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 and the revenue derived from businesses fully disposed of for the first twelve months after the respective transaction. 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 in making the organic growth comparison.
NFP enhances its competitive position by offering its clients a broad array of insurance and financial solutions. NFP’s continued investments in marketing, compliance and product support provide its independent advisors with the resources to deliver strong client service. NFP believes its operating structure allows its businesses to effectively and objectively serve clients at the local level while having access to the resources of a national company. NFP’s senior management team is composed of experienced insurance and financial services leaders. The Company’s employees and principals who manage the day-to-day operations of NFP’s businesses are professionals who are well positioned to understand client needs.
The Company earns revenue that consists primarily of commissions and fees earned from the sale of benefits, insurance and wealth management products and services to its clients. The Company also incurs commissions and fees expense and compensation and non-compensation expense in the course of earning revenue. The Company refers to revenue earned by the Company’s businesses less the operating expenses of its
businesses and allocated shared expenses associated with shared corporate resources as income (loss) from operations. The Company’s operating expenses include commissions and fees, compensation expense-employees, fees to principals, non-compensation expense, amortization of intangibles, depreciation, impairment of goodwill and intangible assets, (gain) loss on sale of businesses, net, change in estimated acquisition earn-out payables and management contract buyout.
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 generally 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 not necessarily comparable from period to period because they are dependent on the outcome of specific transactions. The Company uses Adjusted EBITDA as a measure of operating performance (on an individual business line, segment and consolidated basis); for planning purposes, including the preparation of budgets and forecasts; as the basis for allocating resources to enhance the performance of the Company; to evaluate the effectiveness of its business strategies; as a factor in shaping the Company’s acquisition activity; and as a factor in determining compensation and incentives to employees.
obligations; and a $17.3 million expense for four management contract buyouts. Compensation expense-employees also increased within the CCG, due to acquisitions that had no comparable operations in 2011. The decrease in income from operations was partially offset by an overall increase in revenue.
Adjusted EBITDA for the year ended December 31, 2012 was $141.0 million, compared to $126.4 million for the year ended December 31, 2011, an increase of 15.2%. As a percentage of revenue, the Adjusted EBITDA margin for the year ended December 31, 2012 was 13.3% compared to 12.5% in the prior year. CCG Adjusted EBITDA increased with revenue growth from existing businesses as well as from newly-acquired businesses that had no comparable operations in 2011. ICG Adjusted EBITDA decreased as declines in commissions and fees expense and non-compensation expense were more than offset by an increase in fees to principals expense, compensation expense-employees and a decline in revenue, related to dispositions. ASG Adjusted EBITDA increased as lower commission payouts were partially offset by lower revenue.
Overview of the year ended December 31, 2011 compared with the year ended December 31, 2010
During the year ended December 31, 2011, revenue increased $31.5 million, or 3.2%, as compared to the year ended December 31, 2010. The revenue increase was driven by revenue increases within the ASG and CCG of $34.6 million and $24.3 million, respectively, and offset by a revenue decrease of $27.4 million within the ICG. Results in the CCG included commissions and fees revenues of $15.2 million from acquisitions in 2011 that had no comparable operations in 2010, notably in the property and casualty business line. After the impact from divested businesses of $4.4 million, the remaining net increase of $13.5 million represented growth within existing firms in the CCG, driven by new clients and product sales. Results in the ICG were impacted by challenging conditions in the life insurance market, particularly with respect to transactions involving high net worth individuals. Excluding the impact of dispositions, revenue from existing firms within the ICG declined by $25.9 million. ASG revenue benefited in particular from the sale of 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 fees are generally paid each year as long as the client continues to use the product and maintains its broker of record relationship. 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 value 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. Through the property and casualty business line, the CCG offers property and casualty insurance brokerage and consulting services for which it earns commissions and fees. These fees are paid each year as long as the client continues to use the product and maintains its broker of record relationship.
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, including incentive fees, are recognized when all contractual obligations have been satisfied. Most NFP businesses and members of NFP’s marketing and wholesale organizations conduct securities or investment advisory business through NFPSI.
