National Financial Partners Corp. Q3 2009 Earnings Call Transcript

National Financial Partners Corp. (NFP)

Q3 2009 Earnings Call

November 04, 2009; 08:00 am ET

Executives

Jessica Bibliowicz - President & Chief Executive Officer

Donna Blank - Executive Vice President & Chief Financial Officer

Doug Hammond - Executive Vice President & Chief Operating Officer

Marc Gordon - Investor Relations

Analysts

Mark Finkelstein - FPK

Andrew Kligerman - UBS

[Robert Rowe] - Riversource Investment

Presentation

Operator

Good day, ladies and gentlemen and welcome to the National Financial Partners third quarter 2009 earnings conference call. My name Monica and I’ll be your operator for today. At this time, all participants are in listen-only mode. (Operator Instructions)

At this time, I’d now like to turn the call over to Mr. Marc Gordon, you may proceed, sir.

Marc Gordon

Good morning everyone. Thank you for joining us on our third quarter earnings conference call. During this call management may make certain statements regarding their expectations and projections for NFP relating to future results and events, which are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995.

These forward-looking statements are based on management’s current views with respect to future results and events and are subject to risks and uncertainties that could cause actual results and events to differ materially from those contemplated by a forward-looking statement.

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 statements whether as the result of new information, future events or otherwise. We refer you to the risk factors described in NFP’s filings with the SEC such as NFP’s Annual Report on Form 10-K for the year ending December 31, 2008.

Our third quarter earnings conference call will be accompanied by a presentation that is available for electronic download on NFP’s website at www.nfp.com/ir or upon connecting to the audio webcast of this call at the same website. I would also like to mention that detail regarding NFP’s organic revenue growth by product is included in the appendix of the presentation.

At this time, I’d like to turn the call over to our CEO, Jessica Bibliowicz.

Jessica Bibliowicz

Great, thanks Marc and good morning everyone. Over the past year, we focused on a number of initiatives to increase cash flow reduce expenses, develop our balance sheet and reorganize, and streamline the company. All of these initiatives put the company in the best possible position for future earnings growth.

As you will see on slide six. The cumulative effect of these initiatives was clearly evidences in our third quarter year-over-year comparisons. Gross margin percentage was up meaningfully to 19.1% from 17.5% in the prior year period. Cash flow from operations was up 40% compared with the prior period and operating expenses were down 14% and general and administrative expense was 21.7%.

As of today, the outstanding balance in our credit facilities stands at $65 million down from a $148 million at the beginning of the year. Of the $83 million reduction, $50 million as occurred from the end of the second quarter through today. Third quarter 2009 cash EPS was $0.61.

Looking at slide seven, excluding proceeds from the settlement of an NFP-owned key man life insurance policy, cash EPS with $0.58 up from $0.56 in the third quarter of 2008. We view the stabilization of cash EPS from the prior year period as a testament to the success of our expense management effort and our firms overall resilient and market presence.

Gross margin decline 9.7% compared with the prior year period due primarily the declining organic revenue. However, organic revenue improved to down 16.3% in the third quarter of 2009 from down 21.9% in the second quarter of 2009. The sequential improvement in organic revenue was largely due to our retail life insurance firms, which improved 30 percentage points sequentially, to down 23% in the third quarter of 2009, from down 53% in the second quarter of 2009.

We are pleased to see the sequential improvement in retail life insurance sales. Organic revenue from our largest product line group benefit decreased 6% from the prior year period. Year-to-date group benefits decreased 3%. The decline is reflective of the overall economic environment.

Looking towards the future, our recent initiatives are aimed to driving future earnings growth. We have reorganized our own firms and corporate resources around our two core client group, corporate clients and individual clients. Specifically, we have aligned resources that have traditionally been more dedicated to our wholesale marketing organization and expanded their focus to better serve our own firms.

Next we are selling non-performing firms. This was strengthening the organization by focusing all of our resources on the firm that deliver the most to our bottom line. Finally, we recently instituted a new principal incentive plans in the providing firms with the fresh start for growth and further aligning our firm principals with our shareholders.

