| |||||||||
National Financial Partners 10-K 2007 Documents found in this filing:
Table of ContentsUNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006 Commission File Number: 001-31781
NATIONAL FINANCIAL PARTNERS CORP. (Exact name of registrant as specified in its charter)
(212) 301-4000 (Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x The aggregate market value of the voting common stock held by non-affiliates of the registrant on June 30, 2006, was $1,491,548,406. The number of outstanding shares of the registrant’s Common Stock, $0.10 par value, as of January 31, 2007, was 37,073,906. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant’s definitive proxy statement for the 2007 Annual Meeting of Stockholders to be held May 16, 2007 are incorporated by reference in this Form 10-K in response to Part III.
Table of ContentsNATIONAL FINANCIAL PARTNERS CORP. Form 10-K For the Year Ended December 31, 2006 TABLE OF CONTENTS
i
Table of ContentsForward-Looking Statements National Financial Partners Corp. and its subsidiaries (“NFP” or the “Company”) and their representatives may from time to time make verbal or written statements, including certain statements in this report, which are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, any statement that may project, indicate or imply future results, events, performance or achievements, and may contain the words “anticipate,” “expect,” “intend,” “plan,” “believe,” “estimate,” “may,” “will,” “continue” and similar expressions of a future or forward-looking nature. Forward looking statements may include discussions concerning revenue, expenses, earnings, cash flow, dividends, capital structure, credit facilities, market and industry conditions, premium and commission rates, interest rates, contingencies, the direction or outcome of regulatory investigations and litigation, income taxes and the Company’s operations. These forward-looking statements are based on management’s current views with respect to future results, and are subject to risks and uncertainties. Forward-looking statements are based on beliefs and assumptions made by management using currently available information, such as market and industry materials, experts’ reports and opinions, and trends. These statements are only predictions and are not guarantees of future performance. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated by a forward-looking statement. These factors include, without limitation:
ii
Table of Contents
Additional factors are set forth in NFP’s filings with the Securities and Exchange Commission (the “SEC”), including this Annual Report on Form 10-K. Forward-looking statements speak only as of the date on which they are made. NFP expressly disclaims any obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.
iii
Table of ContentsItem 1. Business Overview National Financial Partners Corp. The Company is a leading independent distributor of financial services products primarily to high net worth individuals and companies. Founded in 1998, the Company has grown internally and through acquisitions and operates a national distribution network with over 175 owned firms. The Company targets the high net worth and growing entrepreneurial corporate markets because of their growth potential and the desire of customers within these markets for more personalized service. NFP defines the high net worth market as households with investable assets of at least $1 million, and the Company seeks to target the segment of that market having net worth, excluding primary residence, of at least $5 million. The Company defines the growing entrepreneurial corporate market as businesses with less than 1,000 employees. The Company also targets the larger corporate market for executive benefits. NFP believes its management approach affords its firms the entrepreneurial freedom to serve their clients most effectively while having access to the resources of a national distribution organization. At the same time, the Company maintains internal controls that allow NFP to oversee its nationwide operations. NFP’s senior management team is composed of experienced financial services leaders who have direct experience building and operating sizeable distribution-related companies. The Company operates as a bridge between large financial services products manufacturers and its network of independent financial services distributors. The Company believes it enhances the competitive position of independent financial services distributors by offering access to a wide variety of products and a high level of marketing and technical support. NFP also provides financial and intellectual capital to further enhance the business expansion of its firms. For the large financial services products manufacturers, NFP represents an efficient way to access a large number of independent distributors and their customers. The Company believes it is one of the largest distributors within the independent distribution channel for many of the leading financial services products manufacturers serving its target markets. NFP currently has relationships with many industry leading manufacturers, including, but not limited to, AIG, AIM, Allianz, Allstate, American Funds, American Skandia, Assurant, AXA Financial, Boston Mutual, Century Healthcare, Fidelity Investments, Genworth Financial, The Hartford, ING, Jackson National Life, John Hancock USA, Jefferson Pilot, Lincoln Benefit, Lincoln Financial Group, Lloyds of London, MassMutual, MetLife, Nationwide Financial, Oppenheimer Funds, Pacific Life, Phoenix Life, Principal Financial, Protective, Prudential, Securian, Standard Insurance Company, Sun Life, Transamerica, United Healthcare, UnumProvident, West Coast Life and WM Group of Funds. These relationships provide a higher level of dedicated marketing and underwriting support and other benefits to many of its firms than is generally available on their own. The Company’s firms, including NFP Securities, Inc., or NFPSI, its principal broker-dealer subsidiary, serve its client base, both directly and indirectly, by providing products and services in one or more of the following primary areas:
1
Table of ContentsThe Company’s principal and executive offices are located at 787 Seventh Avenue, 11th Floor, New York, New York, 10019 and the telephone number is (212) 301-4000. On NFP’s Web site, www.nfp.com, the Company posts the following filings as soon as reasonably practicable after they are electronically filed or furnished with the Securities and Exchange Commission, or the SEC: the Company’s annual reports on Form 10-K, NFP’s quarterly reports on Form 10-Q, NFP’s current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended. All such filings on NFP’s Web site are available free of charge. Information on the Company’s Web site does not constitute part of this report. Industry Background The Company believes that it is well positioned to capitalize on a number of trends in the financial services industry, including:
2
Table of Contents
Key Elements of NFP’s Growth Strategy NFP’s goal is to achieve superior long-term returns for its stockholders, while establishing itself as one of the premier independent distributors of financial services products and services on a national basis to its target markets. To help accomplish this goal, NFP intends to focus on the following key areas:
The Independent Distribution Channel The Company participates in the independent distribution channel for financial services products and services. The Company considers the independent distribution channel to consist of firms:
3
Table of ContentsThis channel includes independent financial advisors and financial planners and independent insurance agents and brokers. It does not include, among others, national wirehouses, affiliates of private banks or commercial banks (many of whom sell the products of companies other than their own). Nonetheless, the Company competes for customers with all of these types of entities. See “—Competition.” The independent distribution channel is different from other methods of financial services distribution in a number of ways. Rather than the standard employer-employee relationship found in many other types of distribution, such as broker-dealers (for example, wirehouses and regional brokerage firms) or insurance companies, participants in the independent distribution channel are independent contractors. Distributors who choose to work in the independent channel tend to be entrepreneurial individuals who strive to develop personalized relationships with their clients. Often, these distributors started their careers with traditional broker-dealer firms or insurance companies, with highly structured product arrangements, and left these highly structured environments in favor of a more flexible environment. For the distributors in the independent distribution channel, building strong client relationships is imperative as they rely largely on their own reputations to prospect for new clients, in contrast to other types of distributors that rely on a parent company to provide substantial advertising and branding efforts. Broker-dealers serving the independent channel, such as NFPSI, often referred to as independent broker-dealers, tend to offer extensive product and financial planning services and heavily emphasize packaged products such as mutual funds, variable annuities and wrap fee programs. The Company believes that broker-dealer firms serving the independent channel tend to be more responsive to the product and service requirements of their registered representatives than wirehouses or regional brokerage firms. Commission payouts to registered representatives of NFPSI have historically exceeded 90% of commission income, which is significantly higher than many securities firms operating outside the independent distribution channel and higher, on average, than many firms within the independent distribution channel. Products and Services The Company provides a comprehensive selection of products and services that enable NFP’s high net worth clients to meet their financial management and planning needs and corporate clients to create, implement and fund benefit plans for their employees and executives. The products that the Company places and the services offered to its customers can be generally classified in three primary areas: Life insurance and wealth transfer services The life insurance products and wealth transfer services that the Company’s firms offer to clients assist them in growing and preserving their wealth over the course of their lives, developing a plan for their estate upon death and planning for business succession and for charitable giving. The Company’s firms evaluate the near-term and long-term financial needs of clients and design a plan that NFP believes best suits the clients’ needs. The life insurance products that the Company’s firms distribute provide clients with a number of investment, premium payment and tax deferment alternatives in addition to tailored death benefits. Corporate and executive benefits The Company’s firms distribute corporate and executive benefit products and offer related services to corporate clients. Using these products and services, the firms help clients design, fund, implement and administer benefit plans for their employees. Corporate benefit plans are targeted at a broad base of employees within an organization and include, among others, products such as group life, medical and dental insurance. Executive benefit programs are used by companies to compensate key executives often through non-qualified and deferred compensation plans.
4
Table of ContentsFinancial planning and investment advisory services The Company’s firms help high net worth clients evaluate their financial needs and goals and design plans to reach those goals through the use of third-party managed assets. The Company contracts with third-party asset managers to provide separately managed accounts, wrap accounts and other investment alternatives to its clients. You can find a description of how the Company earns revenue from these products and services in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Revenue” found elsewhere in this report. The Company’s firms serve their client base by providing some or all the products and services summarized below in one or more of the following primary areas: Life Insurance and Wealth Transfer Services
Corporate and Executive Benefits
5
Table of Contents
Financial Planning and Investment Advisory Services
Acquisition Strategy The Company’s acquisition strategy is based on a number of core principles that NFP believes provide a foundation for continued success. These principles include the following:
Acquisition Model The Company typically utilizes a unique acquisition and operational structure which:
Under the Company’s acquisition structure, the Company acquires 100% of the equity of independent financial services products distribution businesses on terms that are relatively standard across acquisitions. To determine the acquisition price, the Company first estimates the annual operating cash flow of the business to be
6
Table of Contentsacquired based on current levels of revenue and expense. For this purpose, the Company defines 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. The Company refers to this estimated annual operating cash flow as “target earnings.” The acquisition price is a multiple (generally in a range of five to six times) of a portion of the target earnings, which the Company refers to as “base earnings.” Base earnings averaged 48% of target earnings for all firms owned at December 31, 2006. In determining base earnings, the Company’s general rule is not to exceed an amount equal to the recurring revenue of the business. Recurring revenue generally includes 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. The Company enters into a management agreement with the principals of the acquired business and/or certain entities they own. Under the management agreement, the principals and/or such entities are entitled to management fees consisting of:
The Company retains 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 the Company is entitled to receive base earnings together with the prior years’ shortfall before any management fees are paid. Additional purchase consideration is often paid to the former owners based on satisfying specified internal growth thresholds over the three-year period following the acquisition. In some cases, additional purchase consideration is also paid over a shorter period. The principals retain responsibility for day-to-day operations of the firms for an initial five-year term, renewable annually thereafter by the principals and/or certain entities they own, subject to termination for cause and supervisory oversight as required by applicable securities and insurance laws and regulations and the terms of the management agreements. The principals are responsible for ordinary course operational decisions, including personnel, culture and office location, subject to the oversight of the board of directors of the acquired business. Non-ordinary course transactions require the unanimous consent of the board of directors of the acquired business, which always includes a representative of the Company’s management. The principals also maintain the primary relationship with clients and, in some cases, vendors. The Company’s structure allows principals to continue to operate in an entrepreneurial environment, while also providing the principals a significant economic interest in the business after the acquisition through the management fees. Generally, all of the Company’s firms must transition their financial operations to the Company’s cash management and payroll systems and the Company’s common general ledger. Additionally, most principals must transition their broker-dealer registrations to, and be supervised in connection with their securities activities by, the Company’s broker-dealer, NFPSI. The Company requires the owners of the firms to receive a portion of the acquisition price (typically at least 30%) in the form of NFP common stock, and provide them the opportunity to receive options, additional shares of NFP common stock or cash based on their success in managing the acquired business and increasing its financial performance. The Company believes its structure is particularly appealing to firms whose management anticipates strong future growth and expects to stay involved with the business in the long term. The Company generally obtains key-person life insurance on the principals of firms for at least a five-year term in an amount up to the purchase price of the acquired firm. From time to time, the Company has overvalued certain businesses acquired or found that the business of one of the Company’s firms is temporarily or permanently adversely impacted by changes in the markets that it serves. As of December 31, 2006, the Company has restructured 21 transactions. These restructures generally result in either temporary or permanent reductions in base and target earnings and/or change in the ratio of base to target earnings and the principals paying the Company cash, NFP stock, notes or combinations thereof.
7
Table of ContentsAt times the Company may dispose of firms, certain business units within a firm or firm assets for one or more of the following reasons: non-performance, changes resulting in firms no longer being part of the Company’s core business, change in competitive environment, regulatory changes, the cultural incompatibility of an acquired firm’s management team with the Company, change of business interests of a principal or other issues personal to a principal. In certain instances the Company may sell operating companies back to the principal(s). Principals generally buy back businesses by surrendering all of NFP’s common stock and paying cash or giving the Company a note. Through December 31, 2006 and since the Company’s inception, NFP has disposed of 17 firms. Contingent consideration arrangements In order to better determine the economic value of the businesses the Company acquires, the Company has incorporated contingent consideration, or earnout, provisions into the structure of acquisitions that the Company has made since the beginning of 2001. These arrangements generally result in the payment of additional consideration to the sellers upon the firm’s satisfaction of certain compounded growth rate thresholds over the three-year period generally following the closing of the acquisition. In a small number of cases, contingent consideration may also be payable after shorter periods. As of December 31, 2006, 49 acquisitions are within their initial three-year contingent consideration measurement period. Contingent consideration is considered to be additional purchase consideration and is accounted for as part of the purchase price of the Company’s acquired firms when the outcome of the contingency is determinable beyond a reasonable doubt. A summary of a typical contingent consideration or earnout structure is as follows: Typical Earnout Structure (Payable in cash and the Company’s common stock)
The earnout paid is the corresponding multiple times the original acquired base earnings. The earnout is payable in cash and the Company’s common stock in proportions that vary among acquisitions. The earnout calculation in this example works as follows. An acquired firm had base earnings of $500,000 and target earnings of $1,000,000: Earnout Calculation Assumed Earnings
8
Table of ContentsOngoing incentives Effective January 1, 2002, the Company established an ongoing incentive plan for principals having completed their contingent consideration period or option incentive plan eligibility. The ongoing incentive plan pays out an increasing proportion of incremental earnings based on growth in earnings above an incentive target. The plan has a three-year measuring period and rewards growth above the prior period’s average earnings or prior incentive target, whichever is higher. However, once a firm reaches cumulative applicable earnings in a three-year period equal to or in excess of the cumulative amount of its original target compounded at 35% over three years, the new incentive target is fixed. If the principal does not receive an option grant, contingent consideration or incentive payment in a prior period, the incentive target remains unchanged. As illustrated by the chart set forth below, the bonus is structured to pay the principal 5% to 40% of NFP’s share of incremental earnings from growth.
In addition to the incentive award, the Company pays an additional cash incentive equal to 50% of the incentive award elected to be received in the Company’s stock. For firms that began their incentive period prior to January 1, 2005, the principal could elect from 0% to 100% to be paid in the Company’s common stock. For firms beginning their incentive period on or after January 1, 2005 (with the exception of Highland Capital Holding Corporation or “Highland” firms), the principal is required to take a minimum of 30% (maximum 50%) of the incentive award in the Company’s common stock. This election is made subsequent to the completion of the incentive period. The number of shares of the Company’s common stock that a principal will receive is determined by dividing the dollar amount of the incentive to be paid in the Company’s common stock by the average of the closing price of the Company’s common stock on the twenty trading days up to and including the last day of the incentive period. The shares received as an incentive payment under this ongoing plan are restricted from sale or other transfer (other than transfers to certain permitted transferees, which shares are also restricted from sale or other transfer) and the lifting of such restrictions is based on the performance of the firm managed by the principal during the subsequent ongoing incentive period. One-third of the shares will become unrestricted after each of the first three twelve-month periods after the incentive period during which the firm achieves target earnings. If the firm does not achieve target earnings during each such twelve-month period, but does achieve target earnings on a cumulative basis over the thirty-six month incentive period, any shares that remain restricted will become unrestricted. If the firm does not achieve cumulative target earnings during the thirty-six month period, any shares that remain restricted shall continue to be restricted until sixty months following the end of the incentive period.
9
Table of ContentsThe ongoing incentive payment calculation for a firm with base earnings of $500,000, target earnings of $1,000,000 and a new incentive target (based on average annual earnings during the initial three-year earnout period following acquisition of $1,331,000) would be as follows: Ongoing Incentive Calculation Assumed Earnings
For all incentive programs, earnings levels from which growth is measured are adjusted upward for sub-acquisitions and may be adjusted upward for certain capital expenditures.
Operations The Company believes that preserving the entrepreneurial culture of the firms is important to their continued growth. The Company does not typically integrate the sales, marketing and processing operations of the acquired firms, but allow the principals to continue to operate in the same entrepreneurial environment that made them successful before the acquisition, subject to the Company’s oversight and control. The Company does, however, provide cost efficient services, including common payroll, common general ledger and accounts payable processing, to support back office and administrative functions, which are used by the acquired firms. The Company assists these entrepreneurs by providing a broad variety of financial services products and a network that connects each entrepreneurial firm to others. This network serves as a forum for the firms to build relationships, share ideas and provides the opportunity for firms to offer a broader range of financial services products to their customers. The Company also owns two entities, NFP Insurance Services, Inc., or NFPISI, and NFPSI, that serve as centralized resources for other firms. In addition, several of the Company’s firms act as wholesalers of products to its firms and other financial services distributors.
