Our corporate headquarters are located in New York City, where we lease approximately 23,600 square feet of space. Our subsidiaries NFPSI and NFPISI lease approximately 38,600 square feet of space in Austin, Texas. In addition, our firms lease properties for use as offices throughout the United States. We believe that our existing properties are adequate for the current operating requirements of its business and that additional space will be available as needed.
(a) We adopted SFAS No. 142 on January 1, 2002. Under SFAS No. 142, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives (but with no maximum life). Goodwill amortization was $4.4 million and $5.5 million in 2000 and 2001, respectively. In accordance with SFAS No. 142, we recognized an impairment loss on goodwill and identifiable intangible assets not subject to amortization of $0.8 million in 2002 and $5.7 million in 2003. Prior to the adoption of SFAS No. 142, 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 goodwill of $1.1 million and $2.1 million, respectively.
(b) Our bank loan is structured as a revolving credit facility and is due on September 14, 2005, unless we elect to convert the credit facility to a term loan, in which case it will amortize over one year, with a principal payment due on March 14, 2006 and with a final maturity on September 14, 2006. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Borrowings.”
(e) The number of representatives in our broker-dealer refers to NASD-registered representatives of NFPSI, including sales assistants and home office personnel that are registered representatives. These totals include personnel of our owned firms and our affiliated third-party distributors. In addition to NFPSI’s registered representatives, our firms’ distribution network includes (1) certain sales professionals who are registered representatives of other broker-dealers, (2) professionals licensed with state insurance authorities who because of their product focus are not required to be registered with a broker-dealer and (3) professionals affiliated with registered investment advisers who because of their product focus are neither required to be licensed as insurance agents nor required to be registered with other broker-dealers. These professionals are not included in these totals.
Our firms earn revenue that consists primarily of commissions and fees earned from the sale of financial products and services to their clients and incur commission and fee expense and operating expense in the course of earning revenue. We pay management fees to non-employee principals of our firms based on the financial performance of each respective firm. We refer to revenue earned by our firms minus the expenses of our firms, including management fees, as gross margin. Management uses gross margin as a measure of the performance of the firms that we have acquired. Through acquisitions and internal growth, gross margin has grown from $19.8 million, or 19.8% of revenues, in 1999 to $108.1 million, or 22.6% of revenues, in 2003.
Under our acquisition structure, we acquire 100% of the equity of independent financial services products distribution businesses on terms that are relatively standard across our acquisitions. To determine our acquisition price, we first estimate the annual operating cash flow of the business to be acquired based on current levels of revenue and expense. For this purpose, we define operating cash flow as cash revenue of the business less cash and non-cash expenses, other than amortization, depreciation and compensation to the business’s owners or individuals who subsequently become principals. We refer to this estimated annual operating cash flow as “target earnings.” Our acquisition price is a multiple (approximately five times) of a portion of the target earnings, which we refer to as “base earnings.” Base earnings average 48% of target earnings for acquisitions completed through December 31, 2003. In determining base earnings, our general rule is not to exceed an amount equal to the recurring revenue of the business. By recurring revenue, we mean revenue from sales previously made (such as renewal commissions on insurance products, commissions and administrative fees for ongoing benefit plans and mutual fund trail commissions) and fees for assets under management.
We retain a cumulative preferred position in the base earnings. To the extent earnings of a firm in any year are less than base earnings, in the following year we are entitled to receive base earnings together with the prior years’ shortfall before any management fees are paid.
Substantially all of our acquisitions have been paid for with a combination of cash and our common stock, valued at its then fair market value. We require our principals to take typically at least 30% of the total acquisition price in our common stock; however, through December 31, 2003, principals have taken on average approximately 47% of the total acquisition price in our common stock. The following table shows acquisition activity in the following periods:
• Corporate and executive benefits commissions and fees. Our firms earn commissions on the sale of insurance policies written for benefit programs. The commissions are paid each year as long as the client continues to use the product and maintain its broker of record relationship with us. Our firms also earn fees for the development and implementation of corporate and executive benefit programs as well as fees for the duration that these programs are administered. Asset-based fees are also earned for administrative services or consulting related to certain benefits plans.
percentage of assets under management and are generally paid quarterly. In a few 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.
