Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with National Financial Partners Corp. and its subsidiaries’ (the “Company”) consolidated financial statements and the related notes included elsewhere in this report. In addition to historical information, this discussion includes forward-looking information that involves risks and assumptions, which could cause actual results to differ materially from management’s expectations. See “Forward-Looking Statements” included elsewhere in this report.
Executive Overview
National Financial Partners Corp. (“NFP”) is a leading independent distributor of financial services products primarily to high net worth individuals and entrepreneurial companies. Founded in 1998 and commencing operations on January 1, 1999, NFP has grown internally and through acquisitions. As of September 30, 2007, NFP operates a national distribution network with over 180 owned firms. During the nine months ended September 30, 2007 revenue, increased $70.8 million, or 9.2% to $838.4 million from $767.6 million during the nine months ended September 30, 2006. Net income decreased $4.6 million, or 11.6%, to $35.0 million during the nine months ended September 30, 2007 from $39.6 million in the same period a year earlier.
The Company’s firms earn revenue that consists primarily of commissions and fees earned from the sale of financial products and services provided to their clients. The Company’s firms also incur commissions and fees expense and operating expense in the course of earning revenue. NFP pays management fees to non-employee principals of its firms and/or certain entities they own based on the financial performance of each respective firm. The Company refers to revenue earned by the Company’s firms minus the expenses of its firms, including management fees, as gross margin. The Company excludes amortization and depreciation from gross margin. These amounts are separately disclosed as part of “Corporate and other expenses.” Management uses gross margin as a measure of the performance of the firms that the Company has acquired. Gross margin has grown from $140.7 million,
or 18.3% of revenue, during the nine months ended September 30, 2006 to $156.4 million, or 18.7% of revenue, during the nine months ended September 30, 2007.
Gross margin is offset by expenses that NFP incurs at the corporate level, including corporate and other expenses. Corporate and other expenses grew from $72.3 million during the nine months ended September 30, 2006 to $93.5 million during the nine months ended September 30, 2007. Corporate and other expenses include general and administrative expense, which include the operating expenses of NFP’s corporate headquarters and a portion of stock-based compensation. General and administrative expense grew from $38.7 million during the nine months ended September 30, 2006 to $43.9 million during the nine months ended September 30, 2007. General and administrative expense as a percentage of revenue increased to 5.2% during the nine months ended September 30, 2007 from 5.0% for the same period in 2006. Included in corporate and other expense was the expense incurred due to the buyout of the
management agreement in connection with the acquisition of a management company from its former manager for cash, stock and other consideration totaling $13.0 million.
Acquisitions
Under its acquisition structure, NFP acquires 100% of the equity of businesses that distribute financial services products on terms that are relatively standard across all its acquisitions. To determine the acquisition price, NFP’s management first estimates the annual operating cash flow of the business to be acquired based on current levels of revenue and expense. For this purpose, management defines operating cash flow as cash revenue of the business less cash and non-cash expenses, other than amortization, depreciation and compensation to the business’ owners or individuals who subsequently become principals. Management refers to this estimated annual operating cash flow as “target earnings.” Typically, the acquisition price is a multiple (generally in a range of five to six times) of a portion of the target earnings, which management refers to as “base
earnings.” Under certain circumstances, the Company has paid multiples in excess of six times based on the unique attributes of the transaction that justify the higher value. Base earnings averaged 50% of target earnings for all firms owned at September 30, 2007. In determining base earnings, management focuses on the recurring revenue of the business. Recurring revenue refers to revenue from sales previously made (such as renewal commissions on insurance products, commissions and administrative fees for ongoing benefit plans and mutual fund trail commissions) and fees for assets under management.
21
NFP enters into a management agreement with principals and/or certain entities they own. Under the management agreement, the principals and/or such entities are entitled to management fees consisting of:
|
|
•
|
all future earnings of the acquired business in excess of the base earnings up to target earnings; and
|
|
|
•
|
a percentage of any earnings in excess of target earnings based on the ratio of base earnings to target earnings.
|
NFP retains a cumulative preferred position in the base earnings. To the extent earnings of a firm in any year are less than base earnings, in the following year NFP is entitled to receive base earnings together with the prior years’ shortfall before any management fees are paid. In certain recent transactions involving large institutional sellers, the Company has provided minimum guaranteed compensation to certain former employees of the seller who became principals of the acquired business.
Additional purchase consideration is often paid to the former owners based on satisfying specified internal growth thresholds over the three-year period following the acquisition.
Substantially all of NFP’s acquisitions have been paid for with a combination of cash and NFP’s common stock, valued at the fair market value at the time of acquisition. The Company typically requires its principals to take at least 30% of the total acquisition price in NFP common stock. However, in transactions involving institutional sellers, the purchase price typically consists of substantially all cash. Through September 30, 2007, principals have taken on average approximately 36% of the total acquisition price in NFP common stock. The following table shows acquisition activity in the period:
|
(in thousands, except number of acquisitions)
|
|
Nine Months Ended
September 30, 2007
|
|
|
Number of acquisitions closed
|
|
|
22
|
|
|
Consideration:
|
|
|
|
|
|
Cash
|
|
$
|
123,749
|
|
|
Common stock
|
|
|
25,476
|
|
|
Other
(1)
|
|
|
780
|
|
|
|
|
$
|
150,005
|
|
______________
|
(1)
|
Represents capitalized costs of the acquisitions.
|
In certain instances restricted stock units may be issued to key non-principal employees of an acquired firm. The cost of these restricted stock units is treated as compensation and included within operating expenses under Cost of services.
Revenue
The Company’s firms generate revenue primarily from the following sources:
Life insurance commissions and estate planning fees
. Insurance and annuity commissions paid by insurance companies are based on a percentage of the premium that the insurance company charges to the policyholder. First-year commissions are calculated as a percentage of the first twelve months’ premium on the policy and earned in the year that the policy is originated. In many cases, the Company’s firms receive renewal commissions for a period following the first year, if the policy remains in force. Some of the Company’s firms receive fees for the settlement of life insurance policies. These fees are generally based on a percentage of the settlement proceeds received by their clients. The Company’s firms also earn fees for developing estate plans. Revenue from life insurance activities also includes amounts received by the
Company’s life brokerage entities, including the Company’s life settlements brokerage entities, which assist affiliated and non-affiliated producers with the placement and sale of life insurance.
Corporate and executive benefits commissions and fees.
The Company’s firms earn commissions on the sale of insurance policies written for benefit programs. The commissions are paid each year as long as the client continues to use the product and maintain its broker of record relationship with the firm. The Company’s firms also earn fees for the development and implementation of corporate and executive benefit programs as well as fees for the duration that these programs are administered. Asset-based fees are also earned for administrative services or consulting related to certain benefits plans.
22
Financial planning and investment advisory fees and securities commissions.
The Company’s firms earn commissions related to the sale of securities and certain investment-related insurance products as well as fees for offering financial advice and related services. These fees are based on a percentage of assets under management and are generally paid quarterly. In certain cases, incentive fees are earned based on the performance of the assets under management. Some of the Company’s firms charge flat fees for the development of a financial plan or a flat fee annually for advising clients on asset allocation.
Some of the Company’s firms also earn additional compensation in the form of incentive and marketing support payments from manufacturers of financial services products, based on the volume, persistency and profitability of business generated by the Company from these three sources. Incentive and marketing support revenue is recognized at the earlier of notification of a payment or when payment is received, unless there exists historical data and other information which enable management to reasonably estimate the amount earned during the period. These forms of payments are earned both with respect to sales by the Company’s owned firms and sales by the Company’s network of affiliated third-party distributors.