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.
Fees to principals. NFP pays fees to principals and/or Management Companies based on the financial performance of the business they manage. From a cash perspective, NFP may advance monthly fees to principals that have not yet been earned due to the seasonality of the earnings of certain subsidiaries, particularly with respect to life insurance businesses. NFP typically pays a portion of the fees to principals monthly in advance. Once NFP receives its cumulative preferred earnings, or base earnings, the principals and/or Management Company will earn fees to principals equal to earnings above base earnings up to target earnings. Additional fees to principals are 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 receive 60%. As the Company moves towards a more integrated business model, where the former owners of the acquired business become employees instead of principals, such ratios of base to target earnings will be proportionately impacted and become less meaningful.
The Company accounts for stock-based awards to principals as part of fees to principals expense in the consolidated statements of income 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 Management Companies under the terms of the management contract for capital expenditures 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. Since the ASG is primarily comprised of NFPSI, NFP’s registered broker-dealer and investment advisor, no fees to principals are paid in this segment.
Depreciation. The Company incurs depreciation expense related to capital assets, such as investments in technology, office furniture and equipment, as well as amortization for its leasehold improvements. Depreciation expense related to the Company’s businesses as well as allocated amounts related to corporate shared services are recorded within this line item.
Impairment of goodwill and intangible assets. The Company evaluates its amortizing (long-lived assets) and non-amortizing intangible assets for impairment in accordance with U.S. GAAP. See “Note 1-Summary of Significant Accounting Policies” and “Note 15-Goodwill and Other Intangible Assets” to the Company’s Consolidated Financial Statements contained in this report.
Change in estimated acquisition earn-out payables. The recorded purchase price for all acquisitions consummated after January 1, 2009 includes an estimation of the fair value of liabilities associated with any potential earn-out provisions. Subsequent changes in the fair value of these estimated earn-out obligations are recorded in the consolidated statements of income in each reporting period.
Management contract buyout. In management contract buyouts, NFP either purchases the Management Company, or purchases a principal’s economic interest in the management contract, in either scenario acquiring a greater economic interest in the cash flows of the underlying business than it had prior to the management contract buyout. The principals who enter into the management contract buyouts with NFP generally become employees who are party to employment contracts and are subject to certain non-competition and non-solicitation covenants during the term of the employment contract and for a period thereafter. The acquisition of this greater economic interest is treated for accounting purposes as the settlement of an executory contract and expensed in the consolidated statements of income.
The Company paid $10.7 million in cash in 2010, included within fees to principals expense, relating to an incentive plan for the 12-month performance period ending September 30, 2010 (the “2010 PIP”). The 2010 PIP was established such that the greater a business’s earnings growth rate exceeded its performance target rate for the 12-month performance period, the higher the percentage of the business’s earnings growth the Company would pay under the 2010 PIP.
The CCG accounted for 44.1%, 40.7% and 39.5% of NFP’s revenue for the years ended December 31, 2012, 2011 and 2010, respectively. The financial information below relates to the CCG for the periods presented (in thousands, except for percentages):
Income from operations. Income from operations decreased $16.1 million for the year ended December 31, 2012 as compared to the year ended December 31, 2011. Income from operations decreased due to an overall increase in operating expenses, in particular operating expenses due to management contract buyouts and the impairments associated with them, for which there were no comparable expenses in the prior period, as well as increases in compensation expense-employees, commissions and fees expense, non-compensation expense and change in estimated acquisition earn-out payables largely due to acquisitions. These increases in expenses were partially offset by an overall increase in commissions and fees revenue.
Commissions and fees. Commissions and fees expense increased $8.3 million in 2012 compared with 2011, of which approximately $1.7 million represented commissions and fees expense from the net impact of acquisitions and dispositions affecting the current period. Excluding this impact, overall commissions and fees expense in the CCG increased by $6.6 million and was largely attributable to the growth in businesses with higher commission expense ratios, certain management contract buyouts and restructures, in which fees to principals expense was converted into commissions and fees expense.
