Executives
Marc Gordon – Investor Relations
Jessica Bibliowicz – Chairman, President and CEO
Mark Biderman – Executive Vice President and CFO
Analysts
Andrew Kligerman – UBS
Mark Finkelstein – FPK
Jukka Lipponen – KBW
Keith Walsh – Citigroup
Richard Sbaschnig – Oppenheimer
Eric Berg – Lehman Brothers
Peter Seuss – Sunova Capital
National Financial Partners Corp. (NFP) Q4 2007 Earnings Call February 13, 2008 8:00 AM ET
Operator
Good day ladies and gentlemen and welcome to the Fourth Quarter 2007 National Financial Partners Earnings Conference Call. [Operator Instructions] I would now like to turn the presentation over to our host for today’s call Mr. Marc Gordon.
Marc Gordon
Good morning everyone, thank you for joining us on our Fourth Quarter Earnings Conference Call. During this call management may make certain statements regarding their expectations and projections for NFP related to future results and events which are forward looking statements as the 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 forward looking statements.
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 a result of new information, future events or otherwise. We refer you to the risk factors described in NFP’s filings with the Securities and Exchange Commission such as NFP’s annual report on Form 10-K for year ended December 31, 2006, filed with the Securities and Exchange Commission on February 22, 2007.
Our fourth quarter earnings conference call will be accompanied by a presentation at is available for electronic download on NFP’s website at www.NFP.com/IR or upon connecting to the webcast of this call at the same website. The presentation is intended to outline the key points of the following call and highlight new and updated disclosures. We believe the presentation is the appropriate format for this year end call, we may determine in future periods that a presentation along with the earnings call is not necessary.
Mark will review the financials and participate in the Q&A. At this time I would like to turn the call over to our President and CEO, Jessica Bibliowicz who will begin on slide five of the presentation.
Jessica Bibliowicz
Good morning everyone, thank you for joining us for our fourth quarter earnings call. This morning I would like to discuss our 2007 performance, the life insurance benefits and financial advisory businesses as well as other key aspects of the NFP model. I’ll then review our outlook for the longer term.
Turning to slide six, fourth quarter cash earnings per diluted share was $0.83 versus $0.79 a year ago, a 5.1% increase. For the year cash earnings grew 9.6% excluding the management agreement buyout. Same store revenue growth improved from negative 7.6% in the first half of the year to positive 7.3% in the second half. Revenue growth was 10.9% for the year and 15% for the quarter. As expected there was a recovery in the Life insurance market in the second half of the year, however the recovery was not as robust as we anticipated.
The performance of some large case retail life firms was lighter than management expected. In general retail life business does have less predictability to its earnings. We saw no macro trends during the quarter at the firms that were below expectations and many firms produced as anticipated. We believe the fundamentals of our business are strong and that the NFP model and the markets we serve are well positioned for growth. Our principles continue to have significant growth incentives and they continue to be motivated to grow.
Importantly we have the necessary and appropriate financial controls to properly manage our firm including centralized cash management, general ledger, payroll and e-mail systems as well as extensive compliance and internal audit capabilities. We are unique dividend paying financial services growth company that over the long term grows organically and through acquisitions. Our key to our model is our alignment of principles and shareholders.
We provide independent firms in growth markets scale, technology, capital and other resources to grow far in excess of their potential as a stand alone entity. Acquisitions strengthen our distribution reach and strategically broaden our product offerings, facilitate cross selling opportunities, increase recurring revenue and provide for succession planning.
Turning to slide seven, for the year 58% of our revenue at the firm level was life insurance and wealth transfer, down from 63% in the prior year, 32% was benefits up from 28% in the prior year and 10% was financial advisory essentially flat. The shift in business mix reflects our ongoing goal of diversifying our earnings and increasing recurring revenue. The benefits business is more recurring in nature and while the financial advisory business is dependent on broad market fluctuations it is also highly recurring.
While the retail life business has high growth potential its revenue is the least recurring and stable. On the other hand the revenue from our life brokerage operations are more constant in nature because they serve numerous retail agents and institutions. Due to the breadth of their market reach we believe that the performance of our life brokerage and wholesale entity is more indicative of the state of the life insurance market.
As you can see on slide eight the life brokerage business as a percentage of our total life business has increased by design from 24% in 2004 to 53% in 2007. In addition, the growth of our wholesale life brokerage businesses enable us to retain more production within the NFP network and it is a key reason why NFP is one of the largest distributors of high end life products in the US today. We believe the life insurance market continues to strengthen as indicated by a 19% increase in earned first year commissions in the fourth quarter at NFP Insurance Services, Inc. our Austin based marketing organization and Highland Capital Brokerage our largest life insurance brokerage general agent.
Overall carriers are becoming more comfortable with underwriting standards and pricing in the high net worth market place and capacity continues to increase. As always, capacity and appetite does vary from carrier to carrier. We are aware of ten hybrid financing programs that are approved by over ten carriers. More carriers are approving such structures on a case by case basis. The sound infrastructure we have built continues to bond carriers to the NFP network.
We believe life settlements are a natural constructive evolution of a life insurance market, the joint venture we announce with Goldman Sachs and Genworth combines capital market and underwriting expertise with our broad distribution network. The joint venture will create an end to end platform to institutionalize the life settlements market with respect to policy submission, preparation of bid packages, getting, closing, subsequent servicing and transfer and importantly privacy protection.
The joint venture should not only provide growth for our life settlement business but should also span the life insurance market as a whole due to the additional flexibility provided to consumers. The marketing launch of the joint venture will be towards the end of the first quarter of 2008 and it is anticipated that the platform will begin accessing policies during the second and third quarters of the year, consistent with the timing of regulatory approvals. The platform is expected to be funded within the next few weeks and Mark will discuss the financial impact of the joint venture in his remarks.
