c) Effective January 1, 2010, the Company calculates organic revenue growth as a measure of financial performance. Organic revenue growth is generally calculated consistently with the internal revenue growth calculation described above, but with certain principal differences. First, the Company excludes revenue from new acquisitions, sub-acquisitions, and the revenue derived from businesses fully disposed of for the first twelve months after the respective transaction, rather than waiting until the start of the first fiscal quarter that begins one year after acquisition or disposition. Additionally, where a significant portion of a business’ assets have been disposed, the Company reduces the prior year’s comparable revenue proportionally to the percentage of assets that have been disposed of in making the organic growth comparison.
The following discussion should be read in conjunction with the Consolidated Financial Statements of the Company and the related notes contained 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.
Founded in 1998, the Company has grown organically and through acquisitions, operating in the independent distribution channel. This distribution channel offers independent advisors the flexibility to sell products and services from multiple non-affiliated providers to deliver objective, comprehensive solutions. The number of products and services available to independent advisors is large and can lead to a fragmented marketplace. NFP facilitates the efficient sale of products and services in this marketplace by using its scale and market position to contract with leading product providers. These relationships foster access to a broad array of insurance and financial products and services as well as underwriting support and operational services. In addition, the Company is able to operate effectively in this distribution channel by leveraging financial and intellectual capital, technology solutions, the diversification of product and service offerings, and regulatory compliance support across the Company. The Company’s marketing and wholesale organizations also provide an independent distribution channel for benefits, insurance and investment products and services, serving both third-party affiliates as well as member NFP-owned businesses.
Effective January 1, 2010, NFP organized its businesses into three reportable segments: the CCG, the ICG and the ASG. Periods prior to January 1, 2010 have been restated to reflect this basis of segmentation. The CCG is one of the leading corporate benefits advisors in the middle market, offering independent solutions for health and welfare, retirement planning, executive benefits, and property and casualty insurance. The ICG is a leader in the delivery of independent life insurance, annuities, long-term care and wealth transfer solutions for high net worth individuals and includes wholesale life brokerage, retail life and wealth management services. The ASG, including NFPSI, a leading independent broker-dealer and corporate registered investment advisor, serves independent financial advisors whose clients are high net worth individuals and companies, by offering broker-dealer and asset management products and services. The ASG attracts financial advisors seeking to provide clients with sophisticated resources and an open choice of products. NFP promotes collaboration among its business lines to provide its clients the advantages of a single coordinated resource to address their corporate and individual benefits, insurance and wealth management planning needs.
The Company reports its financial results in accordance with GAAP; however, management believes that the evaluation of the Company’s ongoing operating results may be enhanced by a presentation of Adjusted EBITDA, which is a non-GAAP financial measure. Adjusted EBITDA is defined as net income excluding income tax expense, interest income, interest expense, gain on early extinguishment of debt, other, net, amortization of intangibles, depreciation, impairment of goodwill and intangible assets, (gain) loss on sale of businesses, the accelerated vesting of certain restricted stock units (“RSUs”), any change in estimated acquisition earn-out payables recorded in accordance with purchase accounting that have been subsequently adjusted and recorded in the consolidated statements of operations and the expense related to management contract buyouts.
Management believes that the presentation of Adjusted EBITDA provides useful information to investors because Adjusted EBITDA reflects the underlying performance and profitability of the Company’s business by excluding items that do not have a current cash impact and are therefore not representative of the Company’s current operating performance. Additionally, Adjusted EBITDA excludes certain items that are unusual in nature or not comparable from period to period. The Company uses Adjusted EBITDA as a measure of operating
A reconciliation of Adjusted EBITDA to its GAAP counterpart on a consolidated and segment basis for the years ended December 31, 2011, 2010 and 2009 is provided in the tables below. The reconciliation of Adjusted EBITDA per reportable segment does not include the following items, which are not allocated to any of the Company’s reportable segments: income tax expense, interest income, interest expense, gain on early extinguishment of debt and other, net. These items are included in the reconciliation of Adjusted EBITDA to net income on a consolidated basis.
