As of December 31, 2005, we operated in the following leased offices throughout the United States:
In 2005, we received $1.6 million of net life insurance proceeds following the death of an executive in the Healthcare Group.
We design, market, and administer compensation and benefit programs for companies supplementing and securing employee benefits and provide executive compensation and related consulting services to U.S. corporations, banks, and healthcare organizations. A majority of our revenues result from commissions paid by insurance companies that underwrite the insurance policies used to finance our clients’ benefit programs. Most of our clients’ benefit programs are financed by business-owned life insurance and other financial products. We pay commissions to employees and independent producers based upon a percentage of our commission revenue. We work closely with clients to design customized products that meet the specific organizational needs of the client and with insurance companies to develop unique policy features and competitive pricing.
A significant portion of our growth has been acquisition related. Business-owned life insurance programs have tax advantages associated with the products that are attractive to our clients. A portion of our product offerings are interest rate sensitive. Changes in tax and legislative laws can have an affect on our business. We have been expanding our compensation consulting practices to diversify our product offerings. The largest component of our general and administrative expenses is salary and other employee related costs.
On January 27, 2006, we announced the formation of Clark Benson, LLC (“Clark Benson”), a limited liability company and a subsidiary of Clark Consulting, Inc. Clark Benson will concentrate on financial planning, wealth transfer, and employee benefits and will be headed by James M. Benson. Mr. Benson has a 25% ownership stake in Clark Benson and acquisition and working capital will be provided by Clark Consulting. Our intention is that Clark Benson will pursue its business plan through a combination of acquisitions of, or affiliations with, existing entities engaged in this type of business. While it is not possible to predict how many acquisitions or affiliations Clark Benson will complete in 2006 that will generate revenue, it is expected that 2006 start up costs of $2 million to $3 million will be incurred.
On February 27, 2006, we amended a supplemental compensation agreement with one of our insurance carriers. The contract has been extended from September 30, 2008 through September 30, 2011. In exchange for a longer term arrangement, the percentage used to calculate future payments based on our inforce block of business was reduced. We expect that revenue based on our inforce block of business will be approximately $1 million less in 2006 when compared to 2005. However, there are additional opportunities to earn revenue should we meet certain production targets for new business.
commissions and other compensation paid by insurance companies issuing the policies underlying our client’s benefit programs;
Our commission revenue is typically recurring, paid annually, and extends for a period of twenty years or more after the sale. Commissions are paid by insurance companies and vary by policy and by program and represent percentage of the premium or the cash surrender value of the insurance policies underlying the program.
First Year Commissions and Consulting Fees. First year commissions and consulting fees are derived from three principal sources: (a) the commission we earn when the client first purchases the policies, which 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 (which is the effective date of the insurance policy) by the client, to the insurance company or, in certain instances, when cash is received; (b) fees for the services related to the enrollment and initial administration of the benefit programs and underlying policies; and (c) consulting fees.
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:
Our intangible assets represent the excess costs of acquired businesses over the fair values of the tangible net assets associated with an acquisition. Our 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 all other identifiable intangibles are amortized over their useful lives.
Significant judgement is required in determining the provision for income taxes and related accruals, deferred tax assets and liabilities, and any valuation allowance recorded against the deferred tax assets. In the ordinary course of business, there are transactions and calculations where the ultimate tax outcome is uncertain. Additionally, our tax returns are subject to audit by federal and various state authorities. Although we believe our estimates are reasonable, no assurance can be given that the final tax outcome will not be materially different from that which is reflected in our historical income tax provisions and accruals. In assessing the realizability of deferred tax assets, we consider the likelihood that some portion or all of the deferred tax assets may not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.
We make provisions for restructuring costs in accordance with SFAS No.146, Accounting for Costs Associated with Exit or Disposal Activities. To determine the amounts expensed in any period, we estimate the amounts we will receive in the future for subleasing office space that is no longer required for our existing operations. Should these estimates not reflect actual results in future periods, we adjust the provision through the income statement.
Year ended December 31, 2005 compared to year ended December 31,
Financial Statement Overview. Our revenue for the year ended December 31, 2005 was $273.8 million, compared to $315.6 million for the year ended December 31, 2004, a decrease of 13.2%. Our net income for 2005 was $10.6 million, compared to $18.2 million in 2004. Diluted earnings per share for 2005 were $0.58, compared to $0.97 for 2004.
Commission and fee expense. Commission and fee expense for the year ended December 31, 2005 was $53.0 million, or 19.4% of total revenue, compared to $74.3 million, or 23.5% of total revenue, for the year ended December 31, 2004. The percentage paid in commission expense declined primarily due to an increasing percentage of sales by employee consultants who have a lower commission rate than independent producers and the mix of revenues. Renewal revenues generally have lower commissions than first year revenues. In addition, supplemental compensation arrangements and consulting revenues typically have no related commission expense.
Amortization. Amortization expense decreased approximately $2.8 million to $15.4 million for the year ended December 31, 2005, from $18.2 million for the year ended December 31, 2004. The decline is based on the scheduled timing of amortization of our inforce revenue streams purchased in acquisitions.
Interest expense. Interest expense for the year ended December 31, 2005 was $22.0 million compared to $22.3 million for the year ended December 31, 2004. The decrease relates to lower borrowing levels in 2005 compared to 2004 partially offset by higher interest rates.