NFPSI, our registered broker-dealer and investment adviser, also earns commissions and fees on the transactions effected through it. Most principals of our firms, as well as many of our affiliated third-party distributors, conduct securities or investment advisory business through NFPSI. Our affiliated third-party distributors generated commission revenue through NFPSI of $34.7 million, $34.3 million and $45.0 million in the years 2001, 2002 and 2003, respectively.
Commissions and fees. Commissions and fees are typically paid to non-principal producers, who are producers that are employed by or affiliated with our firms but are not principals. When business is generated solely by a principal, no commission expense is incurred because principals are only paid from a share of the
In addition to these incentive programs, we have incurred option compensation expense for stock options granted to employees and directors. Stock options granted to employees through December 31, 2002 were accounted for under the intrinsic-value-based method of accounting in accordance with Accounting Principles Board, or APB, Opinion No. 25. On January 1, 2003, we adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” in accordance with SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” and have adopted the “prospective” method of transition. Under this method, the cost of stock options granted to employees after January 1, 2003 are included in the determination of net income.
Depreciation. We incur depreciation expense related to capital assets, such as investments in technology, office furniture and equipment.
Acquisition bonus and other. We incurred certain expenses through 2001, primarily legal and accounting costs, related to the formation of NFP. In addition, as discussed more fully below in “-Commitments and Contingencies-Acquisition bonus programs,” we established acquisition bonus programs under which some of our founding officers and directors, as well as certain consultants, are eligible to receive payments for acquisitions that they originate that meet specified criteria. We accrue acquisition bonus expenses when transactions that meet these criteria close and adjust the accruals based on the performance of the firms for which the bonuses are paid. Other expense includes a variety of items, including certain reserves taken against notes generally related to transactions involving the disposition of firms.
Through acquisitions and internal growth, we have achieved revenue growth of 34%, 30% and 33% in the years ended December 31, 2001, 2002 and 2003, respectively. While this growth was driven primarily by our acquisitions, it has been augmented by internal growth in the revenues of our acquired firms, as well as the growth of NFPISI and NFPSI. In 2001, 2002 and 2003, our firms had an internal revenue growth rate of 14%, 6% and 14%, respectively.
In addition to internal growth in the revenue of our firms, we monitor acquired firm revenue, commission and fee expense and operating expense from new acquisitions as compared with existing firms. For this purpose, a firm is considered to be a new acquisition for the twelve months following the acquisition. After the first twelve months, a firm is considered to be an existing firm. Within any reported period, a firm may be considered to be a new acquisition for part of the period and an existing firm for the remainder of the period. Additionally, NFPSI and NFPISI are considered to be existing firms. Sub-acquisitions that do not separately report their results are considered to be part of the firm making the acquisition, and the results of firms disposed of are included. The results of operations discussions set forth below include analysis of the relevant line items on this basis.
Year ended December 31, 2003 compared with the year ended December 31, 2002
The following table provides a comparison of our revenues and expenses for the periods presented.
Commissions and fees. Commissions and fees increased $118.5 million, or 32.8%, to $479.6 million in 2003 compared with $361.1 million in 2002. The increase was due to business generated by firms that were acquired in 2002 and in 2003 as well as an increased volume of business from our existing firms. Commissions and fees from new acquisitions was approximately $61.3 million in 2003. Commissions and fees from existing firms was $418.3 million in 2003, an increase of $57.2 million, or 15.8%, from $361.1 million in 2002.