Turning to slide eight, 59% of our current base attributed to firms owned for over a year is above or within 85% of target earnings in the third quarter of 2009. This is down from 65% in the third quarter of 2008. The percentage of firms in terms of base operating below base is increased to 25%. We expect to see some improvement as sold firms are eliminated from the dataset and the economic environment improves.

You’ll see our current business mix on slide nine. Benefits, is now our largest product line due to it strong relative performance. Retail and life brokerage continue to represent a significant portion of our business. NFP’s revenue diversification has served us well through the recession and we expect the diversification will continue be a critical component of our ongoing success.

Moving onto NFP’s revenue outlook, we expect sequential improvements and life insurance to continue into the fourth quarter of this year, which is historically stronger than the third or first quarters due to seasonality of the business. Our firms are highly motivated and are poised to capitalize on an improving environment. The financial conditions and market perception of major careers is much improved.

High net worth individuals are again looking at wealth preservation strategies, particularly in light of the higher tax environment that is broadly anticipated. While we expect some improvement, sales cycles continue to be long and we continue to see a higher percentage of term insurance in our sales mix, than we would see in a stronger economic environment.

As the economy recovers, we expect to return to revenue growth in our life insurance businesses. NFP scales, carrier relationship and superior firm principals position us well as demand increases. Our group benefits firms have been pressured by the economic headwinds facing their clients. We expect that challenge to persist for sometime, particularly in small businesses. However, the client balancing the need to contain benefits cost against the need to retain key employees, our benefits front have opportunities to prove their work.

In addition, our diverse product offering in the benefit states allows us to continue to pursue new business opportunities. Based on these factors, we expect group benefits revenues to be largely stable and while the shape and extents of healthcare reform remains in flush.

We believe NFP’s diverse benefits product offering product, broad expertise and client relationships, put us in a unique position to adapt to changes in the landscape. Overall, we are highly focused on both the revenue and expense sides of our business. We are generating strong cash flow and had substantially reduced the debt, all of which positions NFP well for solid earnings growth.

At this time, I would like to turn the call over to Donna Blank, NFP’s Chief Financial Officer, who’ll review the financial highlights for the quarter. Thanks, Donna.

Donna Blank

Thanks, Jessica. NFP continues to generate solid and growing cash flow. Turning to slide 11, in the third quarter operating cash flow grew 40%. Year-to-date operating cash flow has more than double. Looking at slide 12, of the $50 million in operating cash flow generated during the quarter $40 million was utilized to pay down debt.

In October, we’ve reduced the amount of outstanding by another $10 million to bring the outstanding balance to $65million. As of the end of the third quarter, NFPs consolidated leverage ratio was 2.2 time below the maximum allowable ratio up 3.0 times for the third quarter. The maximum allowable consolidated leverage ratio will decline to 2.5 times in the fourth quarter of 2009 and will remain at that level for the reminder of the term of our credit facility. We expect to remain and compliance with the credit facility covenants.

Moving to slide 13, the decline in total expenses was greater than the decline in revenue. Gross margin percentage increased to 19.1% during the quarter from 17.5% in the prior year period, highlighting the variable components of NFPs cost structure and the success of our expense management initiative.

Commission expense decline more than revenue due to a product mix shift from higher payout life insurance revenue to lower payout benefits from financial advisory revenue, as well as reduced payout across most of our product line. In addition, while operating expenses as a percent of revenue increase in absolute terms operating expenses decline 14%.

Turning to slide 14, management fees have decline faster than income before management fees in recent quarters due partially to a slowdown in earnings and NFP’s priority position in those earnings. As you maybe aware, the management fee calculation it based on firm level year-to-date performance. As the performance of firms that are operating below target, but above based improves year-to-date. Management fee percentage for those firms increases. You will find an example of this on the bottom of slide 14.

Also impacting management fees will be the restructured principal incentive plans. As Doug will discuss in more detail, there are two main components of the incentive plans, our cash fees and an equity fees. The cash base incentive is largely dependent on individual firm performance and it will vary depending on the type of firm.

Therefore the precise impact of this incentive is difficult to project. However, it is worth noting that our incentive plans have historically had a payout of approximately 4% of income before management fees. This payout will vary based on income before management fee growth and firm’s specific performance.

