ITEM 1. BUSINESS
Our Company
Clark/Bardes Holdings, Inc. is a national firm that provides a variety of compensation and benefit services to U.S. corporations, banks and healthcare organizations. Our mission is to aid out clients in attracting, retaining and rewarding their top people. Clark/Bardes Consulting has over 3,000 corporate, banking and healthcare clients and we are unique in that our consulting practices provide the full spectrum of compensation and benefit services for executives. Our services include the evaluation, design, implementation and administration of innovative compensation and benefit programs for executives, key employees and other professionals. Our Corporate headquarters is located at The Clark/Bardes Building, 102 South Wynstone Park Drive, North Barrington, Illinois 60010, and our telephone number is (847) 304-5800.
Generally, our revenue is earned from:
o consulting fees paid by our clients to evaluate and design executive compensation and benefit plans;
o first-year and renewal commissions paid by the insurance companies that underwrite the insurance policies underlying our clients' compensation and benefit programs; and,
o fees paid by our clients for consultative and ongoing administrative services.
We usually receive renewal commissions and service and administration fees as long as the insurance policies underlying our clients' programs remain inforce.
We have four operating divisions:
o Clark/Bardes Consulting -- Compensation Resource Group
o Clark/Bardes Consulting -- Banking Practice
o Clark/Bardes Consulting -- Healthcare Group
o Pearl Meyer & Partners
Each of these divisions is focused on the evaluation, design, implementation and administration of innovative compensation and benefit programs that help their clients attract and retain executives, key employees and other professionals. Each of our divisions operates separately from a different location with its own executive, marketing and administrative staffs. The divisions are independent because of the specific expertise required to serve their distinct markets and the established reputation they enjoy. Through these divisions, we are able to tailor compensation and benefit programs and consulting services to the unique needs of our clients.
Our operating divisions underwent some reorganization in 2000. On September 6, 2000, we acquired all of the stock and business of Compensation Resource Group, Inc. ("CRG"), a major, Los Angeles based, corporate executive compensation and benefits consulting firm. With the acquisition of CRG, we reorganized our Clark/Bardes division, combining the large corporate practice with CRG and transferring all of the banking insurance programs to our Banking Practice division in Minneapolis. Our Clark/Bardes division was renamed Clark/Bardes Consulting -- Compensation Resource Group. The division has over 300 large corporate clients representing a variety of industries. This reorganization became effective on January 1, 2001.
Our Banking Practice division provides programs to over 30 of the top 50 national banks and a number of community banks, which typically have less than $1 billion in assets. We estimate that there are over 7,000 community banks in the United States and the Banking Practice is a market leader with over 1,400 community bank clients. In addition to compensation and benefit programs, the division also performs compensation and incentive consulting as well the design of ownership succession programs.
Our Healthcare Group division markets primarily to large and medium sized not-for-profit healthcare organizations and is a leader in its market with 300 clients that represent over 800 hospital and physician groups.
On June 21, 2000, we acquired Pearl Meyer & Partners, Inc. ("PMP"). becoming our fourth operating division. PMP is a New York City based firm specializing in compensation plan consultation and design primarily for senior level executives and board of directors.
Recent Developments
On March 23, 2001, we acquired the Knowledge Management and Practice Management segments of Partners First, L.L.C. for $1.1 million. Partners First is a St. Louis, Missouri based hospital and physician practice consulting firm and subsidiary of Ascension Health.
On March 12, 2001, we acquired the business along with certain assets and liabilities of Rich, Florin/ Solutions, Inc. ("RFSI"), a compensation consulting company located in Boston, Massachusetts. The assets acquired include accounts receivable, copyrights and office equipment. The liabilities assumed were trade payables and employee benefit obligations as of the acquisition date.
The purchase price was $20.8 million, before acquisition expenses, consisting of a cash payment at closing of $11.3 million and $9.5 million of contingent payments, over the next four years, based on the attainment of established financial performance criteria. When earned, the contingent payments will consist of 60% cash and 40% CBH common stock.
The acquisition of RFSI marks our second significant acquisition in less than one year in the executive compensation consulting field. RFSI and Pearl Meyer & Partners will operate independently.
Since January 1, 2000, we have made seven other acquisitions:
o Forrest, Wagner & Associates, a regional firm specializing in corporate benefit programs;
o Compensation Resource Group, a company specializing in non-qualified deferred compensation plans;
o Pearl Meyer & Partners, an independent executive compensation firm which became our fourth operating segment -- compensation consulting;
o Insurance Alliances Group, an estate planning firm, which has been renamed Clark/Bardes Partners; and,
o The Christiansen Group, the Watson Company and W. M. Sheehan & Company; three add-on acquisitions for our Banking Practice division.
Concurrent with these acquisitions, we created the Clark/Bardes Consulting -- Compensation Resource Group division and the Pearl Meyer & Partners division.
On September 11, 2000, we sold 1,888,887 registered shares of our common stock to a group of investors for $25.1 million, net of expenses, in a private placement transaction. The proceeds from this sale were used for debt reduction and acquisitions.
On August 23, 2000, we expanded our December 28, 1999 credit facility from $100.0 million to $114.3 million and added another bank to the existing group of bank lenders. The principal changes in the structure of the facility are the increase of the working capital limit from $5.0 million to $10.0 million and an expansion of the borrowing base.
Acquisitions
Our acquisition activity has been important to our growth over the last several years, and has been important in the development of our existing markets and for expanding into new business areas such as healthcare and executive compensation consulting.
Clark/Bardes Consulting -- Compensation Resource Group Division
The former Clark/Bardes division, our original core business, was expanded and reorganized with the acquisition of Compensation Resource Group, Inc. ("CRG") in September 2000. As a result, the focus of this division is on the marketing of non-qualified plans, funded by corporate owned life insurance ("COLI"), to major corporations throughout the country. The division was also expanded by three other acquisitions, which were Schoenke & Associates, acquired September 1998; Wiedemann & Johnson, acquired November 1998: and The Wamberg Organization, acquired September 1999. With these acquisitions, we obtained a substantial book of business as well as a number of talented and experienced benefits professionals.
Banking Practice
The September 1997 acquisition of Bank Compensation Strategies, Inc. was our first acquisition and expanded the company's products and services into the community and small regional banking market. During 1999, we acquired National Institute for Community Banking and Banking Consultants of America, expanding the division's employee and client base with companies that could be readily absorbed into Bank Compensation Strategies operating structure. During 2000, we acquired Christiansen & Associates, a former independent consultant in the banking practice, along with the Watson Company and W. M. Sheehan & Company, two strong regional compensation consulting firms in the banking market.
Healthcare Group
During 1999, we purchased Management Compensation Group/HealthCare an executive benefit consulting organization servicing the healthcare industry that became our HealthCare Compensation Strategies division, now known as the Healthcare Group.
Compensation Consulting
On June 21, 2000, we acquired all of the capital stock of Pearl Meyer & Partners, Inc. Pearl Meyer is a New York City based consulting firm specializing in executive compensation and retention programs. The Pearl Meyer organization became our fourth operating division that is focused predominantly on executive compensation consulting for large corporations.
Past, Present and Future of Our Industry
Over the past thirty years, executive compensation and benefit programs have become more complex and sophisticated. Competition for executives as well as legislation affecting executive compensation and retirement planning has required that businesses offer new and innovative programs to attract and retain talent. The implementation of successful executive benefit programs places an emphasis on our ability to custom design programs to meet the needs of both the client company and its executive staff in a rapidly changing environment.
The financing of these programs has also become very specialized. Creative financial techniques can help a company maintain a competitive advantage. For example, before the 1980's, corporations and banks did not normally use life insurance to offset the costs of employee benefit liabilities. Since then, a number of large insurers have committed significant resources in developing a line of business owned life insurance products for use in insurance financed employee programs. These business owned life insurance programs have historically been affected by legislative change. For example, tax legislation was enacted that disallowed interest deductions on policy loans and essentially eliminated a financing technique for corporations known as "leveraged COLI." We believe that income tax legislation could potentially affect our industry in the future.
The prospects and clients of these programs have become more sophisticated and demanding. Clients now perform extensive due diligence on the firms providing their executive benefit programs. Issues relating to the integrity and technological capability are now central to their decision-making process. In addition, the client's expectation on the level of administrative services to be provided has risen substantially. For example, in the early 1990's, community banks went through a consolidation phase. This consolidation gave bank executives a greater appreciation and need for expertise regarding the impact of consolidation on their compensation and benefit programs. This developed into a stronger demand by the community banking industry for expert advice in addressing estate and continuity planning. In addition, healthcare organizations have been faced with growing challenges to attract and retain executives. The tax status of healthcare providers, many of whom are not-for-profit healthcare organizations, requires tailored compensation and benefits programs that comply with the various not-for-profit compensation and benefit rules.
In compensation consulting, businesses will continue to seek creative and competitive ways to compensate, motivate and retain their key executives. Our continued success in this new operating division is depending, in large measure, on our ability similarly motivate and retain our key consultants.
We believe that the ever-changing legislative, economic and market environments require product development systems and personnel that are more sophisticated and cost intensive than most producers and producer groups are able to justify economically. Management believes this will continue to drive consolidation in the industry as smaller firms respond in order to stay competitive.
Strategy and Opportunities for Growth
Through our four operating divisions, our goal is to continue to strengthen our role as a leading provider of innovative compensation and benefit programs and solutions to corporations, banks and healthcare organizations throughout the United States. To accomplish this goal, we intend to continue to:
o Leverage Our Market Reputation. Use our reputation as an industry leader to expand existing operations and enter into related businesses.
o Design Innovative Programs. Use our expertise in program development and our ability to closely monitor legislative change, to create and market innovative, customized programs to penetrate new markets and satisfy the financial needs of our clients in a changing regulatory and economic environment.
o Diversify Our Business. Identify and enter related businesses in which we can profitably employ our competencies. Examples of recent expansion into related businesses include compensation and benefit consulting, and benefit plan administrative services.
o Enhance Our Administrative Capabilities and Efficiencies. Distinguish us from our competitors by continuing to enhance our administrative capabilities, providing high quality administrative services and improving operating efficiencies.
o Pursue Acquisitions. Implement our design, distribution and service model on a wide scale to increase market share, acquire consultant and management talent, enter new markets and improve operating margins through efficiencies achieved by acquisitions.
o Integrate Sales Process. Create a seamless sales approach between our various lines of business to leverage existing relationships within our client companies.
Most importantly, we plan to continue to provide outstanding service to our clients.
We believe our industry offers us additional growth opportunities. The executive compensation and benefits marketplace is under-penetrated, and has significant growth potential. We estimate there are 15,000 corporations, banks and healthcare institutions that can use our services, in which we currently have 3,000 as clients. In addition, the rising pay of executives and the nearing of retirement of the baby-boom generation are significant macro-trends that are in our favor.
Our reputation, comprehensive in-house expertise, sophisticated administrative systems, quality consultants and strong relationships with insurance companies, provide us with distinct competitive advantages. We intend to increase our market share by combining these strengths with our competencies in:
o designing proprietary programs customized to meet clients' needs;
o providing outstanding client service
o responding quickly to develop new products and services brought about by regulatory and legislative changes; and
o leveraging present and future investments in technology over an increasing client base.
We are able to offer clients expertise not available elsewhere through the specialization of our four divisions. Our internal growth efforts will focus on the development of these divisions.
The Clark/Bardes Consulting -- Compensation Resource Group division has designed and currently administers over 300 client cases, covering over 114,000 policies for executives, key employees and other professionals. The large corporate marketplace in which the Clark/Bardes division does business requires a significant degree of customization. Growth in this division will focus on further penetrating the corporate marketplace and providing additional executive compensation and benefits services to corporations.
The Banking Practice division, which as of January 1, 2001 includes our large bank business, services over 1,400 community banks and 30 of the top 50 national banks. Changes in the banking environment present numerous opportunities for growth in this division. Banks are becoming increasingly sophisticated with their compensation and benefit plans as they recruit effective leadership. Growth opportunities for this division include the recent addition of a compensation and benefit consulting service as well as new programs to address estate planning and continuity planning. This division recently completed four acquisitions of strong, regional firms in its industry.
The Healthcare Group division uses a comprehensive benefits approach that encompasses a variety of insurance products, ranging from traditional life insurance policies to disability and long-term care coverage. With approximately 400 clients representing over 800 hospitals and physician groups, the Healthcare Group division is the market leader for compensation and benefit planning for healthcare executives and physicians. The healthcare industry's changing environment and complex structure offer many challenges for the near future. The industry has experienced a great deal of contraction with changes in our national healthcare regulations and compensation structure.
The acquisition of Pearl Meyer & Partners represented a significant shift in financial focus. Prior to acquiring this business, our revenue was derived almost exclusively from the sale of life insurance products and the commissions this activity produces. Pearl Meyer & Partners derives its revenue solely from fees for services in providing consultative service to major corporations on the compensation, motivation and retention of senior executive and board of director members. We feel Pearl Meyer & Partners offers an excellent opportunity to cross utilize our respective abilities and benefit from this growing and profitable new segment of our company.
Our organization has had significant external growth, completing thirteen acquisitions since its August 1998 initial public offering. We continue to see consolidation opportunities within the executive compensation and benefits marketplace. We categorize potential acquisition targets into the following groups:
o smaller companies that have not made the necessary investment in technology and personnel, and are finding it difficult to compete with larger, more developed firms;
o larger and more sophisticated firms with a solid client base, eager to affiliate with a more established organization; and
o firms offering products or services that we currently do not provide or to industry sectors we do not currently serve.
In evaluating a potential acquisition target, we identify organizations that will:
o increase our market penetration;
o retain quality consultants after the acquisition is complete;
o create cross-selling opportunities;
o provide opportunities for administrative cost savings; and,
o add to our earnings per share.
Once we have identified such a target we look at factors such as operating results, financial condition, growth potential, and the quality of its management and consultants. Acquisitions may be financed through cash from our operations, future equity offerings or debt proceeds or any combination thereof.
Programs and Products
We provide compensation and benefit consulting as well as evaluate, design, implement and administer a diverse array of compensation and benefit programs for executives, key employees and other professionals. Our programs are financed by business owned life insurance and other financial products. Business owned life insurance refers to life insurance policies purchased by a company that insures the lives of a number of its employees. The business pays the premiums on, and is the owner and beneficiary of such policies. Business owned life insurance based programs are used primarily to offset a client's cost of providing employee benefits and to supplement and secure benefits for executives, key employees and other professionals. The cash flow characteristics of business owned life insurance policies are designed to closely match the long-term cash flow characteristics of a client's employee benefit liabilities. Additionally, business owned life insurance offers three major advantages:
o the cash value of the policies grows on a tax deferred basis;
o the policies' death benefits are received tax free; and
o the tax deferred nature of the policies provides an attractive return.
We receive most of our revenue from selling insurance products used to fund our proprietary programs. We maintain strategic relationships with insurance companies such as AEGON, AXA/Equitable, General American, Great-West, Mass Mutual, Nationwide, Phoenix Home Life and West Coast Life, in which both parties are committed to developing and delivering creative products with high client value. We also work closely with clients to design custom products that meet the specific organizational needs of the client and with insurance companies to develop unique policy features at competitive pricing.
We have invested significant time and resources in cultivating relationships with selected carriers. However, we do not consider our future success to be dependent on any specific insurance carrier. We limit the number of carriers with which we do business in order to maximize our bargaining power and resource utilization. Substantially all of the policies underlying the programs that we market are underwritten by 20 life insurance companies, of which seven accounted for approximate revenue of 76.3% of our first year commission for 1998, 53.6% for 1999 and 66.3% for 2000. We believe that there are over 50 top-tier insurance companies with the financial strength and resources to effectively compete for large case programs, each of which typically generate in excess of $5 million in premiums, and several hundred carriers suitable for our small case business, each of which typically generate between $1 million and $5 million in premiums.
In selling, designing and implementing a compensation benefit program, we usually proceed in the following manner:
(1) we evaluate a client's existing compensation and benefit programs and their effectiveness in meeting that particular company's organizational needs;
(2) we design or improve the compensation and benefit program;
(3) when needed, we perform the actuarial and insurable interest calculations necessary to determine the executive benefit liabilities and amount of life insurance an organization should purchase to fund those liabilities;
(4) we compare financing alternatives and present the financial strengths of each, to the client;
(5) we arrange for the placement of the insurance coverage, or other financial instruments underlying the program, with a financially stable insurance company; and
(6) we provide the long-term administrative services associated with the program.
Our Clark/Bardes Consulting -- Compensation Resource Group and Banking Practice divisions market a wide variety of business owned life insurance based programs, including bank owned life insurance, deferred income plans, supplemental executive retirement plans, supplemental offset plans and group term carve out plans.
Our Healthcare Group markets predominantly to large and medium sized healthcare organizations. The unique characteristics and concerns of our Healthcare Group clients determine the kinds of compensation and benefit products and programs we develop. Many healthcare organizations are tax exempt and have special rules and regulations that affect the compensation and benefits of their executives.
The following table sets forth the actual and pro forma total revenue by division for the year ended December 31, 1999 and 2000, as if all of our acquisitions had occurred on January 1, 1999:
Year Ended December 31, 1999 2000 ----------------- --------------- Actual Pro forma Actual Pro forma (In millions) Compensation Resource $ 73.5 $101.0 $ 78.6 $100.0 Group................. Banking............... 30.8 30.8 40.2 40.2 HealthCare............ 16.4 22.5 22.1 22.1 Compensation Consulting -- 12.6 6.0 11.5 Other................. -- -- .7 .9 ------ ----- ------- ------ $ 120.7 $166.9 $ 147.6 $174.7 ======= ====== ======= ======
Our Products and Services
Bank Owned Life Insurance. Bank owned life insurance is life insurance purchased and owned by a bank on the lives of its employees. The insurance is used to help finance the bank's employee benefit obligations. The Office of the Comptroller of the Currency provides guidelines that tie the purchase of bank owned life insurance to the costs of offsetting employee benefits on an aggregate basis. We were the first organization to implement large case bank owned life insurance programs, which are designed for banks with assets in excess of $5 billion. We also market smaller case bank owned life insurance programs, which are used to offset benefit costs for executives and directors of regional and community banks that generally have assets of less than $5 billion. We market a wide variety of bank owned life insurance, including fixed yield policies, general account policies, variable yield policies and separate account policies. Effective January 2, 2001, all bank owned life insurance will be marketed by our Banking Practice division.
Deferred Income Plans. Deferred income plans allow corporate executives to defer a portion of their current income on a tax-deferred basis. The deferred income and interest in a properly designed and administered deferred income plans grows on a tax-deferred basis until distributions are made to the executive, usually at retirement. Corporations often purchase life insurance to create an asset in order to offset the costs of the liability created by a deferred income plan. Deferred income plans can be structured in a variety of ways; traditional deferred income plans, which credit the deferred income amount with a fixed rate of interest and use fixed yield life insurance products to offset the costs of the company's liability, or variable deferred income plans, which credit the deferred income amount with interest based on a bond or equity index and use variable yield life insurance products to offset the costs of the company's liability. In an effort to provide additional security for executives, corporations usually create a trust to hold the related insurance policies.
Because deferred income plans provide executives with a method to defer income at little or no cost to the corporation, we believe that the demand for these plans will continue to increase, as corporations implement new plans or expand the availability of existing plans.
Supplemental Executive Retirement Plans. Supplemental executive retirement plans are specifically designed to supplement the dollar limitation on benefits paid from qualified pension plans. The maximum dollar amount of compensation that can be used to determine the pension benefits payable to an executive from a qualified plan is $170,000. Accordingly, non-qualified plans such as supplemental executive retirement plans, which are not subject to the same stringent rule, have increased in popularity. Many supplemental executive retirement plans are funded with the same insurance products and strategies used to fund deferred income plans.