Income from operations increased $5.6 million, or 8.6%, in the year ended December 31, 2011, as compared to the year ended December 31, 2010. The Company’s income from operations was driven equally by growth in existing businesses as well as the impact of acquisitions, offset by an absence of a gain on the early extinguishment of debt in 2010, the expense for the accelerated vesting of certain RSUs in 2010 issued under the Long-Term Equity Incentive Plan (the “EIP”) and an associated amortization expense for those RSUs outstanding prior to the acceleration, and the impact of higher impairments in 2011. Compensation expense-employees also increased, but was partially offset by decreases in non-compensation expense. Gain on sale of businesses also decreased, primarily within the CCG, and impairments increased within the ICG.
Adjusted EBITDA for the year ended December 31, 2011 was $126.4 million, compared to $116.8 million in the last year, an increase of 8.2%. As a percentage of revenue, the Adjusted EBITDA margin was 12.5% compared to 11.9% in the last year. CCG Adjusted EBITDA increased with revenue growth from existing businesses as well as due to newly-acquired businesses that had no comparable operations in 2010, while overall operating expenses increased to partially offset the revenue increases. The CCG also benefited from a decrease in stock-based compensation of approximately $2.8 million, related to the EIP. ICG Adjusted EBITDA increased due to declines in fees to principals of $1.6 million for the PIP accrual, and a decline in stock-based compensation of approximately $2.0 million, related to the EIP. Excluding the impact of these events, Adjusted
EBITDA in the ICG decreased as revenue declines due to uncertainty facing the life insurance market during 2011 were not fully offset by expense decreases. Results in the ASG were driven by general improvements in the financial markets, particularly in increased sales of certain variable annuity products and a slight increase in assets under management.
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, and property and casualty products and services. In the corporate benefits business line, commissions and
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. 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.
From 1999, the year NFP began operations, 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 2011, NFP earned 28% of its revenue in the fourth quarter, whereas 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. 2010’s temporary estate tax laws have also had a continuing impact on the high net worth life insurance market by increasing the value of the estate that is exempt from federal estate tax and thereby decreasing the size of the target market.
With respect to its operating results, NFP provides the following ratios in the discussion that follows: (i) commission expense ratio, (ii) total compensation expense ratio and (iii) non-compensation expense ratio. The commission expense ratio is derived by dividing commissions and fees expense by revenue. The total compensation expense ratio is derived by dividing the sum of compensation expense-employees and fees to principals by revenue. The non-compensation expense ratio is derived by dividing non-compensation expense by revenue. Included within the CCG, ICG, and ASG’s revenue are amounts recorded to eliminate intercompany revenue between the Company’s business lines.
Commissions and fees. Commissions and fees are typically paid to third-party producers who are affiliated with the Company’s businesses. Commissions and fees are also paid to producers who utilize the services of one or more of the Company’s life brokerage entities, including the Company’s life settlements brokerage entities. Additionally, commissions and fees are paid to producers who provide referrals and specific product expertise. When earnings are generated solely by a principal, no commission expense is incurred because principals are only paid from a share of the cash flow of the business through fees to principals. However, when income is generated by a third-party producer, the producer is generally paid a portion of the commission income, which is reflected as commission expense. Rather than collecting the full commission and remitting a portion to a third-party producer, a business 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 respective share of the commissions and fees earned. When this occurs, the business will record only the commissions and fees it receives directly as revenue and have no commission expense. As a result, the business will have lower revenue and commission expense and a higher income from operations as a percentage of revenue. Dollars generated from income from operations will be the same. The transactions in which a business is listed as the sole producer and pays commissions to a third-party producer, compared with transactions in which the carrier pays each producer directly, will cause NFP’s income from operations as a percentage of revenue to fluctuate without affecting income from operations. In addition, within the ASG, NFPSI pays commissions to the Company’s affiliated third-party distributors who transact business through NFPSI.