10
Table of ContentsNFPISI NFPISI is a licensed insurance agency and an insurance marketing organization with 374 member organizations, including 155 owned firms and 219 other firms the Company does not own, as of December 31, 2006. The Company refers to these other firms as members of one of several marketing organizations. NFPISI facilitates interaction among the members of several marketing organizations and provides services to these members. It also holds contracts with selected insurance and benefits manufacturers, which generally offer support for technology investments, co-development of tailored products for use by the Company's producers, enhanced and dedicated underwriting, customer service and other benefits not generally available without such relationships. NFPISI provides overall marketing support including education about various products offered by underwriters, technology-based assistance in comparing competing products and access to customized marketing materials. NFPISI provides a forum for members to interact and learn about products and marketing programs from both manufacturers and other members. NFPISI also provides its members support in underwriting large insurance cases. NFPISI services both third-party distributors as well as NFP firms. Third-party distributors that elect to become members in NFPISI’s life insurance and benefits marketing organizations pay an initiation and annual membership fee. NFPISI actively solicits new members among qualified independent distributors of financial services products who desire the benefits of being part of a large distribution network whether or not they desire to be acquired by the Company. NFP firms can also gain access to some of the services and benefits provided by NFPISI without becoming a member of NFPISI’s life insurance and benefits marketing organizations. NFPSI NFPSI is a registered broker-dealer, investment adviser and licensed insurance agency serving the principals of the Company’s firms and members of its or the Company’s marketing organizations. Most of the Company’s principals conduct securities business through NFPSI. NFPSI is a fully disclosed introducing registered broker-dealer. Succession Planning The Company is actively involved in succession planning with respect to the principals of NFP’s firms. It is in the Company’s interest to ensure a smooth transition of business to a successor principal or principals. Succession planning is important in firms where no obvious successor to the principal or principals exists. Succession planning may involve the Company assisting a firm with a sub-acquisition that will bring a principal into the firm who can be a successor to the existing principal or principals. Succession planning may also involve introducing firms to each other, within the same geographic area where the principals of one firm can be potential successors to the principals of the other firm. In addition, succession planning may involve a principal, producer or employee from the same or a different firm buying another principal’s interest in the management company or applicable management agreement, which provides economic benefits to the selling principal. In rare cases, succession may be accomplished with employees running the operation in the absence of a principal. In certain cases, the Company provides financing for a principal, producer or employees’ purchase of another principal’s management company or applicable management agreement. Sub-Acquisitions To help the Company’s acquired firms grow, NFP provides access to capital and support for expansion through a sub-acquisition program. A typical sub-acquisition involves the acquisition by one of the Company’s firms of a business that is too small to qualify for a direct acquisition by NFP or where the individual running the business wishes to exit immediately or soon after the acquisition. The acquisition multiple paid for sub-acquisitions is typically lower than the multiple paid for a direct acquisition by the Company.
11
Table of ContentsWhen a firm makes a sub-acquisition, the Company typically contributes a portion of the cost of the sub-acquisition in the same ratio as base earnings is to target earnings. The principals of the firm are responsible for contributing the remaining portion of the cost. In most cases, the Company advances the principal’s contribution which is typically repaid with interest over a term of three to five years. The repayment of these loans has priority over the payment of management fees. In almost all cases, base and target earnings of the firm making the sub-acquisition are adjusted upward for the sub-acquisition. Cash Management System The Company employs a cash management system that requires that substantially all revenue generated by owned firms and/or the producers affiliated with the Company’s owned firms be assigned to and deposited directly in centralized bank accounts maintained by NFP. The cash management system enables the Company to control and secure its cash flow and more effectively monitor and control the financial activities of NFP’s firms. Newly acquired firms are converted to the cash management system within a reasonable time, generally one month, following acquisition. Payroll System Since the beginning of 2004, the Company has used a common payroll system for all employees of owned firms. The common payroll system allows the Company to effectively monitor and control new hires, terminations, benefits and any other changes in personnel and compensation because all changes are processed through a central office. Newly acquired firms are transitioned onto the Company’s payroll system generally within three months following the date of acquisition. General Ledger System In 2005, the Company implemented a comprehensive centralized general ledger system for all of its firms. The general ledger system has been designed to accommodate the varied needs of the individual firms and permits them to select one of two platforms in which to manage their business. The shared-service platform is designed to provide firms with a greater level of support from the Company’s corporate office while continuing to provide firm principals flexibility in the decision-making process. The self-service platform is designed for the Company’s larger firms that have a full complement of accounting staff and require less support from NFP’s corporate office. Approximately 20% of the Company’s firms operate on the self-service platform. The remaining firms operate on the shared-service platform. As firms are acquired, they will be transitioned to one of the two platforms, generally, within 30 days. Internal Audit During 2006, the Company continued to expand and upgrade its internal audit department, which reports to the Audit Committee of NFP’s Board of Directors and has the responsibility for planning and performing audits throughout the Company. NFP’s internal audit team is based in the Company’s New York headquarters with additional full-time personnel in the Austin, Texas facility. Compliance and Ethics During 2006, the Company continued to expand and upgrade a company-wide Compliance and Ethics Department, which reports to the chief executive officer and a Compliance and Ethics Committee, comprised of members of the executive management team, including the chief compliance and ethics officer, chief executive officer, chief financial officer, general counsel and executive management of NFPISI and NFPSI. The Company’s Compliance and Ethics Department and Compliance and Ethics Committee monitor and coordinate compliance and ethics activities and initiatives and establish and evaluate controls and procedures designed to ensure that the Company complies with applicable laws and regulations. NFP’s Compliance and Ethics Department is based in the Austin, Texas facility.
12
Table of ContentsOperating Committee The Company’s Operating Committee is responsible for monitoring firm performance, capital and resource allocations, approving capital expenditure requests by firms that are in excess of $100,000, as well as new leases above a certain amount. It reviews firm performance and management fee advances compared with earned management fees to determine if a reduction or cutoff of such advances is warranted. The Operating Committee also directs efforts toward helping under-performing firms improve and, if the under-performance is deemed to be of a long-term nature, directs restructuring activities. The Operating Committee is composed of nine members: the Company’s chief executive officer, chief financial officer, general counsel, chief accounting officer, executive vice-president—marketing and firm operations, senior vice president—mergers and acquisitions, senior vice president—technology and members of executive management of NFPISI and NFPSI. Capital Expenditures If a firm desires to make a capital expenditure and the expenditure is approved by either the Operating Committee or, if below $100,000, the Company’s executive vice president—marketing and firm operations, and the firm’s board of directors, the Company contributes a portion of the cost in the same ratio as base earnings is to target earnings. The principals are responsible for the remainder of the cost. In most cases, the Company advances the principals’ contribution which is repaid with interest over a term which is generally five years or less. The repayment of these advances has priority over the payment of management fees. Earnings levels from which a firm’s growth is measured, as well as a firm’s base earnings, may be adjusted upwards for certain capital expenditures. Corporate Headquarters The Company’s New York headquarters provides support for the acquired firms. Corporate activities, including mergers and acquisitions, legal, finance and accounting, marketing and operations, human resources and technology are centralized in New York. The Company’s mergers and acquisitions team identifies targets, performs due diligence and negotiates acquisitions. The Company’s legal team is heavily involved in the acquisition process, in addition to handling NFP’s general corporate, legal and regulatory needs. Finance and accounting is responsible for working with each firm to integrate the firm’s operations and financial practices with the Company, resolve financial issues and ensure timely and accurate reporting. In addition, finance and accounting is responsible for consolidation of the Company’s financial statements at the corporate level. The Company’s operations team works with the firms to identify opportunities for joint-work and cross-selling and to identify and resolve operational issues. The Company’s human resources department is responsible for establishing and maintaining employment practices and benefits policies and procedures at both the corporate and firm level. The Company’s technology team addresses technology requirements at both the corporate level and at the firm level. The Company’s firms maintain their existing systems except to the extent that they need certain capabilities to interface with NFP’s corporate systems. The Company provides firms with web-enabled software that complements their existing systems. The Company’s technology model and philosophy have enabled principals to immediately begin using NFP’s web-enabled services, leverage their existing technology investments and support growth in products distribution and client reporting capabilities. In 2006, the Company began implementing an enterprise e-mail system with the goal of centralizing the administration of e-mail across the firms. The technology systems responsible for supporting the Company’s business are both highly reliable and redundant with failover capabilities through leading host providers. Recovery testing is regularly performed to ensure that in the event of an unforeseen incident, the business will continue to operate. Clients and Customers The customers of the Company’s life insurance and wealth transfer and financial planning and investment advisory products and services are generally high net worth individuals and the businesses that serve them. The
13
Table of ContentsCompany defines the high net worth market as households with investible assets of at least $1 million. The Company particularly seeks to target the segment of the high net worth market having net worth, excluding primary residence, of at least $5 million, although NFP sells a substantial volume of products to persons having lower levels of net worth. According to Spectrem Group, this higher segment of the high net worth market grew at an estimated compounded annual rate of 15.7% during the period from 1996 to 2005. The Company believes that the current economic and stock market environment has led to increased demand for the specialized services NFP offers to the high net worth market in order to continue to meet their financial goals. The Company’s firms experienced an internal revenue growth rate of 5% in 2006, 22% in 2005, 16% in 2004, 14% in 2003, and 5% in 2002, which NFP believes was driven in part by this increased demand. Further, the Company believes that it is well positioned to benefit from any future growth in the high net worth market. The customers of the Company’s firms’ corporate and executive benefits products and services are generally small and medium-size corporations and the businesses that serve them. The customers of executive benefits products include large corporations as well. Competition The Company faces substantial competition in all aspects of its business. The Company’s competitors in the insurance and wealth transfer business include individual insurance carrier sponsored producer groups, captive distribution systems of insurance companies, broker-dealers and banks. In addition, the Company also competes with independent insurance intermediaries, boutique brokerage general agents and local distributors including M Financial Group and The BISYS Group, Inc. The Company believes it remains competitive due to several factors, including the independence of producers, the “open architecture” platform, the overall strength of the business model, the technology-based support services the Company provides and the training resources available to NFP’s firms. In the corporate and executive benefits business, the Company faces competition which varies based on the products and services provided. In the employee benefits sector, the Company faces competition from both national and regional groups. NFP’s national competitors include Marsh & McLennan Companies, Inc., Aon Corporation, Hilb, Rogal and Hamilton Company, Arthur J. Gallagher & Co., U.S.I. Holdings Corp., Clark Consulting, Inc., Brown & Brown, Inc. and Willis Group Holdings. The Company’s regional competitors include local brokerage firms and regional banks, consulting firms, third-party administrators, producer groups and insurance companies. In the financial planning and investment advisory business, the Company competes with a large number of investment management and investment advisory firms. NFP’s competitors include global and domestic investment management companies, commercial banks, brokerage firms, insurance companies, independent financial planners and other financial institutions. U.S. banks and insurance companies can now affiliate with securities firms, which has accelerated consolidation within the money management and financial services industries. It has also increased the level of competition for assets on behalf of institutional and individual clients. In addition, foreign banks and investment firms have entered the U.S. money management industry, either directly or through partnerships or acquisitions. Factors affecting the Company’s financial planning and investment management business include brand recognition, business reputation, investment performance, quality of service and the continuity of both the client relationships and assets under management. The Company believes that its unique model will allow NFP firms to compete effectively in this market. The Company’s entrepreneurs will be able to maintain and create client relationships while enjoying the brand recognition, quality of service and diversity of opportunities provided by the national network. NFPSI also competes with numerous other independent broker-dealers, including Raymond James Financial, Inc., LPL Financial Services, FSC Securities Corporation, Cambridge Investment Research, Inc., Commonwealth Financial Network, Financial Network Investment Corporation and Royal Alliance Associates, Inc.
14
Table of ContentsRegulation The financial services industry is subject to extensive regulation. The Company’s firms are currently licensed to conduct business in the 50 states, the District of Columbia and Puerto Rico and are subject to regulation and supervision both federally and in each of these jurisdictions. In general, this regulation is designed to protect clients and other third parties that deal with NFP’s firms and to ensure the integrity of the financial markets, and is not designed to protect the Company’s stockholders. NFP’s firms’ ability to conduct business in the jurisdictions in which they currently operate depends on the Company’s firms’ compliance with the rules and regulations promulgated by federal regulatory bodies and the regulatory authorities in each of these jurisdictions. Failure to comply with all necessary regulatory requirements, including the failure to be properly licensed or registered, can subject NFP’s firms to sanctions or penalties. In addition, there can be no assurance that regulators or third parties will not raise material issues with respect to the Company’s firms’ past or future compliance with applicable regulations or that future regulatory, judicial or legislative changes will not have a material adverse effect on the Company. State insurance laws grant supervisory agencies, including state insurance departments, broad regulatory authority. State insurance regulators and the National Association of Insurance Commissioners continually reexamine existing laws and regulations, some of which affect the Company. These supervisory agencies regulate, among other things, the licensing of insurance brokers and agents and other insurance intermediaries, the handling and investment of third-party funds held in a fiduciary capacity and the marketing and compensation practices of insurance brokers and agents. This continual reexamination may result in the enactment of laws and regulations, or the issuance of interpretations of existing laws and regulations, that adversely affect NFP’s business. More restrictive laws, rules or regulations may be adopted in the future that could make compliance more difficult and expensive. Most of the Company’s subsidiaries are licensed to engage in the insurance agency and brokerage business in most of the jurisdictions where NFP does business. In addition, the insurance laws of all United States jurisdictions require individuals who engage in agency, brokerage and certain other insurance service activities to be licensed personally. These laws also govern the sharing of insurance commissions with third parties. NFP believes that any payments made by it, including payment of management fees, are in compliance with applicable insurance laws. However, should any insurance department take the position, and prevail, that certain payments by NFP violate the insurance laws relating to the payment or sharing of commissions, that insurance department could require that the Company stops making those payments or that the entities receiving those payments become licensed. In addition, if this were to occur, the insurance department could impose fines or penalties on the Company. NFP believes, however, that it could continue to operate its business by requiring that these entities be licensed or by making payments directly to licensed individuals. Several of NFP’s subsidiaries, including NFPSI, are registered broker-dealers. The regulation of broker-dealers is performed, to a large extent, by the SEC and self-regulatory organizations, principally the National Association of Securities Dealers, Inc., or NASD, and the national securities exchanges, such as the New York Stock Exchange, or NYSE. Broker-dealers are subject to regulations which cover all aspects of the securities business, including sales practices, trading practices among broker-dealers, use and safekeeping of customers’ funds and securities, capital structure, recordkeeping and the conduct of directors, officers and employees. Violations of applicable laws or regulations can result in the imposition of fines or censures, disciplinary actions, including the revocation of licenses or registrations, and reputational damage. Recently, federal and state authorities have focused on, and continue to devote substantial attention to, the mutual fund, annuity and insurance industries. It is difficult at this time to predict whether changes resulting from new laws and regulations will affect the industry or NFP’s business and, if so, to what degree. The SEC, the NASD and various other regulatory agencies have stringent rules with respect to the maintenance of specific levels of net capital by securities brokerage firms. Failure to maintain the required net capital may subject a firm to suspension or revocation of registration by the SEC and suspension or expulsion from the NASD and other regulatory bodies, which ultimately could prevent NFPSI or the Company’s other
15
Table of Contentsbroker-dealers from performing as a broker-dealer. In addition, a change in the net capital rules, the imposition of new rules or any unusually large charge against net capital could limit the operations of NFPSI or the Company’s other broker-dealers, which could harm NFP’s business. Providing investment advice to clients is also regulated on both the federal and state level. NFPSI and certain of the Company’s firms are investment advisers registered with the SEC under the Investment Advisers Act of 1940, as amended, or Investment Advisers Act, and certain of the Company’s firms are regulated by state securities regulators under applicable state securities laws. Each firm that is a federally registered investment adviser is regulated and subject to examination by the SEC. The Investment Advisers Act imposes numerous obligations on registered investment advisers, including disclosure obligations, recordkeeping and reporting requirements, marketing restrictions and general anti-fraud prohibitions. Each firm that is a state-regulated investment adviser is subject to regulation under the laws of the states in which it provides investment advisory services. Violations of applicable federal or state laws or regulations can result in the imposition of fines or censures, disciplinary actions, including the revocation of licenses or registrations, and reputational damage. The Company’s revenue and earnings may be more exposed than other financial services firms to the revocation or suspension of the licenses or registrations of NFP’s firm principals, because the revenue and earnings of many of the firms are largely dependent on the individual production of their respective principals for whom designated successors may not be in place. Recently, the insurance industry has been subject to a significant level of scrutiny by various regulatory bodies, including state attorneys general and insurance departments, concerning certain practices within the insurance industry. These practices include, without limitation, the receipt of contingent commissions by insurance brokers and agents from insurance companies and the extent to which such compensation has been disclosed, bid rigging and related matters. As discussed under “Item 3—Legal Proceedings,” several of the Company’s subsidiaries received subpoenas and other information requests with respect to these matters. As a result of these and related matters, including actions taken by the New York Attorney General’s office beginning in April 2004, there have been a number of recent revisions to existing, or proposals to modify or enact new, laws and regulations regarding insurance agents and brokers. These actions have imposed or could impose additional obligations on the Company with respect to the insurance and other financial products NFP markets. In addition, in March 2006, NFP received a subpoena from the New York Attorney General’s Office seeking information regarding life settlement transactions. One of the Company’s subsidiaries received a subpoena seeking the same information. Any changes that are adopted by the federal government or the states where the Company markets insurance or conducts life settlements or other insurance-related business could adversely affect the Company’s revenue and financial results. In the Company’s executive benefits business, NFP has designed and implemented supplemental executive retirement plans that use split dollar life insurance as a funding source. Split dollar life insurance policies are arrangements in which premiums, ownership rights and death benefits are generally split between an employer and an employee. The employer pays either the entire premium or the portion of each year’s premium that at least equals the increase in cash value of the policy. Split dollar life insurance has traditionally been used because of its federal tax advantages. However, in recent years, the Internal Revenue Service (the “IRS”) has adopted regulations relating to the tax treatment of some types of these life insurance arrangements, including regulations that treat premiums paid by an employer in connection with split dollar life insurance arrangements as loans for federal income tax purposes. In addition, the Sarbanes-Oxley Act may affect these arrangements. Specifically, the Sarbanes-Oxley Act includes a provision that prohibits most loans from a public company to its directors or executives. Because a split dollar life insurance arrangement between a public company and its directors or executives could be viewed as a personal loan, the Company will face a reduction in sales of split dollar life insurance policies to NFP’s clients that are subject to the Sarbanes-Oxley Act. Moreover, members of Congress have proposed, from time to time, other laws reducing the tax incentive of, or otherwise impacting, these arrangements. As a result, the Company’s supplemental executive retirement plans that use split dollar life insurance may become less attractive to some NFP firms’ customers, which could result in lower revenue to the Company.