Supplemental Offset Plans. Supplemental offset plans are designed to supplement an executive's income by restoring retirement benefits previously limited by legislative changes. Supplemental offset plans are funded with insurance policies using a technique commonly known as "split dollar." Ownership rights to an individual policy are shared between the corporation and the executive. The corporation and the executive share in the insurance policy's increasing cash value and death benefits. The corporation pays the premiums, but recovers these expenditures from its share of the policy's proceeds. The executive's interest in such policy is targeted to equal the present value of the retirement benefits due at the time of such executive's retirement.
As originally structured, supplemental offset plans were owned exclusively by the employer and not by the individual. The sharing of the ownership is a variation known as "equity split dollar." The recent initiatives by the Internal Revenue Service to tax the incremental equity ownership currently to the employees have raised a question as to the continued viability of this program. We will continue to monitor these developments.
Group Term Carve Out Plans. Currently, a corporation can provide its employees with a group term life insurance policy death benefit of up to $50,000 on a tax-free basis. The cost of providing a death benefit in excess of $50,000 is taxed to the employee as ordinary income. Group term carve out plans allow companies to provide portable coverage in a customized program of amounts greater than $50,000 and taxed at lower rates. Group term carve out plans often provide a greater amount of insurance and post-retirement death benefit to the employee at a competitive overall cost. The corporate plan sponsor is not an owner or beneficiary of the permanent life insurance policies.
Compensation Consulting. With the acquisition of Pearl Meyer & Partners, we have entered the market for senior executive and board of director level executive compensation consulting. Pearl Meyer is the largest independent compensation consulting firm in the U.S. and with this acquisition, we expect to enhance our expertise in this area and offer broader services to our clients. Our Healthcare Group and Banking Practice divisions have developed programs in base salary, incentives, deferred compensation, and other compensation design plans. The Clark/Bardes Consulting -- Compensation Resource Group division is now initiating similar programs for its clients.
Community Bankers Scholarship Program. The Community Bankers Scholarship Program is designed for community banks that wish to offer college scholarships for students in their communities. This turnkey program utilizes life insurance to provide a cost-effective method of financing the annual cost of the scholarships. The Community Bankers Scholarship Program is marketed through our Banking Practice division.
Disability Income Plan. Many companies provide group Disability Income Protection for their employees. In many cases, these plans have limits that may not be sufficient to provide reasonable income replacement for executives in the event of a disability. Disability Income Plans marketed by our Clark/Bardes Consulting -- Compensation Resource Group and Healthcare Group divisions supplement the group plans currently in place, and provide additional income for executives in the event of a disability.
ExecuFLEX Program. Our Healthcare Group division provides a total compensation planning approach to the not-for-profit health care market through its "ExecuFLEX" program. The program includes a base level of benefits, such as medical, dental, vision, long-term disability, long-term care, and group term life insurance. In addition, participants are provided an allowance made up of company contributions and voluntary personal deferrals. The flex allowance is used to supplement base coverage and to add to their retirement funding. The ExecuFLEX program is designed to provide maximum flexibility to the participants at a minimal cost to the organization. The success of ExecuFLEX has led us to offer the program to companies serviced by all of our operating divisions as well as additional market segments within the health care industry.
Administrative Services
We believe that we are an industry leader in providing high quality and unique services to our clients. We have developed state of the art administrative capabilities necessary to service the executive benefit and insurance programs we market. As of December 31, 2000, we administered over 200,000 policies for over 2,500 clients. As of the same date, the insurance policies underlying our employee benefit programs represented a total of approximately $81 billion of inforce insurance coverage as follows:
Clark/ Bardes Consulting -- Compensation Resource Group Banking HealthCare Division Practice Group Total ------------ ---------- ------- -------- Policies administered.... 174,000 14,000 12,000 200,000 Clients......... 300 1,400 800 2,500 Inforce coverage $ 69 billion $ 7 billion $5 billion $ 81 billion
We approach administrative services with a strategy that assures our clients' unique requirements and needs are served through customized, value-added services and intensive support, creating brand and client loyalty and lower sensitivity to price. We further differentiate ourselves by employing a focused strategy for a particular buyer group through each of our four divisions. For instance, we service clients in the banking industry through our Banking Practice division and not-for-profit healthcare organizations through our Healthcare Group division with an insider's view of each market resulting in providing high quality administrative services customized to a client's needs while achieving lower costs.
We offer customized enrollment and administrative services for insurance-financed employee benefit programs, including business owned life insurance and non-qualified benefit plans. Due to the many complex requirements of the administrative process, each client is assigned an account team comprised of specialists who are responsible for servicing the needs of that client. The administrative services provided by each of our divisions' account specialists include coordinating and managing the enrollment process, distributing communication materials, monitoring financial, tax and regulatory changes, providing accounting reports, and periodic benefit statements to participants, performing annual reviews and reporting historical and projected cash flow and earnings. Each division's account specialists are supported by actuarial, financial and insurance experts.
We build our client base by fostering long-term client relationships. To this end, the training and focus of each account team centers on our goal of delivering the highest quality program implementation and administrative services in the industry. This benefits both the client, through top professional support, and the consultant, who can focus more closely on the consulting process. To further emphasize long-term client relationships, we enter into administrative agreements with each client, in most cases for a term of five to ten years. Finally, our method of calculating the revenue splits with our consultants ensures that the revenue from new sales is not required to subsidize the administrative costs of existing cases.
Our commitment to providing high quality client and administrative services is one of the primary reasons that we have achieved the success we enjoyed to date. We believe that our continued focus on, and investment in, the personnel and technology necessary to deliver this level of client service will bolster our reputation as an industry leader.
Distribution
Each of our divisions markets its employee benefit programs and related administrative and consulting services through an in-house sales organization as well as consultants in independently operated sales offices located throughout the United States. As of December 31, 2000, we were represented by over 100 consultants in 51 sales offices located in 49 states throughout the United States. Consultants owned approximately 10% of the outstanding shares of our common stock as of December 31, 2000.
Our independent consultants enter into agency agreements with us to market programs and services on our behalf on an exclusive basis. Each agreement defines the duties of the consultant to solicit and sell covered business, the revenue splits between the consultant and ourselves, and includes a confidentiality agreement and operating standards. We pay a substantial portion of the total sales revenue to the independent consultant, usually from 50% to 65% of gross revenue. Most of our independent consultants are responsible for their own operating expenses. Non-solicitation clauses, which prohibit either party from soliciting the other party's clients are normally three years with respect to separate clients and usually five years with respect to joint clients. Some of our divisions, such as the Healthcare Group and Pearl Meyer & Partners, generate a significant portion of their sales revenue through employee-consultants and we bear the administrative expense of the sales consultants in exchange for a lower commission and fee expense.
Our top three consultants collectively accounted for approximately 32.0% of 1999 revenue and 10.8% of 2000 revenue. We recognize the importance of attracting and retaining qualified, productive sales professionals. We actively recruit and develop new sales professionals in order to add to our distribution capacity. Further, our acquisition strategy focuses on retaining the productive sales professionals of the entity being acquired.
As our business has grown, externally and through acquisitions, our reliance on a select few high volume consultants has decreased accordingly. There are still a large number of strong consultants and as they continue in their success, and we continue to acquire other organizations, the base expands proportionally.
Employees
As of December 31, 2000, we employed approximately 593 people as follows:
Compensation Resource Group................. 237 Banking Practice...... 131 Healthcare Group...... 161 Pearl Meyer & Partners 33 Holding Company....... 31 ---
The majority of our employees have college degrees, with several holding advanced degrees in law, accounting, business administration or actuarial science. Professional development is a highly valued industry characteristic, and insurance and financial planning designations such as Chartered Life Underwriter, Fellow of the Life Management Institute, Fellow of the Society of Actuaries and Certified Financial Planner to name a few, are held by a large number of our employees. We actively encourage continuing education for employees through expense reimbursement and reward plans. Due to the specialized nature of the business, we often recruit experienced persons from insurance companies, consulting firms and related industries.
Marketing Support
We have made a substantial investment in establishing highly qualified marketing departments in each division. Each marketing department's primary focus is to support our sales efforts. The marketing departments develop and track sales leads for the consultants and provide marketing materials and research. We distribute external newsletters and other program update pieces to approximately 15,000 current and prospective clients throughout the year and sponsor conferences and meetings featuring industry experts and nationally recognized speakers. Finally, the public relations and corporate marketing functions coordinate the publication of articles written by our employees and consultants and ensure that our representatives are quoted as information sources in major national publications. We believe that the efforts of our marketing departments have helped make us a readily identifiable leader in the insurance-financed employee benefit industry.
During 2000, we launched two new and innovative marketing tools using internet technology. BOLIauction.com debuted April 14, 2000 and BOLInet.com debuted August 14, 2000. Both sites are patent-pending and are VeriSign secure. BOLIauction.com -- is our new online bank-owned life insurance (BOLI) purchasing system. Using BOLIauction.com's proprietary interface, banks access the best carriers and products through this competitive auction environment. After clients set parameters online for their BOLI program, BOLIauction.com distributes these specifications to the participating carriers. Carriers then submit their responses to BOLIauction.com, the auction begins, and a winning bid is selected. The first auction, which involved two banks, ten carriers, and over $150 million in underwriting, occurred on June 16, 2000. To date, four auctions have occurred on BOLIauction.com totaling $500 million in BOLI assets. The five participating institutions experienced an average 15 basis point increase from initial carrier bids. This equates to an additional $750,000 in annual income for these banks.
o Thirty-four banks are registered users of BOLInet.com and expect we expect to enroll an additional 120 in 2001. A total of $6 billion in BOLI assets are managed on the site.
o BOLInet.com allows a client bank to get real-time data on their BOLI assets, and provides powerful data-mining and report writing tools.
Consultant Support
Our consultants are supported by a design and analysis department in each division. The primary responsibility of the design and analysis department is to design customized compensation and benefit programs that will effectively offset the costs of a client's employee benefit liabilities. The design analyst works with the consultant to identify the needs of a prospective client and investigates the availability and pricing of products that are compatible with that client's needs. Finally, the analyst develops the financial projections necessary to evaluate the benefit costs and cost recoveries for the prospective client, together with an analysis of alternatives to assist the client in making a decision.
Technology, Administration and Integration
We have made a significant investment in developing proprietary modeling and administrative systems to support the unique characteristics of benefit programs financed life by insurance and other financial instruments. Reflecting the diversity of our four divisions, each has its own computer based information system and professional support staff. All the systems have been designed and are operated to support the special processing needs of a particular client base. The systems use a relational database to facilitate easy access to client, participant and benefit information. In addition, a telephonic application allows individual plan participants twenty-four hours a day access to account balance and unit price information.
Local area networks link all of our personal computers. Internet mail is utilized to communicate with clients and sales offices. We intend to continue to invest in technology and system development in order to offer additional services to clients, support new markets, integrate acquired operations, improve productivity and reduce costs.
We maintain a disaster recovery plan for local area network and Unix environments in order to minimize downtime in the event of a major system failure. The local area network file servers and Unix database servers are located in physically secure areas and all systems are password-protected to ensure access is limited to authorized individuals. We did not experience any year 2000 related difficulties directly or indirectly with clients, carriers or suppliers.
When acquiring small businesses, we integrate their information systems as well as their staffs, accounting and administrative systems. In this manner, we are able to give them technical and administrative systems support they could not achieve as a stand-alone unit and, at the same time, improve their level of client service.
Persistency
Over the last five years, we have experienced an overall average annual persistency rate of 95% of the inforce insurance underlying our programs. The "persistency" of an insurance policy refers to the length of time it remains continuously in force. We believe that this high persistency rate is attributable to a number of factors.
o The underlying purpose of the compensation and benefit programs is to offset the costs of employee benefit liabilities and provide long-term benefits to executives, key employees and other professionals. Therefore, the policy is held by the corporation to maturity, regardless of whether any particular individual insured remains with the client.
o The clients of our Clark/Bardes Consulting -- Compensation Resource Group or Banking Practice divisions would incur unfavorable tax consequences upon the surrender of an underlying business owned life insurance policy. The cash value of the policy, to the extent it represents amounts beyond the cash premiums paid by the allowable charges against the insurance account is taxed immediately at ordinary income rates upon surrender, and an additional penalty tax applies in certain instances. A client often has the option of making a tax-free exchange to another policy. Upon the exchange, however, the client would incur substantial insurance company-related costs, such as premium taxes.
o The high persistency rates of all of our divisions are partially attributable to provisions in many interest rate sensitive products that disallow a full-scale withdrawal or exchange.
o We provide a high degree of ongoing client service. We believe that the quality of our services provided through each of our divisions enhances persistency by distinguishing us from our competitors.
As we continue to diversify and acquire companies in different market segments, our persistency can begin to vary significantly. While we intend to do all we can to retain our clients, service their accounts and sustain our persistency, there can be no assurance our persistency rates will remain at this level.
Competition
The executive compensation and benefit consulting market is highly competitive. We compete with consulting firms, brokers, third party administrators, producer groups and insurance companies. A number of our competitors offer attractive alternative programs. The direct competitors of our Clark/Bardes Consulting -- Compensation Resource Group division include; Management Compensation Group, Mullin Consulting, Newport Group, TBG Financial, and The Todd Organization.
The competitors of our Banking Practice include The Benefit Marketing Group; Harris, Crouch, Miller, Scott, Long and Mann; and individual insurance agents in the communities where the community banks are located. Additionally, the banking industry is constantly consolidating, which may reduce the number of potential bank clients. In competition with our Healthcare Group division are; Hewitt Associates, Towers Perrin, Mercer Consulting Group and Hay Group, Inc. These firms, however, do not focus exclusively on healthcare and do not restrict their practices to executive and physician compensation.
Although Pearl Meyer & Partners is one of the best established firms in the high level executive compensation consulting market, there are a number of firms that offer this service.
We compete 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 may offer attractive programs on pricing, we believe that we are in a superior competitive position in most, if not all, of the meaningful aspects of our business, because of our track record, name recognition, industry focus, specialization and industry expertise. We do not consider our direct competitors to be our greatest competitive threat. Rather, we believe that our 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 ours.
Government Regulation
State governments extensively regulate our life insurance activities. We sell our insurance products in all 50 states through licensed insurance producers. Insurance laws vary from state to state and states have broad powers over licensing, payment of commissions, business practices, policy forms and premium rates. While we have not encountered regulatory problems in the past, we cannot assure you that we will always be in compliance with all applicable regulatory requirements of each state. Additionally, we cannot be sure if we or our consultants will encounter regulatory problems in the future, including any potential sanctions or penalties for operating in a state without all required licenses.
While the federal government does not directly regulate the marketing of most insurance products, some products, such as variable life insurance, must be registered under the federal securities laws. As a result, our consultants and entities with which we have administrative service agreements related to selling those products must be registered with the National Association of Securities Dealers. We market these insurance products through a registered broker-dealer with which we have a network agreement. While we have not had any regulatory problems in the past related to these products, we cannot be sure if we or our consultants will not have regulatory problems in the future.
ITEM 2.
ITEM 2. PROPERTIES
The following table sets forth certain information with respect to the principal facilities used in our operations, all of which are leased.
Monthly Square Current Division -- Location Rent Footage Lease Expires Clark/Bardes Consulting -- Compensation Resource Group -- Dallas, Texas..................... $48,294 35,619 April 2001 Dallas, Texas..................... 1,913 3,507 August 2004 Bethesda, Maryland................ 14,295 8,519 July 2007 Phoenix, Arizona.................. 3,427 2,056 March 2004 Los Angeles, California........... 55,970 37,313 June 2010 Cleveland, Ohio................... 5,578 3,049 July 2002 Atlanta, Georgia.................. 4,680 2,399 November Chicago, Illinois................. 5,193 4,734 June 2004 New York, New York................ 10,150 2,900 August 2001 Banking Practice-- Bloomington, Minnesota............ 48,861 32,897 September Dallas, Texas..................... 11,088 6,034 February Regional Offices.................. 8,949 2,903 Various Healthcare Group -- Minneapolis, 109,790 56,231 December Minnesota........................... 2003 Pearl Meyer & Partners -- New York, 29,271 19,000 May 2010 New York............................ Clark/Bardes Holdings -- North Barrington, 22,118 11,085 July 2007 Illinois.......................... Clark/Bardes Partners-- Stamford, Connecticut....................... 11,337 3,868 September
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we are involved in various claims and lawsuits incidental to our business, including claims and lawsuits alleging breaches of contractual obligations under agreements with our consultants. The following is a summary of the current legal proceedings pending against us.
M Financial Holdings, Incorporated, et al. v. Clark/Bardes Holdings, Inc.
On June 3, 2000, M Financial Holdings, Incorporated ("M") commenced an action in the Circuit Court of Multnomah County, Oregon, seeking to enjoin a former executive from being employed by us and other relief. The complaint alleges breach of fiduciary duty, unfair competition, civil conspiracy and misappropriation of trade secrets, and charges us with intentional interference with contract.
The complaint requests an injunction barring the executive's employment with the Company for two years, barring disclosure of M confidential information, and requiring the return of all documents. In addition, M seeks a constructive trust with respect to our gross profits from our reinsurance operation for two years, compensatory damages, punitive damages of $1,500,000 plus attorneys fees and costs. Both we and the executive deny any wrongdoing and intend to vigorously defend these claims.
Constellation Energy Group, Inc. and Baltimore Gas and Electric Company, et al. v. Clark/Bardes, Inc.
On July 25, 2000, Constellation Energy Group, Inc. ("Constellation") and related entities filed a civil action against us in the U.S. District Court for the District of Maryland. Constellation claims that we failed to take proper action in connection with the administration of an employee benefit life insurance program, resulting in claimed damages of $7.5 million and pre-judgment interest, post-judgment interest, costs and expenses.
Agreement has been reached with Plaintiffs to stay the matter until April 16, 2001 to facilitate ongoing discussions and a potential nonbinding mediation of the issues. We believe we have meritorious defenses to these claims, intend to deny all allegations and to vigorously defend these claims. Our insurance carrier has acknowledged coverage for this action and the extent of that coverage can only be determined at the outcome of the case in the event we do not prevail.
Madge A. Kunkel, individually and as Personal Representative of the Estate of Donald B. Kunkel, M.D., deceased vs. Banner Health System, et al.
On February 2, 2001, an action was commenced in the Superior Court of Maricopa County, Oregon against various defendants including our Healthcare Group Division ("HCS"). Ms. Kunkel alleges that her deceased husband was entitled to a life insurance policy in the face amount of $525,000 to be issued by the defendant insurance company under a split dollar life insurance plan sponsored by his defendant employer which was administered by HCS. According to the complaint, Dr. Kunkel died before the initial premium was paid by his employer and before the policy was issued. The matter has been submitted to our insurance carriers. We believe we have meritorious defenses to this claim and we intend to vigorously defend the matter.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the fiscal year covered by this Form 10-K to a vote of our security holders, through the solicitation of proxies or otherwise.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Price Range of Common Stock
On August 19, 1998, we completed an initial public offering of the Common Stock at a price of $9.00 per share. Our common stock trades on the over the counter market and is quoted on the Nasdaq National Market under the symbol "CLKB." The following table sets forth the high and low closing sales price as reported by the Nasdaq National Market for our common stock for the periods indicated.
High Low First quarter..... $ 18.25 $ 13.06 Second quarter.... $ 20.50 $ 13.00 Third quarter..... $ 20.63 $ 16.00 Fourth quarter.... $ 20.63 $ 12.25 First quarter..... $ 17.88 $ 3.13 Second quarter.... $ 16.88 $ 13.44 Third quarter..... $ 17.88 $ 8.50 Fourth quarter.... $ 13.84 $ 9.38 First quarter to March 20......... $ 12.13 $ 8.94
As of March 5, 2001, the closing price of our common stock was $10.13, there were 12,675,309 shares of our common stock outstanding, and there were approximately 514 holders of record and 802 beneficial holders of our common stock.
Dividend Policy
Prior to our reorganization in July 1998, we conducted our business as an S corporation for federal income tax purposes. Under this form of organization, all earnings were deemed to be passed through directly to our shareholders, whether distributed or not. In order for our shareholders to pay the federal income taxes imposed by this form of organization, we made distributions to them. These distributions are shown as dividends in prior periods in our financial statements.
