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 included elsewhere in this report. We derived the following selected financial information as of and for each of the three years in the period ended December 31, 2003 from our audited consolidated financial statements and the related notes included elsewhere in this report. We derived the selected financial information as of and for each of the two years in the period ended December 31, 2000 from our audited consolidated financial statements and the related notes not included elsewhere in this report.
We adopted SFAS No. 144 on January 1, 2002. In accordance with SFAS No. 144, long-lived assets, such as property, plant and equipment and 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. We recognized an impairment loss on identifiable intangible assets subject to amortization of $1.0 million in 2002 and $4.2 million in 2003. Prior to the adoption of SFAS No. 144, we accounted for long-lived assets in accordance with SFAS No. 121. For the years ended December 31, 2000 and 2001, we recorded an impairment loss on intangibles subject to amortization of $1.4 million and $2.3 million, respectively.
growth rate calculation at the time of the merger, the combined firm continues to be included in the calculation after the merger. With respect to the sub-acquisitions described above, to the extent the sub- acquired firm does not separately report financial statements to NFP, the acquiring firm is excluded from the calculation from the time of the sub-acquisition until the first fiscal quarter beginning one year following the sub-acquisition. Sub-acquisitions that represent less than 25% of the base earnings of the acquiring firms are considered to be internal growth. For further information about sub-acquisitions, see “Business-Operations-Sub-Acquisitions.” With respect to dispositions, we include these firms up to the time of disposition and exclude these firms for all periods after the disposition. The calculation described above is not adjusted for intercompany transactions that result in the same item of revenue being recorded by two firms.
The following discussion should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this report. In addition to historical information, this discussion includes forward-looking information that involves risks and assumptions which could cause actual results to differ materially from management’s expectations. See “Forward-Looking Information” included elsewhere in this report.
We are a leading independent distributor of financial services products primarily to high net worth individuals and growing entrepreneurial companies. Founded in 1998, and commencing operations on January 1, 1999, we have grown internally and through acquisitions and, as of December 31, 2003, operate a national distribution network with over 1,400 producers in 40 states and Puerto Rico operating through 130 owned firms and 181 affiliated third-party distributors. We acquired 18, 26 and 24 firms in 2001, 2002 and 2003, respectively. Our net income has grown from a net loss of $(10.5) million in 1999 to net income of $23.5 million in 2003. As a result of new acquisitions and the growth of previously acquired firms, we have grown from a base of no revenue at the beginning of 1999 to $479.6 million of revenue in 2003.
Our gross margin is offset by expenses that we incur at the corporate level, including corporate and other expenses. Corporate and other expenses have grown from $36.5 million in 1999 to $59.4 million in 2003. Corporate and other expenses include general and administrative expenses, which are the operating expenses of our corporate headquarters. General and administrative expenses have grown from $10.5 million in 1999 to $24.4 million in 2003. General and administrative expenses as a percent of revenue declined from 10.4% in 1999 to 5.1% in 2003.
• all future earnings of the acquired business in excess of the base earnings up to target earnings; and
• a percentage of any earnings in excess of target earnings based on the ratio of base earnings to target earnings.
• Life insurance commissions and estate planning fees. Insurance and annuity commissions paid by insurance companies are based on a percentage of the premium that the insurance company charges to the policyholder. First-year commissions are calculated as a percentage of the first twelve months’ premium on the policy and earned in the year that the policy is originated. In many cases, our firms receive renewal commissions for a period following the first year, if the policy remains in force. Our firms also earn fees for developing estate plans.
Our firms also earn additional compensation in the form of incentive revenue, including override payments, from manufacturers of financial services products, based on the volume, persistency and profitability of business generated by us from these three sources. These forms of payments are earned both with respect to sales by our owned firms and sales by our network of 181 affiliated third-party distributors.
Although our operating history is limited, management believes that our firms earn approximately 65% to 70% of their revenue in the first three quarters of the year and approximately 30% to 35% of their revenue in the fourth quarter.
cash flow of the acquired firm through management fees. However, when income is generated by a non-principal producer, the producer is generally paid a portion of the commission income, which is reflected as commission expense of the acquired firm. The use of non-principal producers affords principals the opportunity to expand the reach of the business of a firm beyond clients or customers with whom they have direct contact. In addition, NFPSI pays commissions to our affiliated third-party distributors who transact business through NFPSI.
