The following table sets forth certain information with respect to the principal facilities used in Clark/ Bardes' operations, all of which are leased:
The aggregate monthly lease rate for the properties listed above is $96,859. Clark/Bardes subleases approximately 2,046 square feet of its Minneapolis, Minnesota office space at a monthly rate of $4,302. Management believes that Clark/Bardes' existing facilities are adequate to meet its office space requirements for the foreseeable future.
The following discussion and analysis of Clark/Bardes' financial condition and results of operations should be read in conjunction with Clark/Bardes' financial statements and notes thereto and other information appearing elsewhere in this Form 10-K.
Since inception in 1967, Clark/Bardes has designed, marketed and administered insurance-financed employee benefit programs to large corporations and community, regional and money center banks. Clark/ Bardes' clients use these sophisticated programs primarily to offset the costs of employee benefit liabilities and to supplement and secure benefits for key executives.
Effective November 1, 1998, Clark/Bardes acquired substantially all the assets and 75% of the book of business of Wiedemann, based in Dallas, Texas. The total purchase price was $6.1 million, consisting of $4.1 million in cash and 142,857 shares of Common Stock at an agreed upon price of $14 per share. Acquisition related expenses were approximately $54,000. Clark/Bardes allocated approximately $40,000 of the purchase price to tangible assets and the remainder to the net present value of Wiedemann's expected future revenue.
Wiedemann is engaged in the business of the design, implementation and administration of non-qualified executive benefits programs financed through life insurance. Clark/Bardes' primary objective in acquiring the assets and business of Wiedemann was to expand Clark/Bardes' client and revenue base and acquire the experienced Wiedemann support and administrative personnel.
Clark/Bardes has entered into non-binding negotiations to acquire the businesses and substantially all the assets of two unrelated, privately owned companies. The aggregate proposed purchase price would be approximately $45.0 million, subject to change. If consummated, payment of the purchase price would be approximately $19.9 in cash at closing, assumption of approximately $4.1 million in liabilities, a sellers' note for approximately $8.7 million and the issuance of approximately 711,000 shares of Common Stock having an agreed upon value of approximately $12.3 million. Of the potentially issuable shares, 384,000 shares of Common Stock, having a value of $6.8 million, is to be contingent upon the attainment of specified five year revenue and gross profit performance levels.
- Renewal Revenue. Renewal revenue is recognized on the date that the renewal premium is due to the insurance company.
The following is a chart projecting the next ten years of expected gross revenues. Amounts in the chart are not adjusted for potential persistency or mortality lapse. Such expected gross revenues are based upon the beliefs and certain assumptions of management and are not necessarily indicative of the revenues that may actually be achieved in the future.
The following table sets forth unaudited statements of income for the four quarters of each of 1997 and 1998. Such information is not necessarily indicative of results for any full year or for any subsequent period.
(1) Earnings per share prior to July 31, 1998 reflects income before taxes less Clark/Bardes' liability for state taxes only, on a per-share basis. No provision for federal income taxes has been made in those periods because Clark/Bardes elected to be treated as an S corporation for federal income tax purposes prior to the Merger.
COMPARISON OF THREE MONTH PERIODS ENDED DECEMBER 31, 1998 AND DECEMBER 31, 1997 ON A HISTORICAL BASIS
Total Revenue. Total revenue increased to $28.1 million for the three month period ended December 31, 1998 compared to $27.2 million for the three month period ended December 31, 1997, representing an increase of 3.6%. The results for the three month period ended December 31, 1998 reflects contributions of $18.0 million from the core benefits business (including Schoenke) and $10.1 million from BCS community bank business. The results for the three month period ended December 31, 1997 reflects contributions of $19.7 million from the core benefits business and $7.5 million from BCS community bank business. The breakout of first-year and renewal revenue for the years ended December 31 is as follows:
Commission and Fee Expense. Commission and fee expense was $16.9 million for the three month period ended December 31, 1998 compared to $18.0 million for the three month period ended December 31, 1997, representing a decrease of 6.5%. Commission and fee expense as a percentage of total revenue decreased to 59.9% for the three month period ended December 31, 1998 compared to 66.4% for the three month period ended December 31, 1997. This reduction in commission and fee expense as a percentage of total revenue was due to both acquisitions (e.g. Schoenke commission expense was only 8.7% of Schoenke revenues) and a favorable product mix from business on which a smaller than usual percentage of revenue was distributed to
producers. The reduction in commission expense due to acquisitions is expected to continue, and present levels of commission and fee expense as a percentage of total revenue are considered sustainable.
