESULTS MAKE CLARK/BARDES REVENUE AND OPERATING RESULTS DIFFICULT TO ANALYZE AND FORECAST
There is significant uncertainty regarding the potential costs and effects of the year 2000 problem because computer systems that do not properly recognize date sensitive information when the year changes to 2000 could generate erroneous data or altogether fail. Based on previous and ongoing internal reviews, Clark/Bardes
CLARK/BARDES' RELATIONSHIP WITH W. T. WAMBERG COULD PRESENT CONFLICTS OF INTEREST
CBI has a contractual relationship with Mr. Wamberg, the Chairman of the Board of CBH and CBI under a Principal Office Agreement pursuant to which The Wamberg Organization markets, on behalf of Clark/Bardes, life insurance and administrative and consulting services, and Clark/Bardes furnishes to The Wamberg Organization marketing materials and concepts, program design ideas, selected life insurance products, specimen plan documents and administrative services. The Wamberg Organization, which is controlled by Mr. Wamberg, accounted for approximately 17.5% of Clark/Bardes' total revenue in 1998. Pursuant to the terms of the Principal Office Agreement, Clark/Bardes paid approximately $7.8 million and $8.1 million to The Wamberg Organization in 1997 and 1998, respectively, for commissions and fees earned. In July 1998, Clark/Bardes, Mr. Wamberg and The Wamberg Organization entered into an agreement that provides for, among other things, a purchase of the renewal revenues due to Mr. Wamberg and The Wamberg Organization in exchange for a cash payment of approximately $7.5 million. In addition, Clark/Bardes reimbursed Mr. Wamberg up to an aggregate of $100,000 per calendar year for expenses incurred by Mr. Wamberg in his capacity as the Chairman of each of CBH and Clark/Bardes. The interests of Clark/ Bardes, on the one hand, and Mr. Wamberg and The Wamberg Organization, on the other hand, may differ with respect to contractual agreements or other transactions between Clark/Bardes and Mr. Wamberg and The Wamberg Organization resulting in certain conflicts of interest of Mr. Wamberg.
be approved by a majority of the Board of Directors and, in certain cases, thereafter must be approved by a vote of holders of at least 66 2/3% of the total votes eligible to be cast by holders of Common Stock. The bylaws may be amended or repealed by the affirmative vote of a majority of the directors or the affirmative vote of the holders of at least 66 2/3% of the votes eligible to be cast by holders of Common Stock with respect to such amendment or repeal. In addition, the Delaware General Corporation Law restricts certain business combinations and provides that directors serving on staggered boards of directors may be removed only for cause unless the certificate of incorporation otherwise provides. Finally, the bylaws provide that directors can be removed only for cause by a vote of holders of at least 66 2/3% of the total votes eligible to be cast by holders of Common Stock.
The Financial Statements of Clark/Bardes appear beginning on page of this Form 10-K.