Fees to principals. Fees to principals decreased $4.7 million in 2012 compared with 2011. Approximately $0.3 million of the decrease was due to fees to principals from the net impact of acquisitions and dispositions affecting the current period. The remaining decrease of $4.4 million is a result of management contract buyouts and restructures, in which fees to principals expense was converted into commissions and fees expense and compensation expense-employees.
The non-compensation expense ratio was 17.8% for the year ended December 31, 2012 compared with 18.1% for the year ended December 31, 2011.
Amortization of intangibles. Amortization expense increased as a result of a net 4.8% increase in amortizing intangibles, primarily from acquisitions.
Impairment of goodwill and intangible assets. The impairment of goodwill and intangible assets of $7.8 million in 2012 related to four management contract buyouts.
Income from operations. Income from operations increased $5.1 million for the year ended December 31, 2011 as compared to the year ended December 31, 2010. Income from operations increased primarily due to an increase in revenue, driven by both newly-acquired businesses and growth at existing businesses, an increase to the change in estimated acquisition earn-out payables, as well as decreases in fees to principals, non-compensation expense and impairments. These factors were partially offset by increases in commissions and fees expense and compensation expense-employees.
Income from operations. Income from operations decreased $10.7 million in 2012 compared with 2011. The decrease in income from operations was due to an overall increase in operating expenses, in particular operating expenses due to impairments of goodwill and intangible assets, fees to principals and compensation expense-employees, and a decrease in commissions and fees revenue. These changes were partially offset by a gain on sale of businesses, net and decreases in non-compensation expense, commissions and fees expense and amortization of intangibles expense.
Commissions and fees. Commissions and fees revenue decreased $2.4 million in 2012 compared with 2011. Excluding the impact of dispositions of $11.6 million, revenue from existing businesses within the ICG increased by $9.2 million. Excluding this impact, results in the ICG were impacted by stronger sales in the high net worth life insurance market during the fourth quarter and stronger performance in the ICG’s wealth management business line.
Compensation expense-employees. Compensation expense-employees increased $1.2 million in 2012 compared with 2011. Excluding the impact from dispositions of $3.0 million and the reversal of previously-recognized expenses related to certain RSUs of $2.1 million, compensation expense-employees increased by $6.3 million due to increases in headcount in certain businesses and variable compensation paid to employees within performing businesses.
Amortization of intangibles. Amortization expense declined $2.0 million in 2012 compared with 2011. Amortization expense declined as a result of a 24.5% decrease in amortizing intangible assets resulting primarily from dispositions and impairments.
Fees to principals. Fees to principals decreased $19.2 million in 2011 as compared with 2010. Included in 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.
Gain on sale of businesses. During the year ended December 31, 2011, the ICG recognized a net gain from the disposition of two subsidiaries of $1.1 million. 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.
Year ended December 31, 2012 compared with the year ended December 31, 2011
Compensation expense-employees. Compensation expense-employees increased $0.7 million for the year ended December 31, 2012 compared with 2011 due to increases in salaries as well as headcount. The total compensation expense ratio was 6.9% for the year ended December 31, 2012 and 6.5% for the year ended December 31, 2011.
Depreciation. Depreciation expense increased $0.5 million for the year ended December 31, 2012, as compared with 2011. The increase in depreciation resulted from increases in capital expenditures for the ASG due to enhancements in the technology platform provided to advisors.
Commissions and fees. Commissions and fees expense increased $29.1 million for the year ended December 31, 2011 as compared to the prior year. The increase in commissions and fees expense was attributable to the increase in revenue.
Depreciation. Depreciation expense increased $0.8 million for the year ended December 31, 2011, as compared with the prior 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.
Interest income. Interest income decreased $1.1 million in the year ended December 31, 2012 as compared to the year ended December 31, 2011. Interest income decreased mainly due to the satisfaction of certain promissory notes.