General and Administrative Expense. General and administrative expense increased to $6.6 million for the three month period ended December 31, 1998 compared to $4.0 million for the three month period ended December 31, 1997, representing an increase of 65%. General and administrative expense was higher with an increase in administrative staff and resources which was required in order to support new and renewal business gained in 1998. General and administrative expense as a percent of total revenue was 23.4% for the three month period ended December 31, 1998 compared to 15.5% for the three month period ended December 31, 1997. General and administrative expense as a percentage of revenue is usually lower in the fourth quarter than in other quarters, due to the relatively high revenue typically recognized in the fourth quarter associated with relatively level expense patterns for the year. The general and administrative expense as a percent of revenue for the three months ended December 31, 1997 is low, due to the unusually high revenue combined with relatively level expense pattern for that period.
Income from Operations. Income from operations was $4.3 million for the three month period ended December 31, 1998, compared to $4.8 million for the three month period ended December 31, 1997, representing a decrease of 11.8%. The decrease is due to the revenue and general and administrative expense factors discussed above, as well as the increase in amortization expense. Operating Margin was 15.1% for the three month period ended December 31, 1998, as compared to 17.5% for the three month period ended December 31, 1997.
Income before Income Taxes. Income before taxes was $3.8 million for the three month period ended December 31, 1998, compared to $3.9 million for the three month period ended December 31, 1997, representing a decrease of 2.6%.
Income Tax. Effective July 31, 1998, Clark/Bardes changed its tax status from an S corporation to a C corporation, which changed Clark/Bardes' treatment for federal income tax purposes. Clark/Bardes recorded $1.6 million of income tax expense for the three month period ended December 31, 1998, as compared to $60,000 of state income tax expense for the three month period ended December 31, 1997.
Net Income. Net income was $2.2 million for the three month period ended December 31, 1998. Net income was $3.9 million for the three month period ended December 31, 1997. Applying the expected C corporation tax rate, net income is estimated at $2.3 million for the comparable 1997 period.
Total Revenue. Total revenue increased to $74.8 million for the year ended December 31, 1998 as compared to $49.5 million for the year ended December 31, 1997, representing an increase of 51.2%. The results for the year ended December 31, 1998 reflects contributions of $45.4 million from the core benefits business, including Schoenke, and $29.4 million from the BCS community bank business. Results for the year
Commission and Fee Expense. Commission and fee expense increased to $46.1 million for the year ended December 31, 1998 compared to $32.4 million for the year ended December 31, 1997, representing an increase of 42.1%. Commission and fee expense as a percentage of total revenue decreased to 61.6% for the year ended December 31, 1998 compared to 65.6% for the year ended December 31, 1997. This reduction in commission and fee expense as a percentage of total revenue was due to acquisitions and a favorable product mix from business on which a smaller than usual percentage of revenue was distributed to producers. Clark/ Bardes considers present levels of commission and fee expense as a percentage of total revenue to be sustainable.
Other Expense -- Net. Other expense for the year ended December 31, 1998 was $2.6 million compared to $921,473 for the year ended December 31, 1997. The amount for the year ended December 31, 1998 included interest income of $565,575 and interest expense of $3.2 million as compared to interest income of $188,597 and interest expense of $1.1 million for the year ended December 31, 1997. Interest income was higher in 1998 due to larger cash balances resulting primarily from the Clark/Bardes initial public offering. Interest expense was higher primarily due to a full year of outstanding debt associated with the BCS acquisition for the year ended December 31, 1998, compared to four months of outstanding debt in for the year ended December 31, 1997.
Income Tax Expense. On July 31, 1998, Clark/Bardes changed its tax status from an S corporation to a C corporation, which changed Clark/Bardes' treatment for Federal income tax purposes. Clark/Bardes recorded $817,320 of income tax expense for the year ended December 31, 1998, as compared to $60,000 of state income tax expense for the year ended December 31, 1997.
Net Income Loss. Actual net loss was $410,715 for the year ended December 31, 1998. Excluding the non-recurring operating expense and income tax benefit, net income is estimated at $2.5 million for the year. Net income was $4.2 million for the year ended December 31, 1997, which reflects $60,000 of income tax expense.