The cash component will begin in the fourth quarter of this year. The equity component entails the granting of approximately 1.6 million shares during the fourth quarter of this year. The value of the shares at the time of grant will be amortized as part of management fees for three years.

For example, if the shares are granted at yesterday’s closing price of $7.93, we will expense $12.7 million pro rata over three years. This would translate into an expense of $1.1 million a quarter, or approximately 1.3% of third quarter 2009 income before management fees. The number of shares to be included in the diluted share calculation varies based on a variety of factors, so it will not exceed the 1.6 million shares granted.

Taking into the account, both the potential acceleration of earnings for firms operating below target, but about base and the new incentive plans, we do not expect the full year 2009 management fee percentage to be greater than 48%. The 21.7% decline in G&A coupled with the increase in gross margin percentage provided positive operating leverage.

As you can see on slide 15, operating margin which we defined as gross margin less G&A expense declines 4%, while revenue declined 17% during the quarter. This positive trend continues from the second quarter. For the full year 2009, we expect G&A to be down between 19% and 20%.

Other income included $1.9 million from the settlement of a key man life insurance policy pro forma firm principal. Taxes were impacted by the tax free nature of the $5.5 million key man life insurance proceeds, received in the second quarter and a tax benefit from disposition. For the remainder of 2009, we expect an effective tax rate of between 39% and 43%, excluding impairments and dispositions.

At this time, I’d like to turn the call over to our COO, Doug Hammond.

Doug Hammond

Thanks, Donna. I’ll review three areas this morning. The progress of our ongoing expense initiatives, the status of our efforts this year to sell underperforming businesses and our reorganization focusing on the components of our recently announced incentive plans.

Our teams in New York and Austin have made great progress this year, working with our firm principal to reduce expenses during this very difficult cycle. We have exceeded the goal we laid out in the beginning of this year to reduce total operating expenses by 4% to 5%.

As shown on slide 17, over the course of this year, operating expenses have declined at an increasing rate every quarter. In the third quarter, total operating expenses were down 14% and organic operating expenses were down 8.7%. For the full year, we expect total operating expenses to be down between 9% and 10%. This estimate includes some seasonal increase in the level of operating expenses in the fourth quarter.

As you can see on slide 18, half of the cost reductions came from expense cuts at our organic firms and just under 40% of the savings came from the sale of all certain of our firms over the course of this year. Regarding these sales, at the end of last year we prioritized our firms based on financial and strategic value and commenced a process of selling firms that view to the negative or immaterial contributors. This initiative has and will continue to improve our consolidated performance. It also allows us to dedicate more of our resources to our best firms.

Today, we have sold 22 firms, which contributed negative $800,000 to gross margin in the 12 months leading up to sale. We received approximately $22 million in consideration on these sales, $12.5 million of which was cash. As the number suggest, we have maximized the value of these assets without scarifying earnings potential. Of the firms that were initially targeted for this initiative, we have sold nearly all the firms that were negative contributor to gross margin on a trailing four quarter basis.

We expect to continue to sell firms that are immaterial contributors to our gross margin for our non-strategic. We are on track to complete the bulk of this initiative before the end of this year. As Jessica mentioned, we’ve recently announced organizational changes design to improve the delivery of the resources we offer our firms and clients. In connection with these changes we also revised our principal incentive plans to drive future performance.

As you can see on slide 19, the plans encompass and annual cash component that reward superior individual performance, as well as a long term equity component. The individual firm cash components covers an annual performance periods starting October 1, 2009. To receive a payment under this plan, a firm must perform in excess of their target earnings under their management agreement and generate earnings that exceed a revised firm earnings benchmark.

In the first year of the plan the revised firm earnings benchmark is generally the trailing 12 months earnings of an individual firm. We utilize the trailing 12 months as the earnings benchmark in order to reset incentive hurdles at levels that are realistic in the current environment. At increasing growth levels over the earnings benchmark, the firm principals will be paid an increasing portion of the earnings. The growth levels, the trigger payouts vary based on the natural of the business participating in the plan.