Moving on to slide nine we continue to develop our corporate and executive benefits business through acquisitions and through our Austin, Texas based distribution platform. Our goal is to leverage our existing clients and attract new ones by expanding our product offerings and delivering unparalleled service to both the small to mid-size and the niche large corporate marketplace. In the last few years we have added a significant expertise in the long term care, qualified and non-qualified retirement plans, property and casualty, executive benefits and high limit disability markets.
The role of firm operations and the distribution platform in Austin is to facilitate the cross-selling and marketing of our products throughout the NFP network. As you will see on slide 10, financial advisory continues to complement our other two business lines and allows us to offer a wide range of services to our clients. However, our exposure to stock market fluctuations remain small despite challenging markets the assets under management at our corporate RIA increased 23% from $6.9 billion in 2006 to $8.5 billion in 2007. Please note that this number does not include assets under management at our individual firm operated RIA’s.
A key aspect of the NFP model is its ability to line the interest of principles and shareholders and provide incentive to motivate principles for the long term. We believe the base/target structure has created a beneficial arrangement for principles and down side protection for NFP and its shareholders. As you will see on slide 11, 71% of base acquired for the 12 months or more is operating above or within 85% of target. Last year 73% of base acquired was operating within this range.
Our earnouts and incentive plans are also effective in motivating growth. As shown on slide 12, 51% of our firm, in terms of base acquired that have completed an initial earnout period received an earnout. Most firms did not achieve the threshold of 10% compounded annual growth over the three years did provide a solid return to shareholders.
Looking longer term as slide 13 shows, the portion of firms in terms of base acquired that have completed six years with NFP thus finishing the earnout and the ongoing incentive plan 70% of our firms received one or both incentives. Please note that all NFP firms are always in an earnout or an incentive plan that is three years long. As you will see on slide 14 the end of 2007 marks nine years of operating history for our founding firm and our first firms are completing their third incentive cycle.
Of the firms that have completed their third incentive cycle in terms of base acquired 55% achieved the third incentive award. We believe the success of our incentive plan prove the long term earnings growth potential of our firm and the effectiveness of the model. In addition, as shown on slide 15, NFP’s principles, management, employees and other affiliated parties own a significant portion of the company further aligning interest. Typically at least 30% of purchase price consideration for acquisitions is in NFP’s stock and a portion of incentive payments are also in NFP stock. All stock awards are subject to lock up or vesting schedules.
Moving on to organic growth on slide 16, despite market turmoil in 2002 and the life insurance cycle NFP endured in 2006 and 2007 we have not had one year of negative same store revenue growth, our annual weighted average organic growth is 9.6%. On slide 17 of the presentation we highlight 2007 organic growth by acquisition class. Seven of the eight acquisition classes grew in the second half of the year and seven of the eight had stronger growth in the second half of the year than the first part of the year. The 2003 firms, which was the only class to display negative growth in the first and second half of the year was a small acquisition class that in aggregate did perform above target in 2007.
Turning to slide 19 we show historical performance of the same store set, 2006 and 2007 were challenging years due to difficult life insurance market conditions. However, strong growth of revenue and earnings resumed in the second half of 2007 and we showed improvement in critical margin items indicating our prospects for future growth. Mark will touch on this slide in further detail during his comments.
Moving on to acquisitions, we have completed 249 transactions since inception, as you can see on slide 20 the difference between the number of reported firms and the number of transactions is due to sub-acquisitions, dispositions and internal consolidation. Sub-acquisitions are critical components of our growth in distribution strategy; they allow for the expansion of our strong existing firm and sometimes create succession planning opportunities.
In addition, the multiple paid for sub-acquisitions is typically lower. Dispositions which represent 8.4% of our acquisitions since inception relate to exits that we feel enhance the future performance and value of NFP. Our acquisitions have been a vibrant part of our growth story and have allowed us to add more earnings stability to our business. As well as strategically grow our product lines as displayed on slide 21, in 2006, 2007 and year to date 2008 over 75% of base acquired has been in the benefits base.
In addition to the strategic advantages we have focused on this business line to add more recurring revenue to our business and to balance our life insurance business. We also believe that benefit market trends are largely uncorrelated with the life insurance market further adding to the diversification advantages. An important highlight of our 2008 acquisition class so far is the acquisition of a group benefits intermediary and its subsequent merger with an existing NFP firm, also a group benefits intermediary.
The acquisition and subsequent merger increases our presence in a scalable niche market, provides for a succession planning at a large NFP and increases our recurring revenue base. Our M&A and firm operations team and been and will continue to be intricately involved in strategically combining and aligning firms based on the products, successions and/or growth opportunities that may present themselves.
Because of our growth advantages and attractive acquisition model our pipeline remains healthy. In the second half of 2008 we will begin operating expense savings initiatives at the firm levels such as combining six of our own New York based firms into our new corporate headquarters. This structure may serve as a model for other areas with numerous NFP firms and should provide additional cross selling opportunities.
In addition, as we gain scale we are reviewing other initiatives to reduce expenses. We expect such initiatives to be part of attaining more operating leverage at the firm level in the future. Moving on to slide 22 we are targeting high single digit same store revenue growth over the long term. This is based on the demographic trend in the high net worth life transfer market and historical growth of universal life sales, the product most commonly sold to our target market.