Amortization. Amortization expense was $295,000 for the year ended December 31, 1997, reflecting the amortization of intangible assets capitalized as a result of the BCS acquisition in September 1997. There was no amortization expense for the year ended December 31, 1996.
discussed above. No provision for federal income taxes was made for either period since Clark/Bardes was an S corporation prior to the Merger.
Sources of Cash. Clark/Bardes produced net cash flow from operations of $4 million for the year ended December 31, 1998, as compared to $1.9 million for the year ended December 31, 1997. The increase was due largely to strong cash earnings and a decrease in working capital. As of December 31, 1998, Clark/Bardes had cash and cash equivalents of $12.1 million, and total current assets of $20.2 million. The primary source of these cash balances were the proceeds from the issuance of common stock from Clark/Bardes' initial public offering.
Uses of Cash. $15.0 million was used to consummate the Schoenke acquisition. The total purchase price was $17.0 million consisting of a $15.0 million cash and a $2.0 million promissory note issued by Clark/Bardes to the sellers of Schoenke. On August 24, 1998, Clark/Bardes paid warrant holders $4.9 million in exchange for the extinguishment of warrants representing the right to purchase 1,525,424 shares of Common Stock at $5.90 per share. On August 24, 1998, Clark/Bardes made a principal prepayment of $1.0 million on its medium term notes in addition to scheduled principal payments in the amount of $2.9 million for the three months ending December 31, 1998. On November 1, 1998, Clark/Bardes paid 6.1 million to acquire the assets and business of Wiedemann. The total purchase price consisted of $4.1 million paid in cash and the issuance of 142,857 shares of Common Stock.
On July 31, 1998, Clark/Bardes paid a dividend equal to the S Corporation Stockholder's Distribution Account. This dividend, in the amount of $3.2 million or $1.00 per share, was paid from existing cash reserves.
In January 1999, CBI entered into a $65.0 million credit agreement consisting of a $35 million revolving credit Facility and two term loans of $25 million and $5 million. In January 1999 pursuant to the credit agreement, Clark/Bardes obtained a term loan for $25 million at a fixed rate of 7.08% for the first year and at a floating rate based upon the one-year London InterBank offered rate plus 2% thereafter. The term loans are represented by secured promissory notes maturing December 31, 2004. Principal and interest are payable quarterly beginning March 31, 1999. The $25.0 million proceeds were used to retire the Senior Secured Notes, Second Priority Senior Secured Notes, medium term notes, and AAA distribution notes payable. The credit agreement contains restrictive covenants which, among other things, require mandatory prepayments under certain conditions, financial reporting and compliance certificates, maintenance of financial ratios, restrictions on guarantees and additional indebtedness, certain limitations on mergers and acquisitions, prohibition of cash dividends, limitation on investments, loans, and advances, and certain change in control provisions.
Coincident with the credit agreement and floating rate debt agreements, CBI has entered into an interest rate swap agreement with a bank affiliated with the lending group to fix the interest rate at 5.29% on $15 million of the term loan, thus sustaining no gain or loss on rate fluctuations. There was no cost to CBI for this arrangement and it does not present a derivative risk.
Clark/Bardes believes that its net cash flow from operations will continue to provide sufficient funds to service all of its debt obligations. This belief is based on the predictability and magnitude of Clark/Bardes' future revenue stream. Specifically, renewal revenue in future periods, which is not reflected on Clark/Bardes' balance sheet, is estimated by Clark/Bardes to represent approximately $198.4 million in total revenue over the next five years. However, renewal revenue can be affected by policy surrenders or exchanges, material contract changes, asset growth and case mortality rates.
The year 2000 issue is the result of computer programs written using two digits rather than four digits to define "date" fields. Information systems have time sensitive operations that, as a result of this date field limitation could disrupt activities in the normal business cycle. Based on previous and ongoing internal reviews, management believes that the computer equipment and software used by Clark/Bardes will function properly with respect to dates in the year 2000 and thereafter. However, uncertainty still exists concerning the potential costs and effects of the year 2000 problem. Clark/Bardes is continuing its assessment of year 2000 issues and taking steps to prevent these issues from adversely affecting its future operating results. This ready process includes, but is not limited to, preparing an inventory of potential year 2000 issues, determining functions affected, performing remediation as necessary, testing software and equipment and recording results. This assessment and readiness process is expected to be completed by mid-year 1999.