Fees to principals also include an accrual for certain performance-based incentive amounts payable under the PIP and the RTIP. For a more detailed discussion of NFP’s incentive plans, see “Note 4-Commitments and Contingencies-Incentive Plans” to the Consolidated Financial Statements contained in this report.
The Company accounts for stock-based awards to principals as part of fees to principals expense in the consolidated statements of operations as liability awards. Liability classified stock-based compensation is adjusted each reporting period to account for subsequent changes in the fair value of NFP’s common stock.
Fees to principals may be offset by amounts paid by the principals and/or certain entities they own under the terms of the management contract 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 fees to principals.” Amounts recorded in deferred reduction in fees to principals are amortized as a reduction in fees to principals expense generally over the useful life of the asset.
Under the EIP, during the fourth quarter of 2009 NFP issued equity awards to principals and certain employees of its businesses generally based on each business’s performance over the two-year period that ended on September 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. The RSUs became fully vested on September 17, 2010 with a fair market value based on the closing price of NFP’s common stock on the same day of $12.61. The restricted shares were primarily subject to liquidity restrictions until November 24, 2012, which is the original vesting date of the RSUs awarded under the EIP. This action resulted in a pre-tax charge of $13.4 million in the third quarter of 2010.
For the initial 12-month performance period, NFP calculated the amount of a business’s PIP accrual in fees to principals 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. The amount of fees to principals 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 in fees to principals expense therefore varied from quarter to quarter.
During the quarter ended September 30, 2010, NFP introduced the RTIP. The RTIP covers the three-year period from January 1, 2011 through December 31, 2013 and is based on a modified calculation of applicable thresholds over this period. NFP’s Executive Management Committee, in its sole discretion, may adjust the calculation of the RTIP as necessary to account for changed business circumstances. As of December 31, 2011, the Company has not accrued any amounts within fees to principals expense relating to the RTIP, since the Company did not reach the applicable thresholds during the first plan year. The Company does not anticipate that amounts relating to the RTIP will be accrued within fees to principals in remaining plan years, given the applicable thresholds in place. However, to the extent target thresholds are achieved, plan participants may be eligible for cash payments in the first quarter of 2014.
The CCG accounted for 40.7%, 39.5% and 40.0% of NFP’s revenue for the years ended December 31, 2011, 2010 and 2009, respectively. The financial information below relates to the CCG for the periods presented (in millions):
Compensation expense-employees. Compensation expense-employees increased $10.7 million for the year ended December 31, 2011 compared with the last year. Approximately $5.6 million of the increase represented compensation expense-employees from acquisitions that had no comparable operations in 2010. After the impact from a divested business of $1.6 million, compensation expense-employees increased by $6.7 million, due to increased headcount at existing firms and increases in salaries and wages.
Gain on sale of businesses. During the year ended December 31, 2011, the CCG recognized a $0.1 million gain on the disposition of one business. During the year ended December 31, 2010, the CCG disposed of three businesses and contributed certain assets of a wholly-owned subsidiary to a newly formed entity in exchange for preferred units. The contribution of assets resulted in a deconsolidation and re-measurement of the Company’s retained investment for an overall gain of $9.2 million.
Income (loss) from operations. Income from operations increased $362.8 million in 2010 compared with 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 increased as increased revenue, an increase in gain on sale of businesses, and a decline in compensation expense-employees and non-compensation expense were more than offset by an increase in fees to principals related to the accelerated vesting of certain RSUs issued under the EIP of $7.4 million and an increase in commissions and fees expense. Dispositions were also a driver of variances within the CCG, contributing to a decline in revenue of $13.6 million. Dispositions also contributed $1.1 million to the overall decline in commissions and fees expense, a decline of $4.6 million in compensation expense-employees and a decline of $2.8 million in non-compensation expense.
Commissions and fees. Commissions and fees revenue increased $7.9 million for the year ended December 31, 2010, as compared with the prior year. After the impact of divested businesses of $13.6 million, revenue increased by $21.5 million driven by new clients and product sales, strength in certain specialty benefits, and medical inflation, which leads to increases in health insurance premiums and the commissions earned from them.