We intend to retain future earnings to fund growth and do not plan to pay any cash dividends in the foreseeable future. Under the terms of a credit agreement with Bank One, we cannot declare or pay dividends or return capital to our stockholders, nor can we authorize or make any other distribution, payment or delivery of property or cash to our stockholders, unless Bank One gives its prior written consent.
Recent Sales of Unregistered Securities
On February 11, 2000, we issued 43,714 shares of our common stock as part of the purchase price for the acquisition of the Christiansen Group. The issue was exempt from registration under Section 4(2) of the Securities Act of 1933. The total value of the shares issued was $694,000 and constituted 89.5% of the total purchase price.
On May 5, 2000, we issued 49,143 shares of our common stock as part of the purchase price for the acquisition of Insurance Alliances Group, Inc. The issue was exempt from registration under Section 4(2) of the Securities Act of 1933. The total value of the shares issued was $713,000 and constituted 20.0% of the total purchase price.
On June 21, 2000, we issued 250,000 shares of our common stock as part of the purchase price for the acquisition of Pearl Meyer & Partners, Inc. The issue was exempt from registration under Section 4(2) of the Securities Act of 1933. The total value of the shares issued was $4.0 million and constituted 15.4% of the total purchase price.
On September 6, 2000, we issued 596,463 shares of our common stock as part of the purchase price for our acquisition of Compensation Resource Group, Inc. The issuance was exempt from registration under Section 4(2) of the Securities Act of 1933. The total value of the shares issued was $6.1 million and constituted 20.0% of the purchase price.
On September 11, 2000, we sold 1,888,887 shares of common stock to a group of investors for $25.1 million, net of expenses, in a private placement transaction. The 1,888,887 shares have been registered for resale by the investors if they deem it appropriate to resell them.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following historical information of Clark/Bardes should be read in conjunction with information included elsewhere herein, including the financial statements and notes thereto and "Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Tables shown in thousands of dollars, except per share amounts)
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements, the notes thereto and other information appearing elsewhere in this Form 10-K.
Overview
Our net income for 2000 of $11.4 million and $1.05 per diluted common share was the best in our history representing a 29.6% increase over comparable net income of $8.8 million and a 10.5% improvement over diluted earnings per share of $.95 for the year 1999.
In the fourth quarter of 2000, net income was $8.3 million; $.65 per diluted share compared with $4.9 million and $.50 per diluted share for the 1999 fourth quarter, an increase of 69.4% in net income and 30.0% in earnings per share.
The year 2000 produced three unusual and non-recurring events. In the third quarter, we sustained a $518,000 charge to integrate a new acquisition. Also, in the third quarter, we recovered approximately $500,000 of overpaid state income taxes thus giving us an unusually low effective tax rate for the year and a $.05 per share benefit. In the fourth quarter, we received $1.0 million of life insurance proceeds as the result of the death of a sales consultant. This one time credit increased net income for 2000 by $1.0 million or $.09 per share.
Acquisitions
As we stated in last year's report, our acquisition program remains broadly focused on adding new markets or expanding those in which we already have a presence. We feel we furthered this objective in 2000 by acquiring:
o Pearl Meyer & Partners, one of America's leading executive compensation consulting firms, during the second quarter; and,
o Compensation Resource Group, a leading company in the executive compensation and benefits market, in the third quarter.
As we have said previously, the companies we acquire are typically privately owned and structured as S corporations for federal income tax purposes, with the income passed on to the shareholders. Our evaluation focus is on the quality of the management and future earnings and growth potential. In the case of life insurance sales acquisitions, we also acquire the financial value embedded in a book of recurring renewal business to be realized for many years after the acquisition takes place. This raises two important financial issues:
1) Our sellers want a majority of the purchase price in cash, thus requiring a large pool of funds from equity or debt offerings, or both.
2) We acquire little in the way of tangible assets, thus creating a substantial amount of intangible assets on our balance sheet.
Up until now, our future renewal revenue stream has been a major source of collateral for continued acquisitions. As we acquire more businesses that do not have this attribute, our cash flow potential from renewals will be less of a factor to be considered as we seek to expand our borrowing availability.
Rich, Florin/Solutions, Inc.
On March 12, 2001, we acquired the business along with certain assets and liabilities of Rich, Florin/ Solutions, Inc., a Boston, Massachusetts compensation consulting company. The assets acquired include accounts receivable, copyrights and office equipment. The liabilities assumed were for employee benefit obligations existing as of the acquisition date.
The purchase price was $20.8 million; before expenses, consisting of a cash payment at closing of $11.3 million and $9.5 million of contingent payments over the next four years based on the attainment of established financial performance criteria. When earned, the contingent payments will consist of 60% cash and 40% CBH common stock.
The transaction was funded from CBH's existing line of credit. The initial goodwill of approximately $9.0 million will be amortized over twenty years.
Forrest, Wagner & Associates
On October 23, 2000, CBH acquired all of the outstanding stock of Forrest, Wagner & Associates, Inc. ("FWA") for a purchase price of $4.2 million, including expenses, of which $3.5 million was paid in cash at the closing. The balance of $750,000 is payable upon the achievement of certain financial criteria by December 31, 2004.
FWA is a Phoenix, Arizona based firm specializing in marketing and administering non-qualified executive benefit plans funded primarily by Company owned life insurance. FWA was affiliated with Compensation Resource Group, Inc.
The acquisition will be accounted for as a purchase with $2.7 million of the purchase price amortized based on the net present value of future renewal revenue over twenty years. The balance of the purchase price, when made, will be accounted for as goodwill and amortized over the remainder of the initial twenty-year period.
Compensation Resource Group, Inc.
On September 6, 2000, we acquired all the issued and outstanding capital stock of Compensation Resource Group ("CRG") for a total purchase price of $30.5 million, excluding acquisition expenses, consisting of:
o a cash payment to the CRG shareholder Sellers of $11.4 million;
o the issuance by CBH of 596,463 shares of its common stock, par value $0.1 per share (the "Common Stock"), having an aggregate value of $6.1 million based on the closing price of the Common Stock on September 5, 2000;
o the repayment of approximately $13.0 million of CRG's long-term debt.
Acquisition expenses are estimated to be $735,000.
For the periods prior to the acquisition, CRG had revenue and net income as follows:
Fiscal Years Ended Six Months Ended June 30, June 30, 2000 1999 2000 ----------- ----------- -------- (Audited) (Unaudited) Revenue...... $26,286 $27,126 $19,711 Net income (3,268) 45 7,064 (loss).......
CRG is an executive compensation and benefits organization that provides the design, marketing, funding and administration of non-qualified plans. CRG is headquartered in Los Angeles, California and has affiliated offices in seven other cities. Prior to the acquisition, there was no material relationship between CRG and Clark/Bardes.
The $25.1 million cash portion of the purchase price was borrowed under our credit facility with Bank One.
In connection with the acquisition, we entered into a bonus arrangement for present and future key executives and employees of CRG. This arrangement will provide for the payment of bonuses of up to $20 million if certain stipulated financial objectives are achieved during the years ended December 31, 2003 to 2005.
The acquisition of CRG has been accounted for as a purchase with $26.7 million of the purchase price allocated to the present value of in-force revenue and amortized over a period of thirty years and $11.4 million allocated to goodwill, which will be amortized over twenty years.
The unaudited financial information below presents the results of CBH and CRG as if the acquisition had occurred on January 1, 1999.
Twelve Months Ended December 31, 2000 1999 Pro forma Revenue................ $181,787 $148,487 Net income (loss)...... 9,500 5,957 Diluted earnings (loss) .84 .60 per share................
Pearl Meyer & Partners, Inc.
On June 21, 2000, we acquired all of the capital stock of Pearl Meyer & Partners, Inc. for a total purchase price of $25.9 million, excluding expenses. The purchase price consisted of a cash payment of $21.9 million and the issuance of 250,000 shares of our common stock with a value of $4.0 million. Acquisition expenses were $720,000. The $22.6 million cash portion of the purchase price was borrowed under our line of credit.
For the period prior to the acquisition, Pearl Meyer & Partners had revenue and net income as follows:
Years Ended Three Months December 31, Ended March 31, 1999 1998 2000 ------------------ ------------ (Audited) (Unaudited) Revenue.. $12,579 $11,230 $3,176 Net income 757 232 1,346
For income tax purposes, Pearl Meyer & Partners was an S corporation; consequently the net income was passed on to the shareholders.
Pearl Meyer is a New York City based consulting firm specializing in executive compensation and retention programs. The Pearl Meyer organization became our fourth operating division. Prior to the acquisition, there was no material relationship between CBH and Pearl Meyer.
The acquisition has been accounted for as a purchase and goodwill of $23.5 million will be amortized over a twenty-year period.
In addition to the initial purchase price, $2.0 million of additional cash consideration will be paid in the first quarter of 2002 upon the achievement of a defined performance objective during the eighteen months subsequent to the purchase. This payment, when earned, will be accounted for as additional purchase price to be amortized over the remainder of the original twenty-year period.
The unaudited pro forma information below presents the results of us and Pearl Meyer & Partners as if the acquisition had occurred on January 1, 1999.
Twelve Months Ended December 31, 2000 1999 Pro forma Revenue................ $154,557 $133,339 Net income (loss)...... 12,143 7,562 Diluted earnings (loss) 1.10 .79 per share................
W.M. Sheehan & Company, Inc.
On June 13, 2000, we acquired the working capital and equipment, and assumed certain liabilities of W.M. Sheehan & Company, Inc. ("Sheehan"). The purchase price was $367,000 cash. The acquisition has been accounted for as a purchase and the goodwill will be amortized over twenty years.
In addition to the purchase price paid at closing, an additional $650,000 will be paid upon the achievement of certain revenue and earnings objectives during the years ended June 30, 2001 through 2004. The payments will be made 23% in cash and 77% in our common stock based on values at time of issuance. The additional payments will be accounted for as goodwill and amortized over the remaining twenty-year period.
Insurance Alliances Group, Inc.
On May 5, 2000, we acquired the business of Insurance Alliances Group, Inc. ("IAG"). There were no identifiable assets acquired or liabilities assumed. IAG is a Stamford, Connecticut insurance firm specializing in executive estate planning.
The purchase price for the business was $3.5 million consisting of $2.8 million cash and 49,143 shares of our common stock having a value of $713,000. The cash portion of the purchase price was borrowed under our line of credit. The acquisition will be accounted for as a purchase and the entire purchase price has been allocated to the net present value of renewal revenue from insurance in force at the time of the acquisition and will be amortized over a period of thirty years.
Christiansen & Associates
Effective January 1, 2000 we acquired the stock and business of Christiansen & Associates for 43,714 shares of common stock at a value of $694,000 and cash and expenses of $128,913. Christiansen is a former independent consulting organization that sold through our BCS division. The acquisition has been accounted for as a purchase and goodwill will be amortized over twenty years.
In addition to the purchase price, $167,000 cash and 171,632 shares of our common stock are issuable to the former principals of Christiansen & Associates on the attainment of stipulated financial objectives. These payments, when earned, will be accounted for as additional purchase price to be amortized over the remainder of the original twenty year period.
The Watson Company
On February 1, 2000, we acquired the assets of The Watson Company for $328,000, cash and expenses, as an expansion of the Banking Practice division. The acquisition has been accounted for as a purchase and the goodwill amortized over twenty years.
Upon reaching certain stipulated financial goals, former shareholders of The Watson Company will earn the right to receive up to $900,000 of our common stock based on market values at the time of achievement. These payments, when earned, will be accounted for as additional purchase price to be amortized over the remainder of the original twenty-year period.
Other Developments
Private Placement
On September 11, 2000, we sold 1,888,887 shares of our common stock in a registered private placement to a group of unaffiliated investors for $25.1 million, net of expenses. The funds were used to complete the CRG acquisition and retire debt. The shares have been registered for sale if any of the investors wish to do so.
Tax Enforcement Policy
Last year we had reported that the Tax Court had found in favor of the Internal Revenue Service in their efforts to disallow an interest deduction by a company having purchased an executive benefit program funded by a life insurance product known as leveraged COLI. Since then, the IRS has continued to litigate the matter with other companies and has prevailed on three more cases. We have not offered leveraged COLI in our product offerings since 1995. Consequently, we do not expect any adverse effects on our future new business revenue stream. However, because of the varied facts and circumstances surrounding each case, it is impossible to determine the effects of any case on a client's decision to continue or surrender any existing policy. Because of the number of other variables, including adverse tax implications resulting from a surrender of the insurance contracts, it is impossible to predict the ultimate effect, if any, this could have on our future renewal revenues.
In January 2001, the Treasury Department and the Internal Revenue Service served notice on taxpayers of their intent to consider taxing the equity increase in what are known as "equity split dollar" arrangements, to the individual beneficiary of the coverage. Heretofore, the individual did not sustain a tax liability until the policy was closed and the equity distributed. The implementation of this notice may have a negative impact on our ability to market new equity split dollar arrangements and could potentially affect existing split dollar arrangements.
Earnings Guidance
Since our initial public offering on August 19, 1998, our Company has increased in both size and complexity resulting from both internal growth as well as acquisitions. Assisting the reader in assessing our financial performance and preparing statements enhance that understanding, has always been one of our goals. In furtherance of this goal, we are including earnings guidance in the form of a projection with this report.
2001 Quarter Ending Full Year March 31 June 30 September 30 December 31 2001 ---------- ---------- ------------------------------ Revenue First Year........... $ 29,100 $ 24,200 $ 25,700 $ 38,500 $ 117,500 Renewal and Fees..... 28,000 18,100 17,900 24,300 88,300 ---------- ---------- --------- ---------- ---------- Total........ 57,100 42,300 43,600 62,800 205,800 ---------- ---------- --------- ---------- ---------- Gross profit.......... 37,200 28,400 29,600 42,700 137,900 ---------- ---------- --------- ---------- ---------- Earnings Before Interest, Taxes and Amortization.. 12,200 4,500 5,400 18,500 40,600 ---------- ---------- --------- ---------- ----------
Net Income............. $ 5,300 $ 600 $ 1,200 $ 9,500 $ 16,600 ========== ========== ========= ========== ========== Diluted Shares Outstanding............ 13,034,000 13,218,000 13,325,000 13,401,000 13,244,000 Diluted Earnings Per share.................. $ 0.41 $ 0.05 $ 0.09 $ 0.71 $ 1.25 Contributions by Division Revenue Corporate......... $ 22,300 $ 16,500 $ 17,000 $ 24,500 $ 80,300 Banking........... 24,500 18,100 18,700 27,000 88,300 HealthCare........ 6,300 4,700 4,800 6,900 22,700 Compensation 4,000 3,000 3,100 4,400 14,500 ---------- ---------- --------- ---------- ---------- Consulting............. Total........ $ 57,100 $ 42,300 $ 43,600 $ 62,800 $ 205,800 ========== ========== ========= ========== ==========
Earnings Before Interest, Taxes and Amortization Corporate......... $ 4,000 $ 1,500 $ 1,800 $ 6,100 $ 13,400 Banking........... 8,700 3,200 3,800 13,100 28,800 HealthCare........ 600 200 300 900 2,000 Compensation 1,700 600 800 2,600 5,700 Consulting............. Holding Company... (2,800) (1,000) (1,300) (4,200) (9,300) ---------- ---------- --------- ---------- ---------- $ 12,200 $ 4,500 $ 5,400 $ 18,500 $ 40,600 ========== ========== ========= ========== ==========
All of the data in this schedule, constitutes forward-looking statements. They are based on the beliefs of management and information currently available and they are not a guarantee of future performance. Actual results could differ materially from those shown in the forward-looking statement as a result of a number of factors, such as changes in tax legislation, dependence on key consultants, persistency of existing business, credit risk, acquisition risks, competitive factors and pricing pressure, dependence on certain insurance companies, changes in legal and regulatory requirements, general economic conditions and other factors discussed under the caption "Risk Factors".
Revenue Sources and Recognition
Our operating units derive their revenue primarily from:
o commissions paid by the insurance companies that underwrite the policies underlying the various benefit programs;
o program design and administrative service fees paid by clients; and
o executive compensation and benefit consulting fees.
Our commission revenue is usually long term and recurring, is typically paid annually and extends for a period of ten years or more after the sale. Commissions paid by insurance companies vary by policy and by program and usually represent a percentage of the premium or the cash surrender value of the insurance policies underlying our program.
o First Year Revenue. First year revenue is derived from two principal sources; (a) the commission we earn when the client first purchases the policies underlying the program. It is the financial result of our sales efforts. First year 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 by the client, to the insurance company; and (b) fees for the services we perform in advising our clients on their executive compensation programs. These fees are based on a rate per hour arrangement and are earned when the service is rendered and billed to the client.
o Renewal Commission Revenue. Renewal revenue is the commission we earned based on the premiums on the policies underlying the benefit programs we have sold in prior periods. Renewal revenue is recognized on the date that the renewal premium is due or paid to the insurance company depending on the type of policy. Renewal revenue in future periods, which is not recorded on our balance sheet, is estimated to be approximately $297 million 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. Over the last five years, we have experienced a persistency rate of approximately 95% of the inforce insurance underlying our programs. However, we can give no assurances that our persistency rate will remain at this level. We intend to do all we can to retain our clients, service their accounts and sustain our persistency.
o Other Revenue. Other revenue consists of several sources of revenue associated with our operations, including:
o Various consulting fees we may charge incident to the studies we perform in the development of a specific benefit program;
o Fees we charge our clients for the administration of their benefit program.
Both of these fees are recorded as revenue as they are earned in accordance with the governing agreement.
Quarterly Results
The following table presents a summary of key revenue and expense statistics for the most recent eight calendar quarters. This information is not necessarily indicative of results for any full year or for any subsequent period.
Our operating results can fluctuate considerably, especially when compared on a consecutive quarterly basis. We can experience large increases in revenue in the fourth quarter and operating results may be affected by a number of other factors, including:
o new or enhanced programs and services by us or our competitors and client acceptance or rejection of these programs;
o program development expenses;
o competitive, legislative and regulatory changes; and
o general economic conditions.
Many of these factors are beyond our control. Sales cycles often take between twelve to eighteen months, with first year revenue coming from a few large cases. Our revenue is thus difficult to forecast, and we believe that comparing our consecutive quarterly results of operations is not necessarily meaningful, nor does it indicate what results we will achieve for any subsequent period.
Results of Operations -- Combined
Years Ended December 31, % Change ---------------------------------- -------------- 2000 1999 1998 00/99 99/98 ----------- ---------- ----------- ------- ------ Total revenue.............. $ 147,613 $ 120,760 $ 74,766 22.2 61.5 Commissions and fees expense (50,804) (53,108) (46,111) (4.3) 15.2 Gross profit............... 96,809 67,652 28,655 43.1 136.1 % of total revenue 65.6% 56.0% 38.3% General and administrative expenses................. 68,189 45,153 19,616 51.0 130.2 % of total revenue 46.2% 37.4% 26.2% Operating income, excluding amortization, and non-recurring expenses................. 28,620 22,499 9,039 27.2 148.9 % of total revenue 19.4% 18.6% 12.1% Interest-- net............. (4,692) (3,219) (2,601) 45.8 23.8 % of total revenue 3.2% 2.7% 3.5% Income taxes............... 8,064 7,866 12,953 Effective tax rate 33.7% 40.8% 201.2% (2.5) (39.3) Income before amortization and non-recurring expenses and income................. 15,864 11,414 (6,515) 38.9 nmf % of total revenue 10.7% 9.5% (8.7)% Amortization, non-recurring expenses and non-recurring income--net of taxes........ 4,416 2,583 (6,106) 70.9 nmf
Net income (loss).......... $ 11,448 $ 8,831 $ (411) 29.6 nmf % of total revenue 7.8% 7.3% (0.5)% Per common share Basic Income before amortization and non-recurring items...$ 1.48 $ 1.26 $ (1.30) 17.4 nmf Amortization and non-recurring items.................... $ 0.41 $ 0.29 $ (1.22) 44.1 nmf Net income............... $ 1.07 $ 0.97 $ (0.08) 9.5 nmf Weighted average shares... 10,744,719 9,077,775 5,006,009 18.4 nmf Diluted Income before amortization and non-recurring items.. $ 1.46 $ 1.22 $ (1.30) 19.1 nmf Amortization and non-recurring items......................$ 0.41 $ 0.28 $ (1.22) 46.3 nmf Net income............... $ 1.05 $ 0.95 $ (0.08) 11.2 nmf Weighted average shares... 10,880,094 9,328,939 5,006,009 16.6 nmf
The following analyses depict the results of each of our operating divisions on a stand-alone basis. No allocation of corporate overhead or interest has been made.
