The following discussion should be read in conjunction with the consolidated financial statements of the Company and the related notes thereto appearing in Item 8. “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K, and the risk factors appearing in Item 1A. “Risk Factors.” Amounts are in thousands except share and per share amounts.
Recognizing that we were a stronger and much more valuable company, and that the market for control of companies such as ours had recovered considerably since the formation of the Special Committee, our Board of Directors, upon the recommendation of the Special Committee, determined to implement a formal sale process to seek the highest price reasonably attainable for the Company. On June 6, 2005, the Board retained UBS Securities LLC to assist it in that process. Management is committed to the process as the best and most efficient way to provide liquidity for our stockholders. For their part, Mr. Fitzgerald and Capital Partners also fully support the formal sale process, have stated to the Board that they would not participate as a bidder in the process and have committed to sell the shares they control if appropriate value is achieved in the transaction.
There are certain accounting policies that we believe are critical to our business and the understanding of our financial statements, either because of their magnitude to the financial statements or because they require management to make certain estimates and assumptions. Management makes its estimates and assumptions based upon the best information available at the time and a number of underlying variables and range of possible outcomes. The accuracy of these estimates and assumptions is dependent upon the occurrence of future events and circumstances beyond our control, and accordingly, actual results could differ from our original estimates and assumptions. These critical accounting policies are described below. For additional disclosures with respect to our significant accounting policies, see Note 2 of the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K.
Net cash flow from operations in 2004 of $17,339 represented an increase of $4,074 over 2003 net cash flow from operations of $13,265. This increase was primarily due to an increase in unearned revenue of $4,168. Unearned revenue at WC increased $2,897 in 2004 as a result of growth at Octagon and growth in the managed care operations. WC enters into certain service contracts with terms of as much as one year and receives advance payments for services to be provided. Similarly, unearned revenue at Primrose increased $1,271 as the number of prospective franchisees increased in 2004 compared to 2003. Upon the signing of a franchise agreement, franchisees pay a franchise fee and an assignment and real estate services fee for services to be provided by Primrose to the franchisee up until the school receives its certificate of occupancy.
On February 10, 2006, we signed a definitive agreement to sell Primrose to an affiliate of American Capital Strategies, Ltd. for an aggregate purchase price of $85,000, subject to adjustment. After adjustment for transaction costs and certain items specified in the agreement, the net purchase price is anticipated to be approximately $82,800. After taxes, we expect to receive approximately $58,200 million for our 91.5% fully diluted ownership interest in Primrose. If the sale of the balance of the Company is not successful, the Company’s Board of Directors may consider various alternative uses of the proceeds from the sale of Primrose, including, but not limited to, a special dividend to stockholders.
We review long-lived assets, including intangible assets, for impairment in accordance with the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”). SFAS 144 requires companies to test long-lived assets when events or circumstances lead management to believe that the carrying value of an asset may not be recoverable. Recoverability is assessed based on the carrying value of an asset and its fair value, which is generally determined by the sum of the estimated undiscounted cash flows expected to result from the use and eventual disposal of the asset in question. If the fair value is less than the asset’s carrying value, an impairment loss is recognized based on the excess of the carrying amount of the asset over its fair value. Based on our review and analysis conducted during the applicable periods, we have not recognized any impairment losses on long-lived assets, including intangible assets, during each of the three years ended December 31, 2005, 2004 and 2003.
During 2004, WC acquired 100% of the stock of Integrated Claims Strategies (“ICS”) for $800, plus $17 of transaction costs and 100% of the stock of KRAMMCO, Inc. for $975, plus $9 of transaction costs. ICS provides insurance claims processing and administration services in the Tampa, Florida area. KRAMMCO, Inc. is a management company whose sole asset is a management contract with the North American Employer’s Council, Inc. (“NAEC”), an Ohio not-for-profit corporation. NAEC is an Ohio association that provides association members with, among other value-added services, an Ohio group rating sponsor. The allocation of the purchase prices were as follows:
Management evaluates the performance of its segments based upon segment income, defined as earnings before interest, taxes, depreciation, amortization, minority interests, corporate expenses and management fee, other income or expense and income/loss from discontinued operations. Segment income is used to evaluate performance because management believes this is the best financial indicator of value and of our ability to incur and service debt and to generate operating cash flows. It is also one method by which we evaluate and value potential acquisition opportunities and by which we value our current subsidiaries. Segment income is not a substitute for operating income or cash flows from operating activities determined in accordance with GAAP.
Our Employer Cost Containment and Health Services segment has two customers that individually account for more than 10% of consolidated revenues and accounts receivable. One customer accounted for approximately 19%, 22%, and 29% of total consolidated revenues for 2005, 2004 and 2003, respectively, and 15% and 19% of consolidated accounts receivable at December 31, 2005 and 2004, respectively. The current contract with this customer is scheduled to expire in December 2006. CMI considers its relationship with this customer to be good, and while this contract has historically been renewed, no assurances can be given that this contract will be renewed. The other customer accounted for approximately 11% and 12% of consolidated revenues, and 17% and 22% of consolidated accounts receivable, for 2005 and 2004, respectively. This contract was acquired in late 2003 and was not significant to 2003 consolidated revenues. The contract with this customer expires June 30, 2007. The loss of either of these contracts could have a material adverse effect on the financial condition, results of operations and cash flows of our Employer Cost Containment and Health Services segment and the Company.
The Company has revised its 2004 and 2003 condensed statement of cash flows as a result of recent guidance provided by the Securities and Exchange Commission staff regarding the reporting of cash flows from discontinued operations. We had previously disclosed cash flows from discontinued operations on a combined basis. To comply with Statement of Financial Accounting Standards No. 95, Statement of Cash Flows, we have revised our condensed statement of cash flows for 2004 and 2003 to report the cash flows from discontinued operations separately as investing or financing activities.
The minority stockholders of WC (with an aggregate ownership interest of 15.6%) and Primrose (with an aggregate ownership interest of 1.5%) have entered into agreements with the Company providing for restrictions on the transfer of such shares, and other related share restrictions. See Note 8 for information with respect to the agreement to sell Primrose.