16
Table of ContentsLegislation enacted in the spring of 2001 under the Economic Growth and Tax Relief Reconciliation Act of 2001, or EGTRRA, increased the size of estates exempt from the federal estate tax and phases in additional increases between 2002 and 2009. EGTRRA also phases in reductions in the federal estate tax rate between 2002 and 2009 and repeals the federal estate tax entirely in 2010. Under EGTRRA, the federal estate tax will be reinstated, without the increased exemption or reduced rate, in 2011 and thereafter. As enacted, EGTRRA has had a modest negative impact on the Company’s revenue from the sale of estate planning services and products including certain life insurance products that are often used to fund estate tax obligations and could have a further negative impact in the future. Any additional increases in the size of estates exempt from the federal estate tax, further reductions in the federal estate tax rate or other legislation to permanently repeal the federal estate tax, could have a material adverse effect on the Company’s revenue. There can be no assurance that legislation will not be enacted that would have a further negative impact on the Company’s revenue. The market for many life insurance products the Company sells is based in large part on the favorable tax treatment, including the tax-free build up of cash values, that these products receive relative to other investment alternatives. A change in the tax treatment of the life insurance products the Company sells or a determination by the IRS that certain of these products are not life insurance contracts for federal tax purposes could remove many of the tax advantages policyholders seek in these policies. If the provisions of the tax code change or new federal tax regulations and IRS rulings are issued in a manner that would make it more difficult for holders of these insurance contracts to qualify for favorable tax treatment, the demand for the life insurance contracts the Company sells could decrease, which may reduce NFP’s revenue and negatively affect its business. Employees As of December 31, 2006, NFP had approximately 2,642 employees. NFP believes that its relations with the Company’s employees are satisfactory. None of its employees is represented by a union.
17
Table of ContentsItem 1A. Risk Factors Risks Relating to the Company The Company may be unsuccessful in acquiring suitable acquisition candidates, which could adversely affect the Company’s growth. The Company competes with numerous integrated financial services organizations, insurance brokers, insurance companies, banks and other entities to acquire high quality independent financial services distribution firms. Many of the Company’s competitors have substantially greater financial resources than it does and may be able to outbid NFP for these acquisition targets. If NFP does identify suitable candidates, the Company may not be able to complete any such acquisition on terms that are commercially acceptable to the Company. If NFP is unable to complete acquisitions, it may have an adverse effect on the Company’s earnings or revenue growth and negatively impact the Company’s strategic plan because the Company expects a portion of its growth to come from acquisitions. The Company may be adversely affected if the firms it acquires do not perform as expected. Even if NFP is successful in acquiring firms, the Company may be adversely affected if the acquired firms do not perform as expected. The firms NFP acquires may perform below expectations after the acquisition for various reasons, including legislative or regulatory changes that affect the products in which a firm specializes, the loss of key clients after the acquisition closed, general economic factors that impact a firm in a direct way and the cultural incompatibility of an acquired firm’s management team with NFP. The failure of firms to perform as expected at the time of acquisition may have an adverse effect on NFP’s internal earnings and revenue growth rates, and may result in impairment charges and/or generate losses or charges to its earnings if the firms are disposed. As of December 31, 2006, out of a total of 215 acquisitions and sub-acquisitions, the Company has disposed of 17 firms and restructured the Company’s relationship with the principals of another 21 firms due to these factors. Competition in the Company’s industry is intense and, if NFP is unable to compete effectively, NFP may lose clients and its financial results may be negatively affected. The business of providing financial services to high net worth individuals and companies is highly competitive and the Company expects competition to intensify. NFP’s firms face competition in all aspects of their business, including life insurance, wealth transfer and estate planning, corporate and executive benefits, and financial planning and investment advisory services. NFP’s firms compete for clients on the basis of reputation, client service, program and product offerings and their ability to tailor products and services to meet the specific needs of a client. The Company actively competes with numerous integrated financial services organizations as well as insurance companies and brokers, producer groups, individual insurance agents, investment management firms, independent financial planners and broker-dealers. Many of the Company’s competitors have greater financial and marketing resources than it does and may be able to offer products and services that NFP’s firms do not currently offer and may not offer in the future. The passage of the Gramm-Leach-Bliley Act in 1999 reduced barriers to large institutions providing a wide range of financial services products and services. The Company believes, in light of increasing industry consolidation and the regulatory overhaul of the financial services industry, that competition will continue to increase from manufacturers and other marketers of financial services products. The Company’s competitors in the insurance, wealth transfer and estate planning business include individual insurance carrier-sponsored producer groups, captive distribution systems of insurance companies, broker-dealers and banks. In addition, the Company also competes with independent insurance intermediaries, boutique brokerage general agents and local distributors, including M Financial Group and The BISYS Group, Inc. In the employee
18
Table of Contentsbenefits sector, the Company faces competition from both national and regional groups. The Company’s national competitors include Marsh & McLennan Companies, Inc., Aon Corporation, Hilb, Rogal and Hobbs Company, Arthur J. Gallagher & Co., U.S.I. Holdings Corp., Clark Consulting, Inc., Brown & Brown, Inc. and Willis Group Holdings Limited. The Company’s regional competitors include local brokerage firms and regional banks, consulting firms, third-party administrators, producer groups and insurance companies. In the financial planning and investment advisory business, the Company competes with a large number of investment management and investment advisory firms. The Company’s competitors include global and domestic investment management companies, commercial banks, brokerage firms, insurance companies, independent financial planners and other financial institutions. NFPSI also competes with numerous other independent broker-dealers, including Raymond James Financial, Inc., LPL Financial Services, FSC Securities Corporation, Cambridge Investment Research, Inc., Commonwealth Financial Network, Financial Network Investment Corporation, Walnut Street Securities, Inc. and Royal Alliance Associates, Inc. The Company’s operating strategy and structure may make it difficult to respond quickly to regulatory, operational or financial problems and to grow its business, which could negatively affect the Company’s financial results. The Company operates through firms that report their results to NFP’s corporate headquarters on a monthly basis. The Company has implemented cash management and management information systems that allow it to monitor the overall performance and financial activities of its firms. However, if NFP’s firms delay either reporting results or informing corporate headquarters of a negative business development such as the possible loss of an important client or relationship with a financial services products manufacturer or a threatened professional liability or other claim or regulatory inquiry or other action, the Company may not be able to take action to remedy the situation on a timely basis. This in turn could have a negative effect on the Company’s financial results. In addition, if one of its firms were to report inaccurate financial information, it might not learn of the inaccuracies on a timely basis and be able to take corrective measures promptly, which could negatively affect NFP’s ability to report its financial results. In addition, due in part to its management approach, NFP may have difficulty helping its firms grow their business. NFP’s failure to facilitate internal growth, cross-selling and other growth initiatives among its firms may negatively impact the Company’s earnings or revenue growth. The Company’s dependence on the principals of its firms may limit its ability to effectively manage its business. Most of the Company’s acquisitions result in the acquired business becoming its wholly owned subsidiary. The principals enter into management agreements pursuant to which they continue to manage the acquired business. The principals retain responsibility for day-to-day operations of the acquired business for an initial five-year term, renewable annually thereafter by the principals and/or certain entities they own, subject to termination for cause and supervisory oversight as required by applicable securities and insurance laws and regulations and the terms of the Company’s management agreements. The principals are responsible for ordinary course operational decisions, including personnel, culture and office location, subject to the oversight of the board of directors of the acquired business. Non-ordinary course transactions require the unanimous consent of the board of directors of the acquired business, which always includes a representative of the Company’s management. The principals also maintain the primary relationship with clients and, in some cases, vendors. Although the Company maintains internal controls that allow it to oversee its nationwide operations, this operating structure exposes the Company to the risk of losses resulting from day-to-day decisions of the principals. Unsatisfactory performance by these principals could hinder NFP’s ability to grow and could have a material adverse effect on its business and the value of NFP’s common stock.
19
Table of ContentsElimination or modification of the federal estate tax could adversely affect revenue from the Company’s life insurance, wealth transfer and estate planning businesses. Legislation enacted in the spring of 2001 under the Economic Growth and Tax Relief Reconciliation Act of 2001 increased the size of estates exempt from the federal estate tax and phases in additional increases between 2002 and 2009. EGTRRA also phases in reductions in the federal estate tax rate between 2002 and 2009 and repeals the federal estate tax entirely in 2010. Under EGTRRA, the federal estate tax will be reinstated, without the increased exemption or reduced rate, in 2011 and thereafter. As enacted, EGTRRA has had a modest negative impact on the Company’s revenue from the sale of estate planning services and products including certain life insurance products that are often used to fund estate tax obligations and could have a further negative impact in the future. Should additional legislation be enacted that provides for any additional increases in the size of estates exempt from the federal estate tax, further reductions in the federal estate tax rate or other legislation to permanently repeal the federal estate tax, it could have a material adverse effect on the Company’s revenue. There can be no assurance that legislation will not be enacted that would have a further negative impact on the Company’s revenue. A change in the tax treatment of life insurance products the Company sells or a determination that these products are not life insurance contracts for federal tax purposes could reduce the demand for these products, which may reduce the Company’s revenue. The market for many life insurance products NFP sells is based in large part on the favorable tax treatment, including the tax-free build up of cash values and the tax-free nature of death benefits, that these products receive relative to other investment alternatives. A change in the tax treatment of the life insurance products the Company sells or a determination by the IRS that certain of these products are not life insurance contracts for federal tax purposes could remove many of the tax advantages policyholders seek in these policies. In addition, the IRS from time to time releases guidance on the tax treatment of products the Company sells. If the provisions of the tax code were changed or new federal tax regulations and IRS rulings and releases were issued in a manner that would make it more difficult for holders of these insurance contracts to qualify for favorable tax treatment or subject holders to special tax reporting requirements, the demand for the life insurance contracts NFP sells could decrease, which may reduce NFP’s revenue and negatively affect its business. Under current law, both death benefits and accrual of cash value under a life insurance contract are treated favorably for federal income tax purposes. From time to time, legislation that would affect such tax treatment has been proposed, and sometimes it is enacted. For example, federal legislation that would eliminate the tax-free nature of corporate-owned and bank-owned life insurance in certain narrow circumstances was introduced in 2004 and enacted in 2006. Although the effect of the legislation was mitigated as many of the Company’s firms, in line with the life insurance industry generally, modified their business practices in advance of this legislation in order to remain eligible for the tax benefits on such insurance acquisitions, there can be no assurance that the Company’s firms will be able to anticipate and prepare for future legislative changes in a timely manner. In addition, a proposal that would have imposed an excise tax on the acquisition costs of certain life insurance contracts in which a charity and a person other than the charity held an interest was included in the Administration’s Fiscal Year 2006 Budget, but the provision was not ultimately enacted. The recently enacted Pension Protection Act of 2006 requires the Treasury Department to conduct a study on these contracts, and it is possible that an excise tax or similarly focused provision could be imposed in the future. Such a provision could adversely affect, among other things, the utility of and the appetite of clients to employ insurance strategies involving charitable giving of life insurance policy benefits when the policy is or has been owned by someone other than the charity, and the Company’s revenue from the sale of policies pursuant to such strategies could materially decline. On October 22, 2004, President Bush signed into law H.R. 4520, the “American Jobs Creation Act of 2004,” which included provisions affecting deferred compensation arrangements for taxable and tax-exempt employers. The legislation created new Section 409A of the Internal Revenue Code which applies to voluntary deferred compensation arrangements, supplemental executive retirement plans, stock appreciation rights and certain other arrangements which have the effect of deferring compensation. Section 409A generally applies to compensation
20
Table of Contentsdeferrals made after December 31, 2004. Among other things, Section 409A modifies the times at which distributions are permitted from nonqualified deferred compensation arrangements and will require that elections to defer compensation be made earlier than is current practice for many plans. Certain of the Company’s firms sell deferred compensation plans and many of these plans will have to be modified in accordance with these new rules prior to December 31, 2007. Because of the time and effort required to come into compliance with the new rules, the Company’s revenue may be reduced during this transition period. The Company cannot predict the long-term impact that the new rules will have on it. In addition, on January 17, 2007 the Senate Finance Committee approved a proposed amendment to Section 409A that would limit deferred compensation to $1 million per year or, if lower, the average taxable compensation for the previous five years. The proposal would apply to taxable years beginning after December 31, 2006. If enacted, it would be retroactively effective to the beginning of this year. If enacted this proposal, or any similar proposals, could have an adverse effect on executive benefit programs designed and marketed by NFP firms that involve deferred compensation plans, which could have an adverse effect on the Company’s revenue. Changes in the pricing, design or underwriting of insurance products could adversely affect the Company’s revenue. Adverse developments in the insurance markets in which NFP operates could lead to changes in the pricing design or underwriting of insurance products that result in these products becoming less attractive to its customers. For example, the Company believes that changes in the reinsurance market that make it more difficult for insurance carriers to obtain reinsurance coverage for life insurance, including certain types of financed life insurance transactions, have caused some insurance carriers to become more conservative in their underwriting, and to change the design and pricing of universal life policies, which may have reduced their attractiveness to customers. Regulatory developments also could affect product design and the attractiveness of certain products. For example, in December 2005, the Office of the General Counsel of the New York Insurance Department issued an opinion on certain financed life insurance transactions that led to changes in the design and demand for financed life insurance products generally. Any developments that reduce the attractiveness of insurance-related products could result in fewer sales of those products and adversely affect the Company’s revenue. Because the commission revenue the Company’s firms earn on the sale of certain insurance products is based on premiums and commission rates set by insurers, any decreases in these premiums or commission rates could result in revenue decreases for the Company. The Company is engaged in insurance agency and brokerage activities and derives revenue from commissions on the sale of insurance products to clients that are paid by the insurance underwriters from whom the Company’s clients purchase insurance. These commission rates are set by insurance underwriters and are based on the premiums that the insurance underwriters charge. Commission rates and premiums can change based on the prevailing economic and competitive factors that affect insurance underwriters. These factors, which are not within the Company’s control, include the capacity of insurance underwriters to place new business, underwriting and non-underwriting profits of insurance underwriters, consumer demand for insurance products, the availability of comparable products from other insurance underwriters at a lower cost and the availability of alternative insurance products, such as government benefits and self-insurance plans, to consumers. The Company cannot predict the timing or extent of future changes in commission rates or premiums. As a result, the Company cannot predict the effect that any of these changes will have on the Company’s operations. These changes may result in revenue decreases for the Company, which may adversely affect results of operations for the periods in which they occur. While the Company does not believe it has experienced any significant revenue reductions in the aggregate in its business to date due to the following occurrences, the Company is aware of several instances in the last three years of insurance underwriters reducing commission payments on certain life insurance and employee benefits products.
21
Table of ContentsThe Company’s business is subject to risks related to litigation and regulatory actions. From time to time, the Company is subject to lawsuits and other claims arising out of its business operations, including actions relating to the suitability of insurance and financial services products the Company sold to customers and complaints arising out of industry-wide scrutiny of contingent commissions practices. The outcome of these actions cannot be predicted, and no assurance can be given that such litigation or actions would not have a material adverse effect on the Company’s results of operations and financial condition. From time to time, the Company is also subject to new laws and regulations and regulatory actions, including investigations. Recently, the insurance industry has been subject to a significant level of scrutiny by various regulatory bodies, including state attorneys general and insurance departments, concerning certain practices within the insurance industry. These practices include, without limitation, the receipt of contingent commissions by insurance brokers and agents from insurance companies and the extent to which such compensation has been disclosed, bid rigging and related matters. As a result of these and related matters, including actions taken by the New York Attorney General’s office beginning in April 2004, there have been a number of recent revisions to existing, or proposals to modify or enact new, laws and regulations regarding insurance agents and brokers. These actions have imposed or could impose additional obligations on the Company with respect to the insurance and other financial products NFP markets. In addition, several insurance companies have recently agreed with regulatory authorities to end the payment of contingent commissions on insurance products. A portion of the Company’s earnings is derived from commissions and other payments from manufacturers of financial services products that are based on the volume, persistency and profitability of business generated by the Company. If the Company were required to or chose to end these arrangements or if these arrangements were no longer available to it, the Company’s revenue and results of operations could be adversely affected. During 2004, several of the Company’s subsidiaries received subpoenas and other informational requests from governmental authorities, including the New York Attorney General’s Office, seeking information regarding compensation arrangements, any evidence of bid rigging and related matters. The Company cooperated and will continue to cooperate fully with all governmental agencies. In March 2006, the Company received a subpoena from the New York Attorney General’s Office seeking information regarding life settlement transactions. One of the Company’s subsidiaries received a subpoena seeking the same information. The investigation is ongoing and the Company is unable to predict the investigation’s ultimate outcome. Any changes that are adopted by the Company, the federal government or the states where the Company markets insurance or conduct life settlements or other insurance-related business could adversely affect the Company’s revenue and financial results. In December 2006, a key committee of the National Association of Insurance Commissioners, or NAIC, approved amendments to the NAIC Viatical Settlements Model Act. The amended model act will be advanced to the NAIC’s executive committee and plenary for final approval. The amended model act, among other things, would prohibit the sale of a life insurance policy into the secondary market for five years from the date of issuance, subject to limited exceptions. The Company is unable to predict the effect on the life settlement industry the amended model act would have if approved in its current form. If approved, the amended model act generally would serve as a template for new state insurance laws relating to life settlement transactions and may have the effect of reducing the number of life settlement transactions generally, which may lead to a decrease in the Company’s revenue. In 2006, management believes approximately 6 to 9% of the Company’s total revenue was derived from fees earned on the settlement of life insurance policies into the secondary market. Should the amended NAIC Viatical Settlements Model Act be adopted or other new regulations or practices that adversely affect the life settlement industry be instituted, the Company’s revenue could be adversely impacted. The Company, however, is unable to quantify the adverse effect any such regulations or practices could have on its revenue and business.
