- -------------- (1) Includes the results of operations subsequent to the date of acquisition of the following: o Executive Benefits Solutions LLC as of September 30, 2003 o Blackwood Planning Corporation as of October 7, 2003
(3) Includes the results of operations subsequent to the date of acquisition of the following: o Federal Policy Group as of February 25, 2002 o Hilgenberg and Associates as of April 25, 2002 o Comiskey Kaufman as of April 26, 2002 o LongMiller & Associates, LLC as of November 26, 2002
(5) Includes the results of operations subsequent to the date of acquisition of the following: o Christiansen & Associates as of January 1, 2000 o The Watson Company as of February 1, 2000 o Insurance Alliances Group as of May 5, 2000 o W.M. Sheehan & Company, Inc. as of June 13, 2000 o Pearl Meyer & Partners, Inc. as of June 21, 2000 o Compensation Resource Group as of September 6, 2000 o Forrest, Wagner & Associates as of October 23, 2000
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements, the notes thereto and other information appearing elsewhere in this Form 10-K.
As a result of issues arising recently in connection with the marketing by certain companies in the property and casualty insurance, health insurance, and group life insurance markets, there have been a series of proposals to modify various state laws and regulations regarding insurance agents and brokers, including proposals by the California Insurance Commissioner and the National Association of Insurance Commissioners. These proposals, if one or more are adopted, could impose new legal obligations, including disclosure obligations, on us with respect to the insurance and other financial products we market. These proposals are at an early stage and are likely to move forward during 2005. There was also a hearing on similar issues in November 2004 in a U.S. Senate committee. Depending on the changes, if any, which are actually adopted by the federal government or by the states where we market insurance, there could be an adverse impact on our revenues.
On January 25, 2005, our Board of Directors authorized us to pay a dividend of $0.06 per share to all stockholders of record as of March 1, 2005, payable on April 1, 2005. We intend to pay a similar dividend each quarter, assuming we have adequate capital availability, that we continue to be permitted to pay dividends under our senior credit facility, and that cash dividends continue to be in the best interests of our stockholders and us. The Board of Directors also authorized us to expand our existing stock repurchase program to a total of $15 million of our outstanding common stock, from the previously authorized level of $10 million.
policies where we are unable to obtain information to reasonably estimate the expected renewal premiums, revenue is not recognized until the confirmation has been received from the insurance carrier that the client's premium payment has been received. We are notified in advance if a client plans to surrender, so adjustments in subsequent periods due to cancellations are infrequent and minor. Revenue associated with policies to be surrendered is not recognized.
Consulting Fee Revenue. Consulting fee revenue consists of fees charged by Pearl Meyer & Partners, Human Capital Practice, 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 is included in the first year revenue line on our consolidated statements of income.
Administrative Service Fee Revenue. Administrative service fee revenues consist of fees we charge our clients for the administration of their benefit programs and are earned when services are rendered. These revenues are mainly included in our renewal revenue line on our consolidated statements of income.
Supplemental Compensation Arrangements. A portion of our revenue is derived from certain supplemental compensation arrangements with insurance carriers. These arrangements generate additional revenue with respect to primarily existing and, to a lesser extent, new blocks of business. Payments under such arrangements are typically based on the cash value (or fair value) of our existing in-force business with these carriers at specified dates of measurement and, to a much lesser extent, based on the value of new business generated. We realized approximately $11.3 million, $10.3 million and $7.5 million in revenue under such arrangements for the twelve months ended December 31, 2004, 2003, and 2002, respectively.
o act as the principal in the transaction by helping clients select the right product or service;
o take responsibility for the acceptability of the products and services;
We record revenue on a net basis when we provide a lead on a case (in the capacity of a finder) and another company has control of the case and bears the credit risk (i.e., working directly with a client to determine the product and design of the plan).
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.
Financial Statement Overview. Our revenue for the year ended December 31, 2004 was $315.6 million, compared to $325.9 million for the year ended December 31, 2003, a decrease of 3.2%. Our net income for 2004 was $18.2 million, compared to $12.7 million in 2003. Diluted earnings per share for 2004 were $0.97, compared to $0.68 for 2003.
General and administrative expense. General and administrative expense for the year ended December 31, 2004 was $164.3 million, or 52.1% of total revenue, compared to $158.9 million, or 48.8% of total revenue for the year ended December 31, 2003. The increase in general and administrative expenses was attributable to expenditures associated with Sarbanes-Oxley compliance ($1.6 million) and approximately $1.1 million of legal fees associated with the MacDonald litigation. The MacDonald litigation was settled with no cash being exchanged during the year ended December 31, 2004. Also contributing to the increase was approximately $6.9 million of additional bonus expense associated with the improved 2004 operating results versus 2003.
Human Capital Practice reorganization. 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, several partners and staff members were terminated which resulted in exiting certain activities of the Human Capital 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 $3.3 million remains on the consolidated balance sheet as of December 31, 2004. During the year ended December 31, 2004, we recorded net decreases to expense of approximately $200 thousand.