Management fees. We pay management fees to the principals of our firms and/or certain entities they own based on the financial performance of the firms they manage. Once we receive cumulative preferred earnings (base earnings) from a firm, the principals and/or an entity the principals own receive 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, we receive 40% of earnings in excess of target earnings and the principal and/or the entity receives 60%. Management fees also include an accrual for certain performance-based incentive amounts payable under our ongoing incentive program. See “Business-Acquisition Model-Performance incentives.”
General and administrative. At the corporate level, we incur general and administrative expense related to the acquisition of and administration of our firms. General and administrative expense includes compensation, occupancy, professional fees, travel and entertainment, technology, telecommunication, advertising and marketing costs. Option compensation expense is disclosed separately.
Option compensation. Option compensation expense consists primarily of expenses related to stock option grants under two incentive programs offered to the principals and certain employees of our earlier acquisitions.
Amortization. We incur amortization expense related to the amortization of intangible assets. Prior to January 1, 2002, we also incurred costs for amortization of goodwill.
Impairment of goodwill and intangible assets. The firms we acquire may not continue to positively perform after the acquisition for various reasons, including legislative or regulatory changes that affect the products in which a firm specializes, the loss of key clients after the acquisition closed, general economic factors that impact a firm in a direct way and the cultural incompatibility of an acquired firm’s management team with us. In such situations, we may take impairment charges in accordance with SFAS No. 142 and SFAS No. 144 and reduce the carrying cost of acquired identifiable intangible assets (including book of business, management contract and tradename) and goodwill to their respective fair values. Management reviews and evaluates the financial and operating results of our acquired firms on a firm-by-firm basis throughout the year to assess the recoverability of goodwill and other intangible assets associated with these firms. The fair value is based upon the amount at which the acquired firm could be bought or sold in a current transaction between NFP and the principals. The intangible assets associated with a particular firm may be impaired when the firm has experienced a significant deterioration in its business indicated by an inability to produce at the level of base earnings for a period of four consecutive quarters and when the firm does not appear likely to improve its operating results or cash flows in the foreseeable future. Management believes that this is an appropriate time period to evaluate firm performance given the seasonal nature of many firms’ activities. In assessing the recoverability of goodwill and other intangible assets, historical trends are used and projections regarding the estimated future cash flows and other factors are made to determine the fair value of the respective assets.
Loss (gain) on sale of subsidiaries. From time to time, we have disposed of acquired firms when these firms have not produced the expected results. In these dispositions, we may realize a gain or loss on the sale of the subsidiary.
Net income. Net income increased $11.9 million, or 102.6%, to $23.5 million in 2003 compared with $11.6 million in 2002. The increase in 2003 was largely due to acquisitions and the internal growth of our firms and was partially offset by impairment of goodwill and intangible assets, loss on sale of subsidiaries and an increase in general and administrative expenses.
Commissions and fees. Commissions and fees expense increased $22.0 million, or 21.0%, to $126.8 million in 2003 compared with $104.8 million in 2002. The increase was principally due to business generated by firms which were acquired in 2002 and in 2003. As a percentage of revenue, commissions and fees expense decreased to 26.4% in 2003 from 29.0% in 2002. The decline as a percentage of revenue was attributable to lower commission expense as a percentage of revenue at newly acquired firms as well as a reduction in the commission payout rate at our broker-dealer, NFPSI. Commissions and fees expense from new acquisitions were approximately $5.4 million in 2003. Commissions and fees expense from existing firms were approximately $121.4 million in 2003 compared with $104.7 million in 2002.
General and administrative. General and administrative expenses increased $3.0 million, or 14.0%, to $24.4 million in 2003 compared with $21.4 million in 2002. The increase reflects additional expenses associated with operating as a public company, including increased directors and officers liability insurance premiums, costs associated with stockholder services, as well as higher accrued incentive compensation. As a percentage of revenue, general and administrative expense declined to 5.1% in 2003 compared with 5.9% in 2002, as we continue to benefit from the absorption of corporate expenses over an expanding revenue base.
