The Company leases office space to support its reportable segments. NFP’s corporate headquarters is located at 340 Madison Avenue, New York, New York, where NFP leases three floors. In November 2009, NFP subleased one floor to a third party. NFP and certain of its businesses occupy the remaining two floors. NFPISI and NFPSI occupy office space at 1250 Capital of Texas Highway South, Austin, Texas. NFPISI has subleased a portion of this space to various third parties. Additionally, the Company’s businesses lease properties for use as offices throughout the United States and Canada.
Although NFP was founded in August 1998, the Company commenced operations on January 1, 1999. In each year since the Company commenced operations, the Company has completed a significant number of acquisitions with the exception of the years ended December 31, 2010 and December 31, 2009. As a result of the Company’s acquisitions, the results in the periods shown below may not be directly comparable.
a) Prior to January 1, 2010, the Company calculated the internal growth rate of the revenue of its businesses as a measure of financial performance. This calculation compared the change in revenue of a comparable group of businesses for the same time period in successive years. The Company included businesses in this calculation at the beginning of the first fiscal quarter that began one year after acquisition, unless a business internally consolidated with another owned business, made a tuck-in acquisition that represented more than 25% of the base earnings of the acquiring business, or a significant portion of the business’ assets were sold. With respect to two owned businesses that consolidated, the consolidated business was excluded from the calculation from the time of the consolidation until the first fiscal quarter that began one year after acquisition of the most recently acquired firm participating in the consolidation. However, if both firms involved in a consolidation were included in the internal growth rate calculation at the time of the consolidation, the combined firm continued to be included in the calculation after the consolidation. With respect to tuck-in acquisitions, to the extent the acquired firm did not separately report financial statements to NFP, the acquiring firm was excluded from the calculation from the time of the tuck-in acquisition until the first fiscal quarter beginning one year following the tuck-in acquisition. Tuck-in acquisitions that represent less than 25% of the base earnings of the acquiring business were considered internal growth. With respect to situations where a significant portion of a business’s assets were sold, the surviving entity was excluded from the internal growth rate calculation from the time of the sale until one year following the sale. With respect to dispositions, the Company included businesses up to the time of disposition and excluded such businesses for all periods after the disposition.
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 better 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 wealth management products and services, serving both third-party affiliates as well as member NFP businesses.
NFP has organized its businesses into three reportable segments: the CCG, the ICG and the ASG. 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, wealth management, annuities, long-term care and wealth transfer solutions for high net worth individuals and includes wholesale life brokerage and retail life 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. 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.
Information with respect to all sources of revenue and income (loss) from operations and Adjusted EBITDA by reportable segment for the years ended December 31, 2012, 2011 and 2010 is presented below (in thousands).
The Company reports its financial results in accordance with U.S. 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, net; the accelerated vesting of, or reversal of previously-recognized expenses related to, 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 income and the expense related to management contract buyouts.
The Company believes that the use of Adjusted EBITDA provides an additional meaningful method of evaluating certain aspects of the Company’s operating performance from period to period on a basis that may not be otherwise apparent under U.S. GAAP when used in addition to, and not in lieu of, U.S. GAAP measures.
During the year ended December 31, 2012, revenue increased $48.3 million, or 4.8%, as compared to the year ended December 31, 2011. The revenue increase was driven by revenue increases within the CCG of $56.6 million, partially offset by decreases within the ICG and ASG of $2.4 million and $5.9 million, respectively. Results in the CCG included commissions and fees revenue from acquisitions of $39.4 million that had no comparable operations in the same period of 2011. Excluding the impact of dispositions of $4.1 million and of acquisitions, overall revenue in the CCG increased by $21.3 million due to growth at existing businesses and higher profit commission bonuses. Excluding the impact of dispositions within the ICG of $11.6 million, ICG revenue increased by $9.2 million for the year ended December 31, 2012 as compared to the year ended December 31, 2011. Results in the ICG were impacted by stronger sales in the high net worth life insurance market in the fourth quarter and stronger performance in the ICG’s wealth management business line. The overall decline in ASG revenue resulted from a continuation of the lower volume of transactional business heading into the presidential election and the uncertain outcome of tax policy as well as a decline in the sale of variable universal life products. While assets under management increased in the ASG, managed account revenue remained flat because a portion of the increase related to assets where the primary revenues were reflected in the ICG’s wealth management business line and another portion of the increase related to fourth quarter asset values that did not impact ASG revenues because of the timing of related fees.