Our corporate and executive benefits business we believe new clients, acquisitions, cross-selling and retention will drive growth, asset gathering and the power of the advisory based planning should facilitate the growth of our financial advisory business. We believe that the NFP acquisition model is attractive to sellers due to the resources we provide to help them grow their respective businesses. We are targeting $20 million in acquired base earnings for 2008.
We believe that certain strategic acquisitions provide significant growth opportunities for the future of NFP. However, at the current share price valuation and within the limits of our credit facility we are also exploring capital deployment in the form of share buybacks. This could impact our acquisition target for 2008. Once again, while this year’s growth was below our goals business trends remain solid. The fundamentals remain strong, the NFP model is proven and we believe the franchise is positioned well for future growth.
We will continue to build a premier independent distribution company with long term growth potential that focuses on serving our clients and shareholders. At this time I will turn the call over to Mark to discuss the financials.
Mark Biderman
Turning to slide 24, 2007 same store revenue growth was 0.3%, net same store revenue growth was 2.6% and same store gross margin before management fees was a negative 1.2% while same store gross margin growth excluding incentive accruals was negative 2.7%. Performance did improve significantly from the first half of the year to the second half as same store revenue growth rebounded to a positive 7.3% net same store revenue growth was 9.1%, same store gross margin before management fee growth was 8.7% and same store gross margin growth excluding incentive accruals was 5.7%.
As you may recall, as Jessica said, six NFP firms will be moving into NFP’s new corporate headquarters in the spring of 2008 and we began recording rent at the new location during the fourth quarter. As such there was $400,000 of additional rent expense for the NFP firms during the quarter. Excluding this amount, second half 2007 same store gross margin before management fee growth was 8.9% and same store gross margin growth excluding incentive accruals was 6.1%.
Looking forward, we believe that net same store revenue growth is the key measure of our business because it reflects the revenue retained by NFP. Accordingly, when looking at firm operating leverage in the same store set and the impact of growth on NFP’s gross margin we look at the level of net same store revenue growth. As we learned from recent experience firm operating expenses as a whole do not decline when there are short term variations in growth.
Therefore, we expect same store gross margin before management fees to grow slower than net revenue when same store revenue growth is flattened down. We would also expect same store gross margin before management fees to grow equal to or faster than net same store revenue growth when net same store revenue growth is in the mid single digits or higher. Actual growth in same store gross margins includes the impact of management fees which will be discussed separately.
On a consolidated basis, firm operating expenses as a percentage of revenue is also impacted by the effective new firms. In 2007 new firms had a higher operating expense ratio than the same store firms due to a larger concentration of benefit firms which typically have higher operating expenses. As you may recall, there were two items in the third quarter that had a significant impact on the firm operating expense ratio. These items were additional staffing at NFP/ISI and strategic steps taken to reposition the recent acquisition. As we expected the impact of those two items had significantly less of an impact on the fourth quarter results.
As you will note on slide 26, looking to 2008 we expect commission and fee expense to be 32% to 33% of revenue, this is based on the general trends we have seen in the business. However, the ratio can be impacted by shifts in revenue mix between wholesale and retail. Faster growth at the broker dealer which has payouts in the 90% range and the impact of the new acquisitions. We will provide updates to this estimate throughout the year as appropriate.
We expect consolidate management fee percentage to be stable over time as the potentially higher incentive accruals related to a larger percentage of firms in the ongoing incentive plan should be offset by growth in our utilities for which we do not pay management fees and potentially an increased economic ownership percentage in newly acquired firms. More recent acquisitions have had an increased economic ownership percentage and we disposed of one firm of which we had a low economic interest.
As a result, NFP’s economic ownership percentage of all firms has increased from 48% in the fourth quarter of 2006 to 51% currently. Management fee percentage will be higher during periods of strong growth due to increased incentive accruals. This should generally be accompanied by higher firm earnings. Also, Highland, which started their ongoing incentive plan at the time of acquisition ends the initial incentive cycle at the end of the first quarter of 2008. This could potentially result in higher incentive accruals at the end of the first quarter and a larger expense for cash gross up stock elections in the second quarter of the year.
Our current estimate of potential management fee expense related to firms completing the fourth quarter of an incentive cycle during 2008 is $1.6 million with approximately 50% occurring in the fourth quarter. In addition, our current estimate of exposure to additional management fee accrual cash gross ups related to potential stock elections is $5 million with approximately $2.5 million occurring in the first quarter. The accrual for firms completing the fourth quarter of an incentive cycle and the cash gross ups is in addition to accruals for firms in the middle of an incentive cycle.
G&A expense was $14.6 million in the fourth quarter a 16% increase from a year ago. Included in the G&A expense was $1.2 million in additional rent expense due to the corporate office move. Excluding the additional rent expense G&A was $13.4 million an increase of 6.3%. The increase was partially offset by a reduction in cash bonus accruals to senior management and generally an increase in the percent in the proportion of incentive compensation awarded in equity. In 2008 we are targeting corporate G&A growth to 10% to 11% excluding the cost of the move. We are committed to only spending on initiative that are necessary to support firm growth or that are needed to achieve regulatory and compliance goals.
The tax rate in the fourth quarter rose to 48.5% from 45% in the year earlier, excluding the impact of FIN 48 and 49.5% including FIN 48. The primary reason for the increase was because the anticipated level of pre-tax earnings was significantly higher than actual earnings for the quarter. Said another way, NFP’s estimate for non-deductible expenses for tax purposes such as travel and entertainment, life insurance premiums remains relatively stable throughout the year.