22
Table of ContentsThe Company cannot predict the effect of any current or future litigation, regulatory activity or investigations on its business. Given the current regulatory environment and the number of NFP’s subsidiaries operating in local markets throughout the country, it is possible that the Company will become subject to further governmental inquiries and subpoenas and have lawsuits filed against it. The Company’s involvement in any investigations and lawsuits would cause the Company to incur additional legal and other costs and, if the Company were found to have violated any laws, it could be required to pay fines, damages and other costs, perhaps in material amounts. The Company could also be materially adversely affected by the negative publicity related to these proceedings, and by any new industry-wide regulations or practices that may result from these proceedings. Legislative, legal, and regulatory developments concerning financial services products NFP provides may negatively affect the Company’s business and financial results. For example, continuing investigations and proceedings regarding late trading and market timing in connection with mutual funds and variable insurance products could result in new industry-wide legislation, rules or regulations that could significantly affect distributors of financial services products such as itself. Similar to certain mutual fund and insurance companies and other broker-dealers, NFPSI has been contacted by the National Association of Securities Dealers, or NASD, and requested to provide information relating to market timing and late trading. NFPSI is cooperating with the regulatory authorities. Although the Company is not aware of any systemic problems with respect to market timing and late trading that would have a material adverse effect on its consolidated financial position, the Company cannot predict the course that the existing inquiries and areas of focus may take or the impact that any new laws, rules or regulations may have on the Company’s business and financial results. The Company’s revenue and earnings may be affected by fluctuations in interest rates, stock prices and general economic conditions. General economic and market factors, such as changes in interest rates or declines or significant volatility in the securities markets, can affect the Company’s commission and fee income. These factors can affect the volume of new sales and the extent to which clients keep their policies in force year after year or maintain funds in accounts the Company manages. Equity returns and interest rates can have a significant effect on the sale of many employee benefit programs whether they are financed by life insurance or other financial instruments. For example, if interest rates increase, competing products offering higher returns could become more attractive to potential purchasers than the programs and policies the Company markets and distribute. A portion of the Company’s recent sales of life insurance products includes sales of financed life insurance products. If interest rates increase, the availability or attractiveness of such financing may decrease, which may reduce the Company's new sales of life insurance products. Further, a decrease in stock prices can have a significant effect on the sale of financial services products that are linked to the stock market, such as variable life insurance, variable annuities, mutual funds and managed accounts. In addition, a portion of the Company’s earnings is derived from fees, typically based on a percentage of assets under management, for NFP’s firms offering financial advice and related services to clients. Further, NFP’s firms earn recurring commission revenue on certain products over a period after the initial sale, provided the customer retains the product. These factors may lead customers to surrender or terminate their products, ending this recurring revenue. A portion of the Company’s earnings is derived from commissions and other payments from manufacturers of financial services products that are based on the volume, persistency and profitability of business generated by the Company. If investors were to seek alternatives to NFP firms’ financial planning advice and services or to the Company’s firms’ insurance products and services, it could have a negative effect on the Company’s revenue. The Company cannot guarantee that it will be able to compete with alternative products if these market forces make NFP firms’ products and services unattractive to clients. Finally, adverse general economic conditions may cause potential customers to defer or forgo the purchase of products that the Company’s firms sell, for example, to invest more defensively or to surrender products to increase personal cash flow. General economic and market factors may also slow the rate of growth, or lead to a decrease in the size, of the high net worth market and the number of small and medium-size corporations. For example, the size of the high net worth market decreased in 2001 and 2002, in part due to these factors, including in particular the decline in the equity markets. Further, assets under management in the independent distribution channel for financial services products declined in 2002 as a result of the same factors.
23
Table of ContentsIf the Company is required to write down goodwill and other intangible assets, the Company’s financial condition and results would be negatively affected. When NFP acquires a business, a substantial portion of the purchase price of the acquisition is allocated to goodwill and other identifiable intangible assets. The amount of the purchase price which is allocated to goodwill and other intangible assets is determined by the excess of the purchase price over the net identifiable assets acquired. As of December 31, 2006, goodwill of $479.0 million, net of accumulated amortization of $12.6 million, represented 60.2% of the Company's total stockholders’ equity. As of December 31, 2006, other intangible assets, including book of business, management contracts, institutional customer relationships and trade name, of $504.6 million, net of accumulated amortization of $114.3 million, represented 50.4% of the Company's total stockholders’ equity. On January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 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 and intangible assets deemed to have indefinite lives no longer be amortized but instead be tested for impairment at least annually (or more frequently if impairment indicators arise). Other intangible assets will continue to be amortized over their useful lives. In accordance with SFAS 142, the Company recognized an impairment loss on goodwill and identifiable intangible assets not subject to amortization of $5.2 million, $3.1 million, $2.4 million, $5.7 million and $0.8 million for the years ended December 31, 2006, 2005, 2004, 2003 and 2002, respectively. On January 1, 2002, the Company adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). In accordance with SFAS 144, long-lived assets, such as property, plant and equipment and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company recognized an impairment loss on identifiable intangible assets subject to amortization of $5.6 million, $5.0 million, $2.4 million, $4.2 million and $1.0 million for the years ended December 31, 2006, 2005, 2004, 2003 and 2002, respectively. Under current accounting standards, if the Company determines goodwill or intangible assets are impaired, the Company will be required to write down the value of these assets. Any write-down would have a negative effect on the Company’s stockholders’ equity and financial results. Failure to comply with or changes in state and federal laws and regulations applicable to NFP could restrict the Company’s ability to conduct its business. The financial services industry is subject to extensive regulation. NFP’s firms are currently licensed to conduct business in the 50 states, the District of Columbia and Puerto Rico, and are subject to regulation and supervision both federally and in each of these jurisdictions. In general, this regulation is designed to protect clients and other third parties that deal with NFP’s firms and to ensure the integrity of the financial markets, and is not designed to protect the Company’s stockholders. The Company’s firms’ ability to conduct business in the jurisdictions in which they currently operate depends on the Company’s compliance with the rules and regulations promulgated by federal regulatory bodies and the regulatory authorities in each of these jurisdictions. Failure to comply with all necessary regulatory requirements, including the failure to be properly licensed or registered, can subject the Company’s firms to sanctions or penalties. In addition, there can be no assurance that regulators or third parties will not raise material issues with respect to the Company’s firms past or future compliance with applicable regulations or that future regulatory, judicial or legislative changes will not have a material adverse effect on the Company. State insurance laws grant supervisory agencies, including state insurance departments, broad regulatory authority. State insurance regulators and the NAIC continually reexamine existing laws and regulations, some of which affect the Company. These supervisory agencies regulate, among other things, the licensing of insurance brokers and agents and other insurance intermediaries, regulation of the handling and investment of third-party funds held in a fiduciary capacity and the marketing and compensation practices of insurance brokers and agents.
24
Table of ContentsThis continual reexamination may result in the enactment of laws and regulations, or the issuance of interpretations of existing laws and regulations, that adversely affect NFP’s business. More restrictive laws, rules or regulations may be adopted in the future that could make compliance more difficult and expensive. Although the federal government generally does not directly regulate the insurance business, federal initiatives often and increasingly have an impact on the business in a variety of ways. From time to time, federal measures are proposed which may significantly affect the insurance business, including limitations on antitrust immunity, tax incentives for lifetime annuity payouts and simplification bills affecting tax-advantaged or tax-exempt savings and retirement vehicles. In addition, various forms of direct federal regulation of insurance have been proposed in recent years. These proposals have included “The Federal Insurance Consumer Protection Act of 2003” and “The State Modernization and Regulatory Transparency Act.” The Federal Insurance Consumer Protection Act of 2003 would have established comprehensive and exclusive federal regulation over all “interstate insurers,” including all life insurers selling in more than one state. This proposed legislation was not enacted. The State Modernization and Regulatory Transparency Act would maintain state-based regulation of insurance but would change the way that states regulate certain aspects of the business of insurance including rates, agent and company licensing, and market conduct examinations. This proposed legislation remains pending. The Company cannot predict whether this or other proposals will be adopted, or what impact, if any, such proposals or, if adopted, such laws may have on the Company’s business, financial condition or results of operation. Several of the Company’s subsidiaries, including NFPSI, are registered broker-dealers. The regulation of broker-dealers is performed, to a large extent, by the SEC and self-regulatory organizations, principally the NASD and the national securities exchanges, such as the NYSE. Broker-dealers are subject to regulations which cover all aspects of the securities business, including sales practices, trading practices among broker-dealers, use and safekeeping of customers’ funds and securities, capital structure, recordkeeping and the conduct of directors, officers and employees. Violations of applicable laws or regulations can result in the imposition of fines or censures, disciplinary actions, including the revocation of licenses or registrations, and reputational damage. Recently, federal, state and other regulatory authorities have focused on, and continue to devote substantial attention to, the mutual fund and variable annuity industries. It is difficult at this time to predict whether changes resulting from new laws and regulations will affect the industry or NFP’s business and, if so, to what degree. Providing investment advice to clients is also regulated on both the federal and state level. NFPSI and certain of the Company’s firms are investment advisers registered with the SEC under the Investment Advisers Act of 1940, as amended, or Investment Advisers Act, and certain of the Company’s firms are regulated by state securities regulators under applicable state securities laws. Each firm that is a federally registered investment adviser is regulated and subject to examination by the SEC. The Investment Advisers Act imposes numerous obligations on registered investment advisers, including disclosure obligations, recordkeeping and reporting requirements, marketing restrictions and general anti-fraud prohibitions. Each firm that is a state-regulated investment adviser is subject to regulation under the laws of the states in which it provides investment advisory services. Violations of applicable federal or state laws or regulations can result in the imposition of fines or censures, disciplinary actions, including the revocation of licenses or registrations, and reputational damage. The Company’s revenue and earnings may be more exposed than other financial services firms to the revocation or suspension of the licenses or registrations of the Company’s firms’ principals because the revenue and earnings of many of NFP’s firms are largely dependent on the individual production of their respective principals for whom designated successors may not be in place. The geographic concentration of the Company’s firms could leave the Company vulnerable to an economic downturn or regulatory changes in those areas, resulting in a decrease in the Company’s revenue. NFP’s firms located in New York produced approximately 10.1%, 9.2%, 12.2%, 13.5% and 13.9% of the Company’s revenue for the years ended December 31, 2006, 2005, 2004, 2003 and 2002, respectively. NFP’s
25
Table of Contentsfirms located in Florida produced approximately 14.2%, 19.2%, 15.4%, 14.0% and 13.4% of the Company’s revenue for the years ended December 31, 2006, 2005, 2004, 2003 and 2002, respectively. NFP’s firms located in California produced approximately 11.3%, 9.6%, 11.3%, 11.9% and 13.3% of the Company’s revenue for the years ended December 31, 2006, 2005, 2004, 2003 and 2002, respectively. Because the Company’s business is concentrated in these three states, the occurrence of adverse economic conditions or an adverse regulatory climate in any of these states could negatively affect the Company’s financial results more than would be the case if the Company’s business were more geographically diversified. A weakening economic environment in any state or region could result in a decrease in employment or wages that may reduce the demand for employee benefit products in that state or region. Reductions in personal income could reduce individuals’ demand for various financial products in that state or region. Between 2000 and 2002, one of the Company’s firms involved in employee and executive benefits experienced decline in revenue due to reductions in employment in the financial services sectors in New York. The loss of key personnel could negatively affect the Company’s financial results and impair the Company’s ability to implement its business strategy. NFP’s success substantially depends on its ability to attract and retain key members of the Company’s senior management team and the principals of the Company’s firms. If the Company were to lose one or more of these key employees or principals, its ability to successfully implement its business plan and the value of the Company’s common stock could be materially adversely affected. Jessica M. Bibliowicz, the chairman of the Company’s board of directors, president and chief executive officer, is particularly important to the Company. Although she has an employment agreement, there can be no assurance that she will serve the term of her employment agreement or renew her employment agreement upon expiration. Other than with respect to Ms. Bibliowicz and many of the principals of NFP’s firms, the Company does not maintain key person life insurance policies. The securities brokerage business has inherent risks. The securities brokerage and advisory business is, by its nature, subject to numerous and substantial risks, particularly in volatile or illiquid markets, or in markets influenced by sustained periods of low or negative economic growth, including the risk of losses resulting from the ownership of securities, trading, counterparty failure to meet commitments, client fraud, employee processing errors, misconduct and fraud (including unauthorized transactions by registered representatives), failures in connection with the processing of securities transactions and litigation. The Company cannot be certain that its risk management procedures and internal controls will prevent losses from occurring. A substantial portion of the Company’s total revenue is generated by NFPSI, and any losses at NFPSI due to the risks noted above could have a significant effect on the Company’s revenue and earnings. Failure to comply with net capital requirements could subject the Company’s wholly owned broker-dealers to suspension or revocation of their licenses by the SEC or expulsion from the NASD. The SEC, the NASD and various other regulatory agencies have stringent rules with respect to the maintenance of specific levels of net capital by securities brokerage firms. Failure to maintain the required net capital may subject a firm to suspension or revocation of registration by the SEC and suspension or expulsion from the NASD and other regulatory bodies, which ultimately could prevent NFPSI or the Company’s other broker-dealers from performing as a broker-dealer. Although the Company’s broker-dealers have compliance procedures in place to ensure that the required levels of net capital are maintained, there can be no assurance that the Company’s broker-dealers will remain in compliance with the net capital requirements. In addition, a change in the net capital rules, the imposition of new rules or any unusually large charge against net capital could limit the operations of NFPSI or the Company’s other broker-dealers, which could harm NFP’s business.
26
Table of ContentsThe Company’s business, financial condition and results of operations may be negatively affected by errors and omissions claims. The Company has significant insurance agency, brokerage and intermediary operations as well as securities brokerage and investment advisory operations and activities, and is subject to claims and litigation in the ordinary course of business resulting from alleged and actual errors and omissions in placing insurance, effecting securities transactions and rendering investment advice. These activities involve substantial amounts of money. Since errors and omissions claims against the Company’s firms may allege the Company’s liability for all or part of the amounts in question, claimants may seek large damage awards. These claims can involve significant defense costs. Errors and omissions could include, for example, failure, whether negligently or intentionally, to place coverage or effect securities transactions on behalf of clients, to provide insurance carriers with complete and accurate information relating to the risks being insured or to appropriately apply funds that the Company holds on a fiduciary basis. It is not always possible to prevent or detect errors and omissions, and the precautions the Company takes may not be effective in all cases. The Company has errors and omissions insurance coverage to protect it against the risk of liability resulting from alleged and actual errors and omissions by the Company and its firms. Recently, prices for this insurance have increased and coverage terms have become far more restrictive because of reduced insurer capacity in the marketplace. While the Company endeavors to purchase coverage that is appropriate to its assessment of the Company’s risk, NFP is unable to predict with certainty the frequency, nature or magnitude of claims for direct or consequential damages. Although management does not believe that claims against NFP’s firms, either individually or in the aggregate, will materially affect its business, financial condition or results of operations, there can be no assurance that the Company will successfully dispose of or settle these claims or that insurance coverage will be available or adequate to pay the amounts of any award or settlement. The Company’s business, financial condition and results of operations may be negatively affected if in the future the Company’s insurance proves to be inadequate or unavailable. In addition, errors and omissions claims may harm NFP’s reputation or divert management resources away from operating the Company’s business. Because the Company’s firms’ clients can withdraw the assets its firms manage on short notice, poor performance of the investment products and services the Company’s firms recommend or sell may have a material adverse effect on the Company’s business. NFP’s firms’ investment advisory and administrative contracts with their clients are generally terminable upon 30 days’ notice. These clients can terminate their relationship with the Company’s firms, reduce the aggregate amount of assets under management or shift their funds to other types of accounts with different rate structures for any of a number of reasons, including investment performance, changes in prevailing interest rates, financial market performance and personal client liquidity needs. Poor performance of the investment products and services that NFP’s firms recommend or sell relative to the performance of other products available in the market or the performance of other investment management firms tends to result in the loss of accounts. The decrease in revenue that could result from such an event could have a material adverse effect on the Company’s business. The Company’s results of operations could be adversely affected if the Company is unable to facilitate smooth succession planning at its firms. The Company seeks to acquire firms in which the principals are not ready to retire, but instead will be motivated to grow their firm’s earnings and participate in the growth incentives that the Company offers. However, the Company cannot predict with certainty how long the principals of its firms will continue working. The personal reputation of the principals of the Company’s firms and the relationships they have are crucial to success in the independent distribution channel. Upon retirement of a principal, the business of a firm may be adversely affected if that principal’s successor in the firm’s management is not as successful as the original principal. Although the Company has had few successions to date as a result of the Company’s short operating history, succession will be a larger issue for NFP in the future. The Company will attempt to facilitate smooth transitions but if the Company is not successful, the Company’s results of operations could be adversely affected.