In addition to evaluating its own systems for year 2000 compliance. Clark/Bardes is also communicating with and requesting information from its important clients and carriers to determine the extent to which interfaces with such entities are vulnerable to year 2000 issues and the extent to which the internal systems of such entities are vulnerable to year 2000 issues. Third parties that have relationships with Clark/Bardes, including insurance companies and clients, may experience significant operational difficulties if their computer systems do not properly recognize date sensitive information when the year changes to 2000. While these computer malfunction issues may have a material adverse effect on the operations of such third parties, which may, in turn, have a material adverse effect on Clark/Bardes, management presently believes that year 2000 issues will not require Clark/Bardes to incur any material costs and do not pose significant operational problems. However, Clark/Bardes is not able to determine the extent to which such third parties, such as insurance companies and clients, may experience year 2000 issues. Any year 2000 problem of either Clark/ Bardes or third parties that have relationships with Clark/Bardes could have a material adverse effect on Clark/Bardes' business, results of operations and financial condition. Clark/Bardes believes that to the extent that any insurance companies which have a relationship with Clark/Bardes are unable to become year 2000 compliant. Clark/Bardes will be able to enter into relationships on a going forward basis with other insurance companies that are year 2000 compliant.
Clark/Bardes' costs, as of December 31, 1998, related to the above year 2000 compliance efforts total approximately $78,000. Total costs associated with Clark/Bardes' year 2000 readiness process, consisting of both internal and external resources, are expected to range between $150,000 and $200,000. Clark/Bardes anticipates funding these costs with cash generated from operations. Clark/Bardes has not yet fully completed its year 2000 assessment and remediation efforts. Based on its experience to date, Clark/Bardes presently
believes that the year 2000 issues will not pose significant operational problems for Clark/Bardes directly or as a result of any year 2000 issues of suppliers or customers.
Inflation has not had a material effect on the Clark/Bardes' results of operations. Certain of Clark/ Bardes' expenses, such as compensation, benefits and capital equipment costs, are subject to normal inflationary pressures. However, the majority of Clark/Bardes' service and administrative agreements with clients, which generate fee income, have a cost of living adjustment tied to the consumer price index. Management believes that future inflationary pressures will continue to be offset because as inflation increases investment returns will also increase, resulting in higher cash values and higher commission revenue.
The following statements should be considered carefully in reviewing this Form 10-K and qualify, in their entirety, each forward looking statement herein.
Amendments to the federal tax laws enacted in 1996 and 1997 have reduced the advantages of certain purchases of business-owned life insurance. With limited exceptions, the 1996 amendment eliminated the ability to deduct interest on loans against the cash value of life insurance policies. In 1997, legislation imposed an interest disallowance rule that applied to all business-owned life insurance except for policies placed on employees, officers, directors and 20-percent owners. The effect of the 1997 legislation was to reduce otherwise allowable interest deductions by a ratio of unborrowed cash value to all other assets.
During 1998, approximately 44.7% of total revenue was derived from the marketing activities of five offices operated by producers of Clark/Bardes. The largest of these offices, The Wamberg Organization, accounted for approximately 23.0% of total revenue. The offices operated by Steven Cochlan, Malcolm Briggs, and George Blaha collectively accounted for 21.5% of total revenue. The producers operating these offices have entered into producer agreements which include non-competition provisions for a period of time after termination of the agreements. The producer agreements are terminable by Clark/Bardes or the producers with either 90 or 180 days' written notice depending on the individual agreement. From time to time producer relationships have been terminated by Clark/Bardes or by a producer and there is no assurance that such agreements will not be terminated at any time by Clark/Bardes or by a producer in the future or that the non-competition provisions will be enforced in litigation.
CREDIT RISK OF INSURANCE COMPANIES FROM WHICH REVENUE IS RECEIVED COULD ADVERSELY IMPACT RENEWAL INCOME
RISKS ASSOCIATED WITH ACQUISITIONS MAY RESULT IN REVENUES THAT ARE LESS THAN EXPECTED
At December 31, 1998, intangible assets arising from the purchased businesses consisted of the following:
Clark/Bardes competes for clients on the basis of reputation, client service, program and product offerings and the ability to tailor insurance products and administrative services to the specific needs of a client. Although certain competitors have access to proprietary programs and products unavailable to Clark/ Bardes and others offer lower prices for administrative services, management believes that Clark/Bardes is in a superior competitive position in most, if not all, of the meaningful aspects of its business. Management does not consider its direct competitors to be its greatest competitive threat. Rather, management believes Clark/ Bardes' most serious competitive threat will likely come either from large, diversified financial entities which are willing to expend significant resources to gain market share or from the larger competitors that pursue an acquisition or consolidation strategy similar to that of Clark/Bardes.