The estimate for pre-tax earnings on which the effective tax rate is calculated throughout the year was much higher than actual pre-tax earnings. This caused an increase in the full year tax rate and the entire impact of the change has to be made up in the fourth quarter. The full year tax rate was 44.8% in 2007 excluding the impact of FIN 48 compared to 43.2% in 2006. The tax rate in 2007 including the impact of FIN 48 was 46.1%.
The full year and fourth quarter effective tax rate was also impacted by a shift in firm earnings to states that have higher tax rates and changes to a few states rates. There was $1.3 million and $400,000 for the year in the quarter respectively of penalties and interest related FIN 48. In 2008 we expect our tax rate to be in the range of 45% to 45.5% including the impact of FIN 48. Given the breadth of our firms geographically and our regulatory compliance structure our tax rate will continue to be impacted by shifts in earnings between tax jurisdictions. We are constantly reviewing our tax structure in an effort to manage the overall tax expense.
As you will note on slide 27, the corporate office move is expected to impact cash EPS by 2% to 2.5% in 2008. Until the relocation of our corporate headquarters in the spring we will be incurring the full cost of rent at both locations. See slide 27 for the full impact of the move on the line items of the financials. In 2008 approximately 75% of the net expense will impact the first half of the year and 25% in the second half. In addition, a loss on sale of fixed assets will likely occur in the second quarter. I would also say that the ongoing expense beyond 2008 will be pretty much in line with the second half rate.
I would now like to discuss the potential impact of our life settlement and joint venture on our financial statement. Because NFP related entities will have exclusive access to the life settlements joint venture for the first year of its existence NFP may have to consolidate the results of the entity at least until the exclusivity period ends. Accordingly, the revenue and expense of the joint venture may be presented as a portion of the components of income from operations.
To account for Genworth and Goldman Sachs share of the income or loss and offsetting entry will be recorded in minority interest account. Once the exclusivity period is over NFP will reevaluate whether consolidation remains appropriate. We do not expect the joint venture to have a significant impact on our bottom line in 2008 but it could affect the margin. All of our previous discussions exclude the impact of the consolidation.
I would also like to briefly mention that FASB staff position APP14A which relates to accounting for convertible debt instruments that may be settled in cash upon conversion could require us to recognize additional non-cash interest expense on our convertible notes as it they were straight debt. The FASB staff position was recently sent back for re-deliberation. We may comment further when the final statement is issued.
At this time I would like to turn the call over to Marc Gordon to discuss our new disclosures.
Marc Gordon
As we hope you have noted we have provided what we consider to be a significant amount of new disclosure in the fourth quarter of 2007 earnings release, quarterly financial supplement, earnings presentation and conference call. The goal of these disclosures is to provide further insight into the composition of our revenue and earnings, the markets we serve and our prospects for future growth. Going forward we will provide same store gross margin before management fee growth, same store gross margin growth excluding incentive accruals, acquisition class performance, incentive plan performance updates and acquired firm reconciliation on a yearly basis.
The components of same store gross margin before management fees for the next year period comparison which you find on the quarterly financial supplement will be provided on a quarterly basis. I would also like to note that we plan on investor day in early June to provide further insight into our business model and future prospects. We will provide more details as they become available. At this time operator we would like to open up the call for questions.
Question & Answer Session
Operator
[Operator Instructions] Our first question comes from the line of Andrew Kligerman with UBS.
Andrew Kligerman – UBS
I have a few questions, Jessica you made the comment that you were exploring share buy back, could you elaborate on what you meant by that term?
Jessica Bibliowicz
I think you probably saw in our press release we do now have the authorization to repurchase stock so we have the ability to do buy backs and we won’t specify, we don’t intend to specify the timing of any purchases in advance but that authorization is in place.
Andrew Kligerman – UBS
Do you have an appetite to buy back stock and if so, what could you do? I know what you can do but…
Jessica Bibliowicz
We said the authorization was based…
Andrew Kligerman – UBS
But what’s the appetite, do you want to get really active?
Jessica Bibliowicz
At this point with the low stock price we think it’s very appropriate for us to look at the possibility of doing a share buy back. We’ll always balance that with the acquisitions and their long term impact to the company. We think we can handle the balance of it.
Andrew Kligerman – UBS
Handle the balance of it, so that means you might do more than look but I won’t pursue any more. With regard to the 19% gross in Highland and NFP/ISI and then finishing out the quarter with a 7.6% same store growth rate, there was clearly a big short fall in some of your other firms. Could you give us color around some of the firms that sell dramatically short and why?
Jessica Bibliowicz
Yes, we definitely studied it and the impact happened at the retail life firms in general. There was no extensive pattern that we could find. Typically when we see a pattern, a change in the market or capacity or just a change in consumer behavior we will signal that. Frankly for the firms that fell short of expectations we had other firms that were very fluent and met our expectations. It really did happen in the retail life side and as you know that is sometimes very difficult to predict whether cases will actually close. There were some of our firms that typically can be strong retail life in the fourth quarter that were just slower than we expected.
Andrew Kligerman – UBS
No particular reason?
Jessica Bibliowicz
No particular pattern that we can identify and again we get there because other firms performed very well.
Andrew Kligerman – UBS
Mark was alluding to the fact that there would be an accrual for the end of an incentive cycle in the first quarter to the tune of about $2.5 million. It sounds like there is a big group ending the incentive cycle in the first quarter of 2008. Would that normally imply pretty robust sales going into the first quarter given that there is a fair amount of incentive into that period?
Mark Biderman
Let me answer it this way, Highland, when we acquired it, because the principles didn’t control the company we gave the principles an ongoing incentive plan from the beginning and they do end both the earnout for the stockholders of Highland and the ongoing incentive plan. Also, a the beginning of 2005 we switched the ongoing incentive plan from a zero to 100% stock election to a 30 to 50 so we wouldn’t have the wide swings after the fact in the stock election.