Clark/Bardes Consulting -- Compensation Resource Group
Year Ended December 31, Variances- Operating Results Inc. (Dec.) --------------------------- --------------- 2000 1999 1998 00/99 99/98 -------- -------- -------- -------- ------- Revenue First year......... $31,660 $33,547 $13,379 (5.6)% 150.7% Renewal............ 46,928 39,981 32,029 17.4% 24.8% ------- ------- ------- ---- ---- Total...... 78,588 73,528 45,408 6.9% 61.9% Commission expense... 30,486 36,158 26,350 (15.7)% 37.2% ------- ------- ------- ----- ---- Gross profit......... 48,102 37,370 19,058 28.7% 96.1% % of revenue 61.2% 50.8% 42.0% 20.4% 21.1% ------- ------- ------- ---- ---- Expenses General and administrative....... 22,766 15,525 12,924 46.6% 20.1% % of revenue 29.0% 21.1% 28.5% 37.2% (25.8)% Amortization of intangibles.......... 3,339 2,095 323 59.4% 548.6% % of revenue 4.2% 2.8% 0.7% 49.1% 300.6% ------- ------- ------- ---- ----- Total...... 26,105 17,620 13,247 48.2% 33.0% Operating income..... $21,997 $19,750 $ 5,811 11.4% 239.9% % of revenue 28.0% 26.9% 12.8% 4.2% 109.9%
Formerly our Clark/Bardes division the division now consists of the original core business as well as the Schoenke, Wiedemann & Johnson, Wamberg Organization, and Compensation Resource Group acquisitions. The Division was reorganized with the acquisition of Compensation Resource Group and renamed Clark/ Bardes Consulting -- Compensation Resource Group.
In order to streamline the focus of the division, the bank owned life insurance business of this Division will be transferred to the Banking Practice Division, effective January 1, 2001 and the Clark/Bardes Consulting Compensation Resource Group Division will concentrate on non-qualified executive compensation plans.
Despite a disappointing year for first year revenue, down 5.6% or $1.9 million from 1999, this Division still managed to improve over 1999 by $2.2 million or 11.4% due primarily to a 20.4% increase in the gross profit ratio.
Banking Practice
Year Ended December 31, Variances- Operating Results Inc. (Dec.) --------------------------- --------------- 2000 1999 1998 00/99 99/98 -------- -------- -------- -------- ------- Revenue First year......... $28,551 $21,614 $23,462 32.1% (7.9)% Renewal............ 11,621 9,170 5,896 26.7% 55.5% ------- ------- ------- ---- ---- Total...... 40,172 30,784 29,358 30.5% 4.9% Commission expense... 17,453 15,057 19,761 15.9% (23.8)% ------- ------- ------- ---- ----- Gross profit......... 22,719 15,727 9,597 44.5% 63.9% % of revenue 56.6% 51.1% 32.7% 10.7% 56.3% ------- ------- ------- ---- ---- Expenses General and administrative....... 15,293 11,192 4,650 36.6% 140.7% % of revenue 38.1% 36.4% 15.8% 4.7% 129.5% Amortization of intangibles.......... 1,232 914 909 34.8% 0.6% % of revenue 3.1% 3.0% 3.1% 3.3% (4.1)% ------- ------- ------- --- ---- Total...... 16,525 12,106 5,559 36.5% 117.8% Operating income..... $ 6,194 $ 3,621 $ 4,038 71.1% (10.3)% % of revenue 15.4% 11.8% 13.8% 31.1% (14.5)%
The major component of the Banking Practice Division is Bank Compensation Strategies. Operating income was up 71.1% or $2.6 million over 1999 because of several factors;
o first year revenue increased 32.1% or $6.9 million
o renewal revenue was up 26.7% or $2.5 million
o gross profit increased 44.5% or $7.0 million, to more than offset a $4.4 million or 36.5% increase in operating expenses.
The year 1999 was a particularly difficult year for the banking division as operating expense increases of $5.9 million offset a $6.2 million gross profit improvement over 1998.
Healthcare Group
Year Ended December 31, Operating Results Variances- 2000 1999 Inc. (Dec.) Revenue First year......... $16,870 $12,516 34.8% Renewal............ 5,269 3,932 34.0% ------- ------- ---- Total...... 22,139 16,448 34.6% Commission expense... 2,811 1,893 48.5% ------- ------- ---- Gross profit......... 19,328 14,555 32.8% % of revenue 87.3% 88.5% (1.3)% ------- ------- ---- Expenses General and administrative....... 16,932 12,571 34.7% % of revenue 76.5% 76.4% 0.1% Amortization of intangibles.......... 1,795 1,361 31.9% % of revenue 8.1% 8.3% (2.0)% ------- ------- ---- Total...... 18,727 13,932 34.4% Operating income..... $ 601 $ 623 (3.5)% % of revenue 2.7% 3.8% (28.3)%
The Healthcare Group is the result of our acquiring MCG/Healthcare in April 1999, consequently, 1999 results only reflect nine months of operating performance. On an operating basis, this Division continued to experience the difficulties of healthcare providers, in general. Until the outlook for this industry stabilizes, we do not foresee an appreciable improvement in this Division's financial performance.
Compensation Consulting
Year Ended December 31, Revenue First year......... $6,027 Renewal............ -- ----- Total...... 6,027 Commission expense... -- ----- Gross profit......... 6,027 % of revenue 100.0% ------ Expenses General and administrative....... 4,095 % of revenue 67.9% Amortization of intangibles.......... 626 % of revenue 10.4% ------ Total...... 4,721 Operating income..... $1,306 % of revenue 21.7% ------
Although other divisions offer compensation consulting in connection with their benefit plan activities, the acquisition of Pearl Meyer & Partners in June 2000 represented our major initiative into this vital and logical extension of our business.
Results Attributable to Acquisitions
As an acquirer, our operating results are significantly influenced by the contributions of our acquired businesses. For reporting purposes, we consider the operating results from any business not appearing in four complete quarters as being from acquisitions. After that, they become part of existing business. An analysis of our operating results, separating acquisitions from existing business is as follows:
In 2000, approximately 12.9% of gross revenue and 9.4% of operating income came from acquisitions while 13.6% of revenue and 25.1% of operating were from acquisitions in 1999. We do not attribute a great deal of significance to these statistics for several reasons:
o an acquisition's contribution to operating performance in any given period is considerably dependent on the timing of the transaction;
o as stated, an acquisition, by our definition for this purpose, is one in which it has not yet appeared in four quarters' operating results. As the value of these additions adds to our existing business base, the relative contribution of any subsequent acquisition may diminish; and
o acquisitions have made, and will continue to make, a substantial contribution to our operating performance and growth, however, the resources dedicated to our acquisition program could have had an impact on the performance of the existing business had the acquisitions not been made.
Corporate General and Administrative Expenses
In 1999, we established a corporate executive and administrative office in North Barrington, Illinois to house the offices of our Chief Executive Officer, our Chief Operating Officer and to provide direction and coordination for our financial, strategic planning and acquisition activities. This operation began in mid-year 1999 and total expenses for 1999 were $5.9 million. During 2000, the total cost of our Corporate Headquarters amounted to $9.1 million including $518,000 of reorganization expenses, and over $500,000 of expenses relating to acquisitions that were not consummated. Results also include the net loss of $617,000 from the Insurance Alliance Group acquisition, which we expect to eventually become our estate planning division. Excluding this component, Corporate overhead would have been $8.5 million for the year 2000.
Non-Recurring Operating Expense
In 1998, we recognized a $4.8 million expense for the increased market value of certain put warrants. Other than our employee stock option plans, we do not have any other convertible securities outstanding.
Non-operating Income
In the fourth quarter of 2000, we received $1.0 million of life insurance proceeds as the result of the death of one of our employees.
Interest Expense -- Net
Net interest expense was $4.7 million in 2000, a 46.9% increase from the $3.2 million net expense in 1999. Although we enjoyed a favorable $17.9 million of cash flow from operations and received $25.1 million proceeds from the sale of our stock in a private placement, our average net borrowings increased $21.8 million in 2000, which at today's interest rates, accounts for the full amount of the interest expense increase.
Borrowing increased to support our acquisition program. During 2000, our cash outlays for acquisitions were $59.2 million and $3.5 million for new equipment. In addition, on March 12, 2001 we acquired all the assets and business of Rich, Florin/Solutions, Inc. for a cash payment of $11.3 million all of which was borrowed under our line of credit.
Income Taxes
Income taxes in 2000 were $5.8 million or an effective tax rate of 33.7% compared with $6.1 million or an effective tax rate of 40.8% in 1999.
Tax expense in 2000 was reduced by two non-recurring factors:
o The receipt of $500,000 of state tax refunds -- a direct reduction of our state income tax expense.
o The receipt of $1.0 million of non-taxable life insurance proceeds as a result of the death of one of our employees.
Our statutory tax rate is 38%-35% for the federal rate and 4.6% overall for the states, which, when reduced by the federal benefit, is 3%. There are a number of factors that influence our tax rates, the most important of which is the effect of non-deductible amortization arising from our acquisition program. While we make every effort to assure that our tax expense is the lowest we can legally incur, we can give no assurance that our overall effective tax rate can be held to 38%.
Liquidity and Capital Resources
Selected Measures of Liquidity and Capital Resources.
2000 1999 1998 -------- -------- ------ Cash and cash equivalents..... $7,598 $4,832 $12,102 Working capital............... $(2,317) $(1,821) $ 7,155 Current ratio-- to one........ .95 .93 1.55 Shareholders' equity per common $ 8.88 $ 6.47 $ 3.62 share(1)...................... Debt to total capitalization(2) 36.5% 40.7% 49.5% - ----------
(1) total stockholders' equity divided by actual shares outstanding at year end excluding shares on option
(2) current debt plus long term debt divided by current debt plus long term debt plus stockholders' equity
In addition to our recognized balance sheet assets and liabilities, we have an on going renewal revenue stream, estimated to be $636 million over the next ten years. Discounting these renewals to net present value, adjusted for a 95% persistency rate, at the U.S. Treasury ten year note yield was as follows for the last three years:
2000 $457 million 1999 $312 million 1998 $211 million
Our balance sheet currently reflects $86.0 million of renewals, in the form of intangible assets attributed to the net present value of renewals from acquired companies purchased through acquisitions. Other than these intangibles, renewals are not reflected on our balance sheet.
As a financial company with strong operating cash flow, we have little need to retain substantial cash balances. We use the net cash from operating activities to pay down existing debt, fund capital expenditures and finance small acquisitions. We expect that large future acquisitions will be financed primarily through externally available funds. However, we can offer no assurance that such funds will be available and, if so, on terms acceptable to us.
Year Ended December 31, 2000 1999 Change Cash flows from (used in): Operations........ $17,918 $12,552 $5,366 Investing......... (62,655) (40,282) (22,373) Financing......... 47,503 20,460 27,043
Cash Flows from Operating Activities
Our cash flow from operations for the twelve months ended December 31, 2000, improved significantly over that of the comparable twelve-month period in 1999. The components were:
Year Ended December 31, Increase/(Decrease) 2000 1999 in Cash flow -------- -------- ------------ Net income (loss) plus non-cash $19,860 $14,016 $5,844 expenses...................... Changes in operating assets and liabilities................. (1,942) (1,464) (478) ------ ------ ------ Cash flow from operating $17,918 $12,552 $5,366 activities....................
Our working capital ratio at December 31, 2000 was .95 to 1 compared to the ratio of .93 to 1 at December 31, 1999. As an acquiring company, a significant amount of borrowing is done to finance our acquisitions. Because of this and the strong cash generated by operations, management has determined to dedicate all excess cash to the reduction of bank borrowings and, as a result, only cash for reasonably foreseeable needs and expenses is retained. It should be noted that our loan agreements do not impose a working capital covenant or restriction. This is because of the value of our renewal revenue.
The following table represents the estimated gross renewal revenue associated with our inforce business owned life insurance policies as of December 31, 2000. The projected gross revenue is not adjusted for mortality, lapse or other factors that may impair realization. We cannot assure you that commissions under these policies will be received. These projected gross revenues are based on the beliefs and assumptions of management and are not necessarily indicative of the revenue that may actually be achieved in the future.
Clark/ Bardes Consulting Compensation Banking HealthCare Resource Group Practice Group Total ------------------------------- ------- 2001........... $71,124 $11,251 $6,084 $ 88,459 2002........... 68,287 8,546 6,016 82,849 2003........... 60,917 5,085 5,944 71,946 2004........... 52,071 5,167 5,810 63,048 2005........... 50,226 5,206 5,436 60,868 2006........... 47,418 5,259 5,155 57,832 2007........... 44,389 5,318 4,901 54,608 2008........... 42,637 5,368 4,629 52,634 2009........... 42,744 5,406 4,141 52,291 2010........... 42,939 5,349 3,605 51,893 ------- ------- ------ -------- Total $522,752 $61,955 $51,721 $636,428 December 31, $322,450 $49,390 $65,406 $437,246 1999...........
Cash used in Investing Activities
Acquisitions accounted for $59.2 million of the $62.7 million used in investing activities. The balance was comprised of $3.5 million for purchases of equipment.
Cash spending for acquisitions included:
The Wamberg Organization $ 4.8 earn out.................. Insurance Alliances Group. 2.9 Pearl Meyer & Partners.... 22.0 Compensation Resource Group 25.1 Forrest, Wagner & Associates 3.5 All Others................ .9 ------ $ 59.2
Because of the income tax structure of the companies we seek to acquire, a substantial amount of the purchase price is paid in cash. This is also due, in part, to our desire to avoid diluting our existing shareholders. We expect acquisitions to continue and be financed primarily from available credit lines and possible additional equity. However, we can offer no assurances such will be the case.
Cash Flows from Financing Activities
On December 28, 1999, we expanded the credit facility negotiated in January 1999 to $100 million with the same group of bank lenders. The new credit facility provided for a revolving credit line and a term loan. The revolving credit portion terminates on December 31, 2002 and it converts to a term loan at the end of each year. The term loan is payable quarterly at the rate of 5% of the year-end balance and $1,250,000 per quarter so the term portion is repaid by December 31, 2004.
On August 23, 2000, we expanded the credit facility from $100 million to $114.3 million and added another bank to the group of lenders. The principal changes in the structure of the facility are the increase of the working capital limit from $5 million to $10 million and an expansion of the borrowing base. The credit facility contains restrictive covenants requiring mandatory prepayments under certain conditions, financial reporting and compliance certificates, maintenance of financial ratios, restrictions on guarantees and additional indebtedness, limitations on mergers and acquisitions, prohibition of cash dividends, limitation on investments, loans, and advances, and changes in control.
The restrictive covenants under the loan agreement provide for:
o the maintenance of a minimum ratio of fixed charges;
o a maximum allowable leverage ratio;
o a minimum amount of stockholders' equity; and,
o a maximum ratio of debt to capitalization.
We were in compliance with all restrictive covenants as of December 31, 2000.
In an effort to reduce interest costs, all cash beyond reasonably foreseeable needs is used to pay down debt. In September, we sold 1,888,887 shares of common stock to for $25.1 million in a private placement. Approximately $22.0 million was used to pay the debt on our acquisition credit facility.
Depending upon adherence to the criteria in our loan agreements at the time of draw down, we had $57.8 million available under our credit lines at December 31, 2000.
We believe that our net cash flow from operations will continue to provide sufficient funds to service our debt obligations. We estimate renewal revenue in future periods, which is not reflected on our balance sheet, to represent approximately $367 million over the next five years. However, renewal revenue can be adversely affected by policy surrenders or exchanges, material contract changes, asset growth and case mortality rates.
As our business grows, our working capital and capital expenditures requirements will also continue to increase. There can be no assurance, that the net cash flows from operations will be sufficient to meet our anticipated requirements or that we will not require additional debt or equity financing within this time frame. We may continue to issue stock to finance future acquisitions.
Market Risk
Our primary market risk exposure is to changes in interest rates related to of our line of credit. At December 31, 2000, we had total outstanding indebtedness of $64.6 million, or approximately 36.5% of total market capitalization. Our interest rate risk objective is to limit the impact of interest rate fluctuations on earnings and cash flows and to lower overall borrowing costs. To achieve this objective, we manage our exposure to fluctuations in interest rates for borrowings through the use of interest rate swaps to mitigate interest rate risk and to effectively lock the interest rate on a portion of our variable debt.
Interest on borrowings under our line of credit is based on one of two factors, at our option, at the time the funds are borrowed:
o U.S. prime rate, published in the Wall Street Journal, which will float, as adjusted, for as long as this segment of borrowing is outstanding; or,
o London InterBank offered rate, which is based on the published rate at the time of the borrowing and remains fixed at that rate for as long as this segment, or any part of it, is outstanding.
We do not enter into derivative or interest rate transactions for speculative purposes. Approximately 12.5% of our outstanding debt was subject to fixed rates with a weighted average of 10.0% at December 31, 2000. An additional 79.2% of our outstanding debt at December 31, 2000, was effectively locked at an interest rate of 6.5% plus a spread based on our leverage ratio, through an interest rate swap agreement for a notional amount of $44.8 million. We regularly review interest rate exposure on outstanding borrowings in an effort to minimize the risk of interest rate fluctuations.
The following table provides information about our debt obligations that are sensitive to changes in interest rates. The table presents principal cash flows and related weighted average interest rates by expected maturity dates totaling $64.6 million.
The table incorporates only those exposures that exist as of December 31, 2000, and does not consider exposures or positions that could arise after that date. In addition, because firm commitments are not represented in the table above, the information presented therein has limited predictive value. As a result, our ultimate realized gain or loss with respect to interest rate fluctuations would depend on the exposures that arise during future periods, prevailing interest rates, and our hedging strategies at that time. There is inherent rollover risk for borrowings as they mature and are renewed at current market rates. The extent of this risk is not quantifiable or predictable because of the variability of future interest rates and our financing requirements.
Inflation
Inflation has not had a material effect on our results of operations. Certain of our expenses, such as compensation, benefits and capital equipment costs, are subject to normal inflationary pressures. However, the majority of our 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 rates.
Impact of Year 2000
In late 1999, we completed our remediation and testing of systems for year 2000 compliance. As a result of past planning and implementation efforts, we experienced no significant disruptions in mission critical information technology and non-information technology systems, and we believe those systems successfully responded to the year 2000 date change. We expensed approximately $400,000 during 1999 in connection with remediating our systems. We did not experience any material problems resulting from year 2000 issues, either with products, internal systems, or the products and services of third parties.
Recent Accounting Pronouncements
Securities and Exchange Commission Staff Accounting Bulletin No. 101 -- Revenue Recognition in Financial Statements
SAB No. 101 became effective in 2000. SAB 101 gives the SEC's guidance on the applicability of generally accepted accounting principles to revenue recognition on financial statements. We have been in compliance with SAB No. 101 and its adoption did not to have any impact on our net income or stockholders' equity.
FASB Accounting Standard -- Derivatives and Hedging Activities
As of January 1, 2001, CBH will adopt Financial Accounting Standards Board Statement No. 133, Accounting for Derivative Instruments and Hedging Activities (Statement 133) which was issued in June 1998 together with its amendments Statements 137, Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133 and 138, Accounting for Derivative Instruments and Certain Hedging Activities (issued in June 1999 and June 2000, respectively are collectively referred to as Statement 133).