FEDERAL AND STATE REGULATIONS MATERIALLY AFFECT THE WAY CLARK/BARDES OPERATES IN EACH STATE
Clark/Bardes has not encountered regulatory problems in the past, no assurance can be given that Clark/ Bardes or its producers will not encounter regulatory problems in the future.
Clark/Bardes may experience significant fluctuations in its results of operations, in particular when such results are compared on a consecutive quarterly basis. In particular, 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 administrative services, competitive, legislative and regulatory conditions in the insurance-financed employee benefit industry and general economic conditions. Many of these factors are beyond Clark/Bardes' control.
The sales cycles for Clark/Bardes' programs and services are lengthy, lasting generally between twelve to eighteen months, with first year revenue being derived from a small number of large cases and subject to a number of factors beyond Clark/Bardes' control. For these and other reasons, the revenue of Clark/Bardes is difficult to forecast, and Clark/Bardes believes that comparing its consecutive quarterly results of operations is not necessarily meaningful or indicative of the results that Clark/Bardes may achieve for any subsequent period. Thus, past operating results should not be considered a reliable indicator of future performance.
CHANGES IN ECONOMIC AND MARKET CONDITIONS MAY HELP DEVELOPMENT OF COMPETING PROGRAMS AND PRODUCTS
Clark/Bardes' commission income and persistency rates are affected by certain general economic conditions and market factors such as changes in interest rates and stock prices. Interest rate fluctuations may have a significant effect on the sale and profitability of certain insurance-financed employee benefit programs marketed by Clark/Bardes. For example, if interest rates rise, competing products may become more attractive to potential purchasers of the programs marketed by Clark/Bardes. Further, a prolonged decrease in stock prices may have a significant effect on the sale and profitability of Clark/Bardes' programs that are linked to stock market indices. Thus, economic conditions and other factors may negatively affect the popularity or economic attractiveness of the programs marketed by Clark/Bardes. There can be no assurance that Clark/Bardes will be able to compete with alternative products if economic conditions and inflationary increases make the programs marketed by Clark/Bardes financially unattractive.
Clark/Bardes' ability to provide administrative services depends on its capacity to store, retrieve, process and manage significant databases and expand and upgrade periodically its information processing capabilities. Interruption or loss of Clark/Bardes' information processing capabilities through loss of stored data, breakdown or malfunctioning of computer equipment and software systems, telecommunications failure, or damage caused by fire, tornadoes, lightning, electrical power outage, or other disruption could have a material adverse effect on Clark/Bardes' business, financial condition and results of operations. Although Clark/Bardes has disaster recovery procedures in place and insurance to protect against such contingencies, these can be no assurance that such insurance or services will continue to be available at reasonable prices, cover all such losses or compensate Clark/Bardes for the possible loss of clients occurring during any period that Clark/ Bardes is unable to provide services.
ANTI-TAKEOVER PROVISIONS OF DELAWARE LAW AND CLARK/BARDES CHARTER DOCUMENTS COULD PREVENT A TAKEOVER BENEFICIAL TO STOCKHOLDERS
Certain provisions of CBH's certificate of incorporation, CBH's bylaws and the Delaware General Corporation Law may have the effect of discouraging unsolicited proposals for the acquisition of CBH. Pursuant to its certificate of incorporation, CBH may issue shares of preferred stock in the future without stockholder approval and upon such terms and conditions, and having such rights, privileges and preferences, as the Board of Directors may determine. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, any such preferred stock. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions, financings and other corporate transactions, could have the effect of discouraging a third party's acquisition of a majority of the Common Stock. CBH has no present plans to issue any shares of preferred stock. In addition, CBH has adopted a stockholder rights plan that could further discourage attempts to acquire control of CBH. CBH's bylaws provide that stockholders are entitled to call a special meeting only by a vote of holders of at least 66 2/3% of the total votes eligible to be cast by holders of Common Stock. In addition, the ability of the stockholders to consent in writing to the taking of any action in lieu of a meeting is denied. Any changes to provisions of CBH's certificate of incorporation must