Income from operations decreased $26.6 million, or 37.3%, in the year ended December 31, 2012, as compared to the year ended December 31, 2011. The decrease in income from operations was driven by a $21.3 million increase in impairments of goodwill and intangible assets due to management contract buyouts, firm disposals and the performance of the retail life business line; a $9.9 million change in estimated acquisition earn-out payables related to net adjustments in the estimated fair market values of acquisition earn-out payables, primarily due to revised projections as well as the accretion of the discount recorded for prior earn-out
Adjusted EBITDA for the year ended December 31, 2011 was $126.4 million, compared to $116.8 million in the prior year, an increase of 8.2%. As a percentage of revenue, the Adjusted EBITDA margin was 12.5% compared to 11.9% in the prior 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.
Individual Client Group. Commissions paid by insurance companies are based on a percentage of the premium that the insurance company charges to the policyholder. In the marketing organization and wholesale life brokerage business line, the ICG generally receives commissions paid by the insurance carrier for facilitating the placement of the product. Wholesale life brokerage revenue also includes amounts received by NFP’s life brokerage entities, which assist advisors with the placement and sale of life insurance. In the retail life business line, commissions are generally calculated as a percentage of premiums, generally paid in the first year. The ICG receives renewal commissions for a period following the first year. The ICG’s wealth management business line earns fees for offering financial advisory and related services. These fees are generally based on a percentage of assets under management and are paid quarterly. In addition, the ICG may earn commissions related to the sale of securities and certain investment-related insurance products.
Commissions and fees. Commissions and fees are typically paid to third-party producers who are affiliated with the Company. Commissions and fees are also paid to producers who utilize the services of one or more of the Company’s life 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 flows 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 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.
NFP businesses that utilize the Company’s marketing organization, wholesale life brokerage businesses and NFPSI receive commissions and fees that are eliminated in consolidation.
Compensation expense-employees. The Company’s businesses incur operating expenses related to compensating producing and non-producing staff. In addition, NFP allocates compensation expense-employees associated with corporate shared services to NFP’s three reportable segments largely based on performance of the segments and other reasonable assumptions and estimates as it relates to the corporate shared services support of the operating segments. Compensation expense-employees includes both cash and stock-based compensation. NFP records share-based payments related to employees and activities as well as allocated amounts from its corporate shared services to compensation expense-employees as a component of compensation expense-employees.
Fees to principals also include an accrual for certain performance-based incentive amounts payable under the Annual Principal Incentive Plan (the “PIP”). See “Note 4-Commitments and Contingencies-Incentive Plans” to the Company’s Consolidated Financial Statements contained in this report.
As of December 31, 2012, NFP maintained an incentive plan for principals and certain employees of its businesses, the PIP. Certain employees also participate in employee-specific bonus programs that are earned on specified growth thresholds.
The PIP is designed to reward the performance of a business based on performance targets and the business’s earnings growth. NFP calculates and includes the expense related to the PIP accrual in fees to principals expense. NFP’s Executive Management Committee, in its sole discretion, is able to adjust any performance target as necessary to account for changed business circumstances.
The Company paid $7.3 million in cash in 2012, included within fees to principals expense, relating to an incentive plan for the 15-month performance period of October 1, 2010 through December 31, 2011 (the “2011 PIP”). With the 2011 PIP, management migrated to an incentive program that rewards only incremental growth.
Commissions and fees. Commissions and fees revenue for the year ended December 31, 2012 increased $56.6 million as compared to 2011, of which approximately $35.3 million represented commissions and fees revenue from the net impact of acquisitions and dispositions affecting the current period. Excluding this impact, overall revenue in the CCG increased by $21.3 million due to growth at existing businesses, increased profit contingency commissions and other performance bonuses.
The total compensation expense ratio was 50.0% for the year ended December 31, 2012 compared with 52.2% for the year ended December 31, 2011. The decrease in total compensation expense ratio was attributable to revenue growth exceeding the net growth in fees to principals and compensation expense-employees.
Non-compensation expense. Non-compensation expense increased $9.1 million in 2012 compared with 2011. Approximately $5.3 million of the increase represented non-compensation expense from the net impact of acquisitions and dispositions affecting the current period. After this impact, non-compensation expense increased by $3.8 million, due to an increase in professional and promotional fees.
Change in estimated acquisition earn-out payables. During 2012, the CCG recognized $9.3 million of an expense related to net adjustments in the estimated fair market values of earn-out obligations related to the revised projections of future performance and the actual results for certain acquisitions completed in 2011 and 2012. The fair values of the estimated acquisition earn-out payables increased during 2012 primarily due to revised projections of future performance as well as the accretion of the discount recorded for earn-out obligations associated with prior acquisitions.
Management contract buyout. 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. Earn-out payments that have no requirement of continued employment are also expensed in the consolidated statements of income through management contract buyout. During the year ended December 31, 2012, the CCG recognized a $16.9 million expense related to cash payments made in connection with four management contract buyouts. An additional $0.4 million expense related to the accrual of an earn-out for one management contract buyout. During the year ended December 31, 2011, there were no such buyouts.
Commissions and fees. Commissions and fees expense increased $9.2 million in 2011, of which approximately $2.2 million represented commissions and fees revenue from acquisitions that had no comparable operations in 2010. Excluding the impact of these acquisitions, the increase was largely attributable to the growth in businesses with higher commission expense ratios.
Compensation expense-employees. Compensation expense-employees increased $10.7 million for the year ended December 31, 2011 compared with the prior 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.
Fees to principals. Fees to principals decreased $6.9 million in 2011 as compared with 2010. Included in CCG fees to principals for the year ended December 31, 2010 was stock-based compensation expense of $7.4 million related to the accelerated vesting of certain RSUs and an amortization expense of $2.8 million for those RSUs outstanding prior to the acceleration. The total compensation expense ratio was 52.2% for the year ended December 31, 2011 compared with 54.4% in 2010. Excluding the impact of the accelerated vesting of certain RSUs issued under the EIP, fees to principals increased, and the total compensation expense ratio remained relatively flat. The increase in fees to principals was due to higher incentive accruals relating to improvement in firm performance.
Non-compensation expense. Non-compensation expense decreased $0.7 million for the year ended December 31, 2011 compared with the prior year. The non-compensation expense ratio was 18.1% for the year ended December 31, 2011 compared with 19.4% in 2010. Excluding dispositions of $1.4 million, non-compensation expense remained relatively flat.
Impairment of goodwill and intangible assets. Impairment of goodwill and intangible assets decreased $0.7 million. The impairment in 2011 related to a management contract buyout that occurred in the first quarter of 2012.
Change in estimated acquisition earn-out payables. The change in estimated acquisition earn-out payables expense as reported in 2011 compared to 2010 was due to the adoption of revised accounting guidance for business combinations, which was effective January 1, 2009. No material acquisitions were completed in 2010 or 2009, so the impact was seen in the year ended December 31, 2011. During 2011, the CCG recognized $0.4 million of income related to net adjustments in the estimated fair market values of earn-out obligations related to the revised projections of future performance and the actual results for certain acquisitions completed in 2011.
The ICG accounted for 32.9%, 34.7% and 38.5% of NFP’s revenue for the years ended December 31, 2012, 2011 and 2010, respectively. The financial information below relates to the ICG for the periods presented (in thousands, except for percentages):
Commissions and fees. Commissions and fees expense decreased $5.3 million in 2012 compared with 2011. Excluding the impact of dispositions of $3.5 million, commissions and fees expense from existing businesses decreased by $1.8 million. The commission expense ratio was 20.7% in 2012 compared with 22.1% in 2011.
Fees to principals. Fees to principals increased $6.8 million in 2012 compared with 2011. Excluding the impact of dispositions of $1.6 million, overall fees to principals increased by $8.4 million. The increase is a result of improved earnings performance in certain businesses.
The total compensation expense ratio was 51.6% for the year ended December 31, 2012 compared with 49.0% for year ended December 31, 2011. The increase in the total compensation expense ratio is primarily the result of the increase in fees to principals.
Non-compensation expense. Non-compensation expense decreased $3.1 million in 2012 compared with 2011. After the impact from dispositions of $3.1 million, non-compensation expense remained relatively flat.
Impairment of goodwill and intangible assets. Impairment of goodwill and intangible assets increased $14.8 million in 2012 compared with 2011. The impairment taken for 2012 reflects a $15.7 million reduction in carrying value of intangibles for several businesses that were sold in the third and fourth quarters, as well as a $9.6 million reduction in goodwill relating to the Company’s retail life business line. As a result of this impairment, there is no goodwill associated with the retail life business line. 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 were disposed of in the first quarter of 2012, and one anticipated management contract buyout in the first quarter of 2012.
Gain on sale of businesses. During the year ended December 31, 2012, the ICG recognized a net gain from the disposition of twelve businesses of $4.8 million, whereas during the year ended December 31, 2011, the ICG recognized a net gain from the disposition of two businesses of $1.1 million.
Income from operations. Income from operations decreased $1.0 million for 2011 as compared to 2010. The decrease in income from operations was due to a decrease in revenue and an increase in impairment of goodwill and intangible assets, partially offset by a decrease in commissions and fees expense, fees to principals, and non-compensation expense.
Commissions and fees. Commissions and fees expense decreased $11.9 million for 2011 as compared to 2010. The commission expense ratio was 22.1% in the year ended December 31, 2011 compared with 23.6% in 2010. Commissions and fees expense decreased due to declines in overall revenue.
Non-compensation expense. Non-compensation expense decreased $4.8 million for the year ended December 31, 2011 as compared with the prior year. The decline in non-compensation expense was primarily a result of overall reductions in ICG spending.
Amortization of intangibles. Amortization expense declined $0.7 million for 2011 as compared with 2010. Amortization expense declined as a result of a 15.4% decrease in amortizing intangible assets resulting primarily from dispositions and impairments.
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 were disposed of in the first quarter of 2012, and one anticipated management contract buyout in the first quarter of 2012.
Income from operations. Income from operations increased $0.2 million for the year ended December 31, 2012, as compared to the year ended December 31, 2011. The increase in income from operations was due to a decrease in commissions and fees expense, partially offset by increases in non-compensation expense, compensation expense-employees, amortization of intangibles, depreciation and a change in estimated acquisition earn-out payables, as well as a decrease in commissions and fees revenue.
Commissions and fees. Commissions and fees revenue decreased $5.9 million during 2012 as compared to 2011. Results in the ASG were driven by a continuation of the lower volume of transactional business heading into the presidential election and the uncertain outcome of tax policy as well as a decline in the sale of variable universal life products. Assets under management in the ASG increased 11.2% to $10.8 billion as of December 31, 2012 compared to $9.7 billion as of December 31, 2011. While assets under management increased in the ASG, managed account revenue remained flat because a portion of the increase related to assets where the primary revenues were reflected in the ICG’s wealth management business line and another portion of the increase related to fourth quarter asset values that did not impact ASG revenues because of the timing of related fees.
Commissions and fees. Commissions and fees expense decreased $10.8 million for the year ended December 31, 2012, as compared to the year ended December 31, 2011. The decrease in commissions and fees is related to the acquisition of The Fusion Financial Group, LLC (“Fusion”), in which prior commissions and fees expense paid by the Company ceased pursuant to the acquisition. The decrease in commissions and fees also related to the renegotiation of certain service contracts, thereby lowering commissions and fees expense, a decline in sales of variable universal life products and a decline in transactional volume.
Non-compensation expense. Non-compensation expense increased $2.9 million in 2012, compared with 2011. The non-compensation expense ratio was 7.8% for the year ended December 31, 2012, as compared with 6.5% for the year ended December 31, 2011. The increase primarily related to the acquisition of Fusion, and increases in professional and regulatory-related fees.
Amortization of intangibles. Amortization expense increased as a result of the Fusion acquisition.
Income from operations. Income from operations increased $1.5 million for the year ended December 31, 2011, as compared to the year ended December 31, 2010. The increase in income from operations was due to an increase in revenue which was partially offset by a commensurate increase in commissions and fees expense, as well as an increase in compensation expense-employees and non-compensation expense.
Commissions and fees. Commissions and fees revenue increased $34.6 million for 2011 as compared to 2010. Results in the ASG were driven by an increase in sales of certain variable annuity products and a slight increase in assets under management. Assets under management in the ASG increased 3.7% to $9.7 billion as of December 31, 2011 compared to $9.3 billion as of December 31, 2010.
The financial information below relates to items not allocated to any of NFP’s three reportable segments for the periods presented (in thousands, except for percentages):
Interest expense. Interest expense increased $0.8 million for 2012 as compared to 2011. Interest expense increased primarily due to an increase in accretion of the 2010 Notes, a one-month LIBOR-based interest rate swap, which began on April 14, 2011, as well as increased revolver borrowings under the 2010 Credit Facility.
Income tax expense. Income tax expense was $5.5 million in 2012 compared with income tax expense of $28.4 million in the prior year. The effective tax rate for the year ended December 31, 2012 was 15.4%. This compared with an effective tax rate of 43.5% for the year ended December 31, 2011. The effective tax rate for the year ended December 31, 2012 was lower than the effective tax rate for the year ended December 31, 2011 primarily due to the tax benefit associated with dispositions, a reduction in unrecognized tax benefits during 2012 due to statute lapse and the corresponding reduction of interest and penalties.