Because of our minimal use of derivatives, management does not anticipate that the adoption of the new Statement will have a significant effect on our earnings or financial position. The Statement will require us to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings.
Prior to January 1, 2001, we also used interest rate swap contracts for hedging purposes. The net amount paid or received and net amounts accrued through the end of the accounting period were included in interest expense.
RISK FACTORS
Risks Related to Our Industry
The risks described below are not the only risks we face. Any of the following risks could have a material adverse effect on our business, financial condition and operating results. Additional risks and uncertainties of which we are unaware or currently believe may be immaterial may also impair our business operations. You should carefully consider these risks in reviewing this Form 10-K, and these risks qualify, in their entirety, each forward looking statement herein.
Unfavorable federal tax legislation.
Many of the compensation and benefit programs we design and implement for our clients are funded by specifically designed life insurance products. The life insurance products underlying these compensation and benefit programs currently offer a number of tax advantages, such as:
Previous administrations have sought to reduce the income tax advantages of life insurance funded benefit plans. Although we believe such proposals do not have widespread support in Congress, we cannot predict the effect that any amendments will have on our future revenue.
If any changes in federal tax laws reduce or eliminate these advantages, many policies could be surrendered. As a result, we could lose a substantial amount of renewal income and our ability to write new business could be curtailed.
Federal and state regulations.
State governments extensively regulate life insurance activities. We sell our insurance products in all 50 states through licensed insurance producers operating as independent agents as well as Company owned offices. States have broad powers over licensing, payments of commissions, business practices, policy forms and premium rates. Insurance laws related to licensing, marketing activities and the receipt of commissions vary from state to state. While we have not encountered regulatory problems in the past, we cannot assure you that we and the consultants through whom we sell, will always be in compliance with all applicable regulatory requirements of each state.
While the federal government does not directly regulate the marketing of most insurance products, some products, such as variable life insurance, must be registered under the federal securities laws. As a result, our consultants selling these products must be registered representatives of a broker-dealer registered with the National Association of Securities Dealers. While we have not had any regulatory problems in the past related to these products, we cannot be sure that we or our consultants will not have regulatory problems in the future.
U.S. Treasury and Internal Revenue Service policies
During the past two years, the Internal Revenue Service ("IRS") has begun two major enforcement initiatives:
(1) To disallow the interest deduction on certain leveraged COLI programs sold prior to 1995. To our knowledge, the IRS has prevailed on every issue it has litigated.
While we stopped selling leveraged COLI products since 1995 and we do not expect any adverse impact on our revenue, it is impossible to determine the impact of this enforcement initiated or a client's decision to continue or surrender an existing policy.
(2) Under a recently issued Treasury Notice, the IRS and the Treasury Department are advising companies of their intent to recant the tax treatment accorded so called "equity split dollar arrangements" wherein the individual insured would be taxed on the increase in his or her equity in the underlying policy.
We are working with a number of industry groups in an effort to mitigate the impact of this Treasury Notice. It is impossible to assess the impact of this enforcement initiated on our business, at this time.
A small number of insurance companies.
We depend heavily on a select group of insurance companies to underwrite the insurance policies underlying the programs we sell. During 2000, 20 life insurance companies underwrote substantially all of the insurance policies underlying our clients' programs. Seven of these companies accounted for approximately 53.6% of 1999 first year commission revenue and 66.3% of our first year commission revenue for the year ended December 31, 2000. While we are confident they will, we cannot be sure that these relationships will continue or if we will be able to develop relationships with other insurance companies.
Changes in the market and the economy.
General economic conditions and market factors, such as changes in interest rates and stock prices, affect our commission and fee income and the extent to which clients keep a policy inforce year after year. Interest rate fluctuations can have a significant effect on the sale and profitability of many employee benefit programs whether they are financed by life insurance or other financial instruments. For example, if interest rates rise, competing products could become more attractive to potential purchasers of the programs we market. Further, a prolonged decrease in stock prices can have a significant effect on the sale and profitability of our clients' programs that are linked to stock market indices. We cannot be sure that we will be able to compete with alternative products if these market forces make our clients' programs unattractive.
Risks Related to Our Company
Competition.
Our business is highly competitive. We compete with consulting firms, insurance agents, brokers, third party administrators, producer groups and insurance companies. A number of our competitors offer attractive alternative programs. The direct competitors of our Clark/Bardes Consulting -- Compensation Resource Group division include; Management Compensation Group, Newport Group, TBG Financial, and The Todd Organization.
The competitors of our Banking Practice division include The Benefit Marketing Group; Harris, Crouch, Miller, Scott, Long and Mann; and individual insurance agents where community banks are located. Additionally, the community banking industry is constantly consolidating, which may reduce the number of potential bank clients for our division. The primary competition for our Healthcare Group division is Hewitt Associates, Towers, Perrin; Mercer Consulting Group and Hay Group Inc.
Although Pearl Meyer & Partners is one of the best established firms in the high level executive compensation consulting market, there are a number of firms that offer this service.
We also face competition from either from large, diversified financial services firms willing and able to expend the resources to gain market share or from large direct competitors that choose to pursue an acquisition or consolidation strategy similar to ours.
Key consultants.
Before our acquisition of The Wamberg Organization, it was our largest independent consultant organization and accounted for approximately 17.5% of our total revenue in 1998 and 15.2% of our total revenue for the eight month period ended August 31, 1999. The offices operated by our three largest consultants collectively accounted for approximately 22.3% of our total revenue in 1999 and 10.8% of our total revenue for 2000. We enter agency agreements with our consultants in which they agree not to compete with us for a period of time and after their relationship with us terminates. From time to time, we or our consultants have terminated relationships. We cannot be sure if a consultant relationship will be terminated in the future. We cannot be sure that the non-competition provisions in the agreements will be honored or enforceable.
Policy persistency.
We derive a substantial portion of our revenue from business owned life insurance and other financial instruments that underlie our clients' compensation and benefit programs and are maintained year after year. Persistency is the extent to which the premium and commission on a given policy repeat year after year. High persistency rates are especially important to our Clark/Bardes Consulting -- Compensation Resource Group and Banking Practice divisions since we derive a substantial portion of our revenue from these two divisions in the form of renewal commissions and fees. If a business purchaser chooses to let a policy lapse, we will stop receiving any renewal commissions and fees. In the past, we have had high persistency rates, but we cannot assure you that we will continue to have them in the future.
Key personnel.
Our performance depends largely on the performance of our executive officers and key employees. It is important to us to keep and motivate high quality personnel, especially our management, consultants and program development teams. The loss of the services of any of our key employees particularly W. T. Wamberg, chairman of our board of directors and chief executive officer, William L. MacDonald, president of Clark/Bardes Consulting -- Compensation Resource Group, Richard C. Chapman, president of Banking Practice, Donald C. Wegmiller, president of Healthcare Group and Pearl Meyer, president of Pearl Meyer & Partners division, could have a material adverse effect on our business, financial condition and operating results. We cannot assure you that we will be successful in retaining our key personnel.
Our acquisition strategy.
Since September 1997, we have completed fourteen acquisitions. At any point in time, we may also be considering several other potential acquisitions. Future acquisitions may require substantial expenditures that will be financed through cash from operations, bank debt as well as future debt and/or equity offerings. We cannot assure you that funds will be available through the capital markets and, if so, on terms acceptable to us.
Acquisitions involve numerous risks, including:
o the diversion of our management's time and attention to the negotiation of the acquisition and to the assimilation of the businesses acquired;
o the possible need to modify financial and other systems and add management resources;
o the potential liabilities of the acquired businesses; and,
o unforeseen difficulties in the acquired operations.
An acquisition may not produce the revenue and profits we expect. Thus, an acquisition that fails to meet our expectations could have a material adverse effect on our business, financial condition and operating results.
Intangible assets.
When we acquire a company, we normally acquire little in the way of tangible assets such as receivables, furniture and the like. Therefore, virtually the entire purchase price is allocated to intangible assets. Two important elements of our intangible assets affect our cash flow:
o the present value of inforce revenue is the net discounted cash flow form the book of business of those companies having future renewal revenue at the time we acquired them; and
o a potential future tax benefit over the next fifteen years. Approximately $141.1 million of our gross intangible assets are expected to be tax deductible.
Net intangible assets arising from our purchased businesses consist of the following:
2000 1999 Present value of inforce $ 85,962 $59,284 revenue................. Goodwill................ 78,419 34,440 Non-competition 992 1,267 -------- ------- agreements.............. $165,373 $94,991 Total assets............ 75.2% 76.1% Stockholders' equity.... 146.9% 152.3%
The amounts allocated to inforce revenue are determined using the discounted cash flow of future commission adjusted for expected persistency, mortality and associated costs. The balance of the excess purchased price over the net tangible assets is allocated to goodwill. The inforce revenue is amortized over its period of duration, which is normally twenty to thirty years. Many factors outside our control determine the persistency of our inforce business and we cannot be sure that the value we allocated will ultimately be realized.
Goodwill is being amortized over periods of twenty to forty years. Non-competition agreements are amortized over five to ten years, according to the terms of the agreements.
We have adopted Statement of Financial Accounting Standard No. 121 "Accounting for Impairment of Long Lived Assets and Long Lived Assets To Be Disposed Of." On an annual basis, we review the components of our intangible assets and make appropriate adjustments if it becomes apparent that the undiscounted cash flow is less than its unamortized carrying amount. No growth rates are used in the projection of renewal revenue and, in the opinion of management, projections are consistent in all respects. If any component of the inforce revenue base should become unrealizable or accounting regulatory agencies impose shorter amortization periods, this could have a material adverse effect on our business, financial condition and operating results. We cannot assure you that a component of the inforce revenue base will not become unrealizable or that accounting regulatory bodies will not impose shorter amortization periods.
Fluctuations in revenues and operating results.
Our operating results can fluctuate considerably, especially when compared on a consecutive quarterly basis. Because many of our clients' programs are implemented late in the year, we can experience large increases in both first year and renewal revenue in the fourth quarter. Operating results are also affected by a number of other factors, including:
o new or enhanced programs and services by us or our competitors and client acceptance or rejection;
o program development expenses;
o timing of significant sales;
o demand for our administrative services;
o competitive, legislative and regulatory conditions in our industry; and,
o general economic conditions.
Many of these factors are beyond our control. The sales cycles of our programs and services usually last between twelve to eighteen months, with first year revenue often coming from a few large cases and subject to a number of factors beyond our control. Our revenue is thus difficult to forecast, and we believe that comparing our consecutive quarterly results of operations is not necessarily meaningful, nor does it indicate what results we will achieve for any subsequent period. In our business, past operating results are not reliable indicators of future performance.
W.T. Wamberg ownership.
W.T. Wamberg, our Chairman and Chief Executive Officer, owns 18.5% of our outstanding common stock. As a result, Mr. Wamberg is able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may also have the effect of delaying, preventing or deterring a change in control of Clark/Bardes Holdings that may otherwise be beneficial to you.
Delaware law and our charter documents could prevent an unsolicited takeover.
Delaware law, as well as provisions of our certificate of incorporation and bylaws, could discourage unsolicited proposals to acquire us, even though such a proposal may be beneficial to you. These provisions include:
o a board of directors classified into three classes of directors with the directors of each class having staggered, three-year terms;
o our Board's authority to issue shares of preferred stock without shareholder approval; and
o provisions of Delaware law that restrict many business combinations and provide that directors serving on staggered boards of directors, such as ours, may be removed only for cause.
In addition, we have adopted a stockholder rights plan that could further discourage attempts to acquire control of us. These provisions of our certificate of incorporation, bylaws and Delaware law could discourage tender offers or other transactions that might otherwise result in your receiving a premium over the market price for our common stock.
Failure to achieve projected operating results.
In our press release of February 28, 2001, announcing the operating results for the fourth quarter and full year of 2000, we published a quarterly, revenue, net revenue and earnings per share projection. This projection was based on our best and most informed estimate at the time of its preparation but we can offer no assurance that it will be achieved.
Failure to achieve the projected results could have a severely adverse impact on the market price of our common stock.
Litigation.
During the past year, three lawsuits were filed against us. While we intend to contest these actions and are confident we will prevail, we can offer no assurance that we will.
In addition, while our insurance carriers have acknowledged coverage in one of the cases, a loss of this case could damage our business reputation.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this item is incorporated by reference from the Liquidity and Capital Resources section of Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in pages 46 through 47 of this Form 10-K.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our financial statements begin on page of this Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There has been no change in our independent accountants during the past two fiscal years. There have been no material disagreements with our independent accountants on our accounting or financial reporting that would require our independent accountants to qualify or disclaim their report on our financial statements, or otherwise require disclosure in this Form 10-K.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is hereby incorporated by reference from our proxy statement for the 2001 annual meeting of our stockholders under the captions "Proposal One -- Election of Directors," and "Directors and Executive Officers."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is hereby incorporated by reference from our 2001 proxy statement under the caption "Executive Compensation."
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is hereby incorporated by reference from our 2001 proxy statement under the caption "Security Ownership of Certain Beneficial Owners and Management."
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is hereby incorporated by reference from our 2001 proxy statement under the caption "Certain Relationships and Related Transactions."
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)The following documents are filed as part of this report:
(1) Financial Statements
Report of Independent Auditors
Consolidated Balance Sheets as of December 31, 2000 and 1999
Consolidated Statements of Operations for each of the years ended
December 31, 2000, 1999, and 1998
Consolidated Statements of Stockholders' Equity for each of the years ended December 31, 2000, 1999, and 1998
Consolidated Statements of Cash Flows for each of the years ended December 31, 1999, 1998, and 1997
Notes to the Consolidated Financial Statements
(2) Financial Statement Schedules
None.
Schedules not listed above have been omitted because they are not required, are not applicable, are shown in the related financial statement or notes thereto or the amounts are immaterial.
(3) Exhibits
The information required by this Item 14(a)(3) is set forth in the Exhibit Index immediately following our financial statements. The exhibits listed herein will be furnished upon written request to "Director of Investor Relations" located at our headquarters and payment of a reasonable fee that will be limited to our reasonable expense in furnishing such exhibits.
CLARK/BARDES HOLDINGS, INC. AND SUBSIDIARIES
Page Report of Independent Auditors............ Consolidated Balance Sheets as of December 31, 2000 and 1999........................ Consolidated Statements of Operations for the years ended December 31, 2000, 1999, and 1998............................ Consolidated Statements of Stockholders' Equity for the years ended December 31, 2000, 1999 and 1998............................... Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999, and 1998................................... Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT AUDITORS
Board of Directors Clark/Bardes Holdings, Inc.
We have audited the accompanying consolidated balance sheets of Clark/Bardes Holdings, Inc. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Clark/Bardes Holdings, Inc. and subsidiaries at December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States.
ERNST & YOUNG LLP
Dallas, Texas February 23, 2001
CLARK/BARDES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2000 1999 --------- ------- (dollars in thousands except share amounts) ASSETS
Current Assets Cash and cash equivalents...................... $ 7,598 $ 4,832 Accounts and notes receivable, net of allowances of $555 31,134 18,295 and $347, respectively...................... Deposits, advances and prepayments............. 2,809 1,123 Deferred tax asset............................. 1,861 947 ------- ------- Total current assets................... 43,402 25,197 Intangible Assets-- net Present value of in force revenue.............. 85,962 59,284 Goodwill....................................... 78,419 34,440 Non competition agreements..................... 992 1,267 ------- ------- 165,373 94,991 Equipment and Leasehold Improvements-- Net....... 8,376 4,505 Other Assets..................................... 2,704 831 ------- ------- Total assets........................... $219,855 $125,524 ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities Accounts payable............................... $10,786 $ 4,100 Commissions and fees........................... 7,541 3,475 Income taxes................................... 4,121 4,350 Accrued liabilities............................ 10,123 7,841 Deferred income................................ 1,180 -- Debt maturing within one year.................. 11,968 7,252 ------- ------- Total current liabilities.............. 45,719 27,018 Deferred Tax Liability........................... 7,228 665 Deferred Compensation............................ 1,745 -- Long Term Debt................................... 52,605 35,473 Stockholders' Equity Preferred stock Authorized -- 1,000,000 shares; $.01 par value, none -- -- issued..................................... Common stock Authorized-- 20,000,000 shares; $.01 par value Issued and outstanding -- 12,675,309 in 2000 and 127 96 9,629,999 in 1999.......................... Paid in capital................................ 88,810 50,099 Retained earnings.............................. 23,621 12,173 ------- ------- Total stockholders' equity............. 112,558 62,368 ------- ------- Total Liabilities and Stockholders' $219,855 $125,524 ======== ======== Equity........................................... Related party balances included in the above accounts $ 64 $ 20 Accounts receivable -- officers and directors... Accounts receivable-- affiliates............... $ -- $ 461 Commissions and fees payable................... $ 25 $ 26
See accompanying notes to financial statements
CLARK/BARDES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, 2000 1999 1998 ----------- ----------- -------- (dollars in thousands except share amounts) REVENUES Commissions and service fees............. $ 147,021 $119,158 $ 72,264 Other.................................... 592 1,602 2,502 --------- -------- -------- 147,613 120,760 74,766 Commission and fee expenses................ 50,804 53,108 46,111 --------- -------- -------- Gross profit............................... 96,809 67,652 28,655 --------- -------- -------- OPERATING EXPENSES General and administrative............... 68,189 45,153 19,616 Amortization of intangibles.............. 7,138 4,370 1,232 Put warrants............................. -- -- 4,800 Acquisition integration and reorganization 518 -- -- --------- -------- -------- 75,845 49,523 25,648 --------- -------- -------- OPERATING INCOME........................... 20,964 18,129 3,007 NON-OPERATING INCOME....................... 1,001 -- -- INTEREST Income................................... 278 329 565 Expense.................................. (4,970) (3,548) (3,166) --------- -------- -------- (4,692) (3,219) (2,601) --------- -------- -------- Income before taxes........................ 17,273 14,910 406 Income taxes............................... 5,825 6,079 817 --------- -------- -------- NET INCOME (LOSS).......................... $ 11,448 $ 8,831 $ (411) ========= ======== ======== BASIC NET INCOME (LOSS) PER COMMON SHARE Net income (loss).......................... $ 1.07 $ 0.97 $ (0.08) ========== ========= ========= Weighted average shares.................... 10,744,718 9,077,775 5,006,009 ========== ========= ========= DILUTED NET INCOME (LOSS) PER COMMON SHARE Net income (loss).......................... $ 1.05 $ 0.95 $ (0.08) ========== ========= ========= Weighted average shares.................... 10,880,093 9,328,939 5,006,009 ========== ========= ========= Transactions with related parties Commissions and service fees............. $ -- $ 1,434 $ 1,585 Commission and fee expenses.............. $ 25 $ 8,071 $ 8,068 General and administrative expense....... $ 154 $ 45 $ --
See accompanying notes to financial statements
CLARK/BARDES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See accompanying notes to financial statements
CLARK/BARDES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, 2000 1999 1998 --------- --------- ------- (dollars in thousands) OPERATING ACTIVITIES Net income (loss).................. $11,448 $ 8,831 $ (411) Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation and amortization... 8,898 5,232 1,571 Allowance for losses on interest and notes......................... (486) (47) 316 Changes in operating assets and liabilities Accounts receivable........... (9,855) (6,576) (300) Deposits and advances......... (265) (542) (59) Deferred tax asset-- current.. 731 (588) (607) Other assets.................. (741) (201) (203) Accounts payable.............. 5,940 (3,522) 1,783 Commissions and fees payable.. 2,753 40 689 Income taxes payable.......... (229) 3,822 528 Accrued liabilities........... (3,689) 5,190 654 Deferred income............... 797 -- -- Deferred tax liability........ 871 913 -- Deferred compensation......... 1,745 -- -- ------- ------- ------- Cash provided by operating activities 17,918 12,552 3,961 ------- ------- ------- INVESTING ACTIVITIES Purchase of businesses............. (59,158) (38,470) (18,353) Purchases of equipment............. (3,497) (1,812) (801) ------- ------- ------- Cash used in investing activities.... (62,655) (40,282) (19,154) ------- ------- ------- FINANCING ACTIVITIES Proceeds from borrowings........... 63,100 57,000 31 Repayment of borrowings............ (41,251) (53,507) (10,137) Issuance of common stock........... 25,117 16,878 37,135 Exercise of stock options.......... 530 -- -- Notes receivable................... 7 89 163 Dividends.......................... -- -- (3,680) ------- ------- ------- Cash provided by financing activities 47,503 20,460 23,512 ------- ------- ------- INCREASE (DECREASE) IN CASH.......... 2,766 (7,270) 8,319 Cash and Cash Equivalents at Beginning of the Year.......................... 4,832 12,102 3,783 ------- ------- ------- Cash and Cash Equivalents at End of the Year............................. $ 7,598 $ 4,832 $12,102 ======= ======= =======
See accompanying notes to financial statements
CLARK/BARDES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000
(Tables shown in thousands of dollars, except per share amounts)
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Clark/Bardes Holdings, Inc. (CBH) and its wholly owned subsidiaries. Through its four operating divisions, Clark/Bardes Consulting-Compensation Resource Group, Banking Practice, Healthcare Group and Pearl Meyer & Partners, CBH designs, markets and administers life insurance products, compensation, and benefit programs to U.S. corporations, banks and healthcare organizations. CBH assists its clients in using customized life insurance products to generate capital, finance long-term benefit liabilities, and supplement and secure benefits for key employees. In addition, CBH provides long-term administrative services for executive benefits and insurance and provides compensation consulting services.