NFP Securities, Inc. (“NFPSI”), the Company’s registered broker-dealer and investment adviser, also earns commissions and fees on the transactions effected through it. Most principals of the Company’s firms, as well as many of the Company’s affiliated third-party distributors, conduct securities or investment advisory business through NFPSI.
Incidental to the corporate and executive benefits services provided to their customers, some of the Company’s firms offer property and casualty insurance brokerage and advisory services. The Company believes that these services complement the corporate and executive benefits services provided to the Company’s clients. In connection with these services, the Company earns commissions and fees.
Although the Company’s operating history is limited, the Company believes that its firms earn approximately 65% to 70% of their revenue in the first three quarters of the year and approximately 30% to 35% of their revenue in the fourth quarter.
Expenses
The following table sets forth certain expenses as a percentage of revenue for the periods indicated:
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Total revenue
|
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
Cost of services:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
|
32.7
|
|
|
31.9
|
|
|
32.4
|
|
|
32.7
|
|
|
Operating expenses (1)
|
|
|
29.8
|
|
|
28.5
|
|
|
31.8
|
|
|
29.4
|
|
|
Management fees (2)
|
|
|
19.1
|
|
|
20.1
|
|
|
17.1
|
|
|
19.6
|
|
|
Total cost of services
|
|
|
81.6
|
|
|
80.5
|
|
|
81.3
|
|
|
81.7
|
|
|
Gross margin
|
|
|
18.4
|
|
|
19.5
|
|
|
18.7
|
|
|
18.3
|
|
|
Corporate and other expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative
|
|
|
4.6
|
|
|
4.9
|
|
|
5.2
|
|
|
5.0
|
|
|
Amortization
|
|
|
2.8
|
|
|
2.7
|
|
|
3.0
|
|
|
2.7
|
|
|
Depreciation
|
|
|
0.9
|
|
|
0.8
|
|
|
0.9
|
|
|
0.8
|
|
|
Impairment of goodwill and intangible assets
|
|
|
0.8
|
|
|
0.3
|
|
|
0.7
|
|
|
0.8
|
|
|
Management agreement buyout
|
|
|
—
|
|
|
—
|
|
|
1.6
|
|
|
—
|
|
|
(Gain) loss on sale of subsidiaries
|
|
|
—
|
|
|
(0.1
|
)
|
|
(0.2
|
)
|
|
—
|
|
|
Total corporate and other expenses
|
|
|
9.1
|
%
|
|
8.6
|
%
|
|
11.2
|
%
|
|
9.3
|
%
|
______________
|
|
(1)
|
Excludes amortization and depreciation which are shown separately under Corporate and other expenses.
|
|
|
(2)
|
Excludes management agreement buyout which is shown separately under Corporate and other expenses.
|
23
Cost of services
Commissions and fees.
Commissions and fees are typically paid to third-party producers, who are affiliated with the Company’s firms. Commission and fees are also paid to non-affiliated producers who utilize the services of one or more of the Company’s life brokerage entities including the Company’s life settlements brokerage entities. Commissions and fees are also paid to non-affiliated producers who provide referrals and specific product expertise to the Company’s firms. When business is generated solely by a principal, no commission expense is incurred because principals are only paid from a share of the cash flow of the acquired firm through management fees. However, when income is generated by a third-party producer, the producer is generally paid a portion of the full commission income, which is reflected as commission expense of
the acquired firm. Rather than collecting the full commission and remitting a portion to a third-party producer, a firm may include the third-party producer on the policy application submitted to a carrier. The carrier will, in these instances, directly pay each named producer their share of the commissions and fees earned. When this occurs the firm will record only the commissions and fees it receives directly as revenue and have no commission expense. As a result, the NFP firm will have lower revenue and commission expense and a higher gross margin percentage. Gross margin dollars will be the same. The transactions where NFP is listed as the sole producer and pays commissions to a third-party producer, versus transactions in which the carrier pays each producer directly, will cause NFP’s gross margin percentage to fluctuate without affecting gross margin dollars or earnings. In addition, NFPSI pays commissions to the Company’s affiliated third-party distributors who
transact business through NFPSI.
Operating expenses.
The Company’s firms incur operating expenses related to maintaining individual offices, including compensating producing and non-producing staff. Firm operating expenses also include the expenses of NFPSI and of NFP Insurance Services, Inc. (“NFPISI”), another subsidiary that serves the Company’s acquired firms and through which the Company’s acquired firms and its affiliated third-party distributors access insurance and financial services products and manufacturers. The Company records share-based payments related to firm employees and firm activities to operating expenses as a component of cost of services.
24
Management fees.
The Company pays management fees to the principals of its firms and/or certain entities they own based on the financial performance of the firms they manage. The Company typically pays a portion of the management fees monthly in advance. Once the Company receives cumulative preferred earnings (base earnings) from a firm, the principals and/or certain entities the principals own will earn management fees equal to earnings above base earnings up to target earnings. An additional management fee is paid in respect of earnings in excess of target earnings based on the ratio of base earnings to target earnings. For example, if base earnings equal 40% of target earnings, the Company receives 40% of earnings in excess of target earnings and the principal and/or the entity receives 60%. A majority of NFP’s acquisitions have been completed
with a ratio of base earnings to target earnings of 50%. Management fees also include an accrual for certain performance-based incentive amounts payable under NFP’s ongoing incentive program. Incentive amounts are paid in a combination of cash and NFP’s common stock. In addition to the incentive award, the Company pays an additional cash incentive equal to 50% of the incentive award elected to be received in NFP’s stock. This election is made subsequent to the completion of the incentive period. For firms that began their incentive period prior to January 1, 2005, the principal could elect from 0% to 100% to be paid in NFP’s common stock. No accrual is made for these additional cash incentives until the related election is made. However, for firms beginning their incentive period on or after January 1, 2005 (with the exception of Highland Capital Holding Corporation firms), the principal is required to take a minimum of 30% (maximum 50%) of the incentive award in
common stock. The Company accrues on a current basis for these firms the additional cash incentive (50% of the stock portion of the award) based upon the principal’s election or the minimum percentage required to be received in company stock. Management fees are reduced by amounts paid by the principals and/or certain entities they own under the terms of the management agreement for capital expenditures, including sub-acquisitions, in excess of $50,000. These amounts may be paid in full or over a mutually agreeable period of time and are recorded as a “deferred reduction in management fees.” Amounts recorded in deferred reduction in management fees are amortized as a reduction in management fee expense generally over the useful life of the asset. The ratio of management fees to gross margin before management fees is dependent on the percentage of total earnings of the Company’s firms capitalized by the Company, the performance of the Company’s firms relative
to base earnings and target earnings, the growth of earnings of the Company’s firms in the periods after their first three years following acquisition and the earnings of NFPISI, NFPSI, and earnings of a small number of firms without a principal, for which no management fees are paid. Due to the Company’s cumulative preferred position, if a firm produces earnings below target earnings in a given year, the Company’s share of the firm’s total earnings would be higher for that year. If a firm produces earnings at or above target earnings, the Company’s share of the firm’s total earnings would be equal to the percentage of the earnings capitalized by the Company in the initial transaction, less any percentage due to additional management fees earned under ongoing incentive plans. The Company records share-based payments related to principals as management fees which are included as a component of cost of services.