There are a couple of firms out there that are still in the zero to 100% that completed as well as the fourth quarter. All we are giving you on the $2.5 million is what could come in, in the first quarter. Any stock election risk on Highland which is also a zero to 100% would come in the second quarter. That $2.5 million is the maximum exposure of the additional 50% payment if everybody takes stock, which we don’t expect to happen.
It’s just wetting the outside exposure, but Highland will be ending their incentive period at the end of the first quarter clearly incentive periods do motivate people to do well. That could impact the first quarter, but any additional impact of the stock election of Highland principles would come in the second quarter.
Andrew Kligerman – UBS
One last question, I know I’ve been asking a lot, I’ll wrap it up on this; it’s kind of a long one. Your tax rate was higher than you anticipated, maybe a little color around how you were unable to anticipate that 200 basis point pick up from where we might have expected it. On the sales outlook, you’ve highlighted you can do high single digits this year, can you be confident that you are really going to do that and can you really be confident in these expense ratios or is it just too much, too many moving parts?
Mark Biderman
I’ll let Jessica answer the sales question, in terms of the tax rate when you start the year and every quarter, you start with an estimate of pre-tax income. You have your non-deductible expense as I said are primarily they key man life insurance premiums and a portion of your T&E which is non-deductible. If you are looking for a certain level of pre-tax income and that pre-tax income comes in say 10% lower, what happens is the impact of the non-deductible expenses increases your rate.
If you were assuming just to use easy math and there was no seasonality if you were assuming a 40% tax rate through the first nine months and then the full year tax rate came in at 41%, you’re fourth quarter rate would be 44% to catch up. The increase in the full year rate was due to the fact that the level of pre-tax earnings did not grow while our non-deductible expenses grew slightly. As I said, and to a lesser extent, we had some shifts and some increases in state tax rates.
The thing I would tell you on the left is that the tax rate leverage is the same as the operating expenses leverage. The faster your growth in pre-tax income the better you’ll do on tax rate because the non-deductible expenses will be a smaller portion of your pre-tax income. On the operating leverage question, before I turn it back to Jessica, it’s just a plane fact that the firm expenses unless everyone gets very pessimistic you are going to grow to mid to slightly higher mid single digit rates.
I think we’ve soared in the comments at the P&C brokers this week as well. Expenses are not variable, they tend to grow at the basic rate of inflation to slightly higher because people want to build their business that they are optimistic and you see they are earning incentives so they are building their business. Therefore, when you get net same store revenue growth below mid single digits you are going to have negative leverage. When you get it above mid single digits you are going to have flat to positive operating leverage like we showed in ’04 and ’05. That’s just the way the math works.
Jessica Bibliowicz
I just want to stress one thing, when we talk about the same store revenue growth of high single digits it is a long term expectation, we are not doing year by year as we’ve seen there can be some variability to it but it is long term. The components of it really relate to particularly the two niche markets we serve which is the high end life marketplace as well as the benefits marketplace. Our competitiveness in those arenas, the demographics that are behind it and our firms’ ability to both service and add value.
In addition, because of the incentive plans and the success we’ve had with then and the fact that for our incentive plans we typically have the suite spots in 15% to 20% growth rates it allows the average firms that are doing well, are hitting their stride and other firms that might be going through hopefully a temporary period. We are very confident in both our firms’ ability to central resources we add that help encourage and promote that ability as well as the incentive plans themselves.
Operator
Our next question will come from the line of Mark Finkelstein with FPK.
Mark Finkelstein – FPK
Going back to the buy back real quick, you indicated that a repurchase might impact the acquisition pipeline and what I’m curious about, does that suggest that the repurchase is more accretive than the new acquisition. How should we think about that with the valuation of these levels?
Mark Biderman
No, it’s not, we’ve done the math and it’s really not. If you put in growth it still favors acquisition. I think we want to be sensitive to the marketplace and what our opportunities are and it depends on the stock price. I think long term acquisitions particularly given our growth and our success in achieving incentives are always going to be more accretive.
Mark Finkelstein – FPK
You talked about an issue with the large retail life firms that impacted growth in the quarter. I’m curious if there is anything specific that occurred or any specific actions that you can take in terms of improving performance or is it purely just the life market and volatility and capacity out there?
Jessica Bibliowicz
I think it is really just about the volatility, more of the client decisions in the marketplace. Some on individual carriers making decisions but again I would stress no particular pattern to the general statistics. When you look through to brokerage and insurance services would indicate a pretty strong general trend for life insurance and I think that we continue to have our firm operations people we really do try to get our arms around the firm. We believe there is always something we can do to help but there was no trend to this.
Mark Biderman
Let me say also, looking at the firms, the larger life firms where there was the shortfall from our expectations they are all good performing firms, they are not weak firms, they are firms that are performing all of them well above target.
Mark Finkelstein – FPK
On page 17 of your presentation, looking at the performance by vintage year I think the positive is that aside from at least in ’07, ’99 and ’03 all years had positive organic growth. Looking at the chart its an increasing growth as you get more recent in vintage years and I’m just curious how you look at that, is it more a reflection in changes in business mix or do you at all worry about incentives with some of the older.
Jessica Bibliowicz
Interestingly enough the biggest magnitude of change obviously was the ’99 firm and I think that trend there obviously was that they were the biggest life firm, they had the biggest exposure to what we call the access rose and then they come back in the life insurance marketplace. I actually think the velocity of their improvement in the second half was really quite interesting. I also stated that 55% of the firms that have now completed their third incentive actually achieved that award as well and if you look at the first incentive that number was 51%.