Basis of Presentation -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. In the opinion of management, all adjustments, including normal recurring accruals, considered necessary for a fair presentation, have been included. All intercompany amounts and transactions have been eliminated in the accompanying consolidated financial statements.
A summary of the significant accounting policies consistently applied in the preparation of the accompanying financial statements follows.
Cash and Cash Equivalents -- CBH considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. CBH has cash balances at financial institutions in excess of the $100,000 limit insured by the Federal Deposit Insurance Corporation. Uninsured cash in bank balances aggregated approximately $7.0 million and $4.3 million at December 31, 2000 and 1999, respectively. CBI has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents.
Fair Value of Financial Instruments -- The book values of cash and cash equivalents, accounts and notes receivable, accounts payable, commissions and fees payable and other financial instruments approximate their fair values principally because of the short-term nature of these instruments. The carrying value of CBH's long-term debt does not differ significantly from its fair value.
Equipment and Leasehold Improvements -- Equipment and leasehold improvements are carried at cost less accumulated depreciation. Depreciation expense is provided in amounts sufficient to relate the cost of assets to operations over the estimated service lives using an accelerated method. CBH depreciates furniture, equipment and computer software over periods of three to seven years while leasehold improvements are amortized over the lease period.
Intangible Assets -- CBH has intangible assets representing the excess of the costs of acquired businesses over the fair values of the tangible net assets associated with the acquisition. Intangible assets consist of the net present value of future cash flows from existing business at the acquisition date, non-compete agreements with the former owners and goodwill. The amortization periods for the non-compete agreements are 5 years and 10 years. The net present value of future cash flows is amortized over 20 to 30 years (the expected average policy duration). Goodwill is being amortized over a 20 to 40 year period on a straight-line basis. Amortization expense was $7.1 million in 2000, $4.4 million in 1999 and $1.2 million in 1998, respectively. CBH's policy, in accordance with Statement of Financial Accounting Standards ("SFAS") No. 121 -- Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, is to review intangible and other long-lived assets for impairment on an annual basis or whenever changes in circumstances indicate that an impairment might exist. When any indicators are present, the estimated undiscounted cash flows are compared to the carrying amount of the assets. If the undiscounted cash flows are less than the carrying amount, an impairment loss is recorded. Any write-downs are treated as permanent reductions in the carrying amount of the asset.
Revenue -- First year commissions are recognized as revenue at the time the policy application is substantially completed, the premium is paid and the insured party is contractually committed to purchase the insurance policy. Renewal commission revenue is recognized when the premium or commission is due or paid. CBH is 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. Cancellations or other adjustments are accounted for in the period where an adjustment is determined to be necessary and are not significant. Service fees are received annually on the policy anniversary date. Fees related to future services to be provided are recognized as the services are rendered and fees for program design and placement are recognized in a manner consistent with commissions. Fees for compensation and benefit consulting services are based on an agreed hourly rate over the period services are rendered. Fees for benefit consulting services are recognized on a percentage of completion basis as related costs are incurred over the duration of the project.
CBH generated in excess of 25% of its revenue in 2000 from 17 clients, in 1999 from 8 clients, and in 1998 from 8 clients, respectively, creating a concentration of credit risk. Approximately 15.2% and 17.5% of CBI's commission and fee revenue for the years ended December 31, 1999 and 1998 respectively, was generated by The Wamberg Organization, which was wholly owned by CBH's Chairman and Chief Executive Officer and acquired by CBH on September 1, 1999. Substantially, all of the policies underlying the programs marketed by CBH are underwritten by 20 life insurance companies, of which seven accounted for approximately 66.3%, 63.1% and 76.3% of CBI's first-year commission revenue for the years ended December 31, 2000, 1999 and 1998, respectively.
Commissions and Fee Expense -- Commissions and fee expense comprise the portion of the total commission revenue that is earned by and paid to both Company and independent sales consultants.
Advertising -- Advertising and marketing costs provided to third parties are charged to operations when incurred. Total expenses for 2000, 1999 and 1998 were $803,000, $1,080,000 and $289,000, respectively.
Income Taxes -- In connection with its initial public offering, CBH ceased to be taxed as an S corporation and became subject to federal and state income taxation as a C corporation. As an S corporation, CBH's income, whether or not distributed, was taxed directly to the stockholders for federal and certain state income tax purposes. On August 1, 1998, the effective date of change in tax status, CBH recorded the deferred tax effect of the difference between the tax bases and book bases of its assets and liabilities on its balance sheet.
Securities and Exchange Commission Staff Accounting Bulletin No. 101-- Revenue Recognition in Financial Statements-- SAB No. 101 became effective in the first quarter of 2000. CBH's revenue recognition policy has been in accordance with SAB No. 101 and therefore its adoption did not have any impact on CBH's revenue recognition policies.
Derivatives Financial Instruments -- As of January 1, 2001, CBH will adopt Financial Accounting Standards Board Statement No. 133, Accounting for Derivative Instruments and Hedging Activities (Statement 133) which was issued in June 1998 and its amendments Statements 137, Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133 and 138, Accounting for Derivative Instruments and Certain Hedging Activities (issued in June 1999 and June 2000, respectively and collectively referred to as Statement 133).
Because of our minimal use of derivatives, management does not anticipate that the adoption of the new Statement will have a significant effect on our earnings or financial position. The Statement will require us to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings.
Prior to January 1, 2001, the Company used interest rate swap contracts for hedging purposes. The net amount paid or received and net amounts accrued through the end of the accounting period were included in interest expense.
Reclassifications -- CBH has made minor reclassifications of certain prior years' amounts to conform to the current year's presentation.
2. ACQUISITIONS
Following is a description of the Company's acquisitions made during 2000, 1999 and 1998. The results of operations for each acquired entity have been included in the accompanying statements of operations as of the effective date of the respective acquisition.
Forrest, Wagner & Associates -- On October 23, 2000, CBH acquired all of the outstanding stock of Forrest, Wagner & Associates, Inc. ("FWA") for a purchase price of $4.2 million, including expenses, of which $3.5 million was paid in cash at the closing. The remaining $750,000 is payable upon the achievement of certain financial criteria by December 31, 2004.
FWA is a Phoenix, Arizona based firm specializing in marketing and administering non-qualified executive benefit plans funded primarily by Company owned life insurance. FWA was affiliated with Compensation Resource Group, Inc.
The acquisition has been accounted for as a purchase with $2.7 million of the purchase price amortized based on the net present value of future renewal revenue over twenty years. The balance of the purchase price, when made, will be accounted for as goodwill and amortized over the remainder of the initial twenty-year period.
Compensation Resource Group, Inc. -- On September 6, 2000, CBH acquired all the issued and outstanding capital stock of Compensation Resource Group ("CRG") for a total purchase price of $30.5 million, not including acquisition expenses, consisting of the following:
(i) a cash payment to the CRG selling shareholders of $11.4 million;
(ii) the issuance by CBH of 596,463 shares of its common stock, having an aggregate value of $6.1 million based on the closing price on September 5, 2000; and
(iii) the repayment of approximately $13.0 million of CRG's long-term debt.
Acquisition expenses were $735,000.
CRG is an executive compensation and benefits organization that provides the design, marketing and administration of non-qualified benefit plans. CRG is headquartered in Los Angeles, California and has affiliated offices in seven other cities. Prior to the acquisition, there was no material relationship between CRG and CBH.
The $25.1 million cash portion of the purchase price was borrowed under CBH's credit facility with Bank One.
Coincident with this acquisition, CBH entered into a bonus arrangement for certain key executives and employees of CRG. This arrangement will provide for the payment of bonuses of up to $20 million if certain stipulated financial objectives are achieved during the years ended December 31, 2003 to 2005.
The acquisition of CRG has been accounted for as a purchase with $26.7 million of the purchase price allocated to the present value of in-force revenue and amortized over a period of thirty years and $11.4 million allocated to goodwill which will be amortized over twenty years.
The unaudited financial information below presents the results of CBH and CRG as if the acquisition had occurred on January 1, 1999.
Twelve Months Ended December 31, 2000 1999 Pro Forma Revenue............ $181,787 $148,487 Net income......... 9,500 5,957 Diluted earnings per share............ .84 .60
Pearl Meyer & Partners, Inc. -- On June 21, 2000, CBH acquired all of the issued and outstanding capital stock of Pearl Meyer & Partners, Inc. for a total purchase price of $25.9 million, not including expenses. The purchase price consisted of a cash payment of $21.9 million and the issuance of 250,000 shares of CBH common stock with a value of $4.0 million. Acquisition expenses were $720,000. The $22.6 million cash portion of the purchase price was borrowed under CBH's line of credit.
The acquisition has been accounted for as a purchase and goodwill of $23.5 million will be amortized over a twenty-year period.
In addition to the initial purchase price, $2.0 million of additional cash consideration will be paid in the first quarter of 2002 upon the achievement of a defined performance objective during the eighteen months subsequent to the purchase. This payment, when earned, will be accounted for as additional purchase price to be amortized over the remainder of the original twenty-year period.
Pearl Meyer is a New York City based consulting firm specializing in executive compensation and retention programs. The Pearl Meyer organization became CBH's fourth operating division. Prior to the acquisition, there was no material relationship between CBH and Pearl Meyer.
The unaudited pro forma information below presents the results of CBH and Pearl Meyer & Partners as if the acquisition had occurred on January 1, 1999.
Twelve Months Ended December 31, 2000 1999 Pro Forma Revenue............ $154,557 $133,339 Net income......... 12,143 7,562 Diluted earnings per share............ 1.10 .79
W.M. Sheehan & Company, Inc.-- On June 13, 2000, CBH acquired certain assets, principally working capital and equipment, and assumed certain liabilities of W. M. Sheehan & Company, Inc. ("Sheehan"). The purchase price was $367,000 cash. The acquisition has been accounted for as a purchase and the goodwill will be amortized over twenty years.
In addition to the purchase price paid at closing, an additional $650,000 will be paid upon the achievement of certain revenue and earnings objectives during the years ended June 30, 2001 through 2004. The payments will be made 23% in cash and 77% in CBH common stock based on values at time of issuance. The additional payments will be accounted for as goodwill and amortized over the remaining twenty-year period.
Insurance Alliances Group, Inc.-- On May 5, 2000, CBH acquired the business of Insurance Alliances Group, Inc. ("IAG"). There were no assets or liabilities acquired or assumed. IAG is a Stamford, Connecticut insurance firm specializing in executive estate planning.
The purchase price for the business was $3.5 million consisting of $2.8 million cash and 49,143 shares of CBH common stock having a value of $713,000. The cash portion of the purchase price was borrowed under CBH's line of credit. The acquisition will be accounted for as a purchase and the entire purchase price has been allocated to the net present value of renewal revenue from insurance in force at the time of the acquisition and will be amortized over a period of thirty years.
Christiansen & Associates -- Effective January 1, 2000, CBH acquired the stock and business of Christiansen & Associates for 43,714 shares of common stock at a value of $694,000 and cash and expenses of $128,913. Christiansen is a former BCS consultant organization. The acquisition has been accounted for as a purchase and the goodwill will be amortized over twenty years.
In addition to the purchase price, $167,000 cash and 171,632 shares of CBH common stock are issuable to the former principals of Christiansen & Associates on the attainment of stipulated financial objectives. These payments, when earned, will be accounted for as additional purchase price to be amortized over the remainder of the original twenty year period.
The Watson Company -- On February 1, 2000, CBH acquired the assets of The Watson Company for $328,000 cash and expenses as an expansion of the Bank Compensation Consulting practice of BCS. The acquisition has been accounted for as a purchase and the purchase price will be amortized over twenty years.
Upon reaching certain stipulated financial goals, former shareholders of The Watson Company will earn the right to receive up to $900,000 of CBH common stock based on market values at the time of achievement. These payments, when earned, will be accounted for as additional purchase price to be amortized over the remainder of the original twenty year period.
Banking Consultants of America (BCA) -- Effective October 1, 1999, CBH purchased certain assets and the businesses of Banking Consultants of America and Financial Institution Services, Inc. for a purchase price of $1.4 million and expenses of $28,000. BCA is a regional provider of insurance products to banks and was absorbed by CBH's Banking Practice division. BCA has been accounted for as a purchase and the entire purchase price was allocated to the net present value of the future cash flows of BCA's projected renewal revenues.
The Wamberg Organization and Wamberg Financial Corporation -- On September 1, 1999, CBH purchased certain assets and assumed certain liabilities of The Wamberg Organization and purchased all of the outstanding stock of Wamberg Financial Corporation for a total purchase price of $18.0 million consisting of:
(i) a cash payment to The Wamberg Organization of $12.4 million;
(ii) a cash payment to W. T. Wamberg of $50,000 for his shares of Wamberg Financial Corporation;
(iii) a direct payment of $1.5 million for two outstanding loans;
(iv) assumption of a $3.8 million note for the purchase of a corporate aircraft; and,
(v) expenses of approximately $265,000.
The $14.2 million cash portion of the purchase price was funded from CBH's existing cash balances. In addition, the asset purchase agreement provides for the payment of an additional $11.9 million upon the attainment of certain stipulated annual financial objectives starting with the period ended December 31, 1999 through December 31, 2002. As of December 31, 1999 and 2000, the financial objectives for those years have been met and a total cash payment of $5.0 million was made to W. T. Wamberg and recorded as additional purchase price. In accordance with the asset purchase agreement, all renewal revenue acquired as of September 1, 1999, remaining inforce on December 31, 2018, will revert to Mr. Wamberg.
The sole shareholder of The Wamberg Organization and Wamberg Financial Corporation was W. T. Wamberg, Chairman of CBH. The Wamberg Organization has historically been CBH's largest single consultant, accounting for 17.5% of revenue in 1998 and 15.2% in 1999. Upon consummation of the September 1, 1999 acquisition, Mr. Wamberg became President and Chief Executive Officer of Clark/Bardes Holdings, Inc.
The tangible assets acquired consisted primarily of receivables, equipment, and an aircraft. Subsequent to the acquisition, the Company sold the aircraft to an unaffiliated leasing company for a gain of $502,000 -- net of tax, and simultaneously leased it back for a ten year period. The gain was not recognized in income and has been recorded as a reduction of the purchase price. The proceeds from the sale were applied to a full repayment of the related note. The monthly rental under the lease is $27,924 or $335,000 per year. In the five years ended December 31, 2004, total rental will be $1,675,000.
The Wamberg Organization leases its 11,085 square feet of office space from an entity controlled by Mr. Wamberg for an annual rental of $150,000, under a lease expiring on February 21, 2009.
On January 4, 1999, CBH purchased the right to receive approximately 27.5% of the commissions on renewal revenue from certain inforce policies existing on June 30, 1998, due The Wamberg Organization, for a cash payment of $7.5 million. Concurrent with the acquisition of the assets and liabilities of The Wamberg Organization, CBH purchased all of the renewal revenue not acquired and the original January 4, 1999 agreement was superseded. Accordingly, an unamortized balance of $6.9 million at September 1, 1999 under that agreement was combined with the purchase price under the acquisition agreement. The combined purchase price was allocated to the net present value of future revenue to be received until September 1, 2018. Excluding any payments that may be made by virtue of achieving the stipulated annual financial objectives, the total price of The Wamberg Organization and Wamberg Financial Corporation was $24.9 million, including the $6.9 million unamortized balance of the January 4 purchase.
The acquisition of The Wamberg Organization and Wamberg Financial Corporation has been accounted for as a purchase. The pro forma information below presents the results of operations including those of the Wamberg entities as if the acquisition occurred on January 1, 1998.
Year Ended December 31, 1999 1998 Pro Forma: Revenues........... $120,760 $74,766 Net income......... 6,751 725 Diluted earnings per share............. .72 .13
National Institute for Community Banking -- On May 18, 1999, CBH acquired all of the issued and outstanding capital stock of National Institute for Community Banking (NICB) by merging it with and into CBH in exchange for a total of 484,303 shares of CBH common stock. By agreement, the effective date of the NICB acquisition was January 1, 1999. NICB was an independent consultant affiliated with Bank Compensation Strategies.
Of the total, 99,851 shares were issued at the closing and 384,452 shares are issuable upon attaining stipulated revenue and income goals over the four-year period 1999 to 2002. No other consideration was given. The value of the shares received by the selling shareholders was $1.6 million based on CBH's closing price on May 18, 1999. Any subsequent shares issued will be accounted for as additional consideration based on their value at the time of issuance and will increase future amortization expense. The selling shareholders achieved their financial performance goals for 1999 and, on January 26, 2000 an additional 96,113 shares having a value of $1.4 million were issued to them. They did not meet their performance goal for 2000.
The acquisition of NICB has been accounted for as a purchase. The entire cost of the NICB acquisition has been allocated to goodwill and is being amortized over twenty-five years.
MCG/Healthcare -- On April 5, 1999, CBH purchased the assets and business and assumed certain liabilities of Phynque, Inc., d/b/a Management Compensation Group/HealthCare, a Minnesota corporation, for a purchase price of $35.9 million consisting of:
(i) a cash payment of $13.8 million;
(ii) a promissory note for $8.7 million;
(iii) 326,363 shares of CBH common stock, having an aggregate value of $5.3 million based on the closing price on April 5, 1999;
(iv) the direct payment of $3.6 million for outstanding loans;
(v) the assumption of $4.2 million of liabilities; and,
(vi) $372,000 of closing costs.
The assets acquired included cash, receivables and equipment in addition to all intellectual property, customer files, computer software and related licenses. The liabilities assumed include commissions, employee benefits and operating expenses. The $17.7 million cash portion of the purchase price was funded by a borrowing under CBH's credit facility. The promissory note is payable in thirty-two equal quarterly installments of principal and interest at 10% per annum commencing on April 5, 2000. The promissory note is partially secured by a personal guarantee of W. T. Wamberg, Chairman and Chief Executive Office of Clark/ Bardes Holdings.
MCG/HealthCare is a 161 employee executive benefit consulting organization servicing the healthcare industry. MCG/HealthCare is headquartered in Minneapolis, Minnesota. Prior to the acquisition described above, there was no material relationship between CBH and MCG/HealthCare.
The acquisition of MCG/HealthCare has been accounted for as a purchase. The pro forma information below presents the results of CBH and MCG/HealthCare as if the acquisition had occurred on January 1, 1999.
Year Ended December 31, 1999 1998 Pro Forma: Revenues............... $126,518 $100,876 Net income (loss)...... 7,464 (1,826) Diluted earnings (loss) per share................. .79 (.34)
Schoenke Companies -- On September 1, 1998, CBH acquired substantially all of the assets, and the book of business of Schoenke & Associates Corporation and Schoenke & Associates Securities Corporation based in Germantown, Maryland. The Schoenke Companies specialize in designing and administering benefit programs for companies.