The following table summarizes the results of operations of the Company’s firms for the periods presented and shows management fees as a percentage of gross margin before management fees:
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
311,191
|
|
$
|
267,078
|
|
$
|
838,410
|
|
$
|
767,644
|
|
|
Cost of services:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
|
101,666
|
|
|
84,976
|
|
|
271,443
|
|
|
250,752
|
|
|
Operating expenses (1)
|
|
|
92,794
|
|
|
76,071
|
|
|
266,692
|
|
|
226,030
|
|
|
Gross margin before management fees
|
|
|
116,731
|
|
|
106,031
|
|
|
300,275
|
|
|
290,862
|
|
|
Management fees (2)
|
|
|
59,551
|
|
|
53,843
|
|
|
143,904
|
|
|
150,185
|
|
|
Gross margin
|
|
$
|
57,180
|
|
$
|
52,188
|
|
$
|
156,371
|
|
$
|
140,677
|
|
|
Gross margin as percentage of total revenue
|
|
|
18.4
|
%
|
|
19.5
|
%
|
|
18.7
|
%
|
|
18.3
|
%
|
|
Gross margin before management fees as a percentage of total revenue
|
|
|
37.5
|
%
|
|
39.7
|
%
|
|
35.8
|
%
|
|
37.9
|
%
|
|
Management fees, as a percentage of gross margin before management fees
|
|
|
51.0
|
%
|
|
50.8
|
%
|
|
47.9
|
%
|
|
51.6
|
%
|
______________
|
|
(1)
|
Excludes amortization and depreciation which are shown separately under Corporate and other expenses.
|
|
|
(2)
|
Excludes management agreement buyout which is shown separately under Corporate and other expenses.
|
25
Corporate and other expenses
General and administrative.
At the corporate level, the Company incurs general and administrative expense related to the acquisition of and administration of its firms. General and administrative expense includes both cash and stock-based compensation, occupancy, professional fees, travel and entertainment, technology, telecommunication, advertising and marketing, legal and certain corporate compliance costs.
Amortization.
The Company incurs amortization expense related to the amortization of certain identifiable intangible assets.
Depreciation.
The Company incurs depreciation expense related to capital assets, such as investments in technology, office furniture and equipment, as well as amortization for its leasehold improvements. Depreciation expense related to the Company’s firms as well as NFP’s corporate office is recorded within this line item.
Impairment of goodwill and intangible assets.
The firms the Company acquires may not continue to perform positively after the acquisition for various reasons, including legislative or regulatory changes that affect the products in which a firm specializes, the loss of key clients after the acquisition closed, general economic factors that impact a firm in a direct way, the cultural incompatibility of an acquired firm’s management team with the Company and the death or disability of significant principals. In such situations, the Company may take impairment charges in accordance with SFAS 142 and SFAS 144 and reduce the carrying cost of acquired identifiable intangible assets (including book of business, management contract, institutional customer relationships and trade name) and goodwill to their respective fair values. Management reviews and
evaluates the financial and operating results of the Company’s acquired firms on a firm-by-firm basis throughout the year to assess the recoverability of goodwill and other intangible assets associated with these firms. In assessing the recoverability of goodwill and other intangible assets, management uses historical trends and makes projections regarding the estimated future cash flows and other factors to determine the recoverability of the respective assets. If a firm’s goodwill and other intangible assets do not meet the recoverability test, the firm’s carrying value will be compared to its estimated fair value. The estimated fair value is based upon the amount at which the acquired firm could be bought or sold in a current transaction between the Company and the principals and/or the present value of the assets’ future cash flows. The intangible assets associated with a particular firm may be impaired when the firm has experienced a significant deterioration
in its business indicated by an inability to produce at the level of base earnings for a period of more than four consecutive quarters and when the firm does not appear likely to improve its operating results or cash flows in the foreseeable future. Management believes that this is an appropriate time period to evaluate firm performance given the seasonal nature of many firms’ activities.
Management agreement buyout.
From time to time, NFP may seek to acquire an additional economic interest in one of its existing firms through the acquisition of a principals’ ownership interest in a management company which has been contracted by NFP to manage and operate one of its wholly-owned subsidiaries. The acquisition of this ownership interest will be treated for accounting purposes as the settlement of an executory contract in a business combination between parties with a preexisting relationship and expensed as part of corporate and other expenses.
(Gain) loss on sale of subsidiaries.
From time to time, NFP has disposed of acquired firms or certain assets of acquired firms. In these dispositions, NFP may realize a gain or loss on the sale of the acquired firms or certain assets of acquired firms.
26
Effect of New Accounting Pronouncements.
In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) which clarified the accounting for uncertain tax positions by prescribing a minimum recognition threshold that a tax position is required to meet before being recognized in the financial statements. The Company adopted FIN 48 on January 1, 2007. As a result of adoption, the Company recognized a charge of $7.4 million to the January 1, 2007 retained earnings balance. As of the adoption date, the Company had unrecognized tax benefits of $16.3 million of which $9.8 million, if recognized, would affect the effective tax rate. Also, as of the adoption date, the Company had accrued interest and penalties relating to the unrecognized tax benefits of $2.4 million and $0.8 million, respectively. The Company
recognizes accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense. During the nine months ended September 30, 2007, the Company’s liability for unrecognized tax benefits increased by $2.5 million. Estimated interest and penalties related to the underpayment of income taxes totaled $0.3 million and $0.9 million in the three and nine months ended September 30, 2007, respectively.
As of September 30, 2007, the Company is subject to U.S. federal income tax examinations for the tax years 2004 through 2006, and to various state and local income tax examinations for the tax years 2001 through 2006.
The Company believes that it is reasonably possible that the total amounts of unrecognized tax benefits could significantly decrease within the next twelve months due to the settlement of state income tax audits and expiration of statutes of limitations in various state and local jurisdictions, however, quantification of an estimated range cannot be made at this time.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The Company will adopt SFAS 157 on January 1, 2008. Management is currently evaluating the effect, if any, of SFAS 157 on the Company’s consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” (“SFAS 159”), which is effective for fiscal years beginning after November 15, 2007. This statement permits an entity to choose to measure many financial instruments and certain other items at fair value at specified election dates. Subsequent unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. Management is currently evaluating the effect, if any, of SFAS 159 on the Company’s consolidated financial statements.
27
Results of Operations
NFP’s management monitors acquired firm revenue, commissions and fees expense and operating expense from new acquisitions as compared with existing firms. For this purpose, a firm is considered to be a new acquisition for the twelve months following the acquisition. After the first twelve months, a firm is considered to be an existing firm. Within any reported period, a firm may be considered to be a new acquisition for part of the period and an existing firm for the remainder of the period. Additionally, NFPSI and NFPISI are considered to be existing firms. A sub-acquisition involves the acquisition by one of NFP's firms of a business that is too small to qualify for a direct acquisition by NFP or where the individual running the business wishes to exit immediately or soon after the acquisition, prefers to partner with an existing principal or does not wish to be a principal. The
acquisition multiple paid for sub-acquisitions is typically lower than the multiple paid for a direct acquisition by NFP. Sub-acquisitions that do not separately report their results are considered to be part of the firm making the acquisition. The results of firms disposed of are also included in the calculations. The results of operations discussion set forth below include analysis of the relevant line items on this basis.