The long term equity component of the incentive plan is a $1.6 million, restricted stock in a grant that will occur in the fourth quarter. The units are subject to three year cliff vesting from date of grant and will be awarded based generally on a firms contribution to NFP’s gross margin, enhancing the alignment of NFP’s most meaningful contributors to gross margin with our shareholders.

The plan is designed to motivate our principals to drive appreciation in NFP’s stock price by generating earnings growth over the long term. We believe the new incentive programs further solidify alignment with shareholders by providing both short and long term motivation for earnings growth.

At this time, I’d like to turn the call back over to Jessica.

Jessica Bibliowicz

Thanks, Doug. To summarize NFP’s in successful and generating solid and growing cash flow and reducing expenses. In addition, we have taken important step to drive future growth by reorganizing the company, incentivizing principals and streamlining operations.

We have a diverse revenue stream that allows us to be resilient in the pace of changing market dynamics. Our products continue to sell critical long term needs for both consumer’s and companies. Based on all these factors, we are well positioned for future earnings growth.

Operator, at this time, we’d like to open the call for questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Finkelstein - FPK.

Mark Finkelstein - FPK

I guess, Doug, you mentioned that the calling of the firms was still kind of ongoing. Can you give any metrics around how many more firms are targeted and I guess what the revenues of those firms are roughly?

Doug Hammond

I mean, we’re looking probably at around 30 firms’ total, that we have expect to complete by the end of the year, possibly a couple more that will carryover to 2010 and from a revenue standpoint I’d say sort of generally immaterial revenues.

Jessica Bibliowicz

As Doug mentioned Mark, the big ones are completed and so we’re really just finishing up the last ones now.

Mark Finkelstein - FPK

The remaining ones I guess, just to clarify so the view is that the amount of gross margin that they contribute is minimal as well then, that your paths are once had actually in a negative position.

Doug Hammond

Yes.

Jessica Bibliowicz

That’s right.

Mark Finkelstein - FPK

I guess, thinking about the operating expenses at the firm level, is that level of expenses sustainable? I think the ratio was little bit below what I was expecting, I’m just curious if there is anything else going on that we shouldn’t be thinking about that level and that’s kind of a baseline starting point.

Doug Hammond

Yes, I mean I think we’ve gone through a pretty rigid planning process this year and that we’re starting our planning for next year on the budgeting right now. I think the firms have just gotten very focused on sort of what they need to serve their business.

There are some seasonality with respect to the fourth quarter that relates to just what we’ve typically experienced at the end of the year, higher volume, which could sort of move up the numbers a bit in the fourth quarter, but I do think sort of on an organic basis running forward. The firms are, very disciplined in terms of sort of how they’re going to make expense decisions into 2010 and we’ll be tracking that very closely.

Mark Finkelstein - FPK

Then just on the management fee percentage, I know you’ve kind of made some changes to kind of target levels. I mean should we expect that management fee percentage to kind of move back end at the 46% plus level over the next couple of quarters? It’s been trending below that for last couple, I’m just curious, when we should expect that to kind of move back into normalized levels?

Jessica Bibliowicz

We’re hoping that it does move back to that level of which would be a fine that revenues have picked up. As in my remarks I said, 48% maximum and that would include the incentive plan as well, for the whole year, right not just for the quarter. You could see for the quarter, it could be a bigger number.

Mark Finkelstein - FPK

I mean, is there anything you’re saying it kind of the life or life brokerage in terms of pipeline or anything that should give us any indication on how we should think about organic kind of over the next couple of quarters?

Jessica Bibliowicz

Yes, I mean we did think that the sequential improvements in life insurance, particularly retail life insurance sales was the positive, it was something that I think we were signaling in the last quarter. The general environment is significantly better, which I outlined in my comments and we are seeing some bigger cases getting done and the firms are reporting pretty strong pipeline.

So, we do thing that we’ll continue to see that sequential improvement in the fourth quarter. I just with caution by saying that, things take longer to get done tax get take longer to get written, but we do clearly see improvement in the environment and the firms are very focused and working hard.

Operator

Your next question comes from Andrew Kligerman - UBS.

Andrew Kligerman - UBS

Help me understand this management fee a little better. Donna, you said that the maximum would be 48% for the year and that means did in the fourth quarter it could be even higher, did I hear that right?