Amortization. Amortization increased $3.2 million, or 24.1%, to $16.5 million in 2003 compared with $13.3 million in 2002. Amortization expense increased as a result of a 13% increase in net intangible assets resulting primarily from acquisitions consummated in 2003. As a percentage of revenue, amortization was 3.4% in 2003 compared with 3.7% in 2002.
Net income. Net income increased $17.3 million to $11.6 million in 2002 compared with a loss of $5.7 million in 2001. The increase was due primarily to the growth in revenue and expenses as a result of acquisitions and internal growth of our firms and a decline in amortization expense and option compensation expense.
Commissions and fees. Commissions and fees revenue increased $83.0 million, or 29.8%, to $361.1 million in 2002 compared with $278.1 million in 2001. The increase was from business generated by firms that were acquired in 2001 and 2002 as well as an increased volume of business from existing firms. Commissions and fees from new acquisitions was approximately $58.1 million in 2002. Commissions and fees from existing firms was approximately $303.0 million in 2002, an increase of $24.9 million, or 9.0%, from $278.1 million in 2001.
General and administrative. General and administrative expense increased $0.9 million, or 4.4%, to $21.4 million in 2002 compared with $20.5 million in 2001. The growth in general and administrative expenses remains well below the growth rate in total revenue. The increase was due primarily to increased costs associated with our cash management system that was fully implemented during 2002 and to increased costs of professional fees. General and administrative expense as a percentage of revenue was 5.9% in 2002 compared with 7.4% in 2001.
Option compensation. Option compensation expense decreased $10.1 million, or 50.5%, to $9.9 million in 2002 compared with $20.0 million in 2001. The decrease was due to the completion in 2001 and 2002 of the option measurement periods for the principals of 12 and 15 of the 27 founding firms, respectively, that earned options with a $10.00 exercise price under the first option incentive program. As a percentage of revenue, option compensation expense declined to 2.7% in 2002 from 7.2% in 2001.
Interest and other expense. Interest and other expense remained consistent from 2002 compared with 2003. During 2003, we incurred higher interest expense due to higher average borrowings under our line of credit, which was offset in part by lower interest rates on our borrowings, and a decrease in other expenses, none of which was significant.
Income tax expense. Income tax expense increased $11.2 million to $13.1 million in 2002 compared with $1.9 million in 2001. The increase was due to higher taxable income. Our effective tax rate was higher than the statutory rate. The effective tax rate differs from the provision calculated at the federal statutory rate primarily because of the amortization of nondeductible goodwill, disposal of subsidiaries, the effects of state and local taxes and certain other expenses not deductible for tax purposes. We file over 400 returns in 39 tax jurisdictions in the United States and, as a result, make estimates as to the apportionment of taxable income to each jurisdiction. Our overall tax rate can change due to the acquisition of firms in jurisdictions with varying state and local tax rates. In 2002, we recorded an accrual of $2.1 million representing the difference between the final aggregate state and local taxes and those previously estimated and accrued.
As of December 31, 2003, we had cash and cash equivalents of $71.2 million, an increase of $39.4 million from the balance as of December 31, 2002 of $31.8 million. As of December 31, 2002, we had cash and cash equivalents of $31.8 million, a decrease of $3.6 million from the balance of $35.4 million as of December 31, 2001. The increase in cash and cash equivalents during 2003 was due to net cash proceeds of $86.4 million provided by the sale of 4.3 million shares of common stock through our initial public offering in September 2003 and cash provided by operations, offset by $39.5 million in repayments of borrowings under our credit facility. The decrease in cash and cash equivalents during 2002 resulted from investments in acquisitions and capital spending which were partially offset by the increase in cash provided by operations and additional borrowings under the credit facility. In 2001 the increase in cash and cash equivalents of $3.0 million resulted from the combination of a reduction in net loss for the period plus borrowings under the credit facility exceeding amounts invested in acquisitions and capital spending.
The credit facility contains various customary restrictive covenants prohibiting us and our subsidiaries, subject to various exceptions, among other things, from (i) incurring additional indebtedness or guarantees, (ii) creating liens or other encumbrances on our property or granting negative pledges, (iii) entering into a merger or similar transaction, (iv) selling or transferring any of our property except in the ordinary course of business, (v) making dividend and other restricted payments and (vi) making investments. In addition to the foregoing, the credit facility contains financial covenants requiring us to maintain a minimum interest coverage ratio and a minimum amount of Adjusted EBITDA (as defined in the credit agreement) and a maximum consolidated leverage ratio. As of December 31, 2003, we were in compliance with all covenants under the credit facility.
