National Financial Partners Corporation Q2 2008 Earnings Call Transcript

National Financial Partners Corporation (NFP)

Q2 2008 Earnings Call Transcript

August 6, 2008 8:00 am ET

Executives

Marc Gordon – IR

Jessica Bibliowicz – Chairman, President and CEO

Doug Hammond – EVP and COO

Analysts

Andrew Kligerman – UBS

Eric Berg – Lehman Brothers

Ed Spehar – Merrill Lynch

Jukka Lipponen – KBW

John Nadel – Sterne Agee

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2008 National Financial Partners earnings conference call. My name is Heather and I will be your coordinator for today. At this time, all participants are in a listen-only-mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s conference, Mr. Marc Gordon, Investor Relations. Please proceed.

Marc Gordon

Good morning everyone. Thank you for joining us on our second 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 determined and 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 our 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 the year ended December 31, 2007 filed with the Securities and Exchange Commission on February 19, 2008.

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

Jessica Bibliowicz

Thanks, Marc, and good morning everyone. Thank you for joining us on the second quarter conference call. This morning I will discuss key trends currently impacting our business, capital management and important addition to our management team and their long-term outlook. Then Doug and Marc will take you through the quarter's results in more detail.

Second quarter results reflected a continuation in the slowdown in same store revenue growth that began at the end of the first quarter. This slowdown was driven by turmoil in the financial markets, the uncertain economic outlook, and a tighter life underwriting environment in the high net worth older age market. While we cannot predict when the financial environment will stabilize and recover, based on an extensive review of certain of our individual firms and demographic trends, we are confident that the underlying growth in customer demands across our product lines remains strong. In addition, we are actively working with the carriers to improve and expedite the life underwriting process. Let me discus the factors impacting second quarter revenue performance, then talk about operating expenses.

As we break down same store revenue, we looked at our firms in six categories based on concentration of their total revenue. The categories are retail life, wholesale life brokerage, life settlements brokerage, group benefits, executive benefits, and financial advisory.

In the second quarter, our strongest product line in terms of same store revenue growth was wholesale life brokerage, followed by both group benefits and financial advisory. Our weakest areas were life settlements brokerage, retail life, and executive benefits.

We attribute the growth in our wholesale life brokerage firms to the more consistent and broader revenue flow of this business. These firms service a wide array of retail agents. They benefit from institutional referrals and as general matter, are not as concentrated in the high net worth older age marketplace which is experiencing the most restrictive underwriting environment. The revenue growth in our group benefits business during the quarter was due to ongoing medical inflation, the addition of new clients, and diversification of products offered. This was partially upset by decreases in employee headcount and reduced benefits spending by employers and employees. In addition, more and more companies are shopping their benefits book and demanding increased services due to the rise in benefits cost. Although the benefits environment is becoming increasingly competitive, we believe that presents our firms with opportunities to win more clients due to their superior service and capabilities. Our firms continue to invest in their businesses to respond the client's need.

The financial advisory business posted modest revenue growth as revenue from new clients more than offset the negative returns in the financial markets. In these volatile markets, the sound focused financial advice that our firms offer is extremely valuable. Assets under management at our corporate owned RIA increased approximately 7% to $8.7 billion at the end of the second quarter of 2008 from $8.1 billion in the prior year period. Assets under management are up 2% since the end of 2007. Please note that this number does not include assets under management at our individual firm-operated RIAs. Our large firm RIAs are reporting steady growth as well. A rapidly maturing life settlement marketplace coupