The Company leases office space to support its reportable segments. NFP’s corporate headquarters is located at 340 Madison Avenue, New York, New York, where NFP leases three floors. In November 2009, NFP subleased one floor to a third party. NFP and certain of its businesses occupy the remaining two floors. NFPISI and NFPSI occupy office space at 1250 Capital of Texas Highway South, Austin, Texas, where NFPISI leases six floors. NFPISI has subleased a portion of this space to various third parties. Additionally, the Company’s businesses lease properties for use as offices throughout the United States.
You should read the selected consolidated financial data set forth below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the Consolidated Financial Statements and the related notes contained in this report. The Company derived the following selected financial information (excluding Other Data) as of December 31, 2010 and 2009 and for each of the three years in the period ended December 31, 2010 from the Company’s audited Consolidated Financial Statements and the related notes contained in this report. The Company derived the selected financial information (excluding Other Data) as of December 31, 2008, 2007, and 2006 from the Company’s audited Consolidated Financial Statements and the related notes not contained in this report.
NFP and its benefits, insurance and wealth management businesses provide a full range of advisory and brokerage services to the Company’s clients. NFP serves corporate and high net worth individual clients throughout the United States and in Canada, with a focus on the middle market and entrepreneurs. As of December 31, 2010, the Company operated over 140 businesses.
In addition to its evaluation of its reportable segments’ performance, the Company also evaluates the profit it shares with the principals on a reportable segment basis. In order to monitor this it uses the following non-GAAP measures: income before management fees, adjusted income before management fees and management fees as a percentage of adjusted income before management fees. For a reconciliation of these non-GAAP measures to their GAAP counterparts, see “-Operating expenses-Management fees.”
During the year ended December 31, 2010, revenue increased $33.6 million, or 3.5%, to $981.9 million from $948.3 million during the year ended December 31, 2009. The revenue increase was driven by revenue increases within the ASG and CCG of $44.2 million and $7.9 million, respectively, and offset by a revenue decrease of $18.5 million within the ICG. During the year ended December 31, 2010, ICG revenue was negatively impacted by dispositions and changing product offerings at carriers and uncertainty around estate tax exemption levels that were only resolved in December 2010. Existing firms within all segments contributed to an overall revenue increase of $72.8 million, offset by a $39.2 million decline in revenue from disposed firms.
Income (loss) from operations increased $627.6 million or 111.7% to $65.7 million for the year ended December 31, 2010 from a loss from operations of $(561.8) million for the year ended December 31, 2009. The Company’s income from operations increased substantially primarily due to the decline in impairments from $618.5 million in 2009 to $2.9 million in 2010. The decline in impairments was driven by the significant impairment taken during the three months ended March 31, 2009. Income before management fees increased $8.9 million or 3.5% to $265.4 million for the year ended December 31, 2010 from $256.5 million for the year ended December 31, 2009. The Company’s income before management fees improved primarily due to increases in revenue within the CCG and ASG, offset by decreases in revenue at the ICG. Commission expense increased slightly in the CCG and ICG, with commission expense of $37.1 million and $89.4 million, respectively, for the year ended December 31, 2010. This is compared with commission expense of $34.4 million and $84.3 million, respectively for the year ended December 31, 2009. The increase in commission payouts at the ASG was commensurate with the increase in revenue. In addition, compensation expense decreased in each of the three segments and non-compensation expense decreased within the CCG and ICG, primarily due to a $9.0 million loss and related expenses recognized on the sublet of one of the floors of the Company’s New York corporate headquarters in the fourth quarter of 2009. This expense was allocated among the segments.
As of December 31, 2010 the ratio of base earnings to target earnings by segment was 60.7% for the CCG and 47.2% for the ICG. Since the ASG is primarily comprised of NFPSI, NFP’s registered broker-dealer and investment advisor, no management fees are paid and no earnings are shared with principals. Management fees increased primarily as a result of the accelerated vesting of certain RSUs. Excluding the impact of this one-time vesting, management fees increased slightly, due to increases in management fees within the CCG, offset by decreases in management fees within the ICG. The increase in management fees within the CCG is attributable to the year-over-year increase in stock-based compensation, related to the Long-Term Equity Incentive Plan (the “EIP”). The EIP was in place in November 2009, and was terminated in September 2010. The decrease in management fees within the ICG is attributable to increases related to restructuring of certain management agreements and the year-over-year increase in stock-based compensation, offset by decreases in the Annual Principal Incentive Plan (“PIP”) expense.
During the year ended December 31, 2009, revenue decreased $202.1 million, or 17.6%, to $948.3 million from $1,150.4 million during the year ended December 31, 2008. The revenue decrease was driven by revenue decreases within all three business segments. ICG revenue was negatively impacted by the broader economic environment and uncertainty regarding the financial stability of insurance carriers in the first months of 2009. The Company also experienced declines in the CCG, as some clients reduced benefits offered to employees due to cost-cutting measures and rising unemployment. ASG revenue decreased as fees for assets under management declined with declining market values during 2009 as compared to 2008. Acquired firms within the CCG and ICG contributed to an overall revenue increase of $6.2 million, offset by a $24.3 million decline in revenue from disposed firms.
Income (loss) from operations decreased $619.3 million to $(561.8) million for the year ended December 31, 2009 from $57.5 million for the year ended December 31, 2008. The Company’s income (loss) from operations decreased substantially primarily due to an increase in the level of impairments of goodwill and intangible assets from $41.3 million in 2008 to $618.5 million in 2009. Income before management fees decreased $58.0 million to $256.5 million for the year ended December 31, 2009 from $314.4 million for the year ended December 31, 2008. The decline in income before management fees was a result of lower revenue across all three segments. Compensation expense declined from $292.0 million in 2008 to $268.3 million in 2009. Dispositions accounted for $6.1 million of this decline. Compensation expense as a percentage of revenue increased from 25.4% for the year ended December 31, 2008 to 28.3% for the year ended December 31, 2009. Non-compensation expense declined from $181.4 million from the year ended December 31, 2008 to $159.5 million for the year ended December 31, 2009. The decline in non-compensation expense during 2009 was largely a result of cost reduction initiatives across the businesses, offset by a $9.0 million loss and related
Corporate Client Group. The CCG earns commissions on the sale of insurance policies and fees for the development, implementation and administration of corporate and executive benefits programs. In the corporate benefits business line, commissions and fees are generally paid each year as long as the client continues to use the product and maintains its broker of record relationship with the Company. Commissions are based on a percentage of insurance premium or are based on a fee per plan participant. In some cases, such as for the administration of retirement-focused products like 401(k) plans, fees earned are based on the amount of assets under administration or advisement. Generally, in the executive benefits business line, consulting fees are earned relative to the completion of specific client engagements, administration fees are earned throughout the year on policies, and commissions are earned as a calculated percentage of the premium in the year that the policy is originated and during subsequent renewal years, as applicable. The CCG also offers property and casualty insurance brokerage and consulting services for which it earns commissions and fees. NFP believes that these services complement the corporate and executive benefits services provided to the Company’s clients.
Advisor Services Group. The ASG earns fees for providing the platform for financial advisors to offer financial advice and execute financial planning strategies. These fees are based on a percentage of assets under management and are generally paid quarterly. The ASG may also earn fees for the development of a financial plan or annual fees for advising clients on asset allocation. The ASG also earns commissions related to the sale of securities and certain investment-related insurance products. Such commission income and related expenses are recorded on a trade date basis. Transaction-based fees,
Some of the Company’s businesses also earn additional compensation in the form of incentive and marketing support revenue from manufacturers of financial services products, based on the volume, consistency 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 historical data or other information exists which enables 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 businesses and sales by NFP’s third-party affiliates. The vast majority of the Company’s revenue is generated from its United States operations.
Although NFP’s operating history is limited, until 2009 the Company earned approximately 65% to 70% of its revenue in the first three quarters of the year and approximately 30% to 35% of its revenue in the fourth quarter. In 2010 and 2009, NFP earned 29% of its revenue in the fourth quarter. This change resulted primarily from a weaker sales environment for life insurance products in the ICG. Historically, life insurance sales had been concentrated in the fourth quarter as clients’ finalized their estate and tax planning decisions. Continued relative weakness in this market has meant a change in the revenue patterns for the business.
In the discussion that follows, NFP provides the following ratios with respect to its operating results: (i) commission expense ratio, (ii) compensation expense ratio and (iii) non-compensation expense ratio. The commission expense ratio is derived by dividing commissions and fee expense by total revenue. The compensation expense ratio is derived by dividing compensation expense by total revenue. The non-compensation expense ratio is derived by dividing non-compensation expense by total revenue. Included within the CCG’s revenue are amounts required to eliminate intercompany revenue recorded between the Company’s corporate benefits and executive benefits business lines. Included within the ICG revenue are amounts required to be recorded to eliminate intercompany revenue recorded between the Company’s marketing organization and wholesale life brokerage, retail life and investment advisory business lines. Included within ASG revenue are amounts required to be recorded to eliminate intercompany revenue recorded between NFPSI and the ICG.
Compensation expense. The Company’s businesses incur operating expenses related to compensating producing and non-producing staff. In addition, NFP allocates compensation expense associated with corporate shared services to NFP’s three reportable segments largely based on performance by the segments and other reasonable assumptions and estimates as it relates to the corporate shared services support of the operating segments. Compensation expense includes both cash and stock-based compensation. NFP records share-based payments related to employees and activities as well as allocated amounts from its corporate shared services to compensation expense as a component of compensation expense.
Management fees. NFP pays management fees to the principals and/or certain entities they own based on the financial performance of the business they manage. From a cash perspective NFP may advance monthly management fees that have not yet been earned due to the seasonality of the earnings of certain subsidiaries, particularly in the ICG. NFP typically pays a portion of the management fees monthly in advance. Once NFP receives its cumulative preferred earnings, or base earnings, the principals and/or entity 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, NFP receives 40% of earnings in excess of target earnings and the principals and/or the entities they own receives 60%. As of December 31, 2010 the ratio of base earnings to target earnings by segment was 60.7% for the CCG and 47.2% for the ICG. Since the ASG is primarily comprised of NFPSI, NFP’s registered broker-dealer and investment advisor, no management fees are paid and no earnings are shared with principals. Management fees also include an accrual for certain performance-based incentive amounts payable under NFP’s ongoing incentive plan, the PIP, the Business Incentive Plan (the “BIP”) and the EIP. For a more detailed discussion of NFP’s incentive plans, see “-Incentive Plans” below.
fees (excluding accelerated vesting of certain RSUs) as a percentage of adjusted income before management fees is a non-GAAP measure useful to investors because it shows the portion of earnings that would have been paid out to principals but for the disproportionate impact of the one-time accelerated vesting of certain RSUs.
(Gain) loss on sale of businesses. From time to time, NFP has disposed of businesses or certain assets of businesses. In these dispositions, NFP may realize a gain or loss on such sale.
The PIP is designed to reward the annual performance of a business based on the business’s earnings growth. For the initial 12-month performance period of October 1, 2009 through September 30, 2010, a cash incentive payment was made to the extent a business’s earnings exceeded its PIP Performance Target (as defined below). The PIP was established such that the greater a business’s earnings growth rate exceeded its PIP Performance Target rate for the 12-month performance period, the higher the percentage of the business’s earnings growth the Company would pay the principal under the PIP. NFP calculates and includes a PIP accrual in management fees expense. The Company accrued $10.7 million within management fees expense relating to the initial 12-month performance period, which was paid in the fourth quarter of 2010. For this initial 12-month performance period, the incentive target (the “PIP Performance Target”) for each business participating in the PIP was generally set at the lower of (a) such business’s earnings for the 12 months ended June 30, 2009 or (b) such business’s incentive target under the ongoing incentive plan as of June 30, 2009. The initial 12-month performance period used performance targets that rewarded principals for advancing certain corporate goals and initiatives related to the Company’s reorganization and also took the difficult economic environment during the initial 12-month performance period into account. NFP’s Executive Management Committee, in its sole discretion, was able to adjust any PIP Performance Target as necessary to account for extraordinary circumstances, including, without limitation, sub-acquisitions.
For the initial 12-month performance period, NFP calculated the amount of a business’s PIP accrual in management fees expense based on the business’s earnings growth rate above its PIP Performance Target rate. The PIP Performance Target over the course of the initial 12-month performance period was allocated on a straight line basis. NFP calculated a business’s PIP accrual amount and earnings growth rate on a cumulative basis. For example, for the quarter ended March 31, 2010, the business’s PIP accrual amount and earnings growth rate was calculated for the six months from October 1, 2009 (the first day of the initial 12-month performance period for the PIP) to March 31, 2010; and for the quarter ended September 30, 2010, for the twelve months from October 1, 2009 to September 30, 2010. The amount of management fees expense or benefit the Company took in a particular quarter for a business’s PIP accrual depended on the difference between the business’s cumulative performance against the PIP Performance target and what was accrued on a plan to date basis for the period ended on the last day of that quarter and the business’s cumulative performance for the period ended on the last day of the preceding quarter. The amount of PIP accrual taken as management fee expense therefore varied from quarter to quarter.
Under the EIP, during the fourth quarter of 2009 NFP issued equity awards to principals and key employees of its businesses generally based on each business’s performance over the two-year period that ended on June 30, 2009 (the “Initial EIP Performance Period”). The payments made under the EIP for the Initial EIP Performance Period were in the form of RSUs. On September 17, 2010, NFP accelerated the vesting of approximately 1.5 million RSUs granted to certain principals, the majority of which were awarded pursuant to the EIP, which was then terminated. See “Note 11-Stock-Incentive Plans” to the Company’s Consolidated Financial Statements contained in this report.
The CCG accounted for 39.5%, 40.0% and 35.2% of NFP’s revenue for the years ended December 31, 2010, 2009, and 2008, respectively. The financial information below relates to the CCG for the periods presented (in millions):
Commissions and fees. Commissions and fees expense increased $2.7 million, or 7.8%, to $37.1 million in 2010 compared with $34.4 million in 2009. The commission expense ratio was 9.6% in 2010 compared with 9.1% in 2009. Dispositions contributed to a decline of $1.1 million in commissions and fees. The overall increase in commissions and fees expense was largely attributable to the increase in revenue.
Compensation expense. Compensation expense decreased $2.1 million, or 1.6%, to $130.4 million in 2010 compared with $132.5 million in the same period last year. The compensation expense ratio was 33.6% for the year ended December 31, 2010 compared with 34.9% in 2009. Compensation expense declined due to a decrease in corporate expense allocations and due to dispositions of $4.6 million, offset by increases in headcount and in employee-earned commissions and bonuses.
Income (loss) from operations. Income (loss) from operations decreased $372.1 million to $(319.8) million in 2009 compared with income from operations of $52.3 million in 2008. The decrease in income (loss) from operations was due to an increase in the level of impairments of goodwill and intangible assets from $6.8 million in 2008 to $354.4 million in 2009. Excluding the impact of impairments, income (loss) from operations decreased due to declines in revenue, as some clients reduced benefits offered to employees due to cost-cutting measures and the size of programs declined due to rising unemployment. Offsetting this decline was a slight decrease in operating expenses, due to cost cutting measures, headcount reductions and reductions in commission payments among employee producers, reflected in compensation expense, during 2009.
Commissions and fees. Commissions and fees decreased $25.0 million, or 6.2%, to $380.0 million in 2009 compared with $405.0 million in 2008. Corporate benefits revenue decreased approximately $22.4 million or 6.2% from $358.9 million in 2008 to $336.5 million in 2009, accounting for 90% of the decline. The overall decline in CCG revenue was a result of dispositions of $11.2 million, and reduced product demand, due to cost-cutting measures and rising unemployment during 2009 as compared to 2008.
Commissions and fees. Commissions and fees expense decreased $10.6 million, or 23.6%, to $34.4 million in 2009 compared with $45.0 million in 2008. The commission expense ratio was 9.1% in 2009 compared with 11.1% in 2008. The significant decline in commissions and fees expense both in dollars and as a percentage of revenue was largely attributable to the decline in revenue. Dispositions also contributed to a decline of $5.5 million in commissions and fees expense.
Management fees. Management fees increased $2.6 million, or 3.8%, to $70.5 million in 2009 compared with $67.9 million in 2008. Management fees as a percentage of revenue was 18.6% for the year ended December 31, 2009 compared with 16.8% in 2008. Adjusted income before management fees was $166.4 million in 2009, a decrease of $7.5 million, or 4.3%, from adjusted income before management fees of $173.9 million in 2008. Management fees as a percentage of adjusted income before management fees increased to 42.4% for the year ended December 31, 2009 from 39.1% for the year ended December 31, 2008. Included in the increase in management fees was an increase of $2.7 million due to incentive plans and $0.3 million for stock-based compensation over the prior period.
Depreciation. Depreciation expense increased $3.6 million, or 64.3%, to $9.2 million in 2009 compared with $5.6 million in 2008. The increase in depreciation was due to the sublet of one of the floors of the Company’s headquarters in 2009, which required the Company to accelerate depreciation expense on certain items related to the sublet.
Impairment of goodwill and intangible assets. Impairment of goodwill and intangible assets increased $347.6 million to $354.4 million in 2009 compared with $6.8 million in 2008. The increase in impairments was driven by the significant impairment in the first quarter of 2009 as compared with the year ended December 31, 2008. The impairment taken for the year ended December 31, 2009 reflected the incorporation of market data, including NFP’s market value which had remained below net book value for a sustained period, the performance of the Company in the economic environment in 2008, and discount rates that were risk adjusted to reflect both company-specific and market-based credit spreads and other relevant market data.
Loss (gain) on sale of businesses. During the year ended December 31, 2009, the CCG recognized a net loss from the disposition of three businesses and the sale of certain assets of another two businesses totaling less than $0.1 million. During the year ended December 31, 2008, the CCG disposed of 1 business and the sale of certain assets of 3 other businesses totaling $7.3 million.
Income (loss) from operations. Income (loss) from operations increased $259.4 million to $15.2 million in 2010 compared with a loss of $(244.2) million in 2009. The increase in income from operations was due to the substantial decline in the level of impairments. Excluding the impact of impairments, income from operations decreased due to a decrease in revenue and an increase in management fees, due to the accelerated vesting of certain RSUs of $6.0 million, stock-based compensation of $7.5 million, and an increase in commissions and fees, all of which was offset by decreases in compensation expense, non-compensation expense, amortization, and depreciation. Dispositions were a significant driver in the variances mentioned above within the ICG’s retail life and investment advisory business lines as revenue from disposed firms contributed a decline of $25.6 million to the overall revenue decline. Disposed entities also contributed to declines in commissions and fees expense, compensation expense and non-compensation expense in amounts of $4.0 million, $11.5 million, and $7.6 million, respectively.
Compensation expense. Compensation expense decreased $9.3 million, or 7.8%, to $110.5 million in 2010 compared with $119.8 million in 2009. The compensation expense ratio was 29.2% for the year ended December 31, 2010 compared with 30.2% in 2009. The overall decline in compensation expense was primarily driven by the decline in compensation expense from disposed businesses of $11.5 million and a decrease in corporate expense allocations which was somewhat offset by an increase in compensation expense of $1.1 million at the ICG’s marketing organization and wholesale life brokerage business line.
Non-compensation expense. Non-compensation expense decreased $9.6 million, or 12.4%, to $67.6 million in 2010 compared with $77.2 million in 2009. The non-compensation expense ratio was 17.8% for the year ended December 31, 2010 compared with 19.4% in 2009. The decline in non-compensation expense was primarily a result of $7.6 million from disposed businesses and a $4.1 million loss and related expenses recognized on the sublet of one of the floors of the Company’s New York corporate headquarters in the fourth quarter of 2009.
Amortization of intangibles. Amortization expense declined $2.0 million, or 14.7%, to $11.6 million in the year ended December 31, 2010 compared with $13.6 million in the year ended December 31, 2009. Amortization expense declined as a result of a 10.9% decrease in amortizing intangible assets resulting primarily from dispositions and impairments.
Non-compensation expense. Non-compensation expense decreased $16.6 million, or 17.7%, to $77.2 million in 2009 compared with $93.8 million in 2008. The non-compensation expense ratio was 19.4% for the year ended December 31, 2009 compared with 17.4% in 2008. The decline in non-compensation expense at existing firms was largely a result of cost reduction initiatives across the firms. The increase in non-compensation expense as a percentage of revenue was largely a result of the sharp decline in revenue concentrated in retail life, and ICG’s marketing organization and wholesale life brokerage businesses during the year ended December 31, 2009.
Depreciation. Depreciation expense increased $2.0 million, or 29.0%, to $8.9 million in 2009 compared with $6.9 million in 2008. The increase in depreciation is due to the sublet of one of the floors of the Company’s headquarters in 2009, which required the Company to accelerate depreciation expense on certain items related to the sublet.
Impairment of goodwill and intangible assets. Impairment of goodwill and intangible assets increased $229.6 million to $264.1 million in 2009 compared with $34.5 million in 2008. The increase in impairments was driven by the significant impairment in the first quarter of 2009 as compared with the year ended December 31, 2008. The impairment taken for the year ended December 31, 2009 reflected the incorporation of market data, including NFP’s market value which had remained below net book value for a sustained period, the performance of the Company in the economic environment in 2008, and discount rates that were risk adjusted to reflect both company-specific and market-based credit spreads and other relevant market data.
The ASG accounted for 22.0% of NFP’s revenue for the year ended December 31, 2010, and 18.0% of NFP’s revenue for the years ended December 31, 2009 and 2008. The financial information below relates to the ASG for the periods presented (in millions):
Income (loss) from operations. Income (loss) from operations increased $5.3 million to $7.5 million in the year ended December 31, 2010 compared with $2.2 million for the year ended December 31, 2009. The increase in income (loss) from operations is due to an increase in revenue and a decline in compensation expense, offset by an increase in commissions and fees expense and non-compensation expense.
Commissions and fees. Commissions and fees increased $44.2 million, or 25.8%, to $215.2 in the year ended December 31, 2010 from $171.0 million in the year ended December 31, 2009. Results in the ASG were driven by general improvements in the financial markets and increased investor confidence. Assets under management for the ASG increased 18.6%, to $9.3 billion for year ended December 31, 2010 compared to $7.9 billion for the year ended December 31, 2009.
Compensation expense. Compensation expense decreased $0.7 million, or 4.4%, to $15.3 million in 2010 compared with $16.0 million in 2009. The compensation expense ratio was 7.1% for the year ended December 31, 2010 compared with 9.4% in the year ended December 31, 2009. Compensation expense declined commensurate with headcount reductions in 2009.
Income (loss) from operations. Income (loss) from operations increased $5.7 million to $2.2 million in the year ended December 31, 2009 compared with a loss from operations of $(3.5) million for the year ended December 31, 2008. The increase in income from operations was due to a sharp decline in operating expenses in part due to headcount reductions and reductions in commission payments. The decline in expenses was partially offset by a decline in revenue, as fees for assets under management declined with declining market values during 2009.
Non-compensation expense. Non-compensation expense decreased $4.1 million, or 38.7%, to $6.5 million in 2009 compared with $10.6 million in 2008. The non-compensation expense ratio was 3.8% for the year ended December 31, 2009, compared with 5.1% in 2008. The decline in non-compensation expense was largely a result of cost reduction initiatives across the business.
Interest expense. Interest expense decreased $2.1 million, or 10.2%, to $18.5 million in the year ended December 31, 2010 compared with $20.6 million in the year ended December 31, 2009. The decrease was due primarily to the repurchase of the 0.75% convertible senior notes due February 1, 2012 (the “2007 Notes”) and repayment of outstanding amounts under the 2006 Credit Facility, offset by the issuance of the 2010 Notes and NFP’s entry into the 2010 Credit Facility. See “-Liquidity and Capital Resources-Borrowings” for further details.
Other, net. Other, net decreased $3.3 million, or 28.4%, to $8.3 million in the year ended December 31, 2010 compared with $11.6 million in the year ended December 31, 2009. The decline was largely the result from key-person life insurance proceeds of $5.5 million and the receipt of $1.9 million in proceeds from the settlement of an NFP owned key-person life insurance policy on a principal for the year ended December 31, 2009. For the year ended December 31, 2010 other income was comprised of $5.8 million of rental income for the sublet of the Company’s former headquarters, and $1.8 million for the Company’s ownership interest in its joint ventures.
Interest income. Interest income decreased $1.8 million or 36.7%, to $3.1 million in 2009 compared with $4.9 million in 2008. The lower interest income is due to the lower interest rate environment in 2009 as compared with 2008.
Other, net. Other, net increased $10.4 million, to $11.6 million in 2009 compared with $1.2 million in 2008. During the year ended December 31, 2009, the increase of $10.4 million resulted largely from key man life proceeds of $5.5 million, the receipt of $1.9 million in proceeds from the settlement of an NFP-owned key man life insurance policy on a principal, and the increase of approximately $1.2 million from the sublet of the Company’s former headquarters, all offset by a $0.8 million loss resulting from the investment in the Company’s life settlements joint venture.
Income tax (benefit) expense. Income tax (benefit) was $(74.4) million in 2009, compared with income tax expense of $33.3 million in 2008. The effective tax rate in 2009 was 13.1%, compared with an effective tax rate of 79.7% in 2008. The estimated annual effective tax rate was lower for the year ended December 31, 2009 largely as a result of the tax benefits from dispositions, impairments and corporate reorganizations as well as the tax free nature of key man life insurance proceeds received during 2009. The estimated effective tax rate may be affected by future impairments, restructurings, and state tax law changes.
Liquidity refers to the ability of an enterprise to generate adequate amounts of cash to meet its needs for cash. NFP derives liquidity primarily from cash generated by the Company’s businesses and from financing activities. For a detailed discussion of NFP’s recapitalization transactions, which took place in 2010, see “-Borrowings” below.
Historically, this cash flow pattern has led to additional borrowings in the first quarter. However, additional borrowings did not occur for the year ended December 31, 2010 or 2009, because cash flow was sufficient to fund management fees to principals of firms that performed in excess of target earnings and the Company did not make any material acquisitions during this period. This pattern could change to the extent acquisitions or sub-acquisitions increase, or as capital is deployed for other uses.
A summary of the changes in cash flow data is provided as follows:
NFP periodically assesses the impact of market developments, including reviewing access to liquidity in the capital and credit markets. Given NFP’s recent recapitalization transactions, the Company anticipates that short/medium-term liquidity and capital needs have currently been addressed, although such needs may change in the future. Further, the Company’s ability to access capital is subject to the restrictions in the 2010 Credit Facility; see “Risk Factors-The Company’s business may be adversely affected by restrictions and limitations under its credit facility. Changes in the Company’s ability to access capital could adversely affect the Company’s operations.” To the extent that financing needs change due to changing business needs, or to the extent the general economic environment changes, an evaluation of access to the credit markets and capital will be performed. Continuing uncertain conditions in these markets may adversely affect the Company.
Cash and cash equivalents at December 31, 2010 increased $72.8 million from $56.0 million at December 31, 2009 to $128.8 million at December 31, 2010. Significant sources of cash flow in 2010 came from cash received from NFP’s issuance of the 2010 Notes, which resulted in proceeds to NFP of $120.3 million, after certain fees and expenses and cash flow provided by operating activities. Significant uses of cash at December 31, 2010 were for the purchase of certain convertible note hedges, entered into concurrently with NFP’s offering of 2010 Notes, of $33.9 million, repayments of the 2006 Credit Facility of $40.0 million, and the repurchase of the 2007 Notes of $219.7 million.
Some of the Company’s businesses maintain premium trust accounts in a fiduciary capacity, which represent payments collected from policyholders on behalf of carriers. These funds cannot be used for general corporate purposes, and should not be considered a source of liquidity for the Company. At December 31, 2010,
the Company had cash, cash equivalents and securities purchased under resale agreements in premium trust accounts listed as Fiduciary funds-restricted related to premium trust accounts on its balance sheet of $82.6 million, an increase of $6.7 million from the balance of $75.9 million from December 31, 2009. Changes in these accounts are the result of timing of payments collected from insureds on behalf of insurance carriers. Additionally, NFP’s broker-dealer subsidiaries are subject to net capital requirements; see “Note 2-Summary of Significant Accounting Policies-Net capital” to the Company’s Consolidated Financial Statements contained in this report.
The 2006 Credit Facility was structured as a revolving credit facility and was scheduled to mature on August 22, 2011. The maximum revolving borrowings under the 2006 Credit Facility was $200.0 million. As of December 31, 2009, NFP had a balance of $40.0 million outstanding under its 2006 Credit Facility. Upon termination, the year-to-date weighted average interest rate for the 2006 Credit Facility was 4.08%. As of December 31, 2009, the combined weighted average of the 2006 Credit Facility was 3.31%.
On June 30, 2010, NFP paid all principal outstanding and interest due under the 2006 Credit Facility. On July 8, 2010, NFP terminated the 2006 Credit Facility and entered into the 2010 Credit Facility. The Company was in compliance with all of its debt covenants under the 2006 Credit Facility, through the date of termination. See “-2010 Credit Facility” below.
In January 2007, NFP issued the 2007 Notes. The 2007 Notes were used to pay the net cost of certain convertible note hedge and warrant transactions, as discussed in more detail below, repurchase 2.3 million shares of NFP’s common stock from Apollo Investment Fund IV, L.P. and Apollo Overseas Partners IV, L.P. and to repay a portion of outstanding amounts of principal and interest under the 2006 Credit Facility.
Upon conversion, NFP would have paid, 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 2007 Notes was 17.9791 shares of common stock per $1,000 principal amount of 2007 Notes, equivalent to a conversion price of approximately $55.62 per share of common stock. The conversion price was subject to adjustment in some events but was not adjusted for accrued interest. As of December 31, 2009 and through the completion of the retirement of the 2007 Notes, the conversion rate for the notes was 18.0679 shares of common stock per $1,000 principal amount of notes, equivalent to a conversion price of approximately $55.35 per share of common stock. As of December 31, 2009 and through the completion of the retirement of the 2007 Notes, the instrument’s converted value did not exceed its principal amount of $230.0 million.
On June 9, 2010, NFP commenced a cash tender offer (the “Tender Offer”) for any and all of the 2007 Notes, on the terms and conditions of the Offer to Purchase dated June 9, 2010 and the accompanying Letter of Transmittal. The Tender Offer expired at 12:00 midnight, New York City time, on July 7, 2010 (the “Expiration Date”). As of the Expiration Date, $229.9 million aggregate principal amount of 2007 Notes were validly tendered and not withdrawn. NFP accepted $229.9 million aggregate principal amount of the tendered 2007 Notes pursuant to the terms of the Tender Offer. The aggregate consideration (including accrued and unpaid interest) for the accepted 2007 Notes of approximately $220.3 million was delivered promptly to The Depository Trust Company for delivery to the tendering holders on a pro rata basis, based on the aggregate principal amount of 2007 Notes validly tendered and not withdrawn in the Tender Offer. After the purchase of the tendered 2007 Notes pursuant to the terms of the Tender Offer, $100,000 principal amount of the 2007 Notes remained outstanding. On August 10, 2010, the remaining outstanding $100,000 principal amount of the 2007 Notes was repurchased in a privately-negotiated transaction, executed on the same terms as the Tender Offer, for consideration of approximately $0.1 million (including accrued and unpaid interest). As of December 31, 2010, no 2007 Notes remained outstanding.
On June 15, 2010, NFP completed the private placement of $125.0 million aggregate principal amount of the 2010 Notes to the Initial Purchasers pursuant to an exemption from the registration requirements under the
Holders may convert their 2010 Notes at their option on any day prior to the close of business on the scheduled trading day immediately preceding April 15, 2017 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 2010 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 ended June 30, 2010, 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 135% 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 2010 Notes will be convertible, regardless of the foregoing circumstances, at any time from, and including, April 15, 2017, through the second scheduled trading day immediately preceding the maturity date of the 2010 Notes. Default under the 2010 Credit Facility resulting in its acceleration would, subject to a 30-day grace period, trigger a default under the indenture governing the 2010 Notes, in which case the trustee under the 2010 Notes or holders of not less than 25% in principal amount of the outstanding 2010 Notes could accelerate the payment of the notes.
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 60 trading day observation period. The initial conversion rate for the 2010 Notes was 77.6714 shares of common stock per $1,000 principal amount of 2010 Notes, equivalent to a conversion price of approximately $12.87 per share of common stock. The conversion price is subject to adjustment in some events but is not adjusted for accrued interest. In addition, if a “fundamental change” (as defined in the indenture governing the 2010 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 2010 Notes in connection with such fundamental change.
Concurrent with the issuance of the 2010 Notes, NFP entered into convertible note hedge and warrant transactions with affiliates of certain of the Initial Purchasers (the “Counterparties”) for the 2010 Notes. A default under the 2010 Credit Facility would trigger a default under each of the convertible note hedge and warrant transactions, in which case the counterparty could designate early termination under either, or both, of these instruments. The transactions are expected to reduce the potential dilution to NFP’s common stock upon future conversions of the 2010 Notes. Under the convertible note hedge, NFP purchased 125,000 call options for an aggregate premium of $33.9 million. Each call option entitles NFP to repurchase an equivalent number of shares issued upon conversion of the 2010 Notes at the same strike price (initially $12.87 per share), generally subject to the same adjustments. The call options expire on the maturity date of the 2010 Notes. NFP also sold warrants for an aggregate premium of $21.0 million. The warrants expire ratably over a period of 120 scheduled trading days between September 15, 2017 and March 8, 2018, 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; but NFP may elect cash settlement subject to certain conditions. The net cost of the convertible note hedge and warrants to NFP was $12.9 million. The economic impact of the convertible note hedge and warrants was to increase the conversion price of the 2010 Notes to approximately $15.77.
The 2010 Credit Facility contains representations, warranties and covenants that are customary for similar credit arrangements, including, among other things, covenants relating to (i) financial reporting and notification, (ii) payment of obligations, (iii) compliance with applicable laws and (iv) notification of certain events. Financial covenants will also require NFP to maintain (i) a leverage ratio of no greater than 2.5:1.0, (ii) an interest coverage ratio of no less than 4.0 to 1.0 and (iii) a fixed charge coverage ratio of no less than 2.0 to 1.0. The 2010 Credit Facility contains various customary restrictive covenants, subject to certain exceptions, that prohibit NFP from, among other things, incurring additional indebtedness or guarantees, creating liens or other encumbrances on property or granting negative pledges, entering into merger or similar transactions, selling or transferring certain property, making certain restricted payments (such as dividends or share repurchases), making advances or loans, entering into transactions with affiliates and making payments on conversion of the 2007 Notes or the 2010 Notes under certain circumstances.
Under the terms of the 2010 Credit Facility, NFP’s consolidated fixed charge coverage ratio will be calculated, commencing with the first fiscal quarter ended September 30, 2010. The fixed charge coverage ratio is calculated as the ratio of (a) EBITDA (as defined in the 2010 Credit Facility) to (b) consolidated fixed charges. EBITDA under the 2010 Credit Facility is calculated as follows: EBITDA for the trailing twelve months less (i) certain capital expenditures made in cash by NFP and its subsidiaries during such period and (ii) all federal, state and foreign taxes paid in cash during such period. Consolidated fixed charges under the 2010 Credit Facility consist of: (a) consolidated net interest expense paid in cash for the trailing twelve months (total cash interest expense, net of interest income), (b) scheduled payments of certain indebtedness made during the trailing twelve
The failure to comply with the foregoing covenants will constitute an event of default (subject, in the case of certain covenants, to applicable notice and/or cure periods) under the 2010 Credit Facility. Other events of default under the 2010 Credit Facility include, among other things, (i) the failure to timely pay principal, interest, fees or other amounts due and owing, (ii) a cross-default with respect to certain other indebtedness, (iii) the occurrence of certain bankruptcy or insolvency events, (iv) the inaccuracy of representations or warranties in any material respect, (v) the occurrence of a change of control, or other event constituting a “fundamental change” under the indenture governing the 2010 Notes and (vi) the loss of lien perfection or priority. The occurrence and continuance of an event of default could result in, among other things, the acceleration of all amounts owing under the 2010 Credit Facility and the termination of the lenders’ commitments to make loans under the 2010 Credit Facility. NFP’s obligations under the 2010 Credit Facility are guaranteed by certain of NFP’s existing and future direct and indirect wholly-owned domestic subsidiaries, subject to certain limitations. In addition, NFP’s obligations under the 2010 Credit Facility, subject to certain exceptions, are secured on a first-priority basis by (i) pledges of all the capital stock of certain of NFP’s direct and indirect domestic subsidiaries and up to 65% of the capital stock of certain of NFP’s foreign subsidiaries and (ii) liens on substantially all of the tangible and intangible assets of NFP and the guarantors.
Under the terms of the 2010 Credit Facility, loans will bear interest at either LIBOR or the base rate, at NFP’s election, plus an applicable margin, based on NFP’s leverage ratio, as set forth below:
As of December 31, 2010, the year-to-date weighted average interest rate for NFP’s 2010 Credit Facility was 3.53%.
Mandatory prepayments of the new term loan facility are required upon the occurrence of certain events, including, without limitation, (i) sales of certain assets, (ii) the sale or issuance of capital stock during the continuance of an event of default under the 2010 Credit Facility and (iii) the incurrence of certain additional indebtedness, subject to certain exceptions and reinvestment rights. Voluntary prepayments are permitted, in whole or in part, in minimum amounts without premium or penalty, other than customary breakage costs.
The foregoing description of the 2010 Credit Facility is not complete and is qualified by reference to the full text of the 2010 Credit Facility.
Scheduled long-term debt principal repayments under the 2010 Credit Facility are shown below:
As of December 31, 2010 the Company’s future contractual payments, commercial commitments, and other long-term liabilities were as follows:
As of December 31, 2010, the Company’s liability for uncertain tax positions was $22.0 million. The Company was unable to reasonably estimate the timing of liability payments in any individual year due to uncertainties in the timing of the effective settlement of tax positions. NFP has other unrecognized tax positions that were not recorded on the Consolidated Balance Sheet in accordance with the relevant guidance. See “Note 12-Income taxes” to the Company’s Consolidated Financial Statements contained in this report for further discussion regarding the Company’s unrecognized tax positions.
Off-balance sheet arrangements, as defined by the SEC, include certain contractual arrangements pursuant to which a company has an obligation, such as certain contingent obligations, certain guarantee contracts, retained or contingent interest in assets transferred to an unconsolidated entity, certain derivative instruments classified as equity or material variable interests in unconsolidated entities that provide financing, liquidity, market risk or credit risk support. Disclosure is required for any off-balance sheet arrangements that have, or are reasonably likely to have, a material current or future effect on the Company’s financial condition, results of operations, liquidity or capital resources. The Company does not generally enter into off-balance sheet arrangements, as defined, other than those described in “-Contractual Obligations, Commitments and Contingencies” and in “Note 19-Variable Interest Entities” to the Company’s Consolidated Financial Statements contained in this report.
Since the Company’s formation and through December 31, 2010, it has completed 268 acquisition transactions, including 48 sub-acquisitions. All of these transactions have been accounted for using the purchase method, and their related net assets and results of operations were included in the Company’s Consolidated Financial Statements commencing on their respective acquisition dates. Certain of the acquisitions have provisions for additional contingent consideration based upon the financial results achieved over a multi-year period. This additional consideration is reflected as an increase in goodwill when results are achieved and the outcome of the contingency is determinable beyond a reasonable doubt.
Intangible assets are presented net of accumulated amortization and consist of the following:
For the years ended December 31, 2010, 2009, and 2008, the Company recorded impairment losses of $2.9 million, $27.0 million, and $6.3 million respectively, related to management contract and book of business, which is reflected in the consolidated statements of operations.
In accordance with GAAP, goodwill and intangible assets not subject to amortization are tested at least annually for impairment, and are tested for impairment more frequently if events and circumstances indicate that the intangible asset might be impaired. Indicators at the business line level, which is considered a reporting unit for this analysis, include, but are not limited to, a significant deterioration in its operating cash flow compared to its financial plan or prior year performance, loss of key personnel, a decrease in NFP’s market capitalization below its book value, and an expectation that a reporting unit will be sold or otherwise disposed of. If one or more indicators of impairment exist, NFP performs an evaluation to identify potential impairments. If an impairment is identified, NFP measures and records the amount of impairment loss.
The Company earns commissions on the sale of insurance policies and fees for the development, implementation and administration of benefits programs. Commissions and fees are generally paid each year as long as the client continues to use the product and maintains its broker of record relationship with the Company. In some cases, fees earned are based on the amount of assets under administration or advisement. 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 receives renewal
commissions for a period following the first year, if the policy remains in force. Asset-based fees are earned for administrative services or consulting related to certain benefits plans. Insurance commissions are recognized as revenue when the following criteria are met: (1) the policy application and other carrier delivery requirements are substantially complete, (2) the premium is paid, and (3) the insured party is contractually committed to the purchase of the insurance policy. Carrier delivery requirements may include additional supporting documentation, signed amendments and premium payments. Subsequent to the initial issuance of the insurance policy, premiums are billed directly by carriers. Commissions earned on renewal premiums are generally recognized upon receipt from the carrier, since that is typically when the Company is first notified that such commissions have been earned. The Company carries an allowance for policy cancellations, which approximated $1.2 million at each of December 31, 2010, 2009, and 2008 that is periodically evaluated and adjusted as necessary. Miscellaneous commission adjustments are generally recorded as they occur. Some of the Company’s businesses also 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, and recognized as revenue when the policy is transferred and the rescission period has ended. Contingent commissions are recorded as revenue when received which, in many cases, is the Company’s first notification of amounts earned. Contingent commissions are commissions paid by insurance underwriters and are based on the estimated profit and/or overall volume of business placed with the underwriter. The data necessary for the calculation of contingent commissions cannot be reasonably estimated prior to receipt of the commission.
Some of the Company’s businesses earn additional compensation in the form of incentive and marketing support payments from manufacturers of financial services products, based on the volume, consistency 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 historical data or other information exists which enables management to reasonably estimate the amount earned during the period.
The Company accounts for income taxes in accordance with standards established by GAAP, which requires the recognition of tax benefits or expenses on the temporary differences between the financial reporting and tax bases of its assets and liabilities. Deferred tax assets and liabilities are measured utilizing statutory-enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Valuation allowances are established when necessary to reduce the deferred tax assets to the amounts expected to be realized.
Stock-based awards issued to the Company’s employees are classified as equity awards. The Company accounts for equity classified stock-based awards issued to its employees based on the fair value of the award on the date of grant and recorded as an expense as part of compensation expense in the consolidated statements of operations. The expense is recorded ratably over the service period, which is generally the vesting period. The offsetting entry is to additional paid in capital in stockholders’ equity. Stock-based awards issued to the Company’s principals are classified as liability awards, as principals are non-employees. The Company measures the fair value of the stock-based awards granted to its principals at the earlier of the date at which performance is completed or a performance commitment has been reached. The Company’s stock-based awards to principals do not have disincentives for non-performance other than forfeiture of the award by the principals and therefore the Company measures the fair value of the award when the performance is completed by the principal, which is the completion of the vesting period. The Company accounts for liability classified stock-based awards issued to its principals as part of management fee expense in the consolidated statements of operations. Liability classified stock-based compensation is adjusted each reporting period to account for subsequent changes in the fair value of NFP’s common stock. The offsetting entry is to accrued liabilities. See “Note 11-Stock Incentive Plans” to the Company’s Consolidated Financial Statements contained in this report.
Effective January 1, 2007, NFP established an Employee Stock Purchase Plan (“ESPP”). The ESPP is designed to encourage the purchase of common stock by NFP’s employees, further aligning interests of employees and stockholders and providing incentive for current employees. Up to 3,500,000 shares of common stock are currently available for issuance under the ESPP. The ESPP enables all regular and part-time employees who have worked for NFP for at least one year to purchase shares of NFP common stock through payroll deductions of any whole dollar amount of eligible compensation, up to an annual maximum of $10,000. The employees’ purchase price is 85% of the lesser of the market price of the common stock on the first business day or the last business day of the quarterly offering period. The Company recognizes compensation expense related to the compensatory nature of the discount given to employees who participate in the ESPP, which totaled $0.2 million, $0.6 million and $0.5 million for the year ended December 31, 2010, 2009, and 2008, respectively.
For a discussion of recently adopted accounting standards, please see “Note 2-Summary of Significant Accounting policies” to the Company’s Consolidated Financial Statements contained in this report.