Interest income. Interest income decreased $0.5 million in the year ended December 31, 2011 as compared to the year ended December 31, 2010. Interest income decreased mainly due to a decrease in promissory notes entered into by NFP with its principals.
Income tax expense. Income tax expense was $28.4 million in 2011 compared with income tax expense of $26.5 million in the prior year. The effective tax rate for the year ended December 31, 2011 was 43.5%. This compared with an effective tax rate of 38.4% for the year ended December 31, 2010. The effective tax rate for the year ended December 31, 2010 was lower than the effective tax rate for the year ended December 31, 2011, primarily due to tax deductions relating to dispositions during 2010, a reduction in unrecognized tax benefits due to settlements with tax authorities during 2010, and an increase in 2011 in deferred taxes for future repatriation of foreign earnings.
The Company has historically experienced its highest cash usage during the first quarter of each year as incentives and earned fees to principals are calculated and paid out and more acquisitions are completed. The Company has also previously experienced a seasonal revenue and earnings decline at the beginning of the year. In many prior years this has led to borrowings on NFP’s credit facility in the first quarter.
This historical borrowing pattern did not occur in 2011 because cash flow was sufficient to fund fees to principals of firms that performed in excess of target earnings and acquisitions occurred primarily in the third quarter. In addition, the cash balance on hand at the beginning of the year was higher than it had been in the previous several years.
NFP filed a shelf registration statement on Form S-3 with the SEC on September 7, 2012, which was declared effective on September 27, 2012. The shelf registration statement provides NFP with the ability to offer, from time to time and subject to market conditions, common stock, preferred stock, debt securities or warrants for proceeds in the aggregate amount of up to $500.0 million. In addition, up to 5,000,000 shares of NFP common stock may be sold pursuant to the registration statement by the selling stockholders described therein. The shelf registration statement is intended to give NFP greater flexibility to raise capital efficiently and put the Company in a position to take advantage of favorable market conditions as they arise.
On April 28, 2011, the Board authorized the 2011 Share Repurchase Program. The timing and actual number of shares repurchased under the 2011 Share Repurchase Program was dependent on a variety of factors, including limitations under NFP’s credit facility, capital availability, share price and market conditions. The 2011 Share Repurchase Program was completed on February 6, 2012, resulting in 3,992,799 shares being repurchased at an average cost of $12.45 per share and a total cost of approximately $49.7 million. The Company currently intends to hold the repurchased shares as treasury stock. See also “Note 11-Stock Incentive Plans-Stock-based compensation” to the Company’s Consolidated Financial Statements contained in this report.
For the year ended December 31, 2012, total shares repurchased during 2012 through both repurchase programs was 1,371,043 at an average cost of $14.40 and a total cost of approximately $19.8 million. NFP also reacquired 23,658 shares relating to the satisfaction of promissory notes and 7,905 shares relating to the disposal of a business.
During the year ended December 31, 2012, cash provided by operating activities was approximately $53.1 million compared with $116.2 million for the year ended December 31, 2011. The decrease in cash provided for the year ended December 31, 2012 as compared with the prior year period was primarily due to cash payments made in connection with management contract buyouts of $16.9 million, payment, net of reimbursement, of a $5.5 million legal settlement, and a payout of the PIP in the amount of $7.3 million, as the Company aligned the PIP with the 2011 calendar year. During 2011, no PIP payments were made since the plan commenced on October 1, 2010 and ended on December 31, 2011. The change in cash flow from operations was also impacted by unfavorable timing differences in working capital, including an increase in estimated tax payments of $8.4 million and an increase in fees to principals advances of $8.0 million. The remaining differences in cash flow from operations compared with the prior period were associated with increases from acquisitions that were more than offset by performance in the life insurance business that continues to face challenges in the market.
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, 2012, 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 $80.0 million, an increase of $4.5 million from the balance of $75.5 million as of December 31, 2011, offset by a corresponding premium payable to carriers of $77.9 million at December 31, 2012 compared with $74.1 million at December 31, 2011. 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, 2012, cash used in investing activities was $83.8 million, which was primarily due to $79.0 million paid as payments for acquisitions, net of cash acquired, $6.9 million paid for earn-out payments and $8.3 million paid for purchases of property and equipment offset by $10.3 million of cash received from the disposal of businesses. During the year ended December 31, 2011, cash used in investing activities was $53.9 million, which was primarily due to $8.9 million paid for purchases of property and equipment and approximately $48.7 million paid as payments for acquisitions, net of cash acquired.