Three months ended September 30, 2007 compared with the three months ended September 30, 2006
The following table provides a comparison of the Company’s revenue and expenses for the periods presented:
|
|
|
For the Three Months Ended
September 30,
|
|
|
|
|
2007
|
|
2006
|
|
$
Change
|
|
%
Change
|
|
|
|
|
(in millions)
|
|
|
Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
311.2
|
|
$
|
267.1
|
|
$
|
44.1
|
|
16.5
|
%
|
|
Cost of services:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
|
101.7
|
|
|
85.0
|
|
|
16.7
|
|
19.6
|
|
|
Operating expenses (1)
|
|
|
92.8
|
|
|
76.1
|
|
|
16.7
|
|
21.9
|
|
|
Management fees
|
|
|
59.5
|
|
|
53.8
|
|
|
5.7
|
|
10.6
|
|
|
Total cost of services
|
|
|
254.0
|
|
|
214.9
|
|
|
39.1
|
|
18.2
|
|
|
Gross margin
|
|
|
57.2
|
|
|
52.2
|
|
|
5.0
|
|
9.6
|
|
|
Corporate and other expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative
|
|
|
14.3
|
|
|
13.2
|
|
|
1.1
|
|
8.3
|
|
|
Amortization
|
|
|
8.6
|
|
|
7.1
|
|
|
1.5
|
|
21.1
|
|
|
Depreciation
|
|
|
2.8
|
|
|
2.3
|
|
|
0.5
|
|
21.7
|
|
|
Impairment of goodwill and intangible assets
|
|
|
2.6
|
|
|
0.8
|
|
|
1.8
|
|
225.0
|
|
|
(Gain) loss on sale of subsidiaries
|
|
|
—
|
|
|
(0.2
|
)
|
|
0.2
|
|
NM
|
|
|
Total corporate and other expenses
|
|
|
28.3
|
|
|
23.2
|
|
|
5.1
|
|
22.0
|
|
|
Income from operations
|
|
|
28.9
|
|
|
29.0
|
|
|
(0.1
|
)
|
(0.3
|
)
|
|
Interest and other income
|
|
|
2.2
|
|
|
2.4
|
|
|
(0.2
|
)
|
(8.3
|
)
|
|
Interest and other expense
|
|
|
(2.6
|
)
|
|
(2.4
|
)
|
|
(0.2
|
)
|
8.3
|
|
|
Net interest and other
|
|
|
(0.4
|
)
|
|
—
|
|
|
(0.4
|
)
|
NM
|
|
|
Income before income taxes
|
|
|
28.5
|
|
|
29.0
|
|
|
(0.5
|
)
|
(1.7
|
)
|
|
Income tax expense
|
|
|
12.4
|
|
|
12.5
|
|
|
(0.1
|
)
|
(0.8
|
)
|
|
Net income
|
|
$
|
16.1
|
|
$
|
16.5
|
|
$
|
(0.4
|
)
|
(2.4
|
)%
|
______________
NM indicates percentage is not meaningful
|
|
(1)
|
Excludes amortization and depreciation which are shown separately under Corporate and other expenses.
|
28
Summary
Net income.
Net income decreased $0.4 million, or 2.4%, to $16.1 million in the three months ended September 30, 2007 compared with $16.5 million in the same period last year. The decrease in net income was largely due to an increase in firm operating expenses and impairments which were partially offset by an increase in revenue. Net income as a percentage of revenue was 5.2% for the three months ended September 30, 2007, down from 6.2% for the three months ended September 30, 2006 as the increase in expenses outpaced revenue growth.
Revenue
Commissions and fees.
Commissions and fees increased $44.1 million, or 16.5%, to $311.2 million in the three months ended September 30, 2007 compared with $267.1 million in the same period last year. New acquisitions contributed revenue of $24.2 million and existing firms added revenue of $31.1 million during the three months ended September 30, 2007. Improving market conditions and increases in carrier capacity were key drivers in the growth of sales of insurance products and services while investment advisors benefited from upward trends in the financial markets. Offsetting these revenue gains were revenue declines due to the disposition of firms which had revenues of $11.2 million in the third quarter of 2006.
Cost of services
Commissions and fees.
Commissions and fees expense increased $16.7 million, or 19.6%, to $101.7 million in the three months ended September 30, 2007 compared with $85.0 million in the same period last year. New acquisitions accounted for an increase of $5.5 million in commissions and fees expense which was augmented by an increase of $11.2 million at the Company’s existing firms. As a percentage of revenue, commissions and fees expense increased to 32.7% in the three months ended September 30, 2007 from 31.9% in the same period last year. As a percentage of revenue, commission expense rose, reflecting a higher percentage of producer revenue generated from brokerage firms, including settlements brokerages, and NFPSI, which generally have higher payouts than retail firms.
Operating expenses.
Operating expenses increased $16.7 million, or 21.9%, to $92.8 million in the three months ended September 30, 2007 compared with $76.1 million in the same period last year largely due to an increase in personnel related costs and promotional expenses incurred as firms pursued new marketing strategies and product offerings. Approximately $9.9 million of the increase was due to the operating expenses of new acquisitions, and approximately $6.8 million was a result of increased operating expenses at the Company’s existing firms. Operating expenses at existing firms increased 9.0% for the three months ended September 30, 2007 when compared to the same period in the prior year. As a percentage of revenue, operating expenses increased to 29.8% in the three months ended September 30, 2007 from 28.5% in the same period last year. The
increase in operating expenses largely reflects both the increase in key leadership, sales, marketing and support positions at NFPISI and strategic steps taken at a firm recently acquired from a larger institution. Subsequent to the acquisition a new management team was put in place and certain changes in its organizational structure were implemented to ensure its long-term success as a stand alone administration platform within NFP. In addition, a larger number of benefit firms among new acquisitions, which typically have higher operating costs as a percentage of revenue than existing firms, are also contributing to the increase in operating expenses. Stock-based compensation to firm employees and for firm activities included in operating expenses as a component of cost of services in the third quarter of 2007 was $1.0 million versus $0.7 million in the 2006 quarter.
29
Management fees.
Management fees increased $5.7 million, or 10.6%, to $59.5 million in the three months ended September 30, 2007 compared with $53.8 million in the three months ended September 30, 2006. Management fees were 51.0% of gross margin before management fees in the three months ended September 30, 2007 compared with 50.8% in the same period last year. Management fees included an accrual of $5.9 million for ongoing incentive plans in the three months ended September 30, 2007 compared with $1.6 million in the 2006 quarter. Incentive accruals will vary from period to period based on the mix of firms participating in the program and the volatility of their earnings. Excluding incentive payment accruals, management fees as a percentage of gross margin before management fees decreased in the third quarter of 2007 from the prior year period. In
addition, management fees included $0.3 million of stock-based compensation expense in the three months ended September 30, 2007 compared with $0.1 million in the three months ended September 30, 2006. Management fees as a percentage of revenue decreased to 19.1% in the three months ended September 30, 2007 from 20.1% in the same period last year.
Gross margin.
Gross margin increased $5.0 million, or 9.6%, to $57.2 million in the three months ended September 30, 2007 compared with $52.2 million in the same period last year. Gross margin as a percentage of revenue decreased to 18.4% in the three months ended September 30, 2007 from 19.5% in the same period last year. The increase in revenue was more than offset by the increase in commissions and fees expense, operating expenses as a percentage of revenue and the increase in management fees.
Corporate and other expenses
General and administrative.
General and administrative expense increased $1.1 million, or 8.3%, to $14.3 million in the three months ended September 30, 2007 compared with $13.2 million in the same period last year. Stock-based compensation to employees increased $0.4 million to $1.8 million in the 2007 quarter from $1.4 million in the third quarter of 2006. The increase in general and administrative expense consisted of increases of $0.1 million in personnel and personnel related costs, $0.4 million in stock-based compensation and $0.6 million among a wide distribution of other expenses. As a percentage of revenue, general and administrative expense decreased to 4.6% in the three months ended September 30, 2007 compared with 4.9% in the same period last year. The decline as a percentage of revenue reflected the largely fixed nature of these costs which
grew at a slower pace than revenues.
Amortization.
Amortization increased $1.5 million, or 21.1%, to $8.6 million in the three months ended September 30, 2007 compared with $7.1 million in the same period last year. Amortization expense increased due to an 18.4% increase in amortizing intangible assets resulting primarily from new acquisitions. As a percentage of revenue, amortization was 2.8% in the three months ended September 30, 2007 compared with 2.7% in the three months ended September 30, 2006.
Depreciation.
Depreciation expense increased $0.5 million, or 21.7%, to $2.8 million in the three months ended September 30, 2007 compared with $2.3 million in the same period last year. The increase in depreciation resulted from an increase in the number of owned firms and capital expenditures at the Company’s existing firms and at the corporate office.
30
Impairment of goodwill and intangible assets.
Impairment of goodwill and intangible assets increased $1.8 million to $2.6 million in the third quarter of 2007 compared with $0.8 million in the prior year period. The impairment related to two firms in the 2007 quarter and one firm in the 2006 quarter. As a percentage of revenue, impairment of goodwill and intangibles was 0.8% for the three months ended September 30, 2007 and 0.3% for the three months ended September 30, 2006.
(Gain) loss on sale of subsidiaries.
During the third quarter of 2007, the Company did not have any disposition activity. During the third quarter ended September 30, 2006, the Company recognized a gain from the contingent consideration received related to the sale of a subsidiary in 2005.
Interest and other income.
Interest and other income decreased $0.2 million, or 8.3% to $2.2 million in the three months ended September 30, 2007 compared with $2.4 million in the three months ended September 30, 2006, resulting from lower average investable cash balances and the lower interest rate environment during the period ended September 30, 2007.
Interest and other expense.
Interest and other expense increased $0.2 million, or 8.3%, to $2.6 million in the three months ended September 30, 2007 compared with $2.4 million in the same period last year. Interest and other expense increased $0.8 million during the third quarter of 2007 from interest and the amortization of debt issuance costs related to the issuance of $230 million in convertible senior notes in January 2007, which were largely offset by the reduction in interest expenses due to lower average outstanding balances under the Company’s line of credit.
Income tax expense
Income tax expense.
Income tax expense decreased $0.1 million, or 0.8%, to $12.4 million in the three months ended September 30, 2007 compared with $12.5 million in the same period last year. The estimated effective tax rate in the third quarter of 2007 was 42.4%, which increases to 43.5% with the inclusion of interest and penalties totaling $0.3 million accrued in accordance with FIN 48. This compares with an estimated effective tax rate of 43.1% in the third quarter of 2006 and 43.2% for the full year 2006. The estimated effective tax rate may be affected by future impairments, restructurings, state tax changes and other factors which are recognized as discrete items in the quarters in which they arise and, as a result, may impact income tax expense both in terms of absolute dollars and as a percentage of income before income taxes.
31
Nine months ended September 30, 2007 compared with the nine months ended September 30, 2006
The following table provides a comparison of the Company’s revenue and expenses for the periods presented:
|
|
|
For the Nine Months Ended
September 30,
|
|
|
|
|
2007
|
|
2006
|
|
$ Change
|
|
% Change
|
|
|
|
|
(in millions)
|
|
|
Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
838.4
|
|
$
|
767.6
|
|
$
|
70.8
|
|
9.2
|
%
|
|
Cost of services:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
|
271.4
|
|
|
250.7
|
|
|
20.7
|
|
8.3
|
|
|
Operating expenses (1)
|
|
|
266.7
|
|
|
226.0
|
|
|
40.7
|
|
18.0
|
|
|
Management fees (2)
|
|
|
143.9
|
|
|
150.2
|
|
|
(6.3
|
)
|
(4.2
|
)
|
|
Total cost of services
|
|
|
682.0
|
|
|
626.9
|
|
|
55.1
|
|
8.8
|
|
|
Gross margin
|
|
|
156.4
|
|
|
140.7
|
|
|
15.7
|
|
11.2
|
|
|
Corporate and other expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative
|
|
|
43.9
|
|
|
38.7
|
|
|
5.2
|
|
13.4
|
|
|
Amortization
|
|
|
25.0
|
|
|
20.6
|
|
|
4.4
|
|
21.4
|
|
|
Depreciation
|
|
|
7.9
|
|
|
6.7
|
|
|
1.2
|
|
17.9
|
|
|
Impairment of goodwill and intangible assets
|
|
|
5.7
|
|
|
6.2
|
|
|
(0.5
|
)
|
(8.1
|
)
|
|
Management agreement buyout
|
|
|
13.0
|
|
|
—
|
|
|
13.0
|
|
100.0
|
|
|
(Gain) loss on sale of subsidiaries
|
|
|
(2.0
|
)
|
|
0.1
|
|
|
(2.1
|
)
|
NM
|
|
|
Total corporate and other expenses
|
|
|
93.5
|
|
|
72.3
|
|
|
21.2
|
|
29.3
|
|
|
Income from operations
|
|
|
62.9
|
|
|
68.4
|
|
|
(5.5
|
)
|
(8.0
|
)
|
|
Interest and other income
|
|
|
6.9
|
|
|
5.7
|
|
|
1.2
|
|
21.1
|
|
|
Interest and other expense
|
|
|
(7.3
|
)
|
|
(5.4
|
)
|
|
(1.9
|
)
|
35.2
|
|
|
Net interest and other
|
|
|
(0.4
|
)
|
|
0.3
|
|
|
(0.7
|
)
|
(233.3
|
)
|
|
Income before income taxes
|
|
|
62.5
|
|
|
68.7
|
|
|
(6.2
|
)
|
(9.0
|
)
|
|
Income tax expense
|
|
|
27.5
|
|
|
29.1
|
|
|
(1.6
|
)
|
(5.5
|
)
|
|
Net income
|
|
$
|
35.0
|
|
$
|
39.6
|
|
$
|
(4.6
|
)
|
(11.6
|
)%
|
______________
NM indicates percentage is not meaningful
|
|
(1)
|
Excludes amortization and depreciation which are shown separately under Corporate and other expenses.
|
|
|
(2)
|
Excludes management agreement buyout which is shown separately under Corporate and other expenses.
|
Summary
Net income.
Net income decreased $4.6 million, or 11.6%, to $35.0 million in the nine months ended September 30, 2007 compared with $39.6 million in the same period last year. The decrease in net income of $4.6 million resulted from a management agreement buyout in the second quarter of 2007 of $13.0 million ($7.7 million, net of tax benefit). Excluding the buyout, net income was $42.7 million, an increase of $3.1 million from the prior year period. The increase in net income, excluding the effect of the management agreement buyout, was largely the result of higher revenues and lower management fees offset by increases in commissions and fees expense, operating expenses, corporate and other expenses and the effective tax rate. Net income as a percentage of revenue was 4.2% for the nine months ended September 30, 2007, down from 5.2% for the nine months
ended September 30, 2006.
32
Revenue
Commissions and fees.
Commissions and fees increased $70.8 million, or 9.2%, to $838.4 million in the nine months ended September 30, 2007 compared with $767.6 million in the same period last year. New acquisitions contributed revenue of $63.1 million with existing firms contributing $25.7 million which was offset by an $18.0 million decline in revenue from firms disposed of subsequent to September 30, 2006. Revenue in the 2006 period benefited from strong sales of premium financed life insurance products in the senior market which declined subsequent to the first half of 2006 as carriers reassessed their underwriting policies as well as their appetite for certain financed life insurance products in the senior market. During 2007 carriers began to increase capacity in these markets, which has helped to increase revenues from insurance products and services.
Cost of services
Commissions and fees.
Commissions and fees expense increased $20.7 million, or 8.3%, to $271.4 million in the nine months ended September 30, 2007 compared with $250.7 million in the same period last year. New acquisitions accounted for an increase of $10.2 million in commissions and fees expense which was augmented by an increase of $10.5 million at the Company’s existing firms. As a percentage of revenue, commissions and fees expense decreased to 32.4% in the nine months ended September 30, 2007 from 32.7% in the same period last year. The change as a percentage of revenue was largely driven by an increase in the percentage of total revenue from brokerage firms, including settlements brokerages which generally have higher payouts than retail firms.
Operating expenses.
Operating expenses increased $40.7 million, or 18.0%, to $266.7 million in the nine months ended September 30, 2007 compared with $226.0 million in the same period last year largely due to an increase in personnel related costs and promotional expenses incurred as firms pursued new marketing strategies and product offerings. Approximately $23.4 million of the increase was due to the operating expenses of new acquisitions, and approximately $17.3 million was a result of increased operating expenses at the Company’s existing firms. As a percentage of revenue, operating expenses increased to 31.8% in the nine months ended September 30, 2007 from 29.4% in the same period last year. The increase in operating expenses as a percentage of revenue results from the growth in operating expenses, principally compensation related costs and
marketing and promotional costs at NFPISI, outpacing revenue growth. In addition, a larger number of benefit firms among new acquisitions which have higher operating costs as a percentage of revenue than existing firms are also contributing to the increase in operating expenses. Stock-based compensation to firm employees and for firm activities included in operating expenses as a component of cost of services in the nine months ended September 30, 2007 was $3.1 million versus $2.0 million in the nine months ended September 30, 2006.
Management fees.
Management fees decreased $6.3 million, or 4.2%, to $143.9 million in the nine months ended September 30, 2007 compared with $150.2 million in the nine months ended September 30, 2006. Management fees were 47.9% of gross margin before management fees in the nine months ended September 30, 2007 compared with 51.6% in the same period last year. This decrease as a percentage of gross margin before management fees was largely the result of the Company’s increased economic interest in its firms and the acceleration of a deferred reduction in management fees. The Company’s overall economic interest in its firms has increased to 50% in 2007 from 48% in the prior year due to recent larger acquisitions in which the Company is taking a greater economic interest and the disposal of a firm in which the Company had an atypically low economic
interest earlier this year. Management fees included an accrual of $11.5 million for ongoing incentive plans in the nine months ended September 30, 2007 compared with $10.5 million in the nine months ended September 30, 2006. Incentive accruals will vary from period to period based on the mix of firms participating in the program and the volatility of their earnings. During the second quarter of 2007, pursuant to the repayment of a note by a principal, approximately $1.8 million of future obligations of the principal previously being amortized as a deferred reduction in management fee expense was offset against management fee expense and the remaining obligation under a note receivable due from the principal was paid in full. In addition, management fees included $0.7 million of stock-based compensation expense in the nine months ended September 30, 2007 compared with $0.3 million in the nine months ended September 30, 2006. Management fees as a percentage of revenue decreased to
17.1% in the nine months ended September 30, 2007 from 19.6% in the same period last year.
33
Gross margin.
Gross margin increased $15.7 million, or 11.2%, to $156.4 million in the nine months ended September 30, 2007 compared with $140.7 million in the same period last year. Gross margin as a percentage of revenue increased to 18.7% in the nine months ended September 30, 2007 from 18.3% in the same period last year as the increase in revenue and the decrease in commissions and fees expense as a percentage of revenue and management fee expense more than offset the increase in operating expenses.
Corporate and other expenses
General and administrative.
General and administrative expense increased $5.2 million, or 13.4%, to $43.9 million in the nine months ended September 30, 2007 compared with $38.7 million in the same period last year. Stock-based compensation to employees totaled approximately $5.7 million and $4.3 million in the nine months ended September 30, 2007 and 2006, respectively. As a percentage of revenue, general and administrative expense increased to 5.2% in the nine months ended September 30, 2007 compared with 5.0% in the same period last year. The increase in general and administrative expense consisted of increases of $2.4 million in personnel and personnel related costs, $1.4 million in stock-based compensation, a $1.0 million reserve established for a note received as part of a prior year disposal, and an increase of $0.4 million in other expenses. The
increase was largely the result of growth in the corporate infrastructure, particularly in the areas of compliance, internal audit, accounting, technology and human resources to support organic growth, new acquisitions and meet increased regulatory needs.
Amortization.
Amortization increased $4.4 million, or 21.4%, to $25.0 million in the nine months ended September 30, 2007 compared with $20.6 million in the same period last year. Amortization expense increased due to a 18.7% increase in amortizing intangible assets resulting primarily from new acquisitions. As a percentage of revenue, amortization was 3.0% in the nine months ended September 30, 2007 compared with 2.7% in the nine months ended September 30, 2006.
Depreciation.
Depreciation expense increased $1.2 million, or 17.9%, to $7.9 million in the nine months ended September 30, 2007 compared with $6.7 million in the same period last year. The increase in depreciation resulted from an increase in the number of owned firms and capital expenditures at the Company’s existing firms and at the corporate office.
Impairment of goodwill and intangible assets.
Impairment of goodwill and intangible assets decreased $0.5 million, or 8.1%, to $5.7 million in the nine months ended September 30, 2007 compared with $6.2 million in the prior year period. The impairment related to three firms in the nine months ended September 30, 2007 and five firms in the nine month period ending September 30, 2006. As a percentage of revenue, impairment of goodwill and intangibles was 0.7% for the nine months ended September 30, 2007 and 0.8% for the nine months ended September 30, 2006.
Management agreement buyout.
Effective June 30, 2007, NFP acquired an additional economic interest in one of its existing firms through the acquisition of a principal’s ownership interest in a management company. The management company was contracted by NFP to manage and operate one of its wholly-owned subsidiaries. The acquisition of the ownership interest has been treated as a settlement of an executory contract in a business combination between parties in a preexisting relationship in accordance with EITF No. 04-1 “Accounting for Preexisting Relationships between the Parties to a Business Combination.” The Company paid cash, stock and other consideration totaling $13.0 million which has been reflected in the caption entitled “Management agreement buyout” in the Consolidated Statements of Income.
34
(Gain) loss on sale of subsidiaries.
The Company reported a gain on the sale of three subsidiaries and contingent consideration from the sale of assets in a previous year totaling $2.0 million in the nine months ended September 30, 2007 compared to a loss from the sale of five subsidiaries totaling $0.1 million in the nine months ended September 30, 2006.
Interest and other income.
Interest and other income increased $1.2 million, or 21.1%, to $6.9 million in the nine months ended September 30, 2007 compared with $5.7 million in the nine months ended September 30, 2006, resulting from higher interest earnings on average investable balances.
Interest and other expense.
Interest and other expense increased $1.9 million, or 35.2%, to $7.3 million in the nine months ended September 30, 2007 compared with $5.4 million in the same period last year. Interest and other expense increased $2.2 million during the nine months ended September 30, 2007 from interest and the amortization of debt issuance costs related to the issuance of $230 million in convertible senior notes in January 2007. This increase was partially offset by lower average outstanding balances in 2007 as compared to the prior year period.
Income tax expense
Income tax expense.
Income tax expense decreased $1.6 million, or 5.5%, to $27.5 million in the nine months ended September 30, 2007 compared with $29.1 million in the same period last year. The estimated effective tax rate for the nine months ended September 30, 2007 was 42.6%, which increases to 44.0% with the inclusion of interest and penalties totaling $0.9 million accrued in accordance with FIN 48, which became effective January 1, 2007. This compares with an estimated effective tax rate of 42.3% in the nine months ended September 30, 2006 and 43.2% for the full year 2006. The estimated effective tax rate may be affected by future impairments, restructurings, state tax changes and other factors which are recognized as discrete items in the quarters in which they arise and, as a result, may impact income tax expense both in terms of absolute dollars
and as a percentage of income before income taxes.
Liquidity and Capital Resources
A summary of the changes in cash flow data is provided as follows:
|
|
|
Nine Months Ended
September 30,
|
|
|
(in thousands)
|
|
2007
|
|
2006
|
|
|
Net cash flows provided by (used in):
|
|
|
|
|
|
|
|
|
Operating activities
|
|
$
|
44,573
|
|
$
|
43,606
|
|
|
Investing activities
|
|
|
(141,734
|
)
|
|
(99,449
|
)
|
|
Financing activities
|
|
|
87,629
|
|
|
65,228
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
(9,532
|
)
|
|
9,385
|
|
|
Cash and cash equivalents – beginning of period
|
|
|
98,206
|
|
|
105,761
|
|
|
Cash and cash equivalents – end of period
|
|
$
|
88,674
|
|
$
|
115,146
|
|
|
|
|
|
|
|
|
|
|
At September 30, 2007, the Company had cash and cash equivalents of $88.7 million, a decrease of $9.5 million from the balance of $98.2 million at December 31, 2006. The decrease in cash and cash equivalents during the nine months ended September 30, 2007 resulted primarily from cash paid for acquired firms, net of cash and contingent consideration, offset by the net proceeds received from the issuance of NFP’s convertible senior notes.
35
Operating activities
During the nine months ended September 30, 2007, cash provided by operating activities was $44.6 million, primarily due to net income plus non-cash charges of $73.4 million, a decrease in commissions, fees and premiums receivable, net, of $19.7 million, partially offset by a decrease in amounts due to principals and/or certain entities they own of $19.7 million, accounts payable of $14.7 million and income taxes payable of $11.5 million. During the nine months ended September 30, 2006, cash provided by operating activities was $43.6 million, primarily due to net income plus non-cash charges of $73.2 million, a decrease in commissions, fees and premiums receivable, net of $35.7 million, partially offset by a decrease in amounts due to principals and/or certain entities they own of $30.9 million, accrued liabilities of $17.8 million, and a decrease in income taxes payable of $8.7 million.
Investing activities
During the nine months ended September 30, 2007 and 2006, cash used in investing activities was $141.7 million and $99.4 million, respectively, in both cases for the acquisition of firms and property and equipment. During the nine months ended September 30, 2007 and 2006, the Company used $135.3 million and $95.4 million, respectively, for payments for acquired firms and contingent consideration. In each period, payments for acquired firms represented the largest use of cash in investing activities.
Financing activities
During the nine months ended September 30, 2007 and 2006, cash provided by financing activities was $87.6 million and $65.2 million, respectively. During the nine months ended September 30, 2007, NFP issued convertible senior notes resulting in proceeds to NFP, net of associated costs, of $222.4 million. NFP utilized $106.6 million to repurchase 2.3 million shares of its common stock from Apollo Investment Fund IV, L.P. and Apollo Overseas Partners IV, L.P. (collectively, “Apollo”) in a privately negotiated transaction. NFP also sold warrants for aggregate proceeds of $34.0 million and purchased a convertible note hedge for $55.9 million for a net cost to the Company of $21.9 million. The Company also received $9.2 million in cash proceeds payable to the Company from the exercise of principal and employee stock options. This $9.2 million included $4.7 million (including tax
benefit) from the exercise of 349,455 shares in connection with a secondary public offering in January 2007. Net repayments under the Company’s line of credit were $3.0 million during the nine months ended September 30, 2007. Cash dividends paid for the nine months ended September 30, 2007 were $20.6 million.
During the nine months ended September 30, 2006, cash provided by borrowing activities was $71.0 million. Cash provided by financing activities was primarily the result of net borrowings under NFP’s credit facility. The Company uses this credit facility primarily to finance acquisitions and fund general corporate purposes.
Some of the Company’s firms maintain premium trust accounts, which represent payments collected from insureds on behalf of carriers. Funds held in these accounts are invested in cash, cash equivalents and securities purchased under resale agreements (overnight). As of September 30, 2007, the Company had cash, cash equivalents and securities purchased under resale agreements in premium trust accounts of $63.4 million, an increase of $6.0 million from the balance as of December 31, 2006 of $57.4 million. Increases or decreases in these accounts relate to the volume and timing of payments from insureds and the timing of the Company’s remittances to carriers. These increases or decreases are largely offset by changes in premiums payable to insurance carriers.
36
Management believes that the Company’s existing cash, cash equivalents, funds generated from its operating activities and funds available under its credit facility will provide sufficient sources of liquidity to satisfy its financial needs for the next twelve months. However, if circumstances change, NFP may need to raise debt or additional capital in the future.
Borrowings
Credit Facility
On January 16, 2007, NFP entered into an amendment (the “Amendment”) to its $212.5 million credit facility, dated as of August 22, 2006, with various financial institutions party thereto and Bank of America, N.A., as administrative agent. The Amendment, among other things, modified certain covenants to which NFP was subject under the credit agreement and made other changes in contemplation of the issuance by NFP of the convertible senior notes due 2012 (discussed separately below). Under the Amendment, NFP can incur up to $250 million in aggregate principal amount outstanding in unsecured indebtedness and unsecured subordinated indebtedness subject to certain conditions; previously, NFP could incur $75 million of unsecured subordinated debt. The Amendment also provides that cumulative Restricted Payments (as defined in the Amendment), which include but are not limited to
dividends and share repurchases, may not exceed 50% of consolidated net income for the then completed fiscal quarters of the Company commencing with the fiscal quarter ending March 31, 2006 plus $150 million; previously, Restricted Payments could not exceed 50% of consolidated net income for the then completed fiscal quarters of the Company commencing with the fiscal quarter ending March 31, 2006 plus $125 million. In addition, to induce the credit facility lenders to consent to the Amendment, NFP agreed to pay to the administrative agent for the ratable benefit of the credit facility lenders that signed the Amendment an amendment fee equal to 0.05% of the commitments of such lenders. The $212.5 million credit facility replaced NFP’s previous $175 million credit facility and is used primarily to finance acquisitions and fund general corporate purposes.
On May 29, 2007, a new lender was added pursuant to a Lender Joinder Agreement, which increased the $212.5 million credit facility to $225 million.
Borrowings under the credit facility bear interest, at NFP’s election, at a rate per annum equal to: (i) at any time when the Company’s Consolidated Leverage Ratio, as defined in the credit facility, is greater than or equal to 2.0 to 1.0, the ABR plus 0.25% per annum or the Eurodollar Rate plus 1.25%, (ii) at any time when the Company’s Consolidated Leverage Ratio is less than 2.0 to 1.0 but greater than or equal to 1.0 to 1.0, the ABR or the Eurodollar Rate plus 1.00% and (iii) at any time when the Company’s Consolidated Leverage Ratio is less than 1.0 to 1.0, the ABR or the Eurodollar Rate plus 0.75%. As used in the credit facility, “ABR” means, for any day, the greater of (i) the federal funds rate in effect on such day plus 0.5% and (ii) the rate of interest in effect as publicly announced by Bank of America as its prime rate.
The credit facility is structured as a revolving credit facility and matures on August 22, 2011. NFP’s obligations under the credit facility are secured by all of its and its subsidiaries’ assets. Up to $35 million of the credit facility is available for the issuance of letters of credit and there is a $10 million sublimit for swingline loans. The credit facility contains various customary restrictive covenants that prohibit the Company from, subject to various exceptions and among other things: (i) incurring additional indebtedness or guarantees, (ii) creating liens or other encumbrances on property or granting negative pledges, (iii) entering into a merger or similar transaction, (iv) selling or transferring certain property, (v) declaring dividends or making other restricted payments and (vi) making investments. In addition, the credit facility contains financial covenants
requiring the Company to maintain a minimum interest coverage ratio and a maximum consolidated leverage ratio. As of September 30, 2007, the Company was in compliance with all covenants under the facility.
37
NFP’s prior credit facility was structured as a revolving credit facility and was due on June 15, 2008 unless NFP elected to convert the credit facility to a term loan, at which time it would have amortized over one year, with a principal payment due on December 15, 2008 and a final maturity of June 15, 2009.
As of September 30, 2007, the combined year-to-date weighted average interest rate for NFP’s credit facility was 6.33%. The weighted average of its previous credit facility in the prior year period was 6.71%
NFP had outstanding borrowings of $80.0 million under the credit facility at September 30, 2007 and $111.0 million of outstanding borrowings at September 30, 2006. At December 31, 2006, outstanding borrowings were $83.0 million. NFP has historically drawn upon its credit facilities primarily to fund its acquisitions which tend to occur more frequently earlier in the year and reduce borrowings during the latter part of the year.
Convertible Senior Notes
In January 2007, NFP issued $230 million (including over-allotment) aggregate principal amount of 0.75% convertible senior notes due February 1, 2012 (the “notes”). The notes are senior unsecured obligations and rank equally with NFP’s existing or future senior debt and senior to any subordinated debt. The notes will be structurally subordinated to all existing or future liabilities of NFP’s subsidiaries and will be effectively subordinated to existing or future secured indebtedness to the extent of the value of the collateral. The notes were used to pay the net cost of the convertible note hedge and warrant transactions, repurchase 2.3 million shares of NFP’s common stock from Apollo and to repay a portion of outstanding amounts of principal and interest under NFP’s credit facility (all as discussed herein).
Holders may convert their notes at their option on any day prior to the close of business on the scheduled trading day immediately preceding December 1, 2011 only under the following circumstances: (1) during the five business-day period after any five consecutive trading-day period (the “measurement period”) in which the price per note for each day of that measurement period was less than 98% of the product of the last reported sale price of NFP’s common stock and the conversion rate on each such day; (2) during any calendar quarter (and only during such quarter) after the calendar quarter ending March 31, 2007, if the last reported sale price of NFP’s common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 130% of the applicable
conversion price in effect on the last trading day of the immediately preceding calendar quarter; or (3) upon the occurrence of specified corporate events. The notes will be convertible, regardless of the foregoing circumstances, at any time from, and including, December 1, 2011 through the second scheduled trading day immediately preceding the maturity date.
Upon conversion, NFP will pay, at its election, cash or a combination of cash and common stock based on a daily conversion value calculated on a proportionate basis for each trading day of the relevant 20 trading day observation period. The initial conversion rate for the notes was 17.9791 shares of common stock per $1,000 principal amount of notes, equivalent to a conversion price of approximately $55.62 per share of common stock. The conversion price will be subject to adjustment in some events but will not be adjusted for accrued interest. In addition, if a “fundamental change” (as defined in the First Supplemental Indenture governing the notes) occurs prior to the maturity date, NFP will, in some cases and subject to certain limitations, increase the conversion rate for a holder that elects to convert its notes in connection with such fundamental change.
Concurrent with the issuance of the notes, NFP entered into a convertible note hedge and warrant transactions with an affiliate of one of the underwriters for the notes. The transactions are expected to reduce the potential dilution to NFP’s common stock upon future conversions of the notes. Under the convertible note hedge NFP purchased 230,000 call options for an aggregate premium of $55.9 million. Each call option entitles NFP to repurchase an equivalent number of shares issued upon conversion of the notes at the same strike price ($55.62 per share), generally subject to the same adjustments. The call options expire on the maturity date of the notes. NFP sold warrants for an aggregate premium of $34.0 million. The warrants expire ratably over a period of 40 scheduled trading days between May 1, 2012 and June 26, 2012, on which dates, if not previously exercised, the
warrants will be treated as automatically exercised if they are in the money. The warrants provide for net-share settlement. The net cost of the convertible note hedge and warrants to the Company is $21.9 million. Debt issuance costs associated with the notes of approximately $7.6 million are recorded in other current and non-current assets and will be amortized over the term of the notes.
38
In accordance with Emerging Issues Task Force (“EITF”) Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” the Company recorded the cost incurred in connection with the convertible note hedge, including the related tax benefit, and the proceeds from the sale of the warrants as adjustments to additional paid-in capital and will not recognize subsequent changes in fair value.
The Company received proceeds from the issuance of the notes, net of underwriting fees and the cost of the convertible note hedge and warrant transactions, of approximately $201.2 million of which $106.6 million was used to repurchase 2.3 million shares of NFP’s common stock from Apollo in a privately negotiated transaction and $94.6 million was used to pay down balances outstanding under NFP’s credit facility. Apollo received the same proceeds per share, net of underwriting discounts, for the shares it sold pursuant to the repurchase and in the secondary offering, on an aggregate basis, as the other selling stockholders received for the shares they sold in the offering.
Contractual Obligations
In January 2007, NFP issued $230 million (including over-allotment) aggregate principal amount of 0.75% convertible senior notes due February 1, 2012. The notes are senior unsecured obligations and rank equally with NFP’s existing or future senior debt and senior to any subordinated debt. See “– Liquidity and Capital Resources – Borrowings – Convertible Senior Notes” for more information. In September 2007, NFP entered into a new lease for its new corporate headquarters. In August 2007, NFP also entered into a sublease agreement for its existing office space. Other than the issuance of notes and new lease and sublease agreements, there have been no other material changes outside the ordinary course of the Company’s business to the Company’s total contractual cash obligations which are set forth in the table included in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2006 filed with the SEC on February 22, 2007.
The table below shows NFP’s contractual obligations as of September 30, 2007:
|
|
|
Payment due by period
|
|
|
|
|
Total
|
|
Less
than 1
year
|
|
1-3
years
|
|
3-5
years
|
|
More
than
5 years
|
|
|
|
|
(in thousands)
|
|
|
Convertible senior notes
|
|
$
|
237,475
|
|
$
|
1,725
|
|
$
|
5,175
|
|
$
|
230,575
|
|
$
|
—
|
|
|
Operating lease obligations
|
|
|
227,217
|
|
|
21,095
|
|
|
59,743
|
|
|
45,201
|
|
|
101,178
|
|
|
Total contractual obligations
|
|
$
|
464,692
|
|
$
|
22,820
|
|
$
|
64,918
|
|
$
|
275,776
|
|
$
|
101,178
|
|
Dividends
NFP paid a quarterly cash dividend of $0.18 per share of common stock on October 9, 2007. The declaration and payment of future dividends to holders of NFP’s common stock will be at the discretion of NFP’s board of directors and will depend upon many factors, including the Company’s financial condition, earnings, legal requirements, covenants under NFP’s credit facility and other factors which NFP’s board of directors may consider relevant. Based on the most recent quarterly dividend declared of $0.18 per share of common stock and the number of shares held by stockholders of record on September 17, 2007, the total annual cash requirement for dividend payments would be approximately $27.7 million.
Off-Balance Sheet Arrangements
The Company had no material off-balance sheet arrangements during the nine months ended September 30, 2007.
39