Commissions and fees. Commissions and fees expense increased $2.7 million in 2010, as compared with 2009. Dispositions contributed to a decline of $1.1 million in commissions and fees expense. The overall increase in commissions and fees expense was largely attributable to the increase in revenue.
Compensation expense-employees. Compensation expense-employees decreased $2.1 million for the year ended December 31, 2010, as compared with the prior year. Compensation expense-employees declined due to dispositions of $4.6 million, offset by increases in headcount and in employee-earned commissions and bonuses.
Depreciation. Depreciation expense decreased $3.1 million, or 33.3%, to $6.2 million in 2010 compared with $9.3 million in 2009. The decrease in depreciation resulted from dispositions, and from the acceleration of depreciation expense on certain items related to the sublet of one of the floors of the Company’s headquarters in 2009.
The ICG accounted for 34.7%, 38.5% and 42.0% of NFP’s revenue for the years ended December 31, 2011, 2010 and 2009, respectively. The financial information below relates to the ICG for the periods presented (in millions):
Commissions and fees. Commissions and fees revenue decreased $27.4 million for the year ended December 31, 2011 as compared with the prior year. Excluding the impact of dispositions of $1.5 million, revenue from existing firms within the ICG declined by $25.9 million. Results in the ICG were driven by uncertainty facing the life insurance market during 2011.
Fees to principals. Fees to principals decreased $19.2 million in 2011 as compared with 2010. Included in ICG fees to principals for the year ended December 31, 2010 was stock-based compensation expense of $6.0 million related to the accelerated vesting of certain RSUs and an amortization expense of $2.0 million for those RSUs outstanding prior to the acceleration. Excluding the impact of these RSUs, fees to principals decreased, and the total compensation expense ratio remained relatively flat, due to a decline in incentive accruals and the overall decline in revenue.
Impairment of goodwill and intangible assets. Impairment of goodwill and intangible assets increased $9.5 million for the year ended December 31, 2011 as compared with the year ended December 31, 2010. The impairments in 2011 related to three firms that were disposed of in the third and fourth quarters of 2011, as well as three firms that are expected to be disposed of in the first quarter of 2012, and one anticipated management contract buyout in the first quarter of 2012.
Income (loss) from operations. Income (loss) from operations increased $259.2 million for 2010 as compared with 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
Commissions and fees. Commissions and fees expense increased $5.2 million in 2010 compared with 2009. The commission expense ratio was 23.6% in 2010 compared with 21.2% in 2009. The increase corresponded to an increase in revenue generated by those businesses within the ICG that typically have higher commission expense ratios, offset by the decline in commissions and fees expense of $4.0 million relating to dispositions.
Fees to principals. Fees to principals increased $5.5 million in 2010 compared with 2009. Included in ICG fees to principals for the year ended December 31, 2010 was stock-based compensation expense of $6.0 million related to the accelerated vesting of certain RSUs and an amortization expense of $2.0 million for those RSUs outstanding prior to the acceleration, partially offset by a decrease in incentive plan accruals of $4.0 million over the prior period. Excluding the impact of this accelerated vesting, fees to principals decreased and the total compensation expense ratio remained relatively flat. Increases in fees due to the restructuring of certain management agreements, as well as the year-over-year increase in stock-based compensation relating to the EIP, were offset by decreases in the PIP expense for the year. The EIP was in place in November 2009, and was terminated in September 2010.
Non-compensation expense. Non-compensation expense decreased $9.6 million in 2010 compared with 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.
Depreciation. Depreciation expense decreased $4.3 million, or 48.9%, to $4.5 million in 2010 compared with $8.8 million in 2009. The decrease in depreciation resulted from dispositions, and from the acceleration of depreciation expense on certain items related to the sublet of one of the floors of the Company’s headquarters in 2009.