Donna Blank

That’s right. Fourth quarter on a standalone basis, that would be around 48% maximum, would be around 56% for the quarter because remember there’s a year-to-date phenomenon a catch up almost…

Andrew Kligerman - UBS

I mean it seems like a lot for bunch of firms that like only 59% of the firms being, above 85% factoring and in terms of targeted it seems like a lot, so let to try to get a better feel. Let’s say this quarter, where the first quarter that it was implemented and if I go to the percentages, I think it was 44.3% in the third quarter. So, let’s say you implemented in a third quarter. What would that 44.3%, would it be somewhere in the 50%, so in plus or minus a point or two?

Donna Blank

No, I mean I think that the big jump that could happen in the fourth quarter as more related to the year-to-date phenomenon and the incentive, which I think as what you’re asking. It’s really the fact that there’s a catch up and a fourth quarter seasonality that you would find in a fourth quarter, whether or not there was a new comp structure in place

Jessica Bibliowicz

Andrew you pointed, how the key factor, which is you have a lot of firms that are impact in the GAAP or if those firms then we hope they do improve to target that payout is obviously much higher 100% between, it close to the principals, that’s were the management fee expense goes up dramatically. So if we see a lot of improvement in the fourth quarter, you would expect the management fees to up. Not just because of the incentive payout, which will get paid over target, but because of their own improvement?

Andrew Kligerman - UBS

It sounds to be, Jessica, like given your comment about life insurance retail and brokerage sales kind of trending up, you seen encourage you mentioned a few bigger cases. It sounds to me that, if you had to handicap the fourth quarter in terms of the management fee ratio. You would be guessing that it would be more than 48%, would you agree with me as we look to the fourth quarter.

Jessica Bibliowicz

I think it’s highly possible, but I think in these markets that we’ve all lift their handicap and there’s probably not a good thing to be like that. Our handicap in not a good game, but I think it is possible and I think, what Donna did and her number was give you sort of the outside number, the best possible condition.

Andrew Kligerman - UBS

Just going back to the non-performing firms, I guess on having trouble understanding how these firms, if their not producing commissions and fees or producing very minimal levels. How they would have a negative? It would probably be pretty much zero on both ends, right. There would be much by way of operating expenses and wouldn’t be much on the top line. So are they actually negative contributors to gross margins or they just kind of zeros?

Doug Hammond

Remember then we said the 40% of our operating expenses decline came from the disposition. So there are certainly some operating expenses. They were a fair number of negative contributors that were losing money.

Andrew Kligerman - UBS

It sound like these guys were producing next nothing in terms of revenue, is that probably a good observations or…?

Jessica Bibliowicz

In the trailing 12 month period is that would be more than fair observations. They were producing very little, their expenses were they are and they just learn viable businesses for arts going forward.

Andrew Kligerman - UBS

So lastly Jessica, in terms of when you sell these entities and again it sounds like comment was made that, vast majority if it is done and you got a few more to sell, but not a big once. What do you get paid for these? How do you determine a multiple for these entities, which onetime, I assume somewhat expensive? How do you get a payout and how you determine that?

Doug Hammond

We talked about, what the aggregate value of the transaction was, the transactions, which was around $20 million. About $12.5 million of which was in cash and we basically develop an internal methodology could determine sort of what were appropriate values based on the asset that excited then in the value to the front principals to sort of move on from the transaction.

Remember, NFP as sort of meaningful priority position contractually, non-compete, non- selective etc. and in that context that put us in a good position from a negotiation leverage standpoint to extract as much value is possible and that’s how we deal with them one by one.

Jessica Bibliowicz

It’s a negotiated transaction and I would also just say this that, a lot of them were some of the earlier deals, particularly in the life insurance side and so earlier, they probably did have very good returns, but one of things we’re also able to do is, keep them in the family through their memberships and partners financial or high cap with our brokerage group. So we didn’t even lose their revenue altogether, which is kind of a nice add onto it.

Andrew Kligerman - UBS

Just related to that, I think in the first quarter, there was a $600-ish million impairment of goodwill. Would you say that these firms pretty much encompass most of that impairment or did it involves many of your existing firms that have not and you do not plan to sell?