That’s kind of interesting a smaller set clearly but that would dispel that a bit and firms that either did the first and second or the second only actually brought the numbers to 70%. We do not see any significant trends after the third year. What’s different in the later classes is you do have a greater mix of benefits and we believe and part of the reason why we have been so focused that they are steadier growers.
Mark Finkelstein – FPK
My final question is you increased your ownership in an existing firm as part of an acquisition early ’08 and this has been an emerging theme and I’m curious about how you think about the incentives within the existing firm and how you make sure that you are continuing to provide the right balance there.
Jessica Bibliowicz
When we look at these bigger firms and you can really see it, particularly in this case, we created succession when they do get so big and the management fees are so large it actually is more difficult for success because the incoming success is too big enough. With the bigger firms we actually do have enough management fee flow to keep the ongoing principle incentive, they have all the incentive plans and they are vibrant enough to keep them going but it is a chance for us to also get a larger percentage of the recurring revenue and to move the needle on our management fee a bit.
We are very careful to balance it; we look at the management team very carefully before we do it and also the general dynamics of the business.
Operator
Our next question will come from the line of Jukka Lipponen with KBW
Jukka Lipponen – KBW
First of all and putting aside the retail life firms for a minute, we’ve had a number of surprises in recent quarters in various areas. Am I missing something, it appears to me that at the corporate level there seems to be real lack of visibility into what’s going on in your firms on a timely basis if you will?
Mark Biderman
I think visibility on a short term basis is always somewhat difficult; we get a disproportionate share of our revenue in the last month of the quarter and a disproportionate share particularly at year end of accruals which we don’t even see in cash in December. We have very strong controls in terms of cash, in terms of general ledger, in terms of payables but I think the question is the visibility and it’s compounded by the fact that when you are in the life business and you have a broad pipeline you don’t know what’s going to close.
Looking a the production at the Highland and the utilities it shows you the broad market but you could very easily have cases and very large cases that could impact you that just don’t close by year end, that aren’t fully funded and therefore the commission isn’t earned and there’s no way to get visibility of that.
Jessica Bibliowicz
I do want to stress Mark’s point on the controls. The information flow, the cash management that is all very much in place but we understand that with 180 plus firms that you are going to have firms that behave in different ways during the quarter and they are going to have different experiences both positive and negative. It is difficult to see the impact of some of them and so you consolidate the firms. That’s why we were pretty clear to say that we have some of the retail firms performing well, these firms that have typically done well, they just had a slower quarter, it is difficult until consolidation sometimes to see the impact and that’s why we wanted to show you more of these statistics so you could see the overall metrics.
Mark Biderman
Finishing up on this topic, a lot of the issues are not controlled if we have visibility of the pipeline the issues relate to carrier capacity and client issues in terms of when exams are completed and what carrier capacity is and what kind of things they are doing and how quickly they are getting cases through. When you are dealing with large cases as we are that is totally unpredictable.
Jukka Lipponen – KBW
My second question, can you give us an update on the Goldman Sachs joint venture? I don’t know if you commented on it, I got on the call a little late.
Jessica Bibliowicz
I did comment on it, we are very excited, we think that it will truly change the life settlements market both from the execution of the settlements as well as really opening up the life insurance industry as clients have more options. The joint venture is between NFP, Goldman Sachs and Genworth. From NFP’s perspective we have some of our best talent here working on it to get that to fruition. The business will actually fund in the next couple of weeks. We expect that between the second and the third quarters we will begin to take in policies for settlement.
We also mentioned that NFP distribution system has exclusivity on the platform for the first year. Mark also discussed some of the impact on financials but you might have heard that.
Jukka Lipponen – KBW
So far all of the management contracts that have come up for renewal, what percentage have not renewed and are there any particular reason why that might have been the case?
Mark Biderman
We’ve had two or three retirements but they just renew automatically. We’ve had two or three retirements and those cases we’ve merged businesses in with others. Other than that there is nothing significant. If you look at the total number of principles I would say the number is the 1% to 2% range.
Jukka Lipponen – KBW
Essentially there’s been no incidents where somebody decided that they no longer wanted to be part of NFP?
Jessica Bibliowicz
Not without a plan or succession expect for the two cases that Mark said we were still able to do a merger.
Mark Biderman
Or in the cases of the disposition where we decided that we didn’t think it was in the best interest of the people staying a part of NFP.
Jessica Bibliowicz
The answer is yes.
Operator
Our next question will come from the line of Keith Walsh with Citigroup.
Keith Walsh – Citigroup
One question, bear with me as I look at you guys’ growth story with M&A being a key component. I see your ability to do deals as seriously impaired for three reasons and I’d like you to comment on this. First with your currency impacted, secondly the public private arbitrage is essentially gone at this point. You are buying six times base which is about eight EBITDA and that’s where you are trading at right now. Even if you are doing deals you are really not adding value.
Third, if I was an acquisition candidate and I’m going to monetize my life’s work I think I would think twice about being acquired at this point by NFP looking at the stock chart. Those are just three thoughts I’ve got and if you could comment on those I’d appreciate it.
Mark Biderman
Let me do the first one on the arbitrage. You and I have had this discussion over the last few days I think that it can only be right if 100% of the consideration was in stock. Given the 70/30 mix and the weighted average cost of capital the arbitrage is there because effectively what our current interest rates are you could say that the multiple on the debt is 15 times EBITDA. I disagree with you there, I think the arbitrage is there because we think this growth long term is shown by our incentives and therefore the arbitrage is much greater.