Impairment of goodwill and intangible assets. Impairment of goodwill and intangible assets decreased $263.1 million in the year ended December 31, 2010 compared with the prior year. The decline in impairments was driven by the significant impairment in the first quarter of 2009. 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 the prior year period, and discount rates that were risk adjusted to reflect both company-specific and market-based credit spreads and other relevant market data. Among other significant factors, the market value in the prior year period reflected the stressed macroeconomic environment and its impact on the Company’s sales.
Gain on sale of businesses. During the year ended December 31, 2010, the ICG recognized a net gain from the disposition of seven subsidiaries and the sale of certain assets of another business for a total gain of $2.2 million. During the year ended December 31, 2009, the ICG recognized a net gain of $2.1 million from the disposition of 20 businesses and the sale of certain assets of 9 businesses.
The ASG accounted for 24.6%, 22.0% and 18.0% of NFP’s revenue for the years ended December 31, 2011, 2010 and 2009, respectively. The financial information below relates to the ASG for the periods presented (in millions):
Depreciation. Depreciation expense increased $0.8 million for the year ended December 31, 2011, as compared with last year. The increase in depreciation resulted from increases in capital expenditures for the ASG due to enhancements in technology offerings provided to advisors. As a percentage of revenue, depreciation expense was less than 1% in both the years ended December 31, 2011 and 2010.
Income from operations. Income from operations increased $5.3 million in the year ended December 31, 2010 compared with the year ended December 31, 2009. The increase in income from operations was due to an increase in revenue and a decline in compensation expense-employees, offset by an increase in commissions and fees expense and non-compensation expense.
Compensation expense-employees. Compensation expense-employees decreased $0.7 million in 2010 compared with 2009. The total 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-employees declined commensurate with headcount reductions in 2009.
Depreciation. Depreciation expense increased $0.3 million in the year ended December 31, 2010 compared with $1.1 million in 2009. The increase in depreciation resulted from increases in capital expenditures for the ASG due to enhancements in technology offerings provided to advisors. As a percentage of revenue, depreciation expense was less than 1% in both the years ended December 31, 2010 and 2009.
The financial information below relates to items not allocated to any of NFP’s three reportable segments for the periods presented (in millions):
Interest income. Interest income increased $0.7 million in the year ended December 31, 2010 compared with the year ended December 31, 2009. Interest income increased mainly due to interest income from an increase in promissory notes entered into by NFP with its principals that were not in place during the corresponding prior year period. The notes were primarily related to dispositions.
On February 6, 2012, NFP’s Board authorized a new repurchase of up to $50.0 million of NFP’s common stock on the open market, at times and in such amounts as management deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors, including the limitations under the 2010 Credit Facility, capital availability, share price and market conditions.
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. Funds held in these accounts are invested in cash, cash equivalents and securities purchased under resale agreements overnight. At December 31, 2011, the Company had cash, cash equivalents and securities purchased under resale agreements in premium trust accounts listed as fiduciary funds on its balance sheet of $75.5 million, a decrease of $7.1 million from the balance of $82.6 million as of December 31, 2010, offset by a corresponding premium payable to carriers of $74.1 million at December 31, 2011 compared with $83.1 million at December 31, 2010. Changes in these accounts are the result of timing of payments collected from insureds on behalf of insurance carriers.
During the year ended December 31, 2010, cash used in investing activities was $9.7 million, which was primarily due to contingent consideration payments of $13.3 million and $12.4 million paid for purchases of property and equipment. These amounts were offset by $5.7 million in proceeds from the sale of businesses and NFPSI’s release of $10.0 million in restricted cash, which was no longer required upon termination of the 2006 Credit Facility.
On November 5, 2008, NFP’s Board suspended NFP’s quarterly cash dividend. The declaration and payment of future dividends to holders of NFP’s common stock will be at the discretion of NFP’s Board and will depend upon many factors, including the Company’s financial condition, earnings, legal requirements, and other factors as NFP’s Board deems relevant. Additionally, the 2010 Credit Facility contains customary covenants that require NFP to meet certain conditions before making restricted payments such as dividends.
As of December 31, 2011, 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.