The purchase price was $17.0 million plus related expenses of approximately $98,000. The purchase price was comprised of $15.0 million in cash and a promissory note in the principal amount of $2.0 million. CBH allocated approximately $768,000 of the purchase price to tangible assets acquired and the remaining $16 million was allocated to the net present value of estimated realizable future cash flows embedded in the existing inforce book of business. This intangible asset is being amortized over thirty years which approximates the average policy duration based on the terms of the policies and prevailing practices for such benefit programs.
The pro forma information below presents the results of CBI and Schoenke combined as if the acquisition had occurred January 1, 1998:
Year Ended December 31, 1998 Pro Forma: Revenues........... $79,744 Net income......... 96 Diluted earnings per share............ .01
Wiedemann & Johnson Company -- On November 1, 1998, CBH acquired substantially all of the assets and 75% of the book of business of Wiedemann & Johnson Company based in Dallas, Texas. The Wiedemann & Johnson Company specializes in designing, and administering benefit programs for companies. CBH accounted for the acquisition as a purchase and has included the operating results of the Wiedemann & Johnson Companies in the financial statements commencing from the acquisition date.
The purchase price was $6.0 million plus related expenses of approximately $54,000. The purchase price was comprised of $4.0 million in cash and $2.0 million in common stock represented by 142,857 shares at an agreed upon price per share. CBH allocated approximately $40,000 of the purchase price to tangible assets acquired and $6.0 million to the net present value of estimated realizable future cash flow embedded in the in-force book of business. This intangible asset is being amortized over thirty years, which approximates the average policy duration based on the terms of the policies.
Bank Compensation Strategies -- On September 1, 1997, CBI acquired substantially all of the assets and the book of business of Bank Compensation Strategies Group (BCS), a Minneapolis, Minnesota based life insurance agency engaged in designing and marketing life insurance policies and related compensation, salary and benefit plans. The purchase price was $24.4 million. The purchase price was comprised of $13.5 million in cash and promissory notes for $10.5 million. CBH allocated $1.2 million of the purchase price to non-compete agreements, $19.1 million to goodwill and $4.1 million to the net present value of the realizable cash flows embedded in the inforce book of business.
3. INTANGIBLES
Intangible assets represent the excess of the purchase price over the fair values of the tangible assets of acquired businesses. The classification of the amounts determined and allocated to the respective intangible assets are:
December 31, 2000 1999 Present value of future cash flows from $ 94,328 $ 62,711 in force revenue........................ Goodwill................................ 82,330 36,427 Non competition agreements.............. 1,750 1,750 -------- -------- 178,408 100,888 Accumulated amortization................ (13,035) (5,897) -------- -------- Net..................................... $165,373 $ 94,991 ======== ========
The amortization periods for these assets are:
o present value of future cash flows from inforce revenues are amortized over 20 to 30 years, a period representative of the policy duration;
o goodwill is amortized over periods of 20 to 40 years; and
o non competition agreements are amortized over 5 to 10 years, the terms of the agreements.
4. EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Major classifications of equipment and leasehold improvements are as follows:
December 31, 2000 1999 Computer software, office furniture $10,938 $6,458 and equipment....................... Leasehold improvements.............. 1,655 503 ------ ------ 12,593 6,961 Accumulated depreciation and amortization........................ (4,217) (2,456) ------ ------ $8,376 $4,505
Depreciation expense was $1,760,000, $862,000 and $338,000 for the years 2000, 1999 and 1998, respectively.
5. TAXES
Prior to July 31, 1998, CBH elected to be taxed under subchapter S of the Internal Revenue Code. Under this election, CBH did not pay federal income taxes on its taxable income. Instead, the stockholders were liable for individual federal income tax on CBH's taxable income as determined under the cash basis method of accounting. Income taxes, as shown in the accompanying financial statements for periods prior to July 31, 1998, consist primarily of state franchise and income taxes.
In connection with its Initial Public Offering, on August 19, 1998, CBH ceased to be an S corporation and became subject to federal income taxation as a C corporation. At July 31, 1998 the tax bases of CBH's net assets was approximately $1.8 million higher than the financial statement bases because of cash to accrual basis conversion balances and the accumulated amortization of intangible assets.
In the period ended July 31, 1998, CBH had a pre Initial Public Offering loss of $3.8 million, which was passed on to the S corporation shareholders.
Income tax expense (benefit) consists of the following components:
Year Ended December 31, 2000 1999 1998 ------- ------- ------ Current: Federal.... $3,941 $4,848 $1,230 State and local........ 289 856 194 Deferred: Federal.... 1,458 319 (524) State and local........ 137 56 (83) ------ ------ ------ $5,825 $6,079 $ 817 ====== ====== ======
A reconciliation of the 2000 and 1999 income tax expense computed by applying the statutory rate to income before income taxes to the actual taxes is as follows:
Year Ended December 31, 2000 1999 U.S. Federal statutory rate... $6,046 $5,069 State income tax -- net of federal benefit............... 518 895 Non-taxable life insurance proceed....................... (350) -- Tax liability adjustment...... (411) -- Other-- net................... 22 115 ------ ----- $5,825 $6,079
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets are as follows:
Year Ended December 31, 2000 1999 Deferred tax liabilities: Intangible assets...... $ 7,883 $ 912 ------ ----- Deferred tax assets: Cash to accrual adjustment............... 235 495 Accrued liabilities and other.................... 1,529 699 Net operating loss..... 752 -- ------ ----- 2,516 1,194 Net deferred tax assets (liabilities)............ $(5,367) $ 282 ======= =====
In assessing the realizability of deferred tax assets, management considers 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 those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods with respect to which the deferred tax assets are deductible, management believes it is more likely than not that CBH will realize the benefits of these deductible differences. Accordingly, no valuation allowance is deemed necessary.
6. LONG TERM DEBT
December 31, 2000 1999 Term loan payable to banks......... $49,500 $28,000 Revolving credit loan payable to banks.............................. 7,000 5,000 Notes payable to former shareholder of acquired businesses.............. 8,073 9,725 ------ ------ 64,573 42,725 Less current maturities............ 11,968 7,252 ------ ------ $52,605 $35,473
Credit Facility -- On December 28, 1999, CBH expanded the credit facility negotiated in January 1999 to $100 million with the same group of bank lenders. The new credit facility provided for a revolving credit and a term loan. At the end of each year, borrowings under the revolving credit are converted to a five-year term loan. The revolving credit portion terminates on December 31, 2002. The term loan is payable quarterly at the rate of 5% of the year end balance and $1,250,000 per quarter so the term portion is repaid by December 31, 2004.
On August 23, 2000, CBH expanded the December 28, 1999 credit facility from $100 million to $114.3 million and added another bank to the existing group of lenders. The principal changes in the structure of the facility are the increase of the working capital limit from $5 million to $10 million and an expansion of the borrowing base. The credit facility contains restrictive covenants requiring mandatory prepayments under certain conditions, financial reporting and compliance certificates, maintenance of financial ratios, restrictions on guarantees and additional indebtedness, limitations on mergers and acquisitions, prohibition of cash dividends, limitation on investments, loans, and advances, and changes in control. All of the assets of CBI, including the CBI stock owned by CBH, are pledged as collateral under this Agreement.
The restrictive covenants under the loan agreement provide for:
a. the maintenance of a minimum ratio of fixed charges;
b. a maximum allowable leverage ratio;
c. a minimum amount of net worth (stockholders' equity); and,
d. a maximum ratio of debt to capitalization.
CBH was in compliance with all its restrictive covenants as of December 31, 2000.
CBH is obligated to pay a commitment fee based on the daily average of undrawn funds under the credit agreement. The fee is a minimum of .25% and a maximum of .50% based on the ratio of consolidated indebtedness to income before interest, taxes, depreciation and amortization for the most recent four quarters on a rolling quarterly basis. A ratio of one to one produces the lowest fee and three to one, or more, produces the highest.
CBH capitalized $522,000 of costs in connection with the refinancing as Other Assets on the balance sheet at December 31, 1999. These costs are being amortized over the life of the agreements.
Interest on the outstanding indebtedness is at a spread over the Eurodollar (London InterBank Offered) rate or a base rate equal to the prime rate plus 1/2%, at CBH's choice. The Eurodollar rate remains fixed for the period that portion of the loan is outstanding and the base rate floats with changes in the prime rate.
Coincident with the credit facility, CBH entered into two interest rate swap agreements with a bank affiliated with the lending group to set the interest rates. The first agreement went into effect on July 6, 1999 and sets the underlying LIBOR-based interest rate at 5.76% on $15 million of the debt. The second agreement went into effect on January 18, 2000 and sets the underlying LIBOR-based rate at 5.29% on $15 million of the debt. On June 29, 2000, a third interest rate swap went into effect, setting the underlying LIBOR based at interest rate 7.24% on $20.0 million of debt. The combined notional amount of the underlying swap agreements was $44.8 million at December 31, 2000 and declines at the rate of $2.5 million, per quarter, until December 31, 2004.
Phynque, Inc. Notes. In connection with the purchase of Phynque, Inc. d/b/a Management Compensation Group/HealthCare, CBI issued an $8,724,000 promissory note payable in thirty-two equal quarterly installments of principal and interest at 10%. A portion of the promissory note is guaranteed personally by W. T. Wamberg, Chairman and Chief Executive Officer of CBI and CBH.
At December 31, 2000, future payments under all financing arrangements are as follows:
2001.... $ 8,772 2002.... 8,480 2003.... 8,216 2004.... 7,983 2005.... 7,630 Thereafter 23,492
7. STOCKHOLDERS' EQUITY
In June 1998, Clark/Bardes, Inc., a Texas corporation (the Predecessor Company) was merged with Clark/Bardes, Inc., a Delaware corporation, a wholly owned subsidiary of Clark/Bardes Holdings, Inc. Each existing shareholder of the Predecessor Company received one-half share of Clark/Bardes Holdings, Inc. in exchange for each share held and a return of capital distribution was made to them. In accounting for this distribution, all of the existing shareholders' investment, treasury shares and retained earnings were transferred to paid in capital.
All of the foregoing was done in connection with an initial public offering. As part of the initial public offering, CBH redeemed previously issued warrants to purchase 1,525,424 shares of the Company's stock for $4.9 million of which $4.8 million was charged to expense during 1998.
In August 1998, CBH sold 4 million shares of common stock in an initial public offering for net proceeds of $31.7 million.
Other significant equity transactions in 1998 were:
o The conversion of $4.8 million of 8.5% convertible subordinated notes into 813,559 shares at $5.90 per share;
o The issuance of 24,108 shares to the former President of the former Clark/Bardes division under a bonus arrangement; and
o The issuance of 142,857 shares, having a market value of $2 million, to the controlling shareholders of Wiedemann & Johnson Company in partial payment for the purchased assets of that Company.
In July 1998, the Board of Directors approved the authorization of 1,000,000 shares of $.01 par value junior participating preferred stock. No shares have been issued as of December 31, 2000.
On June 7, 1999, CBH sold 1,000,000 shares of common stock to Conning Insurance Capital Partnership V, L.P. for $16.9 million in a private placement transaction. The proceeds from this sale were used for debt reduction and acquisitions.
During 1999, CBH also issued shares of its common stock in connection with certain acquisitions:
o 326,363 shares, having a market value of $5.3 million were issued to the controlling shareholders of Phynque, Inc. in partial payment for the purchase of the assets of that Company.
o 99,851 shares, having a market value of $1.6 million were issued to the shareholders of National Institute for Community Banking in exchange for all of the outstanding shares of that Company. Up to 384,452 additional shares are issuable upon attainment of stipulated performance objectives.
On September 11, 2000, CBH sold 1,888,887 shares of common stock to a group of investors for $25.1 million, net of expenses, in a private placement transaction. The proceeds from this sale were used for debt reduction and an acquisition. The shares were sold to the investors for $13.50 per share and have been registered for resale by the investors.
During 2000, CBH also issued shares of common stock in connection with acquisitions:
o 96,113 shares, having a market value of $1.4 million were issued to the shareholders of National Institute of Community Banking in connection with the attainment of certain stipulated performance objectives at the time of the acquisition.
o 43,714 shares, having a market value of $694,000 were issued in acquiring the business of Christiansen & Associates, producing consultants for Bank Compensation Strategies.
o 49,143 shares, having a market value of $713,000 were issued in connection with the acquisition of Insurance Alliances Group as partial payment for the assets and business of that company.
o 250,000 shares, having a market value of $4.0 million, as partial payment for the acquisition of all the issued stock of Pearl Meyer & Partners.
o 596,463 shares, having a market value of $6.1 million, as partial payment for the acquisition of all the issued common stock of Compensation Resource Group, Inc.
A number of option holders exercised their options to purchase 120,990 net of shares exchanged in payment during the year. The excess of the market value of the shares issued over the shares received in exchange was $405,000 and produced a federal income tax benefit of $245,000.
8. FINANCIAL INSTRUMENTS
Derivative Financial Instruments. The Company uses derivatives only for hedging purposes. The following is a summary of the Company's risk management strategies and the effect of these strategies on the Company's consolidated financial statements.
Cash Flow Hedging Strategy. CBH has entered into three interest-rate sway agreements for interest-rate risk exposure management purposes. The interest-rate swap agreement utilized by CBH effectively modifies CBH's exposure to interest rate risk by converting CBH's floating rate debt to a fixed rate based on LIBOR. The notional amounts of the swaps at December 31, 2000 was $45.5 million and is scheduled to decline as the debt matures. This agreement involves the receipt of floating rate amounts in exchange for fixed rate interest payments over the life of the agreement without an exchange of the underlying principal amount.
During the year, CBH had a net gain of $160,000 as a result of its hedging activities. In addition, CBH had hedged $44.8 million of its long term debt as of December 31, 2000 under its swap agreements. The fair value of the net hedged position was $7,000.
Concentrations of credit risk. Financial instruments that potentially subject CBH to significant concentrations of credit risk consist principally of cash, trade accounts receivable, and derivatives.
CBH maintains cash and cash equivalents and short term investments only with financial institutions having the highest ratings of liquidity. Concentration of credit risk with respect to accounts receivable are limited because of the high quality of the carriers' credit ratings. CBH's revenue recognition policy, among other things, precludes recognition of first year revenue until the client has paid the premium. CBH is exposed to credit risk in the event of non-performance by counterparties to derivative instruments. CBH limits this exposure by entering into its swap arrangements by one of the members of its group of lending banks.
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported in the balance sheet for cash and cash equivalents approximates its fair value.
Accounts receivable and accounts payable: The carrying amounts reported in the balance sheet for accounts receivable and accounts payable approximate their fair value.
Long- and short-term debt: The carrying amounts of the Company's borrowing under its short-term revolving credit arrangements approximate their fair value. The fair values of the Company's long-term debt are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.
Interest Rate Swaps: The fair values of the Company's interest rate swaps are estimated based on the net present value of the net pay/receive differences on swaps in place as of December 31, 2000.
The carrying amounts and fair values of the Company's financial instruments at December 31 are as follows:
December 31, 2000 1999 ---------------- --------------- Carrying Fair Carrying Fair Amount Value Amount Value Cash and cash equivalent......... $7,598 $7,598 $4,832 $4,832 Accounts receivable 31,134 31,134 18,695 18,695 Accounts payable... 10,786 10,786 4,100 4,100 Short-term debt.... 11,968 11,968 7,252 7,252 Long-term debt..... 52,605 52,605 35,473 35,473 Interest rate swaps -- 7 -- --
9. BENEFIT PLANS
Incentive Stock Option Plan. The Incentive Stock Option Plan provided certain employees options to purchase shares for $4.80 and $7.00 per share; 540,830 shares of common stock were reserved for issuance under this plan and 190,832 shares were granted. No additional options may be granted under this program. The $4.80 and $7.00 options became fully vested at the date of the Initial Public Offering. The options expire ten years from the grant date and are voided within 90 days of the employee's termination or one year from date of death.
Director Option. On April 2, 1997, CBH granted stock options to a member of the Board of Directors for 100,000 shares at an exercise price of $4.80. These options were issued in conjunction with services provided to CBH as an advisor to the Board of Directors and for future participation as a member of CBH's Board of Directors. These options vest at the rate of 2,776 shares per month beginning July 1, 1998. The fair value of the common stock at the date of grant was $4.80 as determined by CBH's Board of Directors based on a recent stock transaction; accordingly, no compensation expense has been recorded.
1998 Stock Option Plan. In 1998, the Board of Directors approved a stock option plan providing for certain employees, directors and consultants to purchase shares at the fair market value at the time the option is granted. The Plan is administered by a committee of non-employee directors who have full discretion to determine participation, vesting and term of the option, at the time of the grant providing that no option may have a term greater than ten years from the date of the grant to purchase shares at the fair market value at the time the option is granted. A total of 2,000,000 shares are reserved for issuance under this plan.
The following table summarizes the combined status of all three of CBH's stock options plans.
Weighted Average Options Exercise Price Outstanding at January 1, 1998..................... 290,832 $ 5.93 Granted................ 380,689 $ 9.00 Exercised.............. -- Forfeited.............. -- ------- Outstanding at December 31, 1998................. 671,521 $ 7.67 Granted................ 586,323 $15.52 Exercised.............. (1,250) $ 9.00 Forfeited.............. (18,750) $16.30 ------- Outstanding at December 31, 1999................. 1,237,842 $11.51 Granted................ 338,100 $12.89 Exercised.............. (167,866) $ 6.35 Forfeited.............. (30,800) $12.51 ------- Outstanding at December 31, 2000................. 1,377,276 $12.56 Exercisable at December 31, 2000................. 770,741 $11.91
The options granted in 1999 include 276,600 issued to executives and employees of the Healthcare Group division in connection with the acquisition of Phynque, Inc. d/b/a Management Compensation Group HealthCare. These options vest at the rate of 20% per year beginning in 1999 but are subject to certain forfeiture provisions if the division fails to attain certain financial performance goals.
The following table summarizes the stock options outstanding and exercisable:
Options Outstanding Options Exercisable Weighted Weighted Weighted Average Average Average Range of Number Remaining Exercise Number Exercise Exercise PricesOutstandingContractual Life Price Exercisable Price (years) $ 4.80 68,799 6.2 $ 4.80 52,124 $ 4.80 $ 7.00 79,167 6.2 $ 7.00 79,167 $ 7.00 $ 9.00 340,689 6.2 $ 9.00 222,789 $ 9.00 $10.06-$10.19 150,800 7.5 $ 10.13 52,000 $ 10.13 $14.25-$14.75 201,000 7.0 $ 14.65 124,772 $ 14.65 $15.00-$15.93 87,000 8.3 $ 15.19 13,263 $ 15.19 $16.63-$16.94 375,044 8.2 $ 16.64 204,349 $ 16.64 $ 17.00 37,500 7.6 $ 17.00 2,500 $ 17.00 $ 18.13 37,277 4.8 $ 18.13 19,777 $ 18.13 ------ ------ 1,377,276 770,741
The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of grant over the amount an employee must pay to acquire the stock.
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," established accounting and disclosure requirements using a fair value based method of accounting for stock based employee compensation plans. The Company has elected to remain on its current method of accounting as described above, and has adopted the disclosure requirements of SFAS No. 123.
The pro forma information regarding net income and earnings per share required by SFAS 123 has been determined as if CBH had accounted for its stock based compensation plans under the fair value method. The fair value of each option grant was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 2000, 1999 and 1998, respectively:
2000 1999 1998 ------------- ----- Dividend yield... None None None Volatility....... 64.3% 185.0% 73.0% Risk-free interest rates... 5.1% 6.3% 4.7% Expected life (years).......... 6 6 6
The estimated average fair values of options outstanding in 2000, 1999, and 1998 were $9.03, $9.88 and $4.59 respectively. Had compensation cost for CBH's stock-based compensation plans been determined in accordance with SFAS No. 123, CBH's net income (loss) and earnings (loss) per share would have been reduced to the pro forma amounts indicated below:
Year Ended December 31, 2000 1999 1998 - ------------------------------------------- ------- ------ ----- Net income (loss) As reported.............................. $11,448 $8,831 $(411) Pro forma................................ $10,668 $7,777 $(977) Diluted earnings (loss) per common and common equivalent share $ 1.05$ .95$ (.08) As reported.............................. Pro forma................................ $ .98$ .83$ (.20)
These pro forma amounts are not likely to be representative of the effect on reported net income for future years.