Operating expenses. Operating expenses increased $35.0 million, or 30.4%, to $150.3 million in 2003 compared with $115.3 million in 2002. The increase was principally due to business generated by firms which were acquired during 2002 and 2003 and internal growth at our existing firms. As a percentage of revenue, operating expenses declined to 31.3% in 2003 from 31.9% in 2002 as the rate of expense growth was slightly below the rate of revenue growth. Operating expenses from new acquisitions were approximately $19.5 million in 2003. Operating expenses from existing firms were approximately $130.8 million in 2003 compared with $115.3 million in 2002.
Management fees. Management fees increased $28.8 million, or 43.9%, to $94.4 million in 2003 compared with $65.6 million in 2002. The increase results from higher earnings at our acquired firms generated primarily through new acquisitions and internal growth of existing firms. Management fees represented 46.6% of gross margin before management fees in 2003 compared with 46.5% in 2002. A higher percentage of our firms operated at or above target earnings in 2003 compared with 2002. This resulted in a greater proportion of management fees being accrued than in the prior period. In addition, management fees included an accrual of $2.4 million for ongoing incentive plans in 2003 compared with $0.8 million in 2002, reflecting growth at firms that we have owned for at least three years. Offsetting the increase were higher earnings at NFPISI and NFPSI, for which no management fee expense is realized. Management fees as a percentage of revenue increased to 19.7% in 2003 from 18.2% in 2002.
Gross margin. Gross margin increased $32.7 million, or 43.4%, to $108.1 million in 2003 compared with $75.4 million in 2002. This increase was largely due to the rate of growth in revenue exceeding the growth in commissions and fees expense and operating expenses as described above.
Option compensation. Option compensation expense decreased $9.7 million to $0.2 million in 2003 compared with $9.9 million in 2002. In prior years, we accrued option compensation expense related to options expected to be issued under the option incentive programs (see “Business - Acquisition Strategy - Option incentive programs”). One program expired during the second half of 2002 and the other program expired in the fourth quarter of 2003. In conjunction with the ending of these programs, we reduced accruals for options which were not issued by $2.1 million during 2003. The reduction of these accruals offset option expense of $1.8 million recorded in connection with the option incentive programs and $0.5 million of option compensation expense for the stock-based employee compensation plans. As a percentage of revenue, option compensation expense was less than 0.1% in 2003 compared with 2.7% in 2002.
Impairment of goodwill and intangible assets. Impairment of goodwill and intangible assets increased $8.1 million, to $9.9 million in 2003 compared with $1.8 million in 2002. The impairments were related to five firms in 2003 and three firms in 2002 and resulted in a reduction of the carrying value of the identifiable intangible assets and goodwill associated with these firms to their fair value. As a percentage of revenue, impairment of goodwill and intangible assets was 2.1% in 2003 compared with 0.5% in 2002.
Acquisition bonus and other expense. Acquisition bonus and other expense increased $2.5 million to $1.8 million in 2003 compared with $(0.7) million in 2002. In 2003, we accrued $1.8 million for a production bonus related to the acquisition of an insurance marketing platform completed at the beginning of 2000. The production bonus was accrued based upon the achievement of specific milestones over a thirty-nine month period. The 2002 amount was due to the reversal of acquisition bonuses that were previously accrued as certain contingencies required for the payment of the bonuses were not met.
Interest and other expense. Interest and other expense increased $0.1 million, or 2.9%, to $3.5 million in 2003 compared with $3.4 million in 2002. The increase was due to higher average borrowings under our bank line of credit offset, in part, by lower interest rates.
Commissions and fees. Commissions and fees expense increased $27.4 million, or 35.4%, to $104.8 million in 2002 compared with $77.4 million in 2001. The increase was due to acquisitions completed in 2001 and 2002 as well as an increased volume of business. As a percentage of revenue, commissions and fees expense increased to 29.0% in 2002 compared with 27.8% in 2001 indicating that, in the aggregate, our firms generated a greater portion of revenue through non-principal producers in 2002 than in 2001. Commission and fee expense from new acquisitions was approximately $8.2 million in 2002. Commission and fee expense from existing firms was approximately $96.6 million in 2002 compared with $77.4 million in 2001.