Interest expense. Interest expense for the year ended December 31, 2004 was $22.3 million compared to $24.3 million for the year ended December 31, 2003. The decrease relates to lower borrowing levels in 2004 compared to 2003.
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 taxes.
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 revenues (which includes consulting and reimbursable expense revenue) increased $3.2 million, or 2.0%, in 2003 compared to 2002. Renewal and other recurring revenues were $159.1 million in 2003, up $44.1 million, or 38.4%, 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 supplemental compensation arrangements 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. First year commission revenue in 2002 included $3.1 million related to an agreement with another insurance carrier, which was executed in 2002.
Settlement of litigation. During the year ended December 31, 2003, we received $1.5 million from a favorable lawsuit settlement.
During the first quarter of 2004, we completed agreements with two of our insurance carriers, which will generate additional revenue on our existing blocks of business and future business. The length of one of the contracts is three years and the other contract is one year. The agreements resulted in revenue of approximately $900 thousand for the year ended December 31, 2004. The two new agreements provide for revenue of approximately $175 thousand per quarter and include a variable element tied to our quarterly sales of the carrier's products. 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.
On September 25, 2002, we entered into an Administrative Services Agreement and Bonus Forfeiture Agreement with an affiliate of AUSA Holding, Inc., one of our principal stockholders and insurance carrier. We received approximately $2.4 million and $2.5 million of payments in 2004 and 2003, respectively related to this agreement. During 2002, we received $2.5 million for services rendered prior to and through September 30, 2002 and recognized a total of $3.1 million of revenue in 2002, pursuant to this agreement. Under the terms of this agreement, we expect to continue to receive approximately $2.5 million annually from the carrier for a period of 30 years, depending upon certain conditions. Of this annual amount $2.0 million is included in the cash flows securitizing the asset-backed notes issued to finance the acquisition of LongMiller, and we will not have access to this cash for general corporate purposes until the securitized notes are fully paid. This revenue, net of amounts provided for chargebacks, is being recognized on a monthly basis. The amounts received are subject to chargeback (reimbursement of a portion of amounts received) if any policies under this agreement are surrendered or exchanged. Any chargeback amounts would be deducted from the next scheduled payment.
First year revenue for the year ended December 31, 2003 was approximately $7.9 million lower than for the year ended December 31, 2002, in the Executive Benefits Practice, reflecting the continued difficult economic and legislative environment, which most directly affects this segment of the business. First year revenue for the year ended December 31, 2003, includes approximately $785 thousand from the execution of a supplemental compensation arrangement with one of our insurance carriers. Renewal revenue also declined approximately $5.0 million from the year ended December 31, 2002, as a result of split dollar legislation and lower deferrals into executive benefit plans. Commission expense as a percentage of total revenue declined from 49.0% for the year ended December 31, 2002, to 41.8% for the year ended December 31, 2003, due to the higher percentage of sales by employees who are paid on a lower commission grid. General and administrative expense for the year ended December 31, 2003, includes approximately $800 thousand of restructuring charges recorded for the ongoing consolidation of the business support services and $711 thousand of charges associated with other severance agreements and lease terminations.
Total revenue decreased 12.4% to $145.2 million for the year ended December 31, 2004, from $165.8 million for the year ended December 31, 2003. First year revenues for the year ended December 31, 2004 were impacted by a soft market for BOLI products, interest rates, and sales force changes that occurred in the second quarter of 2004. Total revenue for the year ended December 31, 2004 and 2003 included approximately $6.6 million and $4.7 million, respectively, related to supplemental compensation arrangements. Renewal revenue for the year ended December 31, 2004 and December 31, 2003, was $98.4 million and $99.5 million, respectively. Commission expense for the year ended December 31, 2004, was $41.0 million, or 28.2% of revenue, compared to $55.0 million, or 33.2% of revenue, for the same period in 2003. The commission expense as a percentage of revenue continues to decrease as a result of a higher percentage of first year revenue produced by employee consultants versus independent producers and the mix between first year revenues and renewal revenues. In addition, we do not pay commission expense on the
revenue associated with the supplemental compensation arrangements. In the second half of 2003, Banking Practice acquired two of its former independent producer organizations. General and administrative expense for the year ended December 31, 2004, was $44.9 million, or 30.9% of revenue, compared to $40.4 million, or 24.3% of revenue, for the comparable period in 2003. We terminated seventeen of our Banking Practice employees, representing roughly 6% of the Practice's employees, or 2% of our employees in September of 2004. The actions resulted in $230 thousand of severance costs and are expected to result in annual operating expense savings of approximately $1.5 million. The higher percentage of general and administrative expenses to revenue reflects increased operating expenses relating to former independent producers and the lower revenue base. Amortization expense for the year ended December 31, 2004 and 2003, was $12.3 million and $15.2 million, respectively. The decrease is based on the timing of scheduled amortization of our inforce revenue and a $550 thousand adjustment to the purchase accounting for the LongMiller acquisition in the third quarter of 2003.