Jessica Bibliowicz

The impairment in the first quarter was really more related to the overall economic environment and the impact it had on our market value as a company as a whole. So it really would broad brush across the whole portfolio.

Operator

Your final question comes from [Robert Rowe] - Riversource Investment.

Robert Rowe - Riversource Investment

Some of the questions have been asked. I want to turn back to the balance sheet first and just, given once again the 40% sequential decline in the bank facility and the improvement in operating cash. It now appears that this facility will be paid off entirely in the next couple of quarters.

So I guess, the first is, given the rapid deleveraging in the company, one I’d like to hear the updated thoughts on what the appropriate level of financial leverages for NFP going forward and your thoughts around that? Secondly and importantly, given that your stock is trading at 30% free cash yield. What kind of plans should one expect in terms of capital management via share purchase and dividends in the future?

Jessica Bibliowicz

Donna with the progress on the balance sheet and make some forward comments as well.

Donna Blank

The focus up until now has really been on using all our free cash flow to pay down the facility, but I think what we will be doing over the next several quarters, as really looking at all of our cash needs, or all of our capital allocation priorities and figuring out what make sense from a strategic basis on go forward. So, I wouldn’t necessarily think, there are competing cash needs beyond paying down the credit facility, I wouldn’t necessarily expect every dollar to began against in the future and we will be looking to maximize the capital structure on a going forward basis.

Jessica Bibliowicz

I can correct, I think we want to see the progress in the fourth quarter and the first quarter, which typically is the higher expense quarter for us. Rob, I think you’re right, we’ve made tremendous progress to date, I think this is been more rapid than anybody would have anticipated, which really puts us in the position to engage in more long term planning.

We will be looking at our overall capital structure as well as the best capital allocation for the business that is obviously in the best interest of shareholders. So, I think this is the very important transition point for us and I think it gives us a lot more flexibility as we look forward. So it’s a good place to be.

Robert Rowe - Riversource Investment

Couldn’t agree more, the facility though Q1 obviously seasonally usually a cash user. I’m just curious, do you think that you will keep this facility open even if you have a zero balance at some point for the seasonally cash flow negative first quarter, or how do you see this facility evolving?

Jessica Bibliowicz

I think the facility has a great use in terms of working capital management, so I would foresee potentially borrowing in the first quarter and certainly keeping this facility and a new facility in the future open for that kind of you.

Donna Blank

Yes, I mean I just be optimist point of view, if management fees are higher and the payouts are higher in the first quarter, I would say, that bad bulge very well for revenue growth and that’s something that I think we’d all like to see.

Robert Rowe - Riversource Investment

Do you think that you could get better terms if he downsized it?

Donna Blank

I think the credit market is evolving and we’ll have to see where we are, when we start talking about our renewal and that’s why we always think that going through the fourth quarter and the first quarter and really kind of showing through the entire cycle, just puts us in a very positions, I have all discussions and review all of our options.

Robert Rowe - Riversource Investment

Second and last area is, could you just review again that what you said about, corporate G&A and firm level OpEx through the end of the year in terms of fourth quarter?

Donna Blank

Yes, the G&A we expect to be down on overall year basis between 19% and 20% and that would translate into fourth quarter somewhere between 8% and 12%, I think the reason why there’s such a larger range there is because its more of a difficult comps in terms of an expense reduction, because we actually started our expenses reduction in the fourth quarter last year and so we’re sort of coming full circle in the fourth quarter, but for the year down 19% to 20%.

Doug Hammond

On the operating expenses, we said down to the year 9% and 10%, which would translate into a total operating expenses reduction in the fourth quarter between 5% and 9% and its basically the same logic we started our expense initiatives and feel with back to the fourth quarter work of 2008, it sort of the first time we saw pretty significant drop in the operating expenses, so where lapping also there.

Jessica Bibliowicz

Thank you and that I guess concludes the Q-and-A on the call. Are anymore questions on therefore?

Operator

At this time, there are no additional questions.

Jessica Bibliowicz

Very good, thank you all very much. Have a great day and of course we’re available for any questions that may come to mind. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the presentation. You may now disconnect. Thank you and have a good day.

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