Operating expenses. Operating expenses at the acquired firm level increased $25.9 million, or 29.0%, to $115.3 million in 2002 compared with $89.4 million in 2001. The increase was primarily due to acquisitions completed in 2001 and 2002. Operating expenses at the acquired firm level increased in line with revenue. As a percentage of revenue, operating expenses at the acquired firm level was 31.9% in 2002 compared with 32.1% in 2001. Operating expenses from new acquisitions was approximately $17.5 million in 2002. Operating expenses from existing firms was approximately $97.8 million in 2002 compared with $89.4 million in 2001.
Management fees. Management fees increased $15.8 million, or 31.7%, to $65.6 million in 2002 compared with $49.8 million in 2001. The increase reflected the increased earnings of our firms due to acquisitions and internal growth. Management fees represented 46.8% of gross margin before management fees in 2002 compared with 44.8% in 2001. In 2002, a higher percentage of firms produced earnings at or above target earnings than in 2001, resulting in a greater proportion of earnings being paid out to principals and/or certain entities they own. Management fees as a percentage of revenue was 18.2% in 2002 compared with 17.9% in 2001.
Gross margin increased $13.9 million, or 22.6%, to $75.4 million in 2002 compared with $61.5 million in 2001. This rate was below the rate of growth in revenue due to greater use of non-principal producers, which increased commission and fee expense, and due to the faster growth of management fees as described above.
Amortization. Amortization decreased $2.2 million, or 14.2%, to $13.3 million in 2002 compared with $15.5 million in 2001. Amortization expense declined despite an increase in goodwill and other intangible assets as of December 31, 2002 from December 31, 2001. The decline was due to the elimination of goodwill amortization beginning January 1, 2002. Amortization expense related to the amortization of goodwill was $5.5 million in 2001. As a percentage of revenue, amortization declined to 3.7% in 2002 from 5.6% in 2001.
Impairment of goodwill and intangible assets. Impairment of goodwill and intangible assets decreased $2.6 million, or 59.1%, to $1.8 million in 2002 compared with $4.4 million in 2001. In 2002, we recognized impairment charges due to the poor performance of three of our firms. In connection with these charges, we reduced the carrying value of the identifiable intangible assets and goodwill associated with these firms to their fair value. As a percentage of revenue, impairment of goodwill and intangible assets was 0.5% in 2002 compared with 1.6% in 2001.
Depreciation. Depreciation increased $0.3 million, or 10.7%, to $3.1 million in 2002 compared with $2.8 million in 2001. As a percentage of revenue, depreciation expense increased to 0.9% in 2002 from 1.0% in 2001.
Acquisition bonus and other. Acquisition bonus and other expense decreased $1.1 million to $(0.7) million in 2002 compared with $0.4 million in 2001. The decrease was due to the reversal of acquisition bonuses that were previously accrued as certain contingencies required for the payment of the bonuses were not met. As a percentage of revenue, acquisition bonus and other expense was 0.1% in 2001.
Loss (gain) on sale of subsidiaries. Loss from the sale of subsidiaries was $0.3 million in 2002 compared with a gain of $0.7 million in 2001. In 2002, we experienced a net loss on the sale of two subsidiaries compared with a net gain on the sale of two subsidiaries in 2001. As a percentage of revenue, the loss on sale of subsidiaries was 0.1% in 2002 compared with a gain on sale of subsidiaries of 0.3% in 2001.
Interest and other income. Interest and other income increased $0.8 million, or 72.7%, to $1.9 million in 2002 compared with $1.2 million in 2001.
During 2003, cash provided by operating activities was $50.3 million, resulting primarily from an increase in net income and a decrease in commissions, fees and premiums receivable, net, and partially offset by a decrease in accounts payable and a decrease in amounts due to principals and/or certain entities they own. During 2002, $24.3 million of cash was provided by operating activities, primarily as a result of an increase in net income, partially offset by an increase in notes receivable, net of deposits, and an increase in commissions, fees and premiums receivable. During 2001, $23.8 million of cash was provided by operating activities, primarily the result of the increasing positive cash flow of our firms.