Our ongoing and our earnout plan basically is geared to the fact that we pay five times for incremental growth. We can debate it excessively but I do believe the arbitrage is still there given the cash stock mix.
Jessica Bibliowicz
I would also say that nobody internally or externally obviously is happy about the stock price today of NFP nor do they believe that it is appropriate. There is no group that is more fundamentally connected the power of distribution than our principles. When a firm considers us for acquisition they are really looking at their business, whether or not their business in its own right has organic growth prospects and whether NFP by introducing them to the 2000 producers see the advantages of scale or technology, the ability to diversify their business and the incentive plans whether they will grow faster by being a part of us and still running their own business as they will as just an independent entity out there on their own.
As I said in my comments the pipeline remains healthy, we actually did a transaction as you saw through this difficult period in the marketplace and I think our firms take a long term view and are very focused on their individual businesses to make sure that we can execute the kind of performance that will have a positive impact on the stock price. I would disagree with you on all counts and some of them will say the stock price is cheap, isn’t that nice I get more shares and I think they are thinking like long term shareholders. I don’t think that anybody views this as a realistic value of the company.
Mark Biderman
I think the other thing is that when you say eight times you are taking into account the corporate G&A clearly, and when we look on a deal by deal basis there is very little incremental expense that comes with that so we look at ourselves pay the six times on an incremental acquisition because we still think that over the long term that the G&A will grow slower than our gross margin and we do have operating leverage at the corporate level.
Keith Walsh – Citigroup
We can debate the EBITDA private, public, arbitrage but I think the point is that it is close significantly and you are taking on execution risks with a deal whereas with stock buy backs you are not. A follow up on the share repurchase part. You’ve talked about what you guys are looking at as far as share purchase, on a personal level are you guys looking to buy more stock yourself, if you could comment on that.
Jessica Bibliowicz
Why don’t I just comment on that. First of all a significant part of my life has been NFP stock. We have, as Mark mentioned made major shifts from cash comp into equity comp and when I look at a company like this that has the kind of growth prospects as it does, the stability, the balance sheet and management team clearly I will be making decisions when we are out of the blackout period. You’ll be able to see whatever happens to the filings.
Operator
Our next question comes from the line of Richard Sbaschnig – Oppenheimer.
Richard Sbaschnig – Oppenheimer
Thanks for the increased disclosure, a question for Mark, in terms of the tax rate, using your example where you used the 40% tax rate, to what extend do accountants allow you to perhaps be very conservative in the early quarters let’s say perhaps 41% or 42% in the earlier quarters and then having the potential in line or downward adjustment in the fourth quarter?
Mark Biderman
No they don’t allow you to take reserves that do that they look at what you’re estimates are for full year, pre-tax earnings and your estimates. We actually go through early in the year we base our state tax estimates on the performance last year and when we get to the second half we base it on a firm by firm analysis of what that firm is earning year to date. No, it is totally formulaic I wish it was easier, I wish you could have a fudge factor on a quarterly basis but you don’t.
Richard Sbaschnig – Oppenheimer
You were talking about how you are not sure if the transactions are actually going to close by year end. Clearly you obviously had very strong growth at some of these wholesale firms. Should we think of that growth rate at the wholesale firms as something of an indicator of the potential pipeline at these retail firms?
Jessica Bibliowicz
Yes, our wholesale firms they aggregate production from firms that are outside of NFP acquired firms and also particularly in the case of Highland institutions. Some of it will definitely have an impact on the internal firm production but also I think it just gives you a broad sense of the market.
Mark Biderman
Some of it is the firm pipeline but clearly the activity at Highland and utility reflects not pipeline, its actual closed cases.
Jessica Bibliowicz
Right, in that part but it shows you the scale of the industry.
Richard Sbaschnig – Oppenheimer
The firms that are underperformed I guess there was one pattern in the behavior in the fact that they don’t primarily use NFP’s own wholesalers, is that correct?
Mark Biderman
Some do, some don’t. It was specific circumstances, it isn’t necessarily business per se it could be processing or capacity issues at the carriers they do use. It could be that their flow of business over the course of the year or two. Each one was unique; there was no pattern to it Rich.
Richard Sbaschnig – Oppenheimer
Of those firms there is no clear pattern in terms of NFP’s own wholesaler use?
Mark Biderman
They tended to be less inside the wholesalers but that’s not the pattern, the pattern was unique to each.
Jessica Bibliowicz
Virtually all of our firms use NFP facilities contracts for a big part of their business. There are from time to time, they are going to need to go outside for whatever reason. They all would have some components of their business going through but when you are looking at the pipelines of these bigger areas again you are just seeing a bigger volume of business coming from other areas. We are completely, as you know, open architecture and our firms are charged with doing the best job they can for the client and getting the job done. Virtually most of our firms, particularly in the life side will use our contract somewhere, it’s very advantageous
Operator
Our next question will come from the line of Eric Berg with Lehman Brothers.
Eric Berg – Lehman Brothers
Several questions, first I would think that faced with the uncertainty in your business, uncertainty that is not really new, I’d like you to address for starters what’s changed here because it has always been the case that life production is uncertain. In addition to addressing that, why don’t we start there?
Jessica Bibliowicz
I would say from a model perspective, incentive perspective nothing has changed. What we have done is really consciously tried to reduce some of that volatility in the retail side by complementing the firms with other capabilities. When you look at the percentage of brokerage that was in our business back in ’04 to today, we believe that adds to the constancy while still allowing us to grow our presence profitably in the life insurance marketplace and also to capture more of the internal business.