27
Table of ContentsGovernment regulation relating to the supplemental executive benefits plans the Company designs and implement could negatively affect its financial results. In NFP’s executive benefits business, NFP has designed and implemented supplemental executive retirement plans that use split dollar life insurance as a funding source. Split dollar life insurance policies are arrangements in which premiums, ownership rights and death benefits are generally split between an employer and an employee. The employer pays either the entire premium or the portion of each year’s premium that at least equals the increase in cash value of the policy. Split dollar life insurance has traditionally been used because of its federal tax advantages. However, in recent years, the IRS has adopted regulations relating to the tax treatment of some types of these life insurance arrangements, including regulations that treat premiums paid by an employer in connection with split dollar life insurance arrangements as compensation or loans for federal income tax purposes. In addition, the Sarbanes-Oxley Act has affected these arrangements. Specifically, the Sarbanes-Oxley Act includes a provision that prohibits most loans from a public company to its directors or executives. Because a split dollar life insurance arrangement between a public company and its directors or executives is viewed as a personal loan, the Company has faced a reduction in sales of split dollar life insurance policies to the Company’s clients that are subject to the Sarbanes-Oxley Act. Moreover, members of Congress have proposed, from time to time, other laws reducing the tax incentive of, or otherwise affecting, these arrangements. As a result, the Company’s supplemental executive retirement plans that use split dollar life insurance have become less attractive to some of NFP firms’ customers, which could result in lower revenue to the Company, and, in recent years the Company has seen a reduction in sales of split dollar life insurance policies to its clients. The Company’s business is dependent upon information processing systems. The Company’s ability to provide financial services to clients and to create and maintain comprehensive tracking and reporting of client accounts depends on the Company’s capacity to store, retrieve and process data, manage significant databases and expand and periodically upgrade the Company’s information processing capabilities. As the Company continues to grow, the Company will need to continue to make investments in new and enhanced information systems. Interruption or loss of the Company’s information processing capabilities or adverse consequences from implementing new or enhanced systems could have a material adverse effect on the Company’s business and the value of its common stock. As the Company’s information system providers revise and upgrade their hardware, software and equipment technology, the Company may encounter difficulties in integrating these new technologies into its business. These new revisions and upgrades may not be appropriate for the Company’s business. Although the Company has experienced no significant breaches of the Company’s network security by unauthorized persons, the Company’s systems may be subject to infiltration by unauthorized persons. If the Company’s systems or facilities were infiltrated and damaged by unauthorized persons, NFP’s clients could experience data loss, financial loss and significant business interruption. If that were to occur, it could have a material adverse effect on the Company’s business, financial condition and results of operations. The Company may overestimate management fees advanced to principals and/or certain entities they own, which may negatively affect its financial condition and results. The Company typically advances management fees monthly to principals and/or certain entities they own. The Company sets each principal’s and/or such entity’s management fee amount after estimating how much operating cash flow the firm that the principal and/or such entity manages will produce. If the firm produces less operating cash flow than what the Company estimated, an overadvance may occur, which may negatively affect the Company’s financial condition and results. Further, since contractually the Company is unable to unilaterally adjust payments to the principals and/or certain entities they own until after a three, six or nine-month calculation period depending on the firms, the Company may not be able to promptly take corrective measures, such as adjusting the monthly management fee lower or requiring the principal and/or such entity to repay the overadvance within a limited time period. In addition, if a principal and/or certain entities they own fail to repay an overadvance in a timely manner and any security the Company receives from the principal and/or such entities for the overadvance is insufficient, the Company’s financial condition and results may be negatively affected, which could negatively affect the Company’s results of operations.
28
Table of ContentsNFPSI relies heavily on Pershing and Fidelity, its clearing firms, and termination of its agreements with the clearing firms could harm its business. Pursuant to NFPSI’s clearing agreements with Pershing and Fidelity, the clearing firms process all securities transactions for NFPSI’s account and the accounts of its clients. Services of the clearing firms include billing and credit extension and control, receipt, custody and delivery of securities. NFPSI is dependent on the ability of its clearing firms to process securities transactions in an orderly fashion. Clearing agreements with Pershing and Fidelity may be terminated by either party upon 90 days’ prior written notice. If these agreements were terminated, NFPSI’s ability to process securities transactions on behalf of its clients could be adversely affected. Item 1B. Unresolved Staff Comments None. Item 2. Properties The Company’s corporate headquarters is located at 787 Seventh Avenue, 11th Floor, New York, NY 10019, where the Company leases approximately 35,200 square feet of space. The Company’s subsidiaries NFPSI and NFPISI lease approximately 63,177 square feet of space in Austin, Texas. Additionally, the Company’s firms lease properties for use as offices throughout the United States. The Company believes that its existing properties are adequate for the current operating requirements of NFP’s business and that additional space will be available as needed. Item 3. Legal Proceedings In the ordinary course of business, the Company is involved in lawsuits and other claims. Management considers these lawsuits and claims to be without merit and the Company intends to defend them vigorously. In addition, the sellers of firms that the Company acquires typically indemnify the Company for loss or liability resulting from acts or omissions occurring prior to the acquisition, whether or not the sellers were aware of these acts or omissions. Several of the existing lawsuits and claims have triggered these indemnity obligations. In addition to the foregoing lawsuits and claims, during 2004, several of the Company’s firms received subpoenas and other informational requests from governmental authorities, including the New York Attorney General’s Office, seeking information regarding compensation arrangements, any evidence of bid rigging and related matters. The Company has cooperated and will continue to cooperate fully with all governmental agencies. Also, in March 2006, the Company received a subpoena from the New York Attorney General’s Office seeking information regarding life settlement transactions. One of the Company’s subsidiaries received a subpoena seeking the same information. The Company is cooperating fully with the Attorney General’s investigation. The investigation, however, is ongoing and the Company is unable to predict the investigation’s outcome. Management believes that the resolution of these lawsuits, claims and subpoenas will not have a material adverse impact on the Company’s consolidated financial position. The Company cannot predict at this time the effect that any current or future regulatory activity, investigations or litigation will have on its business. Given the current regulatory environment and the number of its subsidiaries operating in local markets throughout the country, it is possible that the Company will become subject to further governmental inquiries and subpoenas and have lawsuits filed against it. The Company’s ultimate liability, if any, in connection with these matters and any possible future such matters is uncertain and subject to contingencies that are not yet known. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of the Company’s security holders during the fourth quarter of 2006.
29
Table of ContentsItem 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The Company’s shares of common stock have been traded on the NYSE under the symbol “NFP” since the Company’s initial public offering in September 2003. Prior to that time, there was no public market for the Company’s common stock. On January 31, 2007, the last reported sales price of the common stock was $49.10 per share, as reported on the NYSE. As of January 31, 2007, there were 599 common stockholders of record. These figures do not include stockholders with shares held under beneficial ownership in nominee name, which are estimated to be in excess of 21,000. The following table sets forth the high and low intraday prices of the Company’s common stock for the periods indicated as reported on the NYSE:
On February 14, 2007, the Company’s Board of Directors declared a quarterly cash dividend of $0.18 per share of common stock. The dividend will be payable on April 9, 2007, to stockholders of record at the close of business on March 16, 2007. The Company currently expects to continue to pay quarterly cash dividends on its common stock. The declaration and payment of future dividends to holders of its common stock will be at the discretion of the Company’s Board of Directors and will depend upon many factors, including the Company’s financial condition, earnings, legal requirements and other factors as the Board of Directors deems relevant. The information set forth under the caption “Equity Compensation Plan Information” in the Company’s definitive proxy statement for its 2007 Annual Meeting of Stockholders (the “Proxy Statement”) is incorporated herein by reference. On September 6, 2006, in connection with a secondary public offering by certain of the Company’s stockholders of approximately 1.6 million shares of common stock, stock options for 325,915 shares were exercised resulting in cash proceeds to the Company of $3.4 million. Recent Sales of Unregistered Securities Since January 1, 2006 and through December 31, 2006, the Company has issued the following securities: The Company has issued 981,164 shares of its common stock with a value of approximately $47.6 million to principals in connection with the acquisition of firms. The Company has also granted principals of its firms 347,621 shares of NFP’s common stock with a value of approximately $15.3 million in connection with contingent consideration and ongoing incentive plans.
30
Table of ContentsSince January 1, 2007 and through February 22, 2007, the Company has issued the following unregistered securities: The Company has issued or agreed to issue approximately 462,000 shares of its common stock with a value of approximately $20.0 million to principals in connection with the acquisition of firms. The Company has also granted principals of its firms 9,597 shares of NFP’s common stock with a value of approximately $398,000 in connection with contingent consideration and ongoing incentive plans. The issuances of common stock described above were made in reliance upon the exemption from registration under Section 4(2) of the Securities Act of 1933, as amended, and Regulation D promulgated thereunder, for transactions by an issuer not involving a public offering. The Company did not offer or sell the securities by any form of general solicitation or general advertising, informed each purchaser that the securities had not been registered under the Securities Act and were subject to restrictions on transfer, and made offers only to “accredited investors” within the meaning of Rule 501 of Regulation D and a limited number of sophisticated investors, each of whom the Company believes has the knowledge and experience in financial and business matters to evaluate the merits and risks of an investment in the securities and had access to the kind of information registration would provide. Purchases of Equity Securities by the Issuer
31
Table of ContentsItem 6. Selected Financial Data You should read the selected consolidated financial data set forth below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the consolidated financial statements and the related notes included elsewhere in this report. The Company derived the following selected financial information as of December 31, 2006 and 2005 and for each of the three years in the period ended December 31, 2006 from the Company’s audited consolidated financial statements and the related notes included elsewhere in this report. The Company derived the selected financial information as of December 31, 2004, 2003 and 2002 and for each of the two years in the period ended December 31, 2003 from the Company’s audited consolidated financial statements and the related notes not included elsewhere in this report. Although the Company 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. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Acquisitions.” As a result of the Company’s acquisitions, the results in the periods shown below may not be directly comparable.
32
Table of Contents
As a result of adopting SFAS 123R the Company recorded, for firm employees, principals and firm activities, a charge to cost of services of $3.2 million for 2006. The Company recorded $6.0 million of such expense for 2006, in corporate and other expenses—general and administrative. Previously all stock-based compensation was included in general and administrative expense as a component of corporate and other expenses. Total stock-based compensation for 2006 was $9.2 million. Total stock-based compensation of $4.5 million in 2005, $1.4 million in 2004, $0.2 million in 2003, and $9.9 million in 2002 is included in corporate and other expenses—general and administrative to conform to the current period presentation.
33
Table of Contents
34
Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the Company’s consolidated financial statements and the related notes included elsewhere in this report. In addition to historical information, this discussion includes forward-looking information that involves risks and assumptions which could cause actual results to differ materially from management’s expectations. See “Forward-Looking Statements” included elsewhere in this report. Executive Overview The Company is a leading independent distributor of financial services products primarily to high net worth individuals and growing entrepreneurial companies. Founded in 1998, and commencing operations on January 1, 1999, the Company has grown internally and through acquisitions and, as of December 31, 2006, operates a national distribution network with over 175 owned firms. The Company acquired 23, 26 and 19 firms in 2006, 2005, and 2004, respectively. The Company’s operating results have improved from net income of $11.6 million in 2002 to net income of $57.6 million in 2006. As a result of new acquisitions and the growth of previously acquired firms, total revenue has grown from $348.2 million in 2002 to nearly $1.1 billion of revenue in 2006, a compound annual growth rate of over 33.3%. The Company’s firms earn revenue that consists primarily of commissions and fees earned from the sale of financial products and services to their clients and incur commissions and fees expense and operating expense in the course of earning revenue. The Company pays management fees to non-employee principals of its firms based on the financial performance of each respective firm. The Company refers to revenue earned by the Company’s firms minus the expenses of its firms, including management fees, as gross margin. The Company excludes amortization and depreciation from gross margin. These amounts are included in amounts disclosed separately as part of “Corporate and other expenses.” Management uses gross margin as a measure of the performance of the firms that the Company has acquired. Through acquisitions and internal growth, gross margin has grown from $75.4 million in 2002 to $199.2 million in 2006. The Company’s gross margin is offset by expenses that it incurs at the corporate level, including corporate and other expenses. Corporate and other expenses have grown from $49.1 million in 2002 to $99.1 million in 2006. Corporate and other expenses include general and administrative expenses, which are the operating expenses of NFP’s corporate headquarters and a portion of stock-based compensation. General and administrative expenses have grown from $30.6 million in 2002 to $51.3 million in 2006. General and administrative expenses as a percent of revenue declined from 8.8% in 2002 to 4.8% in 2006. Many external factors affect the Company’s revenue and profitability, including economic and market conditions, legislative and regulatory developments and competition. Because many of these factors are unpredictable and generally beyond the Company’s control, the Company’s revenue and earnings may fluctuate from year to year and quarter to quarter. In 2005, the Company’s revenue and net income, particularly in the fourth quarter of 2005, benefited from strong sales of financed life insurance products. Management believes that sales of financed life insurance products diminished in 2006 which was a significant component in the decline in sales growth from prior periods. Acquisitions Under NFP’s typical acquisition structure, the Company acquires 100% of the equity of independent financial services products distribution businesses on terms that are relatively standard across its acquisitions. To determine the Company’s acquisition price, NFP management first estimates the annual operating cash flow of the business to be acquired based on current levels of revenue and expense. For this purpose, the Company defines 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. The Company refers to this estimated annual operating cash flow as “target earnings.” The
35
Table of ContentsCompany’s acquisition price is a multiple (generally in a range of five to six times) of a portion of the target earnings, which the Company refers to as “base earnings.” Base earnings averaged 48% of target earnings for all firms owned at December 31, 2006. In determining base earnings, management focuses on the recurring revenue of the business. Recurring revenue refers to 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. The Company enters into a management agreement with principals and/or certain entities they own. Under the management agreement, the principals and/or such entities are entitled to management fees consisting of:
The Company retains 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 NFP is entitled to receive base earnings together with the prior years’ shortfall before any management fees are paid. Additional purchase consideration is often paid to the former owners based on satisfying specified internal growth thresholds over the three-year period following the acquisition. Substantially all of the Company’s acquisitions have been paid for with a combination of cash and NFP’s common stock, valued at its then fair market value. The Company requires its principals to take typically at least 30% of the total acquisition price in NFP common stock; however, through December 31, 2006, principals have taken on average approximately 40.0% of the total acquisition price in NFP’s common stock. The following table shows acquisition activity (including sub-acquisitions) in the following periods:
Although management believes that the Company will continue to have opportunities to complete a similar number of acquisitions as NFP has in the past, there can be no assurance that NFP will be successful in identifying and completing acquisitions: See “Risk Factors—Risks Relating to the Company—the Company may be unsuccessful in acquiring suitable acquisition candidates, which could adversely affect its growth.” Any change in the Company’s financial condition or in the environment of the markets in which NFP operates could impact its ability to source and complete acquisitions. Revenue The Company generates revenue primarily from the following sources:
36
Table of Contents
Some of the Company’s firms also earn additional compensation in the form of incentive and marketing support revenue from manufacturers of financial services products, based on the volume, persistency and profitability of business generated by the Company from these three sources. These forms of payments are earned both with respect to sales by the Company’s owned firms and sales by NFP’s affiliated third-party distributors. NFPSI, the Company’s registered broker-dealer and investment adviser, also earns commissions and fees on the transactions effected through it. Most principals of the Company’s firms, as well as many of its affiliated third-party distributors, conduct securities or investment advisory business through NFPSI. Incidental to the corporate and executive benefits services provided to their customers, some of the Company’s firms offer property and casualty insurance brokerage and advisory services. The Company believes these services complement the corporate and executive benefits services provided to the Company’s clients. NFP earns commissions and fees in connection with these services. Although the Company’s operating history is limited, the Company believes that its firms earn approximately 65% to 70% of their revenue in the first three quarters of the year and approximately 30% to 35% of their revenue in the fourth quarter.
37
Table of ContentsExpenses The following table sets forth certain expenses as a percentage of revenue for the periods indicated:
Cost of services Commissions and fees. Commissions and fees are typically paid to third party producers, who are producers that are affiliated with NFP’s firms. Commissions and fees are also paid to non-affiliated producers who utilize the services of one or more of the Company’s life brokerage entities including the Company’s life settlements brokerage entity. Commissions and fees are also paid to non-affiliated producers who provide referrals and specific product expertise to NFP firms. When business is generated solely by a principal, no commission expense is incurred because principals are only paid from a share of the cash flow of the acquired firm through management fees. 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 of the acquired firm. In addition, NFPSI pays commissions to members of the marketing organizations that transact business through NFPSI. Operating expenses. The Company’s firms incur operating expenses related to maintaining individual offices, including compensating producing and non-producing staff. Firm operating expenses also include the expenses of NFPSI and NFPISI, two subsidiaries that serve the Company’s acquired firms and through which the Company’s acquired firms and its third-party distributors who are members of its marketing organizations access insurance and financial services products and manufacturers. With the adoption of SFAS 123R the Company now records share-based payments related to firm employees and firm activities to operating expenses as a component of cost of services. Previously all share-based expense components for year end periods prior to December 31, 2006 were recorded under Corporate and other expenses – general and administrative expense. Management fees. The Company pays management fees to the principals of its firms and/or certain entities they own based on the financial performance of the firms they manage. The Company typically pays a portion of the management fees monthly in advance. Once the Company receives cumulative preferred earnings (base earnings) from a firm, the principals and/or an entity the principals own will earn management fees equal to earnings above base earnings up to target earnings. An additional management fee is paid in respect of earnings in excess of target earnings based on the ratio of base earnings to target earnings. For example, if base earnings equal 40% of target earnings, the Company receives 40% of earnings in excess of target earnings and the principal and/or the entity receives 60%. A majority of the Company’s acquisitions have been completed with a ratio of base earnings to target earnings of 50%. Management fees also include an accrual for certain performance-based incentive amounts payable under the Company’s ongoing incentive plan. Incentive amounts are paid in a combination of cash and the Company’s common stock. For firms that began their incentive period prior to January 1, 2005, the principal could elect from 0% to 100% to be paid in the Company’s common stock.