During 2003, 2002 and 2001, cash provided by financing activities was $48.3 million, $5.1 million and $32.1 million, respectively. In 2003 cash provided by financing activities was primarily the result of the sale of 4.3 million shares of our common stock in our initial public offering in September 2003 and was partially offset by cash used in the repayment of borrowings under our credit facility. In 2002 and 2001, cash provided by financing activities was primarily the result of borrowings under our credit facility.
Some of our firms maintain premium trust accounts, which represent payments collected from insureds on behalf of carriers. Funds held in these accounts are invested in cash, cash equivalents and securities purchased under resale agreements (overnight). As of December 31, 2003, we had cash, cash equivalents and securities purchased under resale agreements in premium trust accounts of $41.3 million, an increase of $15.7 million from the balance as of December 31, 2002 of $25.6 million. The increase was due primarily to acquisitions of firms with premiums trust accounts. As of December 31, 2002, we had cash, cash equivalents and securities purchased under resale agreements in premium trust accounts of $25.6 million, an increase of $3.1 million from the balance as of December 31, 2001 of $22.5 million.
In September 2000, we entered into a $40 million credit facility with a group of banks and, in November 2001, the credit facility was increased to $65 million. In April 2003, the credit facility was amended and restated to, among other things, increase it to a $90 million credit facility and to add additional lenders. Borrowings under the credit facility bear interest, at our discretion, at (1) the greatest of (a) the prime rate, (b) the three-month certificate of deposit rate plus 1% or (c) the federal funds effective rate plus ½ of 1%; or (2) the Eurodollar rate for one, two, three or six-month periods plus 2%. The rates under (1) above float with changes in the indicated rates and under (2) are fixed for the indicated Eurodollar rate period. Interest is computed on the daily outstanding balance. The weighted average interest rate under the credit facility at December 31, 2003 was 3.3%. The credit facility is structured as a revolving credit facility and is due on September 14, 2005, unless we elect to convert the credit facility to a term loan, in which case it will amortize over one year, with a principal payment due on March 14, 2006 and a final maturity on September 14, 2006. As of December 31, 2003, we did not have an outstanding balance under the credit facility. Our obligations under our credit facility are collateralized by all of our assets.
cannot repay the overadvance, we have allowed principals and/or such entities to repay the advance over time. In these cases, we have generally required the principals and/or such entities to provide us with a note in an amount equal to the overadvance, secured by the principals’ and/or such entities’ shares of our common stock.
At the time of NFP’s founding, it established an acquisition bonus program (“first bonus program”) under which certain founding officers and directors were eligible to receive a payment equal to $1.25 million in cash or common stock of NFP, at their election, for each $5 million of average base earnings of the applicable acquired firms over a three-year period. This acquisition bonus program period commenced with eligible acquisitions effective January 1, 1999 through and including those eligible acquisitions closed by December 31, 2000. Accordingly, the three-year measurement periods ended between December 31, 2001 and December 31, 2003. The bonuses related to this program were accrued at the close of each eligible acquisition in an amount equal to 25% of the base earnings of the acquired firm and the amounts in the bonus pool were adjusted over the appropriate three-year measurement period based on the actual earnings of the applicable firms. For the years ended December 31, 2002 and 2001, we reduced previous accruals by $(1.3) million and $(1.1) million, respectively. There were no adjustments made during 2003.