For a discussion of NFP’s refinancing transactions, see “Note 7-Borrowings” to the Company’s Consolidated Financial Statements contained in this report. Additionally, 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” to the Company’s Consolidated Financial Statements contained in this report.
As of December 31, 2012 the Company’s future contractual payments, commercial commitments, and other long-term liabilities were as follows:
(1) See “Note 4-Commitments and Contingencies” to the Company’s Consolidated Financial Statements contained in this report.
(2) See “Note 7-Borrowings” to the Company’s Consolidated Financial Statements contained in this report.
As of December 31, 2012, the Company’s liability for uncertain tax positions was $15.2 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 2-Variable Interest Entities” to the Company’s Consolidated Financial Statements contained in this report.
The Company’s Consolidated Financial Statements are prepared in accordance with U.S. GAAP. The preparation of the Company’s Consolidated Financial Statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The Company continuously evaluates its estimates, which are based on historical experience and on assumptions that the Company believes to be reasonable under the circumstances. These estimates form the basis for judgments about the carrying values of the Company’s assets and liabilities, which values are not readily apparent from other sources. Actual results may differ from these estimates.
Of its significant accounting policies (see “Note 1-Summary of Significant Accounting Policies” to the Company’s Consolidated Financial Statements contained in this report), the Company believes that the following critical accounting policies may involve a higher degree of judgment and complexity.
All of the Company’s transactions have been accounted for using the acquisition 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 earn-outs 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.
Book of Business: The Company refers to a book of business as the acquired firm’s existing client relationships that provide a significant source of income through recurring revenue over the course of the economic life of the relationships. NFP estimates the useful life of a book of business to be typically 10 years.
Management Contract: The management contract secures the services of the principal(s) and encourages growth of the business through the terms of the agreement. The compensation terms are generally such that the principals receive 100 percent of the differential between base earnings and target earnings. The management contracts generally include three-year non-compete agreements which become effective upon termination of the contract and therefore discourage the possibility of competition against NFP. NFP views the value of the management contract as being based on the future expectation of the principals’ ability to replace the diminishing acquired book of business, such that base earnings is maintained on an ongoing basis. NFP estimates the useful life of a management contract to be 25 years, based on an assumed average service life of the principals.
These intangibles primarily represent the present value of the underlying cash flows expected to be received over their estimated future renewal periods. Consequently, the valuation of book of business, management contracts, non-compete agreements, and goodwill involves significant estimates and assumptions concerning matters such as cancellation frequency, expenses and discount rates and the stock volatility of NFP as well as other market participants in the insurance brokerage market. Any change in these assumptions could affect the carrying value of these intangibles. Intangibles related to book of business, management contracts, institutional customer relationships and non-compete agreements are amortized over a 10-year, 25-year, 18-year, and 6-year period, respectively.
In management contract buyouts, NFP either purchases the Management Company or purchases a principal’s economic interest in the management contract. In either scenario, NFP is 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 of the business 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. Management contract buyouts result in an expense to NFP. Additional payments may be paid to the former principals upon the satisfaction of certain compounded growth rate thresholds following the closing of the transaction.
There are three accounting impacts to NFP as a result of the management contract buyouts:
Any subsequent consideration earned by the former principal is treated as compensation expense, as long as those earnings are tied to a requirement that the former principal continue employment. Earn-out payments that have no requirement of continued employment is expensed in the consolidated statements of income through management contract buyout.
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
Additional earn-outs 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. For acquisitions effective prior to January 1, 2009, earn-outs paid to the former owner of the businesses is considered to be additional purchase consideration and is accounted for as part of the purchase price of the Company’s acquired businesses when the outcome of the contingency is determined beyond a reasonable doubt.
Some of the Company’s businesses earn additional compensation in the form of incentive and marketing support payments from manufacturers of financial services products, based on the volume, consistency and profitability of business generated by the Company. 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.
As of December 31, 2012, the Company is subject to U.S. federal income tax examinations for the tax years 2009 through 2011, and to various state and local income tax examinations for the tax years 2004 through 2011.
Stock-based awards issued to the Company’s employees are classified as equity awards. The Company accounts for equity-classified stock-based awards issued to its employees based on the fair value of the award on the date of grant and recorded as an expense as part of compensation expense-employees in the consolidated statements of income. The expense is recorded ratably over the service period, which is generally the vesting period. The offsetting entry is to additional paid in capital in stockholders’ equity.