38
Table of ContentsIn addition to the incentive award, the Company pays an additional cash incentive equal to 50% of the incentive award elected to be received in the Company’s stock. This election is made subsequent to the completion of the incentive period. No accrual is made for these additional cash incentives until the related election is made. However, for firms beginning their incentive period on or after January 1, 2005 (with the exception of Highland firms), the principal is required to take a minimum of 30% (maximum 50%) of the incentive award in common stock. The Company accrues on a current basis for these firms the additional cash incentive (50% of the stock portion of the award) based upon the principal’s election of the minimum percentage required to be received in company stock. The ratio of management fees to gross margin before management fees is dependent on the percentage of total earnings of the Company’s firms capitalized by the Company, the performance of the Company’s firms relative to base earnings and target earnings, the growth of earnings of the Company’s firms in the periods after their first three years following acquisition and the earnings of NFPISI, NFPSI and earnings of a small number of firms without a principal, from which no management fees are paid. Due to the Company’s cumulative preferred position, if a firm produces earnings below target earnings in a given year, the Company’s share of the firm’s total earnings would be higher for that year. If a firm produces earnings at or above target earnings, the Company’s share of the firm’s total earnings would be equal to the percentage of the earnings capitalized by the Company in the initial transaction, less any percentage due to additional management fees earned under ongoing incentive plans. With the adoption of SFAS 123R, effective January 1, 2006, the Company now records share-based payments related to principals in management fees which are included as a component of cost of services. Previously, all shared-based expense components for year end periods prior to December 31, 2006 were recorded under Corporate and other expenses–general and administrative expense. The following table summarizes the results of operations of NFP’s firms for the periods presented and shows management fees as a percentage of gross margin before management fees:
Corporate and other expenses General and administrative. At the corporate level, the Company incurs general and administrative expense related to the acquisition and administration of its firms. General and administrative expense includes both cash and stock-based compensation, occupancy, professional fees, travel and entertainment, technology, telecommunication, advertising and marketing, internal audit and certain corporate compliance costs. Prior to the adoption of SFAS 123R on January 1, 2006, all stock-based compensation was included in general and administrative expense. Effective January 1, 2006, all stock-based compensation related to firm employees, principals or firm activities has been included in cost of services. Stock-based compensation related to firm employees and firm activities issued prior to the adoption of SFAS 123R totaled approximately $3.2 million, $1.1 million, and $0.2 million for the full year 2006, 2005 and 2004 respectively. Total stock-based compensation for 2006 was $9.2 million. Total stock-based compensation of $4.5 million in 2005 and $1.4 million in 2004 is included in corporate and other expenses-general and administrative.
39
Table of ContentsAmortization. The Company incurs amortization expense related to the amortization of certain identifiable intangible assets. 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 firms as well as the Company’s corporate office is recorded within this line item. Impairment of goodwill and intangible assets. The firms the Company acquires may not continue to positively perform after the acquisition for various reasons, including legislative or regulatory changes that affect the products in which a firm specializes, the loss of key clients after the acquisition closed, general economic factors that impact a firm in a direct way, the cultural incompatibility of an acquired firms management team with the Company and the death or disability of significant principals. In such situations, the Company may take impairment charges in accordance with SFAS No. 142 and SFAS No. 144 and reduce the carrying cost of acquired identifiable intangible assets (including book of business, management contracts, institutional customer relationships and tradename) and goodwill to their respective fair values. Management reviews and evaluates the financial and operating results of the Company’s acquired firms on a firm-by-firm basis throughout the year to assess the recoverability of goodwill and other intangible assets associated with these firms. In assessing the recoverability of goodwill and other intangible assets, management uses historical trends and makes projections regarding the estimated future cash flows and other factors to determine the recoverably of the respective assets. If a firm’s goodwill and other intangible assets do not meet the recoverability test, the firm’s carrying value will be compared to its estimated fair value. The fair value is based upon the amount at which the acquired firm could be bought or sold in a current transaction between the Company and the principals and/or the present value of the assets’ future cash flows. The intangible assets associated with a particular firm may be impaired when the firm has experienced a significant deterioration in its business indicated by an inability to produce at the level of base earnings for a period of four consecutive quarters and when the firm does not appear likely to improve its operating results or cash flows in the foreseeable future. Management believes that this is an appropriate time period to evaluate firm performance given the seasonal nature of many firms’ activities. Loss (gain) on sale of businesses. From time to time, the Company has disposed of acquired firms or certain assets of acquired firms. In these dispositions, the Company may realize a gain or loss on the sale of acquired firms or certain assets of acquired firms. Results of Operations Through acquisitions and internal growth, the Company has achieved revenue growth of 21%, 39%, and 38% in the years ended December 31, 2006, 2005 and 2004, respectively. This growth was driven by the Company’s acquisitions and internal growth in the revenue of its acquired firms, augmented by the growth of NFPISI and NFPSI. In 2006, 2005 and 2004, the Company’s firms had an internal revenue growth rate of 5%, 22% and 16%, respectively. As a measure of financial performance, the Company calculates the internal growth rate of the revenue of the Company’s firms. This calculation compares the change in revenue of a comparable group of firms for the same time period in successive years. The Company includes firms in this calculation at the beginning of the first fiscal quarter that begins one year after acquisition by the Company unless a firm has merged with another owned firm or has made a sub-acquisition that represents more than 25% of the base earnings of the acquiring firm. With respect to two owned firms that merge, the combined firm is excluded from the calculation from the time of the merger until the first fiscal quarter that begins one year after acquisition by the Company of the most recently acquired firm participating in the merger. However, if both firms involved in a merger are included in the internal growth rate calculation at the time of the merger, the combined firm continues to be included in the calculation after the merger. With respect to the sub-acquisitions described above, to the extent the sub-acquired firm does not separately report financial statements to NFP, the acquiring firm is excluded from the calculation from the time of the sub-acquisition until the first fiscal quarter beginning one year following the sub-acquisition. Sub-acquisitions that represent less than 25% of the base earnings of the acquiring firms are considered to be
40
Table of Contentsinternal growth. For further information about sub-acquisitions, see “Business—Operations—Sub-Acquisitions.” With respect to dispositions, the Company includes these firms up to the time of disposition and excludes these firms for all periods after the disposition. The calculation is adjusted for intercompany transactions for all periods after December 31, 2005. Management believes that the intercompany adjustments made to the internal revenue growth rate for periods after December 31, 2005 does not significantly impact its comparability with prior year periods. The Company’s management also monitors acquired firm revenue, commissions and fees 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. A sub-acquisition involves the acquisition by one of NFP's firms of a business that is too small to qualify for a direct acquisition by NFP or where the individual running the business wishes to exit immediately or soon after the acquisition, prefers to partner with an existing principal or does not wish to be a principal. The acquisition multiple paid for sub-acquisitions is typically lower than the multiple paid for a direct acquisition by NFP. 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 in the calculations. The results of operations discussions set forth below include analysis of the relevant line items on this basis. Year ended December 31, 2006 compared with the year ended December 31, 2005 The following table provides a comparison of the Company’s revenue and expenses for the periods presented.
41
Table of ContentsSummary Net income. Net income increased $1.4 million, or 2.5%, to $57.6 million in 2006 compared with $56.2 million in 2005. The growth in net income was driven by a 20.8% increase in revenue, principally from new acquisitions, which were largely offset by increased commissions and fees and increased firm operating expenses. Revenue Commissions and fees. Commissions and fees increased $185.7 million, or 20.8%, to $1,077.1 million in 2006 from $891.4 million in 2006. The Company’s revenue growth was derived from both internal growth at existing firms and the acquisition of new firms. Commissions and fees generated from existing firms totaled $975.7 million in 2006, an increase of $84.2 million or 9.4% over the prior year’s total revenue. Revenue growth at NFPISI and NFPSI contributed more than $57.4 million or 68% of the total revenue growth from existing firms in 2006. Revenue growth was constrained during the latter half of 2006 due to reduced sales of premium finance insurance products which had fueled revenue growth in the second half of 2005. New firms contributed $101.4 million to revenue in 2006. Cost of services Commissions and fees. Commissions and fees expense increased $100.3 million, or 40.5%, to $348.1 million in 2006 from $247.8 million in 2005. Commissions and fees expense from existing firms increased $71.0 million, to $318.8 million in 2006 from $247.8 million in 2005. Commissions and fees expense from new firms in 2006 totaled $29.2 million. As a percentage of revenue, commissions and fees expense increased to 32.3% in 2006 from 27.8% in 2005. The increase in commissions and fees expense was primarily due to increased production with third party producers and other non-affiliated firms and higher payouts in wholesale entities. In addition, there was an increase in the mix of revenue generated through wholesale operations which have higher payouts. Operating expenses. Operating expenses increased $52.0 million, or 20.0%, to $311.9 million in 2006 compared with $259.9 million in 2005. As a percentage of revenue, operating expenses declined to 29.0% in 2006 from 29.2% in 2005. Operating expenses from existing firms were approximately $282.0 million in 2006, an increase of $22.2 million, or 8.5%, from $259.9 million in 2005. Effective January 1, 2006, and in connection with the adoption of SFAS 123R, stock-based compensation to firm employees and related to firm activities have been included in cost of services. In 2006, stock-based compensation of $2.7 million was expensed as part of operating expenses. There was no stock-based compensation included in cost of services in 2005. Operating expenses from new acquisitions were approximately $29.8 million in 2006. Management fees. Management fees increased $9.3 million, or 4.5%, to $217.9 million in 2006 compared with $208.6 million in 2005. The increase in management fee expenses is due to increased earnings at acquired firms. Management fees as a percentage of revenue decreased to 20.2% in 2006 from 23.4% in 2005. Management fees were 52.2% of gross margin before management fees in 2006 compared with 54.4% in 2005. The decrease in management fees, as a percentage of both revenues and gross margin before management fees, results from higher earnings at NFPISI and NFPSI for which no management fee expense is incurred and additional management fees of $6.1 million incurred in 2005 due to the transition to a single methodology for both calculating and paying management fees partially offset by increased accruals for ongoing incentive plans in 2006. The accrual for ongoing incentive plans was $17.0 million in 2006 as compared to $13.6 million in 2005. Gross margin. Gross margin increased $24.1 million, or 13.8%, to $199.2 million in 2006 compared with $175.1 million in 2005. As a percentage of revenue, gross margin declined to 18.5% in 2006 compared with 19.6% in 2005 as increased commissions and fees payouts more than offset the decrease in management fee expense as a percentage of revenue and the benefits of scale gained in firm operating expense.
42
Table of ContentsCorporate and other expenses General and administrative. General and administrative expenses increased $5.6 million, or 12.3%, to $51.3 million in 2006 compared with $45.7 million in 2005. Included in general and administrative expenses in 2006 and 2005 was $6.0 million and $4.5 million of equity compensation expense, respectively, which accounted for $1.5 million of the total increase. The remaining increase of $4.1 million is due to higher compensation and other personnel costs, which rose $6.1 million and were related to planned increases in the corporate infrastructure to support internal growth and acquisitions partially offset by a decline of $2.0 million net, principally related to legal matters associated with industry related regulatory issues. Effective January 1, 2006, and in connection with the adoption of SFAS 123R, stock-based compensation of firm employees and for firm activities have been included in cost of services. In 2006, stock-based compensation of $3.2 million was expensed as part of cost of services. Amortization. Amortization increased $4.3 million, or 18.1%, to $28.0 million in 2006 compared with $23.7 million in 2005. Amortization expense increased as a result of a 17.7% increase in amortizing intangible assets resulting primarily from new acquisitions. As a percentage of revenue, amortization was 2.6% in 2006 compared with 2.7% in 2005. Depreciation. Depreciation expense increased $1.3 million, or 16.7%, to $9.1 million in 2006 compared with $7.8 million in 2005. The increase in depreciation resulted from an increase in the number of owned firms and capital expenditures at the Company’s existing firms and at the corporate office. As a percentage of revenue, depreciation expense was 0.8% in 2006 and 0.9% in 2005. Depreciation expense attributable to firm operations totaled $5.5 million and $5.3 million in 2006 and 2005, respectively, which has not been included in “Cost of services.” Impairment of goodwill and intangible assets. Impairment of goodwill and intangible assets increased $2.6 million, to $10.7 million in 2006 compared with $8.1 million in 2005. The impairments were related to six firms in 2006 and eight firms in 2005 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 1.0% in 2006 compared with 0.9% in 2005. Loss (gain) on sale of businesses. Loss (gain) on sale of businesses decreased $6.3 million to a loss of less than $0.1 million in 2006 compared with a gain of $6.3 million in 2005. The loss (gain) on sale resulted from the disposal of four subsidiaries in 2006 and the disposal of four subsidiaries and from the sale of assets in 2005. Interest and other income. Interest and other income increased $1.9 million, to $8.3 million in 2006 compared with $6.4 million in 2005. The increase was largely due to a $3.7 million increase in interest income in 2006 offset by the $2.3 million in key person life insurance net proceeds received in 2005. The increase in interest income is attributable to a 17% increase in average cash balances in 2006 as compared to 2005 and a 200 basis point increase in the weighted average yield earned on those cash balances. The increase in cash balances result from the increased revenue and cash flow in the business while the increased return was due to both the increased interest rate environment and improved cash management. Interest and other expense. Interest and other expense increased $1.5 million, or 27.3%, to $7.0 million in 2006 compared with $5.5 million in 2005. The increase was principally comprised of higher interest expense resulting from increased average borrowings for acquisitions and an increased interest rate environment (see “—Liquidity and Capital Resources”). Income tax expense Income tax expense. The effective tax rate was 43.2% in 2006 compared with 42.1% in 2005. The effective tax rate differs from the provision calculated at the federal statutory rate primarily because of certain expenses that are not deductible for tax purposes, as well as the effects of state and local taxes. The effective tax rate rose in 2006 resulting largely from higher nondeductible expenses related to impairments and the absence of non-taxable key person life insurance proceeds received in 2005.
43
Table of ContentsYear ended December 31, 2005 compared with the year ended December 31, 2004 The following table provides a comparison of the Company’s revenue and expenses for the periods presented.
NM indicates not meaningful. Summary Net income. Net income increased $16.1 million, or 40.1%, to $56.2 million in 2005 compared with $40.1 million in 2004. The increase in 2005 was primarily a result of the continued growth of existing firms, the acquisition of new firms (both terms as previously defined) and a decrease in the estimated effective tax rate to 42.1% in 2005 from 44.4% in 2004. Revenue Commissions and fees. Commissions and fees increased $251.9 million, or 39.4%, to $891.4 million in 2005 from $639.5 million in 2004. The Company’s revenue growth was derived from both internal growth at existing firms and the acquisition of new firms. Commissions and fees generated from existing firms totaled $770.4 million in 2005, an increase of $130.9 million over the prior year’s total revenue. Commissions and fees from existing firms benefited in part from strong sales of financed life insurance products. Commissions and fees totaled $104.1 million for firms acquired in 2005, including $71.0 million from the acquisition of Highland which was acquired effective April 1, 2005.
44
Table of ContentsCost of services Commissions and fees. Commissions and fees expense increased $84.0 million, or 51.3%, to $247.8 million in 2005 from $163.8 million in 2004. Commissions and fees expense from existing firms increased $81.7 million, to $217.1 million in 2005 from $135.4 million in 2004. Commissions and fees expense from firms acquired in 2005 totaled $26.0 million. As a percentage of revenue, commissions and fees expense increased to 27.8% in 2005 from 25.6% in 2004. An increase in commission payouts at several of the Company’s wholesale entities resulted in higher commission expense as a percentage of revenue as well as an increase in the percentage of revenue from wholesale entities which tend to have higher commission payout rates. Operating expenses. Operating expenses increased $69.7 million, or 36.6%, to $259.9 million in 2005 compared with $190.2 million in 2004. As a percentage of revenue, operating expenses declined to 29.2% in 2005 from 29.7% in 2004 as the rate of expense growth was below the rate of revenue growth. Operating expenses from new acquisitions were approximately $49.1 million in 2005. Operating expenses from existing firms were approximately $210.8 million in 2005, an increase of $36.0 million, or 20.6%, from $174.8 million in 2004. Management fees. Management fees increased $63.5 million, or 43.8%, to $208.6 million in 2005 compared with $145.1 million in 2004. Management fees as a percentage of revenue increased to 23.4% in 2005 from 22.7% in 2004. The increase in management fees resulted from higher earnings at acquired firms. The increase in management fees as a percentage of revenue is due to significantly higher earnings at certain of the Company’s acquired firms, incentive accruals and an additional management fee expense of $6.1 million. During the fourth quarter of 2005 the Company determined it was appropriate as part of its efforts to enhance controls over this significant expense item to transition to a single methodology for both calculating and paying management fees. As part of this transition process, additional balances became due to principals which resulted in further expense. Additionally, a higher percentage of the Company’s earnings in 2005 were earned by firms in which the principals have a greater economic interest, compared with 2004. This resulted in a greater proportion of management fees being accrued in 2005 than in the prior period. Further, management fees included an accrual of $13.6 million for ongoing incentive plans in 2005 compared with $9.3 million in 2004, primarily reflecting growth at firms who are in their incentive cycle. Partially offsetting this increase were higher earnings at NFPISI and NFPSI, for which no management fee expense was incurred. Gross margin. Gross margin increased $34.7 million, or 24.7%, to $175.1 million in 2005 compared with $140.4 million in 2004. As a percentage of revenue gross margin declined to 19.6% in 2005 compared with 22.0% in 2004 as a result of the higher commissions and fees and management fees paid partially offset by a lower rate of growth of firm operating expenses. Excluded from gross margin are stock-based compensation and depreciation expense related to firm operations which have historically been shown as separate line items in Corporate and other expenses. Total stock-based compensation and depreciation expense related to firm operations totaled $1.1 million and $5.3 million in 2005 and $0.2 million and $5.1 million in 2004, respectively. Corporate and other expenses General and administrative. General and administrative expenses increased $8.9 million, or 24.2%, to $45.7 million in 2005 compared with $36.8 million in 2004. The increase resulted primarily from $4.0 million of expenses related to the Company’s internal review of its insurance operations coupled with an increase in compensation and related costs, including compensation of $5.8 million principally due to planned increases in the corporate infrastructure to support acquisitions and internal growth, partially offset by lower cost related to the implementation of Sarbanes-Oxley. The increase in compensation of $5.8 million includes a $3.1 million increase in stock-based compensation which was principally due to new awards granted during the fourth quarters of 2004 and 2005. As a percentage of revenue, general and administrative expense declined to 5.1% in 2005 compared with 5.7% in 2004, as the Company continues to benefit from the absorption of corporate expenses over an expanding revenue base.