Other, net. Other, net, which primarily consists of income from equity method investments, rental income and net expenses relating to the settlement or reserving of legal matters, decreased $1.4 million for the year ended December 31, 2012 as compared to the year ended December 31, 2011. The decrease in other, net was due to a decrease in income from equity method investments of $1.4 million, as the Company acquired the controlling interest of Nemco Group, LLC in the beginning of the second quarter of 2012.
Interest expense. Interest expense decreased $2.8 million for 2011 as compared to 2010. Interest expense decreased primarily due to NFP’s 2010 refinancing, which involved terminating NFP’s prior credit facility among NFP, the lenders party thereto and Bank of America, N.A., as administrative agent (as amended, the “2006 Credit Facility”) and entering into the 2010 Credit Facility, as well as retiring NFP’s 0.75% convertible senior notes due February 1, 2012 (the “2007 Notes”) and issuing the 2010 Notes. Interest expense accretion declined from $8.3 million during the year ended December 31, 2010 to $4.3 million for the year ended December 31, 2011. The decline in interest expense accretion was partially offset by an increase of $0.5 million relating to the higher coupon rate on NFP’s 2010 Notes and an increase in the average borrowings relating to the 2010 Credit Facility.
This historical borrowing pattern occurred in the first quarter of 2012. NFP borrowed from the 2010 Credit Facility in order to (i) pay consideration in connection with certain acquisitions and management contract buyouts during the first quarter of 2012, (ii) satisfy payables due to principals for fees and incentives earned by year-end 2011 and paid out during the first quarter of 2012, and (iii) complete the 2011 Share Repurchase Program.
The Company anticipates that its short/medium-term liquidity and capital needs have currently been addressed. Subsequent to December 31, 2012, NFP terminated the 2010 Credit Facility and entered into a new $325.0 million credit facility governed by the Credit Agreement, among NFP, the lenders party thereto and Bank of America, N.A., as administrative agent. See “Note 19-Subsequent Events.” As the Company’s financing needs evolve, as capital market conditions change or as the general economic environment fluctuates, NFP reviews its capital structure and its access to capital and the credit markets. Additionally, NFP may from time to time seek to retire or repurchase a portion of its outstanding 2010 Notes. Such refinancings, retirements or repurchases, if any, will depend on a variety of factors, including capital availability, market conditions and limitations under NFP’s credit facility.
During the year ended December 31, 2011, cash provided by operating activities was approximately $116.2 million compared with $119.4 million for the year ended December 31, 2010. The decrease in operating cash flow for the year ended December 31, 2011 as compared with the prior period was primarily due to a decrease in accounts payable related to commission payments on a particularly large transaction that was accrued for at December 31, 2010, offset by a decrease in notes receivable as cash collections on balances owed by principals have increased, and an increase in accrued liabilities, primarily relating to the alignment of the end of the PIP to the 2011 calendar year. During 2011 no PIP payments were made, whereas in the prior year, the Company paid PIP payments in the fourth quarter of 2010 as the initial PIP 12-month performance period ended September 30, 2010.
During the year ended December 31, 2012, cash used in financing activities was approximately $15.9 million compared with $55.8 million during the prior year period. Cash used in financing activities during the year ended December 31, 2012 consisted mainly of repurchases of common stock of $19.8 million, net payments on long-term borrowings under the 2010 Credit Facility of $12.5 million, payments on acquisition earn-out payables of $9.1 million and net payments for stock-based awards, including shares cancelled to pay withholding taxes, of $4.6 million, which were partially offset by net proceeds from revolver borrowings under the 2010 Credit Facility of $30.0 million.
During the year ended December 31, 2011, cash used in financing activities was approximately $55.8 million, while cash used in financing activities was $36.9 million during the prior year period. The primary uses of cash, during 2011, were the purchase of common stock of approximately $41.8 million, as well as repayments of $12.5 million under the 2010 Credit Facility.
Goodwill: Goodwill is the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed. In the case of NFP’s businesses, goodwill is expected to represent the value associated with workforce, management expertise, the value of future cash flow generated beyond the useful lives of the existing books of businesses and the management contract. If an earn-out payable is recorded, such liability would be an offset to an increase in goodwill.