All of the Company’s 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. In connection with these acquisitions, the Company records the estimated value of the net tangible assets purchased and the value of the identifiable intangible assets purchased, which typically consist of book of business, management contracts, and non-compete agreements.
Non-Compete Agreement: In certain deals where a management contract structure is not in place, the non-compete agreements included in the employment contracts of employees are measured and recorded as an intangible asset separate from goodwill. The useful life of a non-compete agreement is primarily a function of the contractual terms of the agreement. Non-compete agreements are valued based on their duration and any unique features of particular agreements.
Long-lived assets, such as purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company establishes an internal financial plan for each of its business lines and measures the actual performance of its business lines against these financial plans. Events or changes in circumstances include, but are not limited to, when a business line experiences a significant deterioration in its operating cash flow compared to the financial plan or prior year performance, a change in the extent or manner in which the long-lived asset is being used, or a current expectation that, more likely than not, a long-lived asset will be sold or otherwise disposed of before the end of its previously estimated useful life.
A two-step impairment test is performed on goodwill for reporting units that demonstrate indicators of impairment. In the first step, NFP compares the fair value of each reporting unit to the carrying value of the net assets assigned to that reporting unit. NFP determines the fair value of its reporting units by blending two valuation approaches: the income approach and a market value approach. In order to determine the relative fair value of each of the reporting units the income approach is conducted first. These relative values are then scaled to the estimated market value of NFP.
Additional contingent consideration may be paid to the former owners of the business upon the satisfaction of certain compounded growth rate thresholds over the three-year period generally following the closing of the acquisition, or over a shorter, negotiated period. NFP has incorporated contingent consideration, or earn-out, provisions into the structure of acquisitions since the beginning of 2001.
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 applicable NFP business. In some cases, fees earned are based on the amount of assets under administration or advisement. Asset-based fees are earned for administrative services or consulting related to certain benefits plans. 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. 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. 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, 2011, 2010 and 2009, 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 commissions paid by insurance underwriters and are based on the estimated profit and/or overall volume of business placed with the underwriter. Contingent commissions are recorded as revenue after the contractual period or when cash is received.
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. The Company also earns income in certain foreign countries, and this income is subject to the laws of taxing jurisdictions within those countries, as well as U.S. federal and state tax laws. Deferred tax assets and liabilities are measured using statutorily-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.
As of December 31, 2011, the Company has provided $2.7 million of deferred taxes, net of applicable foreign tax credits, relating to 2011 and prior earnings outside the United States that are not deemed indefinitely reinvested. The Company continues to evaluate whether to indefinitely reinvest earnings in certain foreign jurisdictions as it continues to analyze its global financial structure. Currently, management intends to continue to reinvest earnings in Canadian jurisdictions indefinitely, and therefore has not recognized U.S. income tax expense on these earnings. The U.S. federal and state income taxes, net of applicable credits, on these Canadian unremitted earnings would have an immaterial impact on the Company’s deferred tax liability related to foreign unremitted earnings as of December 31, 2011.
The Company has not issued stock-based awards to its principals since the accelerated vesting date of the RSUs awarded under the EIP. All stock-based awards that were previously issued to the Company’s principals are classified as liability awards, as principals are non-employees. The Company previously measured the fair value of the liability stock-based awards at the earlier of the date at which the performance was completed or when a performance commitment had been reached. The Company’s stock-based awards to principals did not have disincentives for non-performance other than forfeiture of the award by the principals and therefore the Company measured the fair value of the award when the performance was completed by the principal, which was the completion of the vesting period. The Company accounted for liability classified stock-based awards issued to its principals as part of fees to principals expense in the consolidated statements of operations. Liability classified stock-based compensation was adjusted each reporting period to account for subsequent changes in the fair value of NFP’s common stock. The offsetting entry was to accrued liabilities. As of December 31, 2011, the Company does not have any outstanding liability awards. 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 was $0.2 million for the years ended December 31, 2011 and 2010 and $0.6 million for the year ended December 31, 2009. As of December 31, 2011, an aggregate of 2,804,297 shares of NFP common stock were available for issuance under the ESPP.