Principals and certain employees of our acquired firms are eligible to participate in two option incentive programs. Under our original option incentive program, principals and certain employees of 27 firms (certain acquisitions that closed during the period from January 1, 1999 to October 1, 1999) were eligible to receive option grants with a $10.00 strike price based on each such firm’s growth in earnings over a three-year measurement period which ended in the fourth quarter of 2002. The second option program is open to principals and certain employees of 40 firms (certain acquisitions that closed during the period from April 1, 1999 to October 31, 2000). Under this program, principals and certain employees of these firms are eligible to receive option grants at the fair market value of our common stock at the time the options are granted based on their firm’s growth in earnings over a three-year measurement period. This program expired in 2003. For the years ended December 31, 2001 and 2002, option expense under both of these programs totaled $19.1 million and $9.7 million, respectively, and for the year ended December 31, 2003, previous accruals were reduced by $(2.1) million. The reduction of this accrual offset option expense of $1.8 million recorded in connection with the option incentive programs.
In order to better determine the economic value of the businesses we have acquired, we incorporated contingent consideration, or earnout, provisions into the structure of our acquisitions since the beginning of 2001. These arrangements generally provide for the payment of additional consideration to the sellers upon the firm’s
The minimum contingent payments which could be payable as purchase consideration and employee compensation in each year is zero. The maximum contingent payment which could be payable as purchase consideration and employee compensation based on commitments outstanding as of December 31, 2003 consists of the following:
The table below shows our contractual obligations as of December 31, 2003:
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” This statement establishes standards for the way companies
We had no off-balance sheet arrangements as of December 31, 2003.
Since our formation we have completed over 140 acquisitions. All of these acquisitions have been accounted for using the purchase method, and their related net assets and results of operations were included in our consolidated financial statements commencing on their respective acquisition dates. Certain of the acquisitions have provisions for contingent additional consideration based upon the financial results achieved over a multi-year period. This additional consideration is reflected as an increase in goodwill when results are achieved and the outcome of the contingency is determinable beyond a reasonable doubt.
On January 1, 2002, we adopted SFAS No. 142, which addresses the financial accounting and reporting standards for the acquisition of intangible assets outside of a business combination and for goodwill and other intangible assets subsequent to their acquisition. This accounting standard requires that goodwill be separately disclosed from other intangible assets in the consolidated statement of financial condition, and no longer be amortized but tested for impairment on a periodic basis. Intangible assets deemed to have indefinite lives are no longer amortized but are subject to impairment tests at least annually. Other intangible assets will continue to be amortized over their useful lives. The transitional impairment test indicated there was no goodwill impairment as of January 1, 2002. The impact of adoption of SFAS No. 142 resulted in $154 million of goodwill and tradename no longer being amortized. In accordance with SFAS No. 142, we recognized an impairment loss on goodwill and identifiable intangible assets not subject to amortization of $0.8 million and $5.7 million for the years ended December 31, 2002 and 2003, respectively.
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.
We are authorized under the 1998, 2000 and 2002 Stock Incentive Plans, and the 2000 and 2002 Stock Incentive Plans for Principals and Managers, to grant stock options to officers, employees, principals of our acquired firms and/or certain entities principals own, independent contractors, consultants, non-employee directors and certain advisory board members. Options granted under the 1998, 2000 and 2002 Stock Incentive Plans generally vest 20% per year over a 5-year period. Options granted under the 2000 and 2002 Stock Incentive Plans for Principals and Managers generally vest immediately upon grant.
We apply the intrinsic-value-based method of accounting prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations including the Financial Accounting Standards Board, or FASB, Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation,” an interpretation of APB Opinion No. 25, issued in March 2000, to account for our fixed-plan stock options to employees for options granted through December 31, 2002. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123, “Accounting for Stock-Based Compensation,” established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, we have elected to continue to apply the intrinsic-value-based method of accounting for the options granted through December 31, 2002, and have adopted only the disclosure requirements of SFAS No. 123. Effective January 1, 2003, we have adopted the fair value recognition provisions of SFAS No. 123 in accordance with SFAS No. 148 and have adopted the “prospective” method for transition.
recognition and measurement provisions of FASB Interpretation No. 45 are applicable to guarantees issued or modified after December 31, 2002 and did not have a material effect on our financial statements. The disclosure requirements were effective for financial statements of interim and annual periods ending after December 15, 2002.