45
Table of ContentsAmortization. Amortization increased $4.2 million, or 21.5%, to $23.7 million in 2005 compared with $19.5 million in 2004. Amortization expense increased as a result of a 20.7% increase in amortizing intangible assets resulting primarily from new acquisitions. As a percentage of revenue, amortization was 2.7% in 2005 compared with 3.0% in 2004. Depreciation. Depreciation expense increased $1.1 million, or 16.4%, to $7.8 million in 2005 compared with $6.7 million in 2004. The increase in depreciation resulted from an increase in the number of owned firms, capital expenditures at the Company’s existing firms and at the corporate office. As a percentage of revenue, depreciation expense was 0.9% in 2005 and 1.1% in 2004. Depreciation expense attributable to firm operations totaled $5.3 million and $5.1 million in 2005 and 2004, respectively, which has not been included in “Cost of services.” Impairment of goodwill and intangible assets. Impairment of goodwill and intangible assets increased $3.3 million, to $8.1 million in 2005 compared with $4.8 million in 2004. The impairments were related to eight firms in 2005 and seven firms in 2004 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 0.9% in 2005 compared with 0.8% in 2004. Gain on sale of businesses. Gain on sale of businesses increased $6.2 million to $6.3 million in 2005 compared with $0.1 million in 2004. The gain on sale resulted from the disposal of four subsidiaries and from the sale of assets in 2005 and the disposal of one subsidiary in 2004. Interest and other income. Interest and other income increased $4.2 million, to $6.4 million in 2005 compared with $2.2 million in 2004. The increase was primarily attributable to a $2.3 million net contribution related to benefits received under the Company’s key person life insurance program. It is the Company’s practice to maintain key person life insurance on NFP principals during the initial term of their management contracts and on a selective basis subsequent thereto. Interest and other expense. Interest and other expense increased $2.7 million, or 96.4%, to $5.5 million in 2005 compared with $2.8 million in 2004. The increase was principally comprised of higher interest expense resulting from increased average borrowings for acquisitions (see “—Liquidity and Capital Resources”). Income tax expense Income tax expense. The effective tax rate was 42.1% in 2005 compared with 44.4% in 2004. The effective tax rate differs from the provision calculated at the federal statutory rate primarily because of certain expenses that are not deductible for tax purposes, as well as the effects of state and local taxes. The effective tax rate declined in 2005 principally as a result of the proportional increase in pretax income relative to nondeductible expenses, the tax benefit related to the key person life insurance proceeds and the reduction in adjustments to deferred tax assets and liabilities partially offset by taxable income resulting from the restructuring of certain management contracts. The 2004 effective tax rate included $2.9 million of adjustments to deferred tax assets and liabilities, of which $1.1 million related to purchase accounting adjustments and partnership earnings from the period 1999 through 2001. Liquidity and Capital Resources The Company, a leading independent distributor of financial services products, has grown to over 175 owned firms through a unique acquisition and operational structure. The Company has, since its initial public offering in September 2003, supported its acquisition and growth strategy through cash flows generated from operations and borrowings under its bank credit facility. The performance of its acquired businesses is largely
46
Table of Contentsreflected in cash flows from operating activities. Investing activities also include capital expenditures, largely to support the corporate technology infrastructure and those acquired firms engaged in providing third party administration services or platforms. Financing activities reflect the use of available credit facilities, capital transactions and dividends returned to shareholders. The Company’s cash requirements are principally impacted by the timing of the Company’s acquisitions and the Company uses its bank credit facility to provide for the excess cash needs, which typically occurs earlier in the fiscal year. As acquisitions slow in the latter part of the fiscal year, the Company’s cash flow from operations are used to reduce outstanding borrowings. The Company expects this pattern of cash usage to continue in 2007. A summary of the changes in cash and cash equivalents is as follows (in thousands):
Cash and cash equivalents at December 31, 2006 declined by $7.6 million from the prior year end principally due to a decrease in cash flows provided by financing activities as fewer stock-based awards were exercised and dividends to shareholders increased. Cash flows provided by operations and used in investing activities were comparable to the prior year. Cash and cash equivalents at December 31, 2005 had increased $22.7 million from December 31, 2004 as the increased cash flows used in investing activities, principally acquisitions, were supported by increased cash flows from financing activities, including borrowings under the Company’s bank credit facility and proceeds received from the exercise of stock-based awards. At December 31, 2004 cash and cash equivalents increased $11.9 million from the prior year end. During 2006, cash provided by operating activities was $81.9 million resulting primarily from net income and non-cash charges and an increase in accounts payable. The increase was partially offset by an increase in commissions, fees and premiums receivable, net, and a decrease in amounts due to principals and/or certain entities they own due to lower firm earnings in the fourth quarter compared to the prior period. During 2005, cash provided by operating activities was $87.2 million resulting primarily from net income and an increase in due to principals and/or certain entities they own, accounts payable and accrued liabilities. The increase was partially offset by an increase in commissions, fees and premiums receivable, net, notes receivables, net non-current and other non-current assets. During 2004, cash provided by operating activities was $86.1 million resulting primarily from net income and an increase in premiums payable to insurance carriers, due to principals and/or certain entities they own and accrued liabilities. The increase was partially offset by an increase in cash, cash equivalents and securities purchased under resale agreements in premium trust accounts, commissions, fees and premiums receivable, net, and other current assets. During 2006, 2005 and 2004, cash used in investing activities was $120.3 million, $113.1 million, and $70.9 million, respectively, in each case principally for the acquisition of firms and property and equipment. During 2006, 2005 and 2004, the Company used $112.1 million, $113.1 million, and $60.2 million, respectively, in payments for acquired firms, net of cash acquired, and contingent consideration. In each period, payments for acquired firms represented the largest use of cash in investing activities. During 2006, 2005 and 2004, cash provided by (used in) financing activities was $30.9 million, $48.5 million, and $(3.4) million, respectively. During 2006, cash provided by financing activities was primarily the
47
Table of Contentsresult of net borrowings under the Company’s line of credit of $43.0 million and cash proceeds received from the exercise of stock options, including tax benefit of $10.4 million, offset by approximately $22.6 million in dividend payments. During 2005, cash provided by financing activities was primarily the result of net borrowings under the Company’s line of credit of $40.0 million and cash proceeds received from the exercise of stock options, including tax benefit, of $25.4 million offset by approximately $17.0 million in dividend payments. In 2004, cash used in financing activities was largely the result of $13.3 million of common stock dividends paid offset by $8.0 million of cash proceeds from the exercise of stock options, including tax benefit. Some of the Company’s 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). At December 31, 2006, the Company had cash, cash equivalents and securities purchased under resale agreements in premium trust accounts of $57.4 million, an increase of $5.0 million from the balance of $52.4 million at December 31, 2005. At December 31, 2005, the Company had cash, cash equivalents and securities purchased under resale agreements in premium trust accounts of $52.4 million, a decrease of $1.3 million from the balance of $53.7 million at December 31, 2004. Changes in these accounts are the result of timing of payments collected from insureds on behalf of insurance carriers. Management believes that the Company’s existing cash, cash equivalents, funds generated from its operating activities and funds available under its bank credit facility will provide sufficient sources of liquidity to satisfy its financial needs for the next twelve months. However, if circumstances change, the Company may need to raise debt or additional equity capital in the future. Borrowings On August 22, 2006, the Company entered into a $212.5 million credit facility with Bank of America, N.A., as administrative agent. This credit facility replaced the Company’s previous $175 million credit facility and is used to finance acquisitions and fund general corporate purposes. Borrowings under the credit facility bear interest, at the Company’s election, at a rate per annum equal to (i) at any time when the Company’s Consolidated Leverage Ratio, as defined in the credit facility, is greater than or equal to 2.0 to 1.0, the ABR plus 0.25% per annum or the Eurodollar Rate plus 1.25%, (ii) at any time when the Company’s Consolidated Leverage Ratio is less than 2.0 to 1.0 but greater than or equal to 1.0 to 1.0, the ABR or the Eurodollar Rate plus 1.00% and (iii) at any time when the Company’s Consolidated Leverage Ratio is less than 1.0 to 1.0, the ABR or the Eurodollar Rate plus 0.75%. As used in the credit facility, “ABR” means, for any day, the greater of (i) the federal funds rate in effect on such day plus 0.5% and (ii) the rate of interest in effect as publicly announced by Bank of America as its prime rate. The credit facility is structured as a revolving credit facility and matures on August 22, 2011. The Company’s obligations under the credit facility are secured by all of its and its subsidiaries’ assets. Up to $35 million of the credit facility is available for the issuance of letters of credit and there is a $10 million sublimit for swingline loans. The credit facility contains various customary restrictive covenants that prohibit the Company and its subsidiaries from, subject to various exceptions and among other things, (i) incurring additional indebtedness or guarantees, (ii) creating liens or other encumbrances on property or granting negative pledges, (iii) entering into a merger or similar transaction, (iv) selling or transferring certain property, (v) declaring dividends or making other restricted payments and (vi) making investments. In addition, the credit facility contains financial covenants requiring the Company to maintain a minimum interest coverage ratio and a maximum consolidated leverage ratio. In 2006, the combined year-to-date weighted average interest rate for both credit facilities was 6.67%. In 2005, the Company replaced its previous $90 million credit facility with the $175 million credit facility. The combined weighted average of both of these previous credit facilities for the prior year period was 6.00%.
48
Table of ContentsThe Company had a balance of $83 million under its credit facility as of December 31, 2006 and a balance of $40 million under its previous credit facility at December 31, 2005. At December 31, 2006 management believes that the Company was in compliance with all covenants under the facility. The Company’s prior bank loan was structured as a revolving credit facility and was due on June 15, 2008 unless the Company elected to convert the credit facility to a term loan, at which time it would have amortized over one year, with a principal payment due on December 15, 2008 and a final maturity of June 15, 2009. In August 2006, the Company entered into a credit facility and terminated its bank loan. On June 9, 2006 the Company filed a shelf registration statement on Form S-3 with the SEC. The shelf registration statement allows NFP to borrow using various types of debt instruments, such as fixed or floating rate notes, convertible or other indexed notes, as well as to issue preferred and/or common stock. In addition, NFP’s restricted stockholders are permitted to use the shelf to sell shares into the secondary market. As of December 31, 2006 there were no issuances under the shelf registration statement. Subsequent to year end, NFP issued $230 million of convertible senior notes and certain of the Company’s stockholders offered 1,850,105 shares of NFP common stock through a secondary offering under this shelf. See also Item 8—Financial Statements and Supplementary Data—Note 19—Subsequent Events. Dividends The Company paid a quarterly cash dividend of $0.15 per share of common stock on January 6, April 7, July 7 and October 6, 2006 and of $0.12 per share of the Company’s common stock on January 7, 2005, April 7, 2005, July 7, 2005 and October 7, 2005. On November 15, 2006, the Company declared a quarterly cash dividend of $0.18 per share of the Company’s common stock that was paid on January 8, 2007 to stockholders of record on December 15, 2006. On February 14, 2007, the Company’s Board of Directors declared a quarterly cash dividend of $0.18 per share of common stock payable on April 9, 2007 to stockholders of record at the close of business on March 16, 2007. The declaration and payment of future dividends to holders of the Company’s common stock will be at the discretion of the Company’s Board of Directors and will depend upon many factors, including the Company’s financial condition, earnings, legal requirements, and other factors as the Company’s Board of Directors deems relevant. Based on the most recent quarterly dividend declared of $0.18 per share of common stock and the number of shares held by stockholders of record on December 15, 2006, the total annual cash requirement for dividend payments would be approximately $27.9 million. Notes receivable The Company encourages succession planning in the management of its firms. See “Business—Operations—Succession Planning.” The Company has financed several purchases of interests in entities owned by principals or applicable management agreements to facilitate succession. This financing is secured by management fees and, in many cases, is secured by other assets. The Company typically advances management fees monthly to principals and/or certain entities they own for up to nine months while monitoring the performance of the firms to determine if the actual earnings are on track to meet or exceed target earnings. If earnings are not equal to or greater than pro rata target earnings, the Company ceases to pay or reduces the management fee advance. If an overadvance of a management fee exists, the principal and/or such entities are expected to repay the advance within thirty days of the end of the calendar year. If a principal and/or such entities cannot repay the overadvance, the Company has allowed principals and/or such entities to repay the advance over time. In these cases, the Company generally requires the principals and/or such entities to provide it with an interest-bearing note in an amount equal to the overadvance, secured by the principals’ and/or such entities’ shares of NFP’s common stock. The Company has from time to time disposed of firms. The Company has also agreed, in certain cases, to reduce the levels of base earnings and target earnings in exchange for a payment from the principals of a firm. In these situations, the Company typically takes back a note for a portion of the cost of the disposition or the restructuring to the principal.
49
Table of ContentsAs of the following dates, notes receivable were as follows:
Commitments and Contingencies Legal matters In the ordinary course of business, the Company is involved in lawsuits and other claims. Management considers these lawsuits and claims to be without merit and the Company intends to defend them vigorously. In addition, the sellers of firms that the Company acquires typically indemnify it for loss or liability resulting from acts or omissions occurring prior to the acquisition, whether or not the sellers were aware of these acts or omissions. Several of the existing lawsuits and claims have triggered these indemnity obligations. During 2004, several of the Company’s firms received subpoenas and other informational requests from governmental authorities, including the New York Attorney General’s Office, seeking information regarding compensation arrangements, any evidence of bid rigging and related matters. The Company has cooperated and will continue to cooperate fully with all governmental agencies. In March 2006, the Company received a subpoena from the New York Attorney General’s Office seeking information regarding life settlement transactions. One of the Company’s subsidiaries received a subpoena seeking the same information. The Company is cooperating fully with the Attorney General’s investigation. The investigation, however, is ongoing and the Company is unable to predict the investigation’s outcome. Management believes that the resolution of these lawsuits, claims and subpoenas will not have a material adverse impact on the Company’s consolidated financial position. The Company cannot predict at this time the effect that any current or future regulatory activity, investigations or litigation will have on its business. Given the current regulatory environment and the number of the Company’s subsidiaries operating in local markets throughout the country, it is possible that the Company will become subject to further governmental inquiries and subpoenas and have lawsuits filed against it. The Company’s ultimate liability, if any, in connection with these matters and any possible future such matters is uncertain and subject to contingencies that are not yet known.
50
Table of ContentsLeases At December 31, 2006, future minimum rentals for operating leases (which are subject to escalation clauses) primarily consisted of real estate and equipment leases that had initial or uncancelable lease terms in excess of one year and were payable as follows: Schedule of lease obligations (in thousands)
In connection with an acquisition during 2005, the Company remains secondarily liable on three assigned leases. The maximum potential of undiscounted future payments is $1.4 million as of December 31, 2006. Lease options dates vary with some extending to 2011. Letter of credit The Company’s $212.5 million credit facility provides for the issuance of letters of credit of up to $35 million on NFP’s behalf, provided that, after giving effect to the letters of credit, the Company’s available borrowing amount is greater than zero. As of December 31, 2006 the Company was contingently obligated for letters of credit in the amount of $1.6 million. As of December 31, 2005, the Company was contingently obligated for letters of credit under its previous $175 million credit facility in the amount of $1.3 million. Contingent consideration and contingent firm employee payments In order to better determine the economic value of the businesses the Company has acquired, the Company has incorporated contingent consideration, or earnout, provisions into the structure of its acquisitions since the beginning of 2001. These arrangements generally provide for the payment of additional consideration to the sellers upon the firm’s satisfaction of certain compounded growth rate thresholds over the three-year period following the closing of the acquisition. In some cases, contingent consideration may be payable after shorter periods. As of December 31, 2006, 49 acquisitions are within their initial three-year contingent consideration measurement period. Contingent consideration is recorded when the outcome of the contingency is determinable beyond a reasonable doubt. Contingent consideration paid to the selling stockholders of the Company’s acquired firms is treated as additional purchase consideration. In connection with certain acquisitions, the Company also has agreed to make certain contingent payments to employees of its acquired firms, contingent upon the satisfaction of established performance milestones. These payments are expensed as employee compensation.