Total first year revenue increased 3.1% to $66.1 million for the year ended December 31, 2003 from $64.2 million for the year ended December 31, 2002. Revenue in 2003 from the large bank sector of the business declined significantly from 2002 due to the sustained low interest rate environment. Increases in the community bank sector more than offset the first year revenue decrease in the large bank sector. Renewal revenue for the year ended December 31, 2003 includes $2.0 million related to the Administrative Services Agreement entered into on September 25, 2002 with an affiliate of AUSA Holding, Inc along with $2.7 million in first year revenue from the execution of supplemental compensation arrangements with two other insurance carriers during 2003. Approximately $40.0 million of the 2003 increase in renewal revenue is attributable to the securitized inforce revenue stream from the acquisition of LongMiller. Commission expense for the year ended December 31, 2003 was $55.0 million, or 33.2% of revenue, compared to $45.3 million, or 39.1% of revenue, in the same period in 2002. The commission expense as a percentage of revenue continues to decrease as a result of a higher percentage of first year revenue produced by employees. In addition, a larger percentage of total revenue consisted of renewal revenue, which has a lower commission expense percentage. We do not pay commission expense on the revenue associated with the supplemental compensation arrangements. General and administrative expense for the year ended December 31, 2003, was $40.2 million, or 24.2% of revenue, compared to $30.8 million, or 26.6% of revenue, for the comparable period in 2002. 2003 expenses included twelve months for the LongMiller operation compared to one month in 2002, and operating expenses for the fourth quarter 2003 acquisition of Shoemaker and Blackwood. The lower percentage of general and administrative expenses to revenue reflects the relatively lower costs associated with the revenue stream from the LongMiller acquisition.
Healthcare Group revenues were slightly lower (1.2%) for the year ended December 31, 2004, compared to the prior year. First year commission revenue for the year ended December 31, 2004, was lower by $3.3 million than the prior year due to a lower number of new implementation projects and lower add-on commissions as a result of split dollar regulations and clients electing to split consulting engagements from the company who sells the funding solution. However, consulting revenue (included in first year revenue) increased over the prior year by $1.7 million due to growth in several services. Renewal revenue for the year ended December 31, 2004 was approximately $10.4 million compared to $9.1 million for the year ended December 31, 2003. General and administrative expenses remained flat due to cost containment efforts.
Healthcare Group revenues were slightly lower (4.8%) for the year ended December 31, 2003, compared to the prior year. Healthcare's 2002 performance was strong and the 2003 healthcare environment was 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.
The Human Capital Practice was formed by combining our existing Rewards and Performance Group with 10 partners and 74 employees from Arthur Andersen's Human Capital Practice in May 2002. The Human Capital Practice results have been negatively affected by the inability of the former Andersen employees to retain their Andersen client base or develop and sell into new relationships.
Federal Policy Group was acquired on February 25, 2002. Federal Policy Group is a consulting practice representing Fortune 500 companies, trade associations, and other businesses before Congress, the Treasury Department, and other federal agencies on legislative and regulatory matters. 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. Results for the year ended December 31, 2002 represented 10 months of activity.
AS OF DECEMBER 31, ------------------ 2004 2003 ------- ------ Cash and cash equivalents.................. $23,199 $3,156 Working capital (1) ....................... $ 9,087 $2,623 Current ratio -- to one.................... 1.12 1.04 Stockholders' equity per common share (2).. $ 14.92 $13.95 Debt to total capitalization (3) .......... 54.2% 57.7%
- -------------- (1) Includes restricted cash and current portion of debt associated with asset-backed notes. (2) Total stockholders' equity divided by actual shares outstanding at year-end. (3) Current debt plus long-term debt divided by current debt plus long-term debt plus stockholders' equity
In addition to our tangible balance sheet assets and liabilities, we have an on-going non-securitized renewal revenue stream, estimated to be $790.6 million, on a gross basis, over the next ten years. This on-going renewal revenue stream reflects current conditions and is not necessarily indicative of the revenue that may actually be achieved in the future and we cannot assure you that commissions under these policies will be received. See "Estimated Future Gross Renewal Revenue" section in the next few pages.
Based on our historically strong operating cash flow and revolving credit facility, we believe we have little need to maintain substantial cash balances. We use net cash from operating activities primarily to fund capital expenditures, small acquisitions, and service existing debt. We expect large cash outlays and future acquisitions will be financed primarily through externally available funds. However, we can offer no assurance such funds will be available and, if so, on terms acceptable to us.
YEAR ENDED DECEMBER 31, ------------------------------------------- 2004 2003 2002 ---- ---- ---- Cash flows from (used in): Operating activities........ $61,183 $74,613 $ 21,520 Investing activities........ (13,992) (13,585) (371,005) Financing activities........ (27,148) (72,138) 353,544
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, 2004, not including estimated securitized inforce revenues, which are set forth in a separate table.
The 10-year inforce revenue net of commission expense is $403.0 million and $438.0 million, as of December 31, 2004 and 2003, respectively.
Pearl Meyer & Partners, Human Capital Practice, and Federal Policy Group generate fee-based revenues and do not produce inforce revenues.
For the year ended December 31, 2004, approximately $27.1 million of cash was used primarily ($28.0 million) for the net repayment of borrowings.
Our financial statements are included under Part IV of this Form 10-K.