I think the growth of the benefits side of the business and you saw that as a portion move up to 32% again creating more recurring, more predictable revenues where a firm that was once independent to being a part of NFP can really do many more things for their clients, adding qualified plans and long term care and whatever that client needs, NFP is a very fluid environment for them to really reach out and diversify.
Adding those things we think creates more steadiness and more opportunity for our firms and also helping our individual firms become micro-NFP’s where they too at the local level are diversified, they are serving the entrepreneur client, they are dealing with them on their life side as well as the benefits business if they own a company and their asset gathering side. As you look at the trend and the changes in the life insurance marketplace I think we have signaled for the last couple of years it has become tougher.
You have a period of non-recourse that was very opportunistic as we came out of that you had the carriers really thinking about their capacity, how they want to be in the market, how much business they were taking to markets and the whole process became very fluid and very important in today’s market and demographics support it. It just became harder to execute and you see that in some of the trough period and you see the recovery now.
Eric Berg – Lehman Brothers
I would think that faced with the uncertainty that you face, let’s put aside whether there is more uncertainty today than there used to be. I would think that most companies would say we expect our earnings to grow at ‘x’ percent over time or over the long term. That’s how they would deal with it. That’s not what has happened here, what has happened here, correct me if I don’t have the chronology right is that you have not only injected the concept over time it certainly feels like you ratcheted down you’re expectations for the growth of the business. First 20% then 15% down double digit, at least that’s how it feels, could you react to that?
Jessica Bibliowicz
First of all I think you are right, expectations should be over the long term and that is what we are talking about in terms of high single digits. Our move has been to give you more data points, more understanding of the business and the flows of the business so that people can make solid evaluations. We remain very optimistic on the business; we believe it’s very strong, we think the company is stronger today than it was three, four years ago when we did the IPO.
It could get stronger every year, the acquisitions have created more diversity of the business but we are very conscious to make sure we are delivering you key data points that will help you make your own assessments while we also talk about long term objectives.
Eric Berg – Lehman Brothers
Last question concerns your slide 13. Help me understand why this paints a flattering picture, looking at it one could look at this picture and say 30% in the red, 25% in the green plus 15% in the yellow, 70% of the firms that join NFP have some sort of stumble in years one through six, that’s how I read that, am I reading this. It’s certainly true in the blue 30% of the firms have continued ongoing rapid growth for six years, doesn’t this tell me that 70% do not, they stumble along the way?
Mark Biderman
Let me answer it this way, I think it’s more impressive that if you have 50% that earn an initial earnout. People would have told us in the past, after the initial earnout they are done because it’s so attractive. What we are seeing that even those firms that don’t, say there is 50% that don’t, at least 30% plus are motivated a second time. Yes, firms are not going to grow constantly, maybe they earn the first and don’t the second. Maybe they earn the second and not the first, and then you have the class of ’99 where 55% earned the third.
The point is that at some point in the six year cycle 70% are growing and there are firms moving in and out. It’s not always the same and guys who don’t hit the first are motivated to hit the second. I think that’s a very positive slide.
Jessica Bibliowicz
Don’t forget that the threshold is 10% annual growth every year so it is not a low incentive. Firms that are doing within 85% of their target are doing generally fine based on their business, it’s not exciting, it’s not the growth we want but its still providing a return and they always have the chance. The firms that earn the two, the earnout and the ongoing incentive have had their ongoing incentive target ratcheted up so you have to give them particular credit for having both having been done and I think Mark’s point is a great one that the way we designed this even if you didn’t make it in the first three year earnout it could be lots of reasons and local issues. Firms still come back; there are still incentives year three to six to get us to the back end. I actually think it’s a pretty positive story.
Mark Biderman
Don’t forget the point that Jessica made that the incentive target for the people who earn the first goes up and yet a sizeable percentage of them are still growing from a much higher level.
Eric Berg – Lehman Brothers
When you refer to target what percentage achieving, you are talking about not the original target earnings at time of acquisition but the incentive target?
Mark Biderman
In other words, the incentive target for the next cycle is always the higher the original target or what they did in the prior three years with the cap once they virtually doubled the business. A firm that basically hits the maximum on the earnout now has to basically grow from a level that’s basically two times what their original target was to achieve an ongoing incentive and a fair number of those did as you see particularly in the class of ’99 with the third incentive. They are still achieving incremental growth beyond their first three years. I think it’s a great story.
Operator
Our final question is coming from the line of Peter Seuss with Sunova Capital.
Peter Seuss – Sunova Capital
I wanted to follow up on Eric’s point about the longer term target. Due to the earnings volatility on a quarterly basis it makes sense to remove your annual guidance. I’m wondering if that’s something that management truly believes? An indicator of that would be have you guys, or do you plan to change the growth target that management compensation is tied to?
Jessica Bibliowicz
I would say that on compensation targets and we are really held to the highest standard obviously the comp committee and the board but I have no expectation that there will be any change in the targets for us and not achieving targets you will see that cash bonus for senior management are down and there has been a move to more of a percentage in equity. I think that we aligned our interests completely with shareholders both on the up as well as on the negative side.
Peter Seuss – Sunova Capital
Thanks again for the increased disclosure I hope it helps to dispel any in the long term sustainability model is great transparency.
Operator
That concludes the question and answer session for today’s call. I would now like to turn the presentation back over to Jessica for closing remarks.
Jessica Bibliowicz
I thank all of you; I truly appreciate everybody walking through all the metrics here. As Mark said we do have the presentation up on the website and we look forward to hearing any feedback and I wish you all a very good day. Thank you very much.
Operator
Thank you for your participation in today’s conference, this concludes your presentation you may now disconnect.
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