The purchase of a Management Company or a principal’s economic interest in the management contract results in the termination of the management contract. The termination of the management contract is treated for accounting purposes as the settlement of an executory contract and the upfront consideration payment to each principal is expensed in the consolidated statements of income through management contract buyout.
Goodwill and intangible assets not subject to amortization are tested at least annually for impairment, and are tested for impairment more frequently if 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: (i) when a business line experiences a significant deterioration in its Adjusted EBITDA compared to its financial plan or prior year performance, (ii) loss of key personnel, (iii) a decrease in NFP’s market capitalization below its book value or (iv) 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.
If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that reporting unit, goodwill is not impaired and NFP is not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying value of the goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in a manner that is consistent with the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit.
See “Note 15-Goodwill and Other Intangible Assets” to the Company’s Consolidated Financial Statements contained in this report.
For acquisitions completed after January 1, 2009, earn-out payables are recorded at fair value at the acquisition date and are included on that basis in the purchase price consideration at the time of the acquisition. Subsequent changes in the fair value of earn-out obligations are recorded in the consolidated statements of income when incurred. The fair value of earn-out payables is based on the present value of the expected future payments to be made to the sellers of the acquired businesses in accordance with the provisions outlined in the respective purchase agreements. In determining fair value of the earn-out, the acquired business’s future performance is estimated using financial projections for the acquired business developed by management. These are measured against performance targets specified in each purchase agreement. The fair value of the Company’s earn-out payables is established using a simulation model in a risk-neutral framework. For each simulation path, the earn-out payments are calculated and then discounted to the valuation date. The value of the earn-out is then estimated to be the arithmetic average of all simulation paths.
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, 2012, 2011 and 2010, that is periodically evaluated and adjusted as necessary. Miscellaneous commission adjustments are generally recorded
as they occur. 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 earns commissions related to the sale of securities and certain investment-related insurance products. The Company also earns fees for offering financial advice and related services. These fees are based on a percentage of assets under management and are generally paid quarterly. In certain cases, incentive fees are earned based on the performance of the assets under management. Some of the Company’s businesses charge flat fees for the development of a financial plan or a flat fee annually for advising clients on asset allocation. Any investment advisory or related fees collected in advance are deferred and recognized as income on a straight-line basis over the period earned. Transaction-based fees, including performance fees, are recognized when all contractual obligations have been satisfied. Securities and mutual fund commission income and related expenses are recorded on a trade date basis.
The Company accounts for income taxes in accordance with standards established by U.S. 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.
The Company accounts for uncertain tax positions by prescribing a minimum recognition threshold that a tax position is required to meet before being recognized in the consolidated financial statements. The Company recognizes accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense. The Company’s unrecognized tax benefits decreased by $2.4 million, $0.3 million and $4.0 million during the years ended December 31, 2012, 2011 and 2010, respectively. Estimated interest and penalties related to the underpayment of income taxes and reported in income tax expense totaled $(1.6) million in 2012, $0.7 million in 2011, and $0.4 million in 2010. The Company believes that it is reasonably possible that the total amounts of unrecognized tax benefits could significantly decrease within the next twelve months due to the settlement of state income tax audits and expiration of statutes of limitations in various state and local jurisdictions, in an amount ranging from $1.3 million to $3.2 million based on current estimates.
As of December 31, 2012, the Company has provided $2.7 million of deferred taxes, net of applicable foreign tax credits, relating to 2012 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, 2012.
The Company accounts for stock-based compensation expense in accordance with the applicable FASB authoritative guidance, which requires the measurement and recognition of compensation expense based on estimated fair values for all share-based compensation awards made to employees and non-employees over the vesting period of the awards. Determining the fair value of share-based awards at the grant date requires judgment to identify the appropriate valuation model and make assumptions, including the expected term of the stock options and expected stock price volatility, to be used in the calculation. Judgment is also required in estimating the percentage of share-based awards that are expected to be forfeited. The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing model with assumptions based primarily on historical data.
See “Note 11-Stock Incentive Plans” to the Company’s Consolidated Financial Statements contained in this report.