We advance management fees monthly to principals and/or certain entities they own for up to nine months while monitoring the performance of the firms to determine if the actual earnings are on track to meet or exceed target earnings. If earnings are not equal to or greater than pro rata target earnings, we cease to pay or reduce the management fee advance. If an overadvance of a management fee exists, the principal and/or such entities are expected to repay the advance within thirty days of the end of the calendar year. If a principal and/or such entities
Effective January 1, 2001, a second acquisition bonus program was implemented (“second bonus program”), which replaced the first bonus program for eligible acquisitions closed on or after January 1, 2001. The new program is for the same founding officers and directors that were eligible for the first bonus program as well as certain outside consultants. These individuals are eligible to receive payments of: (i) 6% of base earnings of an acquisition at the close of a transaction, paid in cash and (ii) 2% of the base earnings on an annual basis for each of the first three years following the close of the transaction, subject to the acquired firm’s achieving target earnings in each year, or cumulatively as of each anniversary of the acquisition, also paid in cash. The amount
Our $90 million credit facility provides for the issuance of letters of credit on our behalf, provided that, after giving effect to the letters of credit, our available borrowing amount is greater than zero. The maximum amount issuable under letters of credit that is permitted by our credit facility is $10 million. As of December 31, 2003 and 2002, we were contingently obligated for letters of credit in the amount of $2.5 million and $2.2 million, respectively.
satisfaction of certain compounded growth rate thresholds over the three-year period following the closing of the acquisition. In some cases, contingent consideration may be payable after shorter periods. As of December 31, 2003, 67 acquisitions include contingent consideration features.
Contingent consideration payable for acquisitions consummated in 2001 would generally be payable by the end of 2004. Similarly, contingent consideration payable for acquisitions consummated in 2002 would be payable by the end of 2005. We currently anticipate using contingent consideration arrangements in future acquisitions, which would result in an increase in the maximum contingent consideration amount in 2006 and thereafter.
The maximum contingent consideration is generally payable upon a firm achieving a 35% rate of growth, or higher, in earnings during the first three years following acquisition. The payments of purchase consideration are generally made in cash and our common stock (based on the market price of our common stock for the twenty trading days up to and including the end of the period), in proportions that vary among acquisitions. Contingent firm employee payments are payable in cash.
report information about operating segments in financial statements. It also establishes standards for related disclosures about products and services, geographic areas and major customers. In accordance with the provisions of SFAS No. 131, we have determined that we operate in a single segment entirely within the United States of America.
Accumulated amortization on the intangible assets and goodwill, including impairment loss, at December 31, 2001, 2002 and 2003 was $39.7 million, $53.7 million and $80.1 million, respectively.
On January 1, 2002, we adopted SFAS No. 144. In accordance with SFAS No. 144, long-lived assets, such as property and equipment and 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. We recognized an impairment loss on identifiable intangible assets subject to amortization of $1.0 million and $4.2 million for the years ended as of December 31, 2002 and 2003, respectively.
Our firms earn commissions related to the sale of securities and certain investment-related insurance products. Our firms also earn fees for offering financial advice and related services. These fees are based on a percentage of assets under management and are generally paid quarterly. In certain cases, incentive fees are earned based on the performance of the assets under management. Some of our firms charge flat fees for the development of a financial plan or a flat fee annually for advising clients on asset allocation. Any investment
Our firms earn additional compensation in the form of incentive and marketing support revenue, including override payments, from manufacturers of financial services products, based on the volume, persistency and profitability of business they generate. Incentive and marketing support revenue is recognized when earned, which is typically when payment is received.
Option awards to non-employees, including principals, are accounted for under SFAS No. 123. Fair value is determined using the Black-Scholes option-pricing method.
In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others,” an interpretation of FASB Statement Nos. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. FASB Interpretation No. 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. FASB Interpretation No. 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial
See Financial Statements and Financial Statement Index commencing on Page hereof.