51
Table of ContentsThe 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, 2006 consists of the following: Schedule of maximum contingent payments
Contingent consideration payable for acquisitions consummated in 2003 would generally be payable by the end of 2006. The Company currently anticipates using contingent consideration arrangements in future acquisitions, which would result in an increase in the maximum contingent consideration amount in 2007 and thereafter. The maximum contingent consideration is generally payable upon a firm achieving a 35% rate of growth, or higher, in earnings during the first three years following acquisition. The payments of purchase consideration are generally made in cash and the Company’s common stock (based on the average closing price of NFP common stock for the twenty trading days up to and including the end of the period), in proportions that vary among acquisitions. Contingent firm employee payments are generally payable in cash and recorded as an expense in the year earned. Contractual Obligations The table below shows the Company’s contractual obligations as of December 31, 2006:
Segment Information In June 1997, the FASB issued SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” This statement establishes standards for the way companies report information about operating segments in financial statements. It also establishes standards for related disclosures about products and services, geographic areas and major customers. In accordance with the provisions of SFAS No. 131, the Company has determined that it operates in a single segment within the financial services industry entirely within the United States of America and its territories. Critical Accounting Policies Business acquisitions, purchase price allocations and intangible assets Since the Company’s formation it has completed 215 acquisitions and sub-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 the Company’s 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.
52
Table of ContentsIn connection with the Company’s acquisition of Highland, the Company recognized institutional customer relationships as a new intangible asset during 2005. Institutional customer relationships consist of relationships with institutions such as banks, wire houses, regional broker dealers and CPA networks. The value of the asset is derived from recurring income generated from these institutional customers in place at the time of the acquisition, net of an allocation of expenses and is assumed to decrease over the life of the asset due to attrition of the institutional relationships acquired. Institutional customer relationships was valued at $15.7 million at the time of the acquisition at April 1, 2005 and is being amortized using the straight-line method over an 18-year period. The Company allocates the excess of purchase price over net assets acquired to book of business, management contracts, institutional customer relationships, trade name and goodwill. The Company amortizes intangibles over a 10-year period for book of business, a 25-year period for management contracts and an 18-year period for institutional customer relationships. Intangible assets are presented net of accumulated amortization and consist of the following:
Amortization expense and impairment loss consisted of the following:
Impairment of goodwill and other intangible assets The Company assesses the recoverability of its goodwill and other intangibles based on assumptions regarding estimates of future cash flows and fair value based on current and projected revenue, business prospects, market trends and other economic factors. In accordance with SFAS No. 142, the Company recognized an impairment loss on goodwill and identifiable intangible assets not subject to amortization of $5.2 million, $3.1 million, and $2.4 million for the years ended December 31, 2006, 2005 and 2004, respectively. In accordance with SFAS No. 144, the Company recognized an impairment loss on identifiable intangible assets subject to amortization of $5.6 million, $5.0 million and $2.4 million for the years ended as of December 31, 2006, 2005 and 2004, respectively.
53
Table of ContentsFuture events could cause the Company to conclude that impairment indicators exist and that its remaining goodwill and other intangibles are impaired. Any resulting impairment loss could have a material adverse effect on the Company’s reported financial position and results of operations for any particular quarterly or annual period. Revenue recognition Insurance and annuity commissions paid by insurance companies are based on a percentage of the premium that the insurance company charges to the policyholder. First-year commissions are calculated as a percentage of the first twelve months’ premium on the policy and earned in the year that the policy is originated. In many cases, the Company’s firms receive renewal commissions for a period following the first year, if the policy remains in force. The Company’s firms also 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 NFP. The Company’s 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. Insurance commissions are recognized as revenue, when the following three criteria are met (1) the policy application is substantially complete, (2) the premium is paid, and (3) the insured party is contractually committed to the purchase of the insurance policy. The Company carries an allowance for policy cancellations, which is periodically evaluated and adjusted as necessary. Miscellaneous commission adjustments are recorded as they occur. Contingent commissions are recorded as revenue when received which, in many cases, is the Company’s first notification of amounts earned. 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. The data necessary for the calculation of contingent commissions cannot be reasonably obtained prior to receipt of the commission. Certain of the Company’s firms may also receive fees for the settlement of life insurance policies. These fees are generally based on a percentage of the settlement proceeds received by their clients, and recognized as revenue when the policy is transferred and the rescission period has ended. The Company’s firms earn commissions related to the sale of securities and certain investment-related insurance products. NFP firms also earn fees for offering financial advice and related services. These fees are based on a percentage of assets under management and are generally paid quarterly. In certain cases, incentive fees are earned based on the performance of the assets under management. Some of the Company’s firms 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’s firms earn additional compensation in the form of incentive and marketing support revenue payments, from manufacturers of financial services products, based on the volume, persistency and profitability of business generated by the Company’s firms from these three sources. Incentive and marketing support revenue is recognized at the earlier notification of a payment or when payment is received. Stock incentive plans The Company is authorized under its Amended and Restated 1998, 2000 and 2002 Stock Incentive Plans, and the Company’s Amended and Restated 2000 and 2002 Stock Incentive Plans for Principals and Managers, to grant stock options, stock appreciation rights, restricted stock units, and performance units to officers, employees, principals of its acquired firms and/or certain entities principals own, independent contractors, consultants, non-employee directors and certain advisory board members. Awards granted under the 1998, 2000 and 2002 Stock Incentive Plans are generally subject to a vesting period from 0 to 10 years from the date of grant. Awards granted under the 2000 and 2002 Stock Incentive Plans for Principals and Managers generally vest immediately upon grant.
54
Table of ContentsEffective January 1, 2006, the Company adopted the provisions of SFAS No. 123R which is a revision of SFAS 123, which superseded APB 25 and amended SFAS No. 95, “Statement of Cash Flows.” The Company adopted the modified prospective transition method provided for under SFAS 123R and, accordingly, has not restated prior year amounts. Under the transition method, compensation expense for 2006 includes compensation expense for all share-based payment awards granted prior to, but not yet vested as of, January 1, 2003, the date of the Company’s adoption of SFAS 123, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. Stock-based compensation expense includes an estimate for forfeitures which is recognized over the expected term of the award on a straight-line basis. The Company evaluated the need to record a cumulative effect adjustment relating to estimated forfeitures for unvested previously issued awards and the impact was not deemed to be material. Income taxes The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes,” which requires the recognition of tax benefits or expenses on the temporary differences between the financial reporting and tax bases of the Company’s assets and liabilities. Deferred tax assets and liabilities are measured using 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. New Accounting Pronouncements In June 2006, the FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty in income taxes recognized in financial statements in accordance with Statement No. 109, “Accounting for Income Taxes.” FIN 48 prescribes thresholds and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The Company will adopt FIN 48 on January 1, 2007 with any cumulative effect of applying FIN 48 recorded as an adjustment to opening retained earnings. The Company does not believe that FIN 48 will have a material impact on stockholders’ equity. In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”) which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The Company will adopt SFAS 157 on January 1, 2008. Management is currently evaluating the effect, if any, of SFAS 157 on the Company’s consolidated financial statements. In December 2004, the Financial Accounting Standards Board issued SFAS No. 123 which eliminates the intrinsic value method under APB 25 as an alternative method of accounting for stock-based awards. SFAS 123R also revises the value-based method of accounting for share-based payment liabilities, forfeitures and modifications of stock-based awards and clarifies SFAS 123’s guidance in several areas, including measuring fair value, classifying an award as equity or as a liability and attributing compensation cost to reporting periods. In addition, SFAS 123R amends SFAS No. 95, “Statement of Cash Flows,” to require that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid, which is included within operating cash flows. In April 2005, the SEC amended the required adoption date of SFAS 123R, which is effective for public companies at the beginning of the next fiscal year instead of the first interim or annual period beginning after June 15, 2005. The Company adopted SFAS 123R on January 1, 2006. In connection with the issuance of SFAS 123R the SEC issued, in March 2005, Staff Accounting Bulletin No. 107, “Share-Based Payment” (“SAB 107”) which stated that a company should present the expense related to share-based payment arrangements in the same line or lines as cash compensation paid to the same employees. With the adoption of SFAS 123R the Company now records stock-based compensation expense related to stock awards to employees of the Company’s acquired firms in “Cost of services.” Stock-based compensation for stock
55
Table of Contentsawards to employees of the Company’s acquired firms and firm activities totaled $3.2 million, $1.1 million and $0.2 million in 2006, 2005 and 2004, respectively. Previously, all stock-based compensation was included in general and administrative expense as a component of corporate and other expenses. Total stock-based compensation for 2006 was 9.2 million. Total stock based compensation of $4.5 million in 2005 and $1.4 million in 2004 is included in corporate and other expenses—general and administrative. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Through the Company’s broker-dealer subsidiaries, it has market risk on buy and sell transactions effected by its firms’ customers. The Company is contingently liable to its clearing brokers for margin requirements under customer margin securities transactions, the failure of delivery of securities sold or payment for securities purchased by a customer. If customers do not fulfill their obligations, a gain or loss could be suffered equal to the difference between a customer’s commitment and the market value of the underlying securities. The risk of default depends on the creditworthiness of the customers. The Company assesses the risk of default of each customer accepted to minimize its credit risk. The Company is further exposed to credit risk for commissions receivable from clearing brokers and insurance companies. This credit risk is generally limited to the amount of commissions receivable. The Company has market risk on the fees its firms earn that are based on the market value of assets under management or the value of assets held in certain mutual fund accounts and variable insurance policies for which ongoing fees or commissions are paid. Certain of the Company’s firms’ performance-based fees are impacted by fluctuation in the market performance of the assets managed according to such arrangements. The Company has a credit facility and cash, cash equivalents and securities purchased under resale agreements in premium trust accounts. Interest income and expense on the preceding items are subject to short-term interest rate risk. The Company’s credit facility, which the Company entered into in August 2006, replaced a previous credit facility. See “—Liquidity and Capital Resources—Borrowings.” Based on the weighted average borrowings under the Company’s current and previous credit facilities during the years ended December 31, 2006 and 2005, a 1% change in short-term interest rates would have affected the Company’s income before income taxes by approximately $0.9 million and $0.7 million for 2006 and 2005, respectively. Based on the weighted average amount of cash, cash equivalents and securities purchased under resale agreements in premium trust accounts, a 1% change in short-term interest rates would have affected the Company’s income before income taxes by approximately $0.5 million and $0.5 million in both 2006 and 2005, respectively. The Company does not enter into derivatives or other similar financial instruments for trading or speculative purposes. See also “Risk Factors—Risks Relating to the Company—The Company’s revenue and earnings may be affected by fluctuations in interest rates, stock prices and general economic conditions” and “Risk Factors—Risks Relating to the Company—Because the Company’s firms’ clients can withdraw the assets NFP’s firms manage on short notice, poor performance of the investment products and services firms recommend or sell may have a material adverse effect on the Company’s business.” Item 8. Financial Statements and Supplementary Data See Financial Statements and Financial Statement Index commencing on page F-1 hereof. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None.
56
Table of ContentsItem 9A. Controls and Procedures Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures As of the end of the period covered by this report, NFP’s management carried out an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the disclosure controls and procedures (as such term is defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act) of NFP. Based on this evaluation, the CEO and CFO have concluded that, as of the end of period covered by this report, the Company’s disclosure controls and procedures were effective. Changes in Internal Control over Financial Reporting There have been no changes in the Company’s internal controls over financial reporting (as such term is defined in Rules 13a-15(f) or 15d-15(f) under the Exchange Act) during the last fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Management’s Report on Internal Control Over Financial Reporting Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles (GAAP). As of December 31, 2006, management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting based on the framework established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2006, is effective. The Company’s internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on its financial statements. Management has excluded from its assessment of internal control over financial reporting at December 31, 2006, twenty-three financial services firms acquired in purchase business combinations during 2006. These firms, each of which is wholly-owned and individually insignificant to the consolidated results of the Company, comprised, in aggregate, 5.9% and 14.0% of consolidated total revenue and consolidated total assets, respectively, for the year ended December 31, 2006. Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, was audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report appearing on pages F-2 and F-3, which expressed unqualified opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006. None.
57
Table of ContentsItem 10. Directors and Executive Officers and Corporate Governance Information regarding the directors and executive officers of the Company and compliance with Section 16(a) of the Exchange Act is incorporated herein by reference from the sections captioned “Information About the Company’s Directors and Executive Officers” and “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement. Information regarding the Company’s Audit Committee is incorporated herein by reference from the section captioned “Corporate Governance” in the Proxy Statement. The Company has adopted a Code of Ethics for the Company’s CEO and Senior Financial Officers (the “Code of Ethics for CEO and Senior Financial Officers”). In addition, the Company has adopted a Code of Business Conduct and Ethics (the “Code of Business Conduct and Ethics”) that applies to all directors and employees, including the Company’s chief executive officer, chief financial officer and chief accounting officer. Copies of the Company’s Code of Business Conduct and Ethics and Code of Ethics for CEO and Senior Financial Officers are available on the Company’s Web site at http://www.nfp.com and may also be obtained upon request without charge by writing to the Corporate Secretary, National Financial Partners Corp., 787 Seventh Avenue, 11th Floor, New York, New York 10019. The Company will post to its Web site any amendments to the Code of Ethics for CEO and Senior Financial Officers or the Code of Business Conduct and Ethics, and any waivers that are required to be disclosed by the rules of either the SEC or the NYSE. On February 20, 2007, the Company’s Board of Directors, or the Board, amended and restated the Company’s By-laws, effective as of that date. The Amended and Restated By-laws specify that the Company’s Board has the sole ability to call a special meeting of stockholders and fix the number of directors on the Board. Prior to the amendment and restatement of the Company’s By-laws, stockholders were also authorized to take these actions. Additionally, the Amended and Restated By-laws outline procedures that stockholders must comply with in order to transact business at an annual meeting or nominate directors to the Board. Stockholders must, among other things, provide notice to the Company not less than 90 days nor more than 120 days prior to the anniversary date of the immediate preceding annual meeting of stockholders and include a description of any understanding or arrangement such stockholder has with others regarding the proposal or nomination. Other provisions were approved by the Board to clarify procedures regarding the adjournment of meetings of stockholders and the methods by which a stockholder may authorize another as proxy. The Amended and Restated By-laws also clarify the setting of the record date to determine those stockholders entitled to act by written consent and provides standards for the validity of such stockholder written consent. Further, the Amended and Restated By-laws provide that the indemnification rights of directors, officers and employees survive termination of service and any repeal or modification of the indemnification provisions, in each case to the extent such rights were in existence at the time of such termination, repeal or modification. Pursuant to the Amended and Restated By-laws, the Company is not obligated to indemnify a director or officer in a proceeding initiated by such director or officer against the Company or its directors and officers unless the Board consents to such proceeding. The Amended and Restated By-laws are filed as Exhibit 3.3a to this Form 10-K. Copies of the Company’s Corporate Governance Guidelines and the charters of the Company’s Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee are available on the Company’s Web site at http://www.nfp.com and may also be obtained upon request without charge by writing to the Corporate Secretary, National Financial Partners Corp., 787 Seventh Avenue, 11th Floor, New York, New York 10019.
58
Table of ContentsItem 11. Executive Compensation The information set forth under the captions “Compensation of Executive Officers” and “Director Compensation” in the Proxy Statement is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information set forth under the captions “Security Ownership of Certain Beneficial Owners and Management” and “Compensation of Executive Officers” in the Proxy Statement is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions, and Director Independence The information set forth under the caption “Certain Relationships and Related Transactions” and the information regarding director independence from the section captioned “Corporate Governance” in the Proxy Statement is incorporated herein by reference. Item 14. Principal Accounting Fees and Services The information set forth under the caption “Fees Paid to Independent Registered Public Accounting Firm” in the Proxy Statement is incorporated herein by reference.
59
Table of ContentsItem 15. Exhibits and Financial Statement Schedules (a) List of documents filed as part of this report: (1) Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm See Index on page F-1. (2) Financial Statement Schedules: Financial statement schedules are omitted as not required or not applicable or because the information is included in the Financial Statements or notes thereto. (3) List of Exhibits:
60
Table of Contents
61
Table of ContentsSIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused the report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.
62
Table of ContentsINDEX TO FINANCIAL STATEMENTS NATIONAL FINANCIAL PARTNERS CORP. AND SUBSIDIARIES
F-1
Table of ContentsReport of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of National Financial Partners Corp.: We have completed integrated audits of National Financial Partners Corp.’s consolidated financial statements and of its internal control over financial reporting as of December 31, 2006, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below. Consolidated financial statements In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of National Financial Partners Corp. and its subsidiaries (the “Company”) at December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. Internal control over financial reporting Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable
F-2
Table of Contentsassurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. As described in Management’s Report on Internal Control over Financial Reporting, management has excluded twenty-three financial services subsidiaries (the “firms”) from its assessment of internal control over financial reporting as of December 31, 2006 because the firms were acquired by the Company in purchase business combinations during 2006. We have also excluded the twenty-three firms from our audit of internal control over financial reporting. The firms are wholly-owned subsidiaries whose combined total revenues and combined total assets represent 5.9% and 14.0%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2006. /s/ PricewaterhouseCoopers LLP New York, New York February 22, 2007
F-3
Table of ContentsNATIONAL FINANCIAL PARTNERS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION DECEMBER 31, 2006 and 2005 (in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
F-4
Table of ContentsNATIONAL FINANCIAL PARTNERS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2006, 2005 and 2004 (in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
F-5
Table of ContentsNATIONAL FINANCIAL PARTNERS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY YEARS ENDED DECEMBER 31, 2006, 2005 and 2004 (in thousands)
See accompanying notes to consolidated financial statements.
F-6
Table of ContentsNATIONAL FINANCIAL PARTNERS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2006, 2005, and 2004 (in thousands)
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||