Savings Investment Plan. The Savings Investment Plan is a defined contribution profit sharing plan, qualifying under Section 401(k) of the Internal Revenue Code, covering substantially all eligible employees. At CBH's discretion, CBH may contribute up to 100% of an eligible participant's contributions to the Plan up to a maximum of 3% of salary. Company contributions to the Plan were $746,000, $388,000, and $214,000 for the years ended December 31, 2000, 1999, and 1998 respectively.
Stock Purchase Plan. On July 10, 1998, the Board of Directors adopted the Stock Purchase Plan, under which a total of 200,000 shares of common stock have been reserved for issuance. Any employee who has been employed by CBH for 90 days is eligible to participate in offerings under the Stock Purchase Plan.
The Stock Purchase Plan consists of eight semi-annual offerings of common stock beginning on each January 1 and July 1 in each of the years 1999, 2000, 2001 and 2002, and terminating on June 30 and December 31 of each such year. The maximum number of shares issued in such years will be 50,000 in 1999, and 50,000 plus the number of unissued shares from prior offerings for each of 2000, 2001 and 2002. The price of the shares under each offering segment is 85% of the lower of the closing market price on the day before the offering period begins or on the day the offering period ends.
CBH has, for the four expired periods prior to December 31, 2000, determined that it will purchase the requisite shares on the open market and has not issued any additional shares to fulfill this obligation. Future fulfillment under this Plan may be made through open market purchases or unissued shares, at CBH's discretion.
CBH employees purchased 49,780 shares of CBH common stock at an average cost, to them, of $10.34. CBH's open market purchases of these shares for the employees were made at an average cost of $12.78. Accordingly, CBH's cost of this program was $95,000 including administrative expenses.
Key Executive Life Insurance. CBH maintains key man life insurance policies of $22.0 million on its Chairman and Chief Executive Officer and policies ranging from $4.0 to $8.5 million on certain other key executives.
10. COMMITMENTS
Leases -- CBH conducts operations from leased office facilities. Management expects that, in the normal course of business, leases that expire will be renewed or replaced by other leases; thus it is anticipated that future minimum lease commitments will not be less than the amount shown for the year ended December 31, 2000.
Rental expense for the years ended December 31, 2000, 1999, and, 1998 was $4.1 million, $2.0 million, and $916,000, respectively.
At December 31, 2000, approximate minimum rental commitments under all non-cancelable leases having terms in excess of a year are as follows:
2001.... $5,426 2002.... 5,042 2003.... 4,717 2004.... 4,448 2005.... 3,858 Thereafter 8,915
11. RELATED PARTY TRANSACTIONS
A summary of CBH's related party balances and transactions at December 31, 2000, 1999 and 1998 and for the years then ended are:
2000 1999 1998 ------------ ----- Balances: Accounts receivable -- officers and directors.................... $ 64 $ 20 -- Accounts receivable-- affiliates -- $ 461 $ 872 Commissions and fees payable... $ 25 $ 26 -- Debt maturing within one year.. -- -- $ 425 Long term debt................. -- -- $6,113 Transactions: Commissions and service fees... -- $1,434 $1,585 Commission and fee expense..... $ 25 $8,071 $8,068 General and administrative expense........................ $ 154 $ 45 --
CBH has entered into compensation and employment agreements with certain key employees. The agreements provide for an indefinite employment term, compensation, stock bonuses, expense reimbursements and participation in benefit plans and are subject to the employees' compliance with certain provisions. In addition, nine administrative employees of the Company's Healthcare Group are entitled to a severance payment in the event they voluntarily terminate their employment. This was an obligation of MCG/ HealthCare at the time of its acquisition and was $1.1 million at December 31, 2000.
CBH and its Chairman and Chief Executive Officer, Mr. Wamberg, were parties to a Principal Office Agreement dated July 29, 1993, pursuant to which The Wamberg Organization marketed, life insurance and administrative and consulting services on behalf of CBH, and CBH furnished support to The Wamberg Organization. Pursuant to the terms of the Principal Office Agreement, The Wamberg Organization was paid approximately $8.1 million and $8.1 million in 1999, 1998, respectively, for commissions and fees earned. This agreement was subsequently terminated on September 1, 1999, as a result of the acquisition of The Wamberg Organization.
CBH has transactions with affiliated entities. CBH provides services for these affiliates and is reimbursed for these services at the Company's respective costs. Among these affiliates is Clark/Bardes Financial Services, Inc. a registered broker-dealer through which CBH sells all its securities products and receives a commission.
12. EARNINGS PER SHARE
The following table sets forth the computation of historical basic and diluted earnings per share:
2000 1999 1998 ---------- --------- ------- (dollars in thousands) Numerator: Net income (loss) for basic earnings per share.............. $ 11,448 $ 8,831 $ (411) ---------- -------- --------- Numerator for diluted earnings per share........................... $ 11,448 $ 8,831 $ (411) ========== ======== ========= Denominator: Basic earnings per share -- weighted average shares........... 10,744,719 9,077,775 5,006,009 Effect of dilutive securities: Stock options.................... 135,375 251,164 * ---------- -------- --------- Diluted earnings per share -- weighted average shares plus assumed conversions 10,880,094 9,328,939 5,006,009 ========== ========= ========= Per share: Basic earnings (loss)............ $ 1.07 $ 0.97$ (0.08) =========== =================== Diluted earnings (loss).......... $ 1.05 $ 0.95$ (0.08) =========== =================== - ----------
* The effects of options and convertible debt have not been included as such effects would be antidilutive.
13. SIGNIFICANT RISKS AND UNCERTAINTIES
Federal tax laws create certain advantages for the purchase of life insurance products by individuals and corporations; therefore the life insurance products underlying the benefit programs marketed by the Company are vulnerable to adverse changes in tax legislation and policy. Amendments to the federal tax laws enacted in 1996 and 1997 reduced the advantages of certain business owned life insurance programs.
During the past two years, a number of U.S. corporations have been faced with a significant income tax liability as a result of Internal Revenue Service challenges and court rulings disallowing interest deductions related to a program known as a leveraged COLI. Although CBH stopped selling leveraged COLI programs in June 1997, this development may cause some current holders of leveraged COLI policies to elect to surrender their policies, which could reduce the amount of commissions that CBH would realize from the total pool of leveraged COLI policies.
In addition, the Internal Revenue Service has begun a new initiative with respect to certain aspects of split-dollar insurance known as "equity split-dollar." Under this initiative, the individual insured could suffer adverse income tax consequences over the term of the policy.
14. SEGMENTS AND RELATED INFORMATION
CBH has four reportable segments:
Clark/Bardes Consulting -- Compensation Resources Group Clark/Bardes Consulting -- Banking Practice Clark/Bardes Consulting -- Healthcare Group Compensation Consulting
On September 6, CBH acquired all of the outstanding common stock of Compensation Resource Group, Inc. (CRG) an independent company specializing in the design, marketing and administration of non-qualified executive compensation plans using company owned life insurance (COLI) products. In acquiring CRG, CBH reorganized this divisions as follows:
o The division formerly known as Clark/Bardes was renamed Clark/Bardes Consulting -- Compensation Resource Group and will consist of a Los Angeles, California headquarters with service centers in Dallas, Texas and Bethesda, Maryland.
o In 1999, CBH reported Clark/Bardes of Washington, D.C. (formerly Schoenke & Associates) as a segment. During 1999, this segment was combined with the operations of the Clark/Bardes division and was no longer a separately reportable segment.
o All of these divisions are now grouped in the Clark/Bardes Consulting-Compensation Resources Group segment.
o The bank owned life insurance product sold by the Clark/Bardes division will be transferred to the Banking Practice thus placing all of CBH's bank owned life insurance business in one division, commencing in 2001. The effect of this transfer is not yet reflected in the operations of the affected segments.
Healthcare Group became a segment with the acquisition of MCG HealthCare on April 5, 1999. Compensation Consulting became a segment with the acquisition of Pearl Meyer & Partners, Inc. on June 21, 2000.
The four reportable segments operate as independent and autonomous business units with a central corporate staff responsible for finance, strategic planning, and human resources. CBH's segments are in the business of designing, marketing and administering employee benefit programs for large corporations; community, regional and money center banks; healthcare organizations and executive compensation consulting. The distinction between these segments is each has its own client base as well as its own marketing, administration and management.
CBH evaluates performance and allocates resources based on profit and loss from operations before income taxes, interest or corporate administrative expenses. The accounting policies of the reporting segments are the same as those described in the summary of significant policies. There are no inter-segment revenues or expenses.
For the Years Ended December 31, 2000 1999 1998 --------- --------- ------- Revenues from External Customers Clark/Bardes Consulting -- Compensation Resource Group.......................................$.78,588...$ 73,528 $45,408 Clark/Bardes Consulting-- Banking Practice...40,172.... 30,784 29,358 Clark/Bardes Consulting-- Healthcare Group...22,139.... 16,448 -- Compensation Consulting.......................6,027.......-- -- - ---------------------------------------------------------------------- Total segments-- reported....................146,926 120,760 74,766 Reconciling items..............................687........-- -- - ---------------------------------------------------------------------- Total consolidated-- reported...............$147,613 $120,760 $74,766 ----------------------------- Operating Income and Income Before Taxes Clark/Bardes Consulting -- Compensation Resource $21,997 $19,750 $5,811 Group............................... Clark/Bardes Consulting -- Banking 6,194 3,621 4,038 Practice................................. Clark/Bardes Consulting -- Healthcare 601 623 -- Group.................................... Compensation Consulting................ 1,306 -- -- ------- ------- ------ Total segments-- reported...... 30,098 23,994 9,849 Corporate overhead..................... (9,134) (5,865) (2,042) Put warrants........................... -- -- (4,800) Non-operating income................... 1,001 -- -- Interest-- net......................... (4,692) (3,219) (2,601) ------- ------- ------ Income before taxes............ $17,273 $14,910 $ 406 ======= ======= ====== Depreciation and Amortization Clark/Bardes Consulting -- Compensation Resource $ 3,904 $ 2,481 $ 503 Group............................... Clark/Bardes Consulting -- Banking 1,562 1,151 1,067 Practice................................. Clark/Bardes Consulting -- Healthcare 2,479 1,600 -- Group.................................... Compensation Consulting................ 783 -- -- ------- ------- ------ Total segments-- reported...... 8,728 5,232 1,570 Reconciling items...................... 149 -- -- ------- ------- ------ Total consolidated-- reported.. $ 8,579 $ 5,232 $1,570 ======= ======= ====== Identifiable Assets Clark/Bardes Consulting -- Compensation Resource $112,505 $58,280 $38,232 Group............................... Clark/Bardes Consulting -- Banking 36,615 30,841 28,654 Practice................................. Clark/Bardes Consulting -- Healthcare 33,768 35,456 -- Group.................................... Compensation Consulting................ 29,627 -- -- ------- ------- ------ Total segments-- reported...... 212,515 124,577 66,886 Deferred tax asset..................... 1,861 947 607 Holding company assets-- non operating. 5,479 -- -- ------- ------- ------ Total consolidated-- reported.. $219,855 $125,524 $67,493 ======== ======== ======= Capital Expenditures Clark/Bardes Consulting -- Compensation Resource $ 1,091 $ 878 $ 310 Group............................... Clark/Bardes Consulting -- Banking 1,161 498 330 Practice................................. Clark/Bardes Consulting -- Healthcare 663 2,812 -- Group.................................... Compensation Consulting................ 550 -- -- ------- ------- ------ Total segments-- reported...... 3,465 4,188 640 Reconciling items...................... 32 -- -- ------- ------- ------ Total consolidated-- reported.. $ 3,497 $ 4,188 $ 640 ======= ======= ======
Geographic Information -- All the Company's revenues are derived from clients located in the United States.
Major Customers and Clients -- CBH derives its revenues from the commissions it earns from the carriers it represents, based on sales of benefit programs on behalf of those carriers, to its clients. CBH generated in excess of 25% of its revenue in 2000 from 17 clients, in 1999 from 8 clients, and in 1998 from 8 clients, respectively. None of Banking Practice or Healthcare Group carriers accounted for more than 10% of revenue. Approximately 15.2% and 17.5% of CBH's commission and fee revenue for the years ended 1999 and 1998 respectively, was generated by The Wamberg Organization, which was wholly owned by CBH's Chairman and Chief Executive Officer. Substantially all of the policies underlying the programs marketed by CBH are underwritten by 20 life insurance companies, of which eleven accounted for approximately 80% of CBH's first year revenue for the year ended December 31, 2000 and eleven accounted for approximately 76.1% for the year ended December 31, 1999, and seven accounted for approximately 63.1% for the year ended December 31, 1998.
15. ADDITIONAL FINANCIAL INFORMATION
The table that follows provides additional financial information related to the consolidated financial statements.
Cash Flow Information
Years Ended December 31, 2000 1999 1998 ------- ------- ------ (in thousands) Cash paid for: Interest......................... $3,965 $3,125 $3,323 Taxes............................ $4,213 $2,335 $ 896 Financing Activities: Notes issued in connection with acquisition..................... $ -- $8,724 $2,000 Reduction of borrowing on conversion of notes............. $ -- $ -- $4,800
Statement of Operations -- Non operating income includes $1 million death benefit proceeds under a key person insurance policy as the result of the death of an executive of the Banking Practice division.
16. LITIGATION
From time to time, CBH is involved in various claims and lawsuits incidental to its business.
M Financial Holdings, Incorporated, et al. v. Clark/Bardes Holdings, Inc.
On June 3, 2000, M Financial Holdings, Incorporated ("M") commenced an action seeking to enjoin one of its former executives from being employed by CBH, and other relief. The complaint alleges breach of fiduciary duty, unfair competition, civil conspiracy, misappropriation of trade secrets and charges CBH with intentional interference with contract.
The complaint requests an injunction barring the executive's employment by CBH for two years, barring disclosure of M confidential information, and requiring the return of all documents. In addition, M seeks a constructive trust with respect to CBH's gross profits from its new reinsurance operations for two years, compensatory damages, punitive damages of $1.5 million plus attorneys fees and costs. Both the executive and CBH deny any wrongdoing and intend to vigorously defend these claims.
Constellations Energy Group, Inc. and Baltimore Gas and Electric Company, et al. v. Clark/Bardes, Inc.
On July 25, 2000, Constellation Energy Group, Inc. ("Constellation") and related entities filed a civil action against Clark/Bardes, Inc. ("CBI"), a wholly owned subsidiary of CBH, in the U.S. District Court for the District of Maryland. Constellation claims that CBH failed to take proper action in connection with the administration of an employee benefit life insurance program for certain employees, resulting in claimed damages of $7.5 million and pre-judgment interest, post-judgment interest, costs and expenses.
Agreement has been reached with Plaintiffs to stay the matter until April 16, 2001 to facilitate ongoing discussions and a potential nonbinding mediation of the issues. CBI believes it has meritorious defenses to these claims, intends to deny all allegations and to vigorously defend these claims. CBI's insurance carrier has acknowledged coverage for this action.
Madge A. Kunkel, individually and as Personal Representative of the Estate of Donald B. Kunkel, M.D., deceased vs. Banner Health System, et al.
On February 2, 2001, this action was commenced against various defendants including the Health Care Compensation Strategies Division of Clark/Bardes, Inc. ("HCS"). Ms. Kunkel alleges that her deceased husband was entitled to a life insurance policy in the face amount of $525,000 to be issued by the defendant insurance company under a split dollar life insurance plan sponsored by his defendant employer and administered by HCS. According to the complaint, Dr. Kunkel died before the initial premium was paid by his employer and before the policy was issued. The matter has been submitted to CBH's insurance carriers. CBH believes it has meritorious defenses to this claim and intends to vigorously defend the matter.
17. SUBSEQUENT EVENTS (UNAUDITED)
On March 12, 2001, CBH acquired certain assets, all of the business, and assumed certain liabilities of Rich, Florin/Solutions, Inc., a Boston, Massachusetts compensation consulting company. The assets acquired include accounts receivable, copyrights and office equipment. The liabilities assumed were for employee benefit obligations.
The purchase price is $20.8 million, before expenses, consisting of a cash payment at closing of $11.3 million and $9.5 million of contingent payments over the next four years based on the attainment of established financial performance criteria. When earned, the contingent payments will consist of 60% cash and 40% CBH common stock.
The transaction will be funded from CBH's existing line of credit. The initial amount of goodwill of approximately $9.0 million will be amortizable over twenty years.
On March 23, 2001 CBH acquired the business of Partners First, a division of Ascension Health and a provider of consulting services to Ascension Health's 79 hospitals and physician practices. Partners First will become a part of CBH's Healthcare Group and will be based in St. Louis, Missouri.
The purchase price was $1.1 million cash at the closing and contingent payments of up to $1.7 million based on achievement of certain revenue objectives. This acquisition will be accounted for as a purchase with goodwill of approximately $1.1 million amortized over 20 years. The allocation of the purchase price is preliminary.
18. INTERIM FINANCIAL DATA (UNAUDITED)
Quarter First Second Third Fourth Total (in millions except per share data) Summary of Quarterly Results: Revenue................ 2000 $ 31.1 $ 24.4 $ 34.6 $ 57.5 $147.6 1999 24.1 29.7 25.7 41.3 120.8 1998 13.8 15.2 17.6 28.2 74.8 Gross profit........... 2000 $ 20.3 $ 16.3 $ 22.9 $ 37.3 $ 96.8 1999 9.9 16.7 15.2 25.9 67.7 1998 4.6 6.2 6.6 11.3 28.7 Pre-tax income (loss).. 2000 $ 3.1 $ -- $ 1.7 $ 12.5 $ 17.3 1999 2.5 2.4 1.8 8.2 14.9 1998 0.2 (5.2) 1.6 3.8 0.4 Net income (loss)...... 2000 $ 1.8 $ 0.2 $ 1.2 $ 8.3 $ 11.5 1999 1.5 1.4 1.0 4.9 8.8 1998 0.2 (5.2) 2.4 2.2 (0.4) Basic earnings (loss) 2000 $ 0.18 $ 0.02 $ 0.11 $ 0.66 $ 1.07 per share................ 1999 0.18 0.16 0.11 0.52 0.97 1998 0.06 (1.61) 0.44 0.27 (0.08) Diluted earnings (loss) 2000 $ 0.18 $ 0.02 $ 0.11 $ 0.65 $ 1.05 per share................ 1999 0.17 0.16 0.11 0.50 0.95 1998 0.06 (1.61) 0.39 0.27 (0.08)
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CLARK/BARDES HOLDINGS, INC.
By: /s/ W. T. WAMBERG - --------------------------- W. T. Wamberg President and Chief Executive Officer
Date: March 28, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ W. T. WAMBERG Chairman of the Board, March 28, 2001 - ------------------- President, Chief Executive W. T. Wamberg Officer and Director
/s/ THOMAS M. PYRA Vice President and March 28, 2001 - -------------------- Chief Financial Officer, Thomas M. Pyra Principal Accounting Officer and Chief Operating Officer
/s/ RANDOLPH A. POHLMAN Director March 28, 2001 - ------------------------- Randolph A. Pohlman
/s/ L. WILLIAM SEIDMAN Director March 28, 2001 - ------------------------ L. William Seidman
/s/ GEORGE D. DALTON Director March 28, 2001 - ----------------------- George D. Dalton
/s/ STEVEN F. PIAKER Director March 28, 2001 -------------------- Steven F. Piaker
/s/ BILL ARCHER Director March 28, 2001 --------------- Bill Archer