Amortization. Amortization expense decreased approximately $3.4 million to $18.2 million for the year ended December 31, 2004, from $21.6 million for the year ended December 31, 2003. For year ended December 31, 2003, there were costs of approximately $550 thousand relating to an adjustment to the purchase accounting for the LongMiller acquisition. The remaining decline is based on the scheduled timing of amortization of our inforce revenue streams purchased in acquisitions.
Income taxes. Income taxes for the year ended December 31, 2004 were $11.2 million, an effective tax rate of 38.2%, compared to $8.1 million, an effective tax rate of 38.9%, for the year ended December 31, 2003. There were net adjustments of approximately $380 thousand reducing income tax expense for the year ended December 31, 2004 reflecting favorable revisions to our state income tax rate as a result of implementation of several strategies aimed at reducing state income taxes.
The following analysis depicts the results of each of our operating segments on a stand-alone basis. The practices are allocated a charge to cover centralized Resource Center expenditures in the areas of property and casualty insurance, human resources, marketing, and information technology.
In August 2005, we announced our intent to combine our Executive Benefits Practice, Banking Practice, and Insurance Company Practice into one practice that will serve those markets. The new practice will be reported as a single reporting segment in our consolidated financial statements effective January 1, 2006. The purpose of this combination is to be able to leverage the expertise of our top producers across a wider customer base, and improve our level of client service by streamlining operations and sharing a broader set of best practices.
Total revenue for the year ended December 31, 2004 was $81.5 million compared to $78.5 million for the year ended December 31, 2003. First year commission revenue for the year ended December 31, 2004, was $26.2 million compared to $21.5 million for the year ended December 31, 2003. First year revenue for the year ended December 31, 2004 included $8.6 million for one large case. Renewal revenue for the year ended December 31, 2004, was $46.5 million compared to $48.2 million for the year ended December 31, 2003. The increase in first year revenues was partially offset by decreases in renewal revenues relating to the loss of three large clients ($2.3 million) and over funding of certain corporate plans. Commission expense as a percentage of total revenue declined to 35.9% for the year ended December 31, 2004, from 37.4% for the year ended December 31, 2003, due to the mix of sales by employee consultants who are paid a lower commission and the mix between first year versus renewal revenue. General and administrative expense for the year ended December 31, 2004, was lower than the year ended December 31, 2003, due mainly to lower headcount (272 for 2004 and 300 for 2003) and facility costs despite a charge of approximately $1.1 million for legal costs associated with the MacDonald settlement in June of 2004.
Pearl Meyer and Steve Hall, president of Pearl Meyer and Partners, announced their resignations in late August, 2005. Effective August 30, 2005, Joe Rich replaced Steve Hall as president of Pearl Meyer and Partners. Subsequently, several client facing professionals resigned. As a result of the voluntary resignations, there were seven involuntary terminations of certain Pearl Meyer and Partners’ employees in October, 2005. The costs associated with these terminations were approximately $200 thousand, which were recorded in the fourth quarter of 2005. Estimated annual cost savings related to the voluntary terminations are $3.4 million and $1.4 million for the involuntary terminations. As a result, 2006 revenues, operating expenses, and operating income are expected to be lower than 2005.
Revenue for the year ended December 31, 2005 was $12.1 million compared to $15.7 million for the year ended December 31, 2004 due to a lower number of clients in 2005. Results for the years ended December 31, 2005 and 2004, included approximately $1.7 million and $3.0 million of revenue, respectively, from success fees. Operating expenses for the year ended December 31, 2005 were $9.6 million compared to $11.0 million. The reduction in 2005 expense compared to 2004 is a result of lower success fees generating less bonus expense and $100 thousand of 2004 client expenses, which was billed back to the client and also included in revenue for 2004.
Revenue for the year ended December 31, 2004 was $15.7 million compared to $14.9 million for the year ended December 31, 2005. Results for the years ended December 31, 2004 and 2003, included approximately $3.0 million of revenue from success fees. Results for the year ended December 31, 2004 and 2003 included approximately $2.6 million and $1.6 million of revenue and approximately $551 thousand and $265 thousand of operating income, respectively, related to four employees hired during the second quarter of 2003.
(2) Total stockholders' equity divided by actual shares outstanding at year-end.
Our cash flows from operating activities for the years ended December 31, 2005, 2004, and 2003 were as follows:
Non-cash expenses include primarily depreciation of equipment and leasehold improvements, amortization of intangibles, and deferred tax expense. The 2005 increase in cash relating to changes in operating assets and liabilities relates primarily to the increased liability balances in our deferred compensation plans ($4.1 million).
Securitized Gross Inforce Revenues. The following table represents the estimated gross renewal revenue associated with our securitized inforce bank-owned life insurance policies as of December 31, 2005. 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.
The 10-year inforce revenue net of commission expense is $402.0 million and $403.0 million, as of December 31, 2005 and 2004, respectively.
On August 31, 2005, we added a participant bank to our senior credit facility ($10 million) and one of the existing participants increased their commitment ($7 million). As a result, the current amount available under this facility is $89 million. As of December 31, 2005, there was $2.3 million outstanding on the facility. Our assets are pledged to the bank group as part of the credit facility except for cash flows from commissions to be received upon the renewals of specified inforce policies acquired in connection with the acquisition of LongMiller. In September 2004, we amended our credit agreement to allow for potential stock repurchases and dividend payments. The remaining provisions of the agreement remained substantively the same. Our credit facility expires on December 31, 2006. We expect the credit facility to be renewed on substantially similar terms.
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, 2005.
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, 2005, which are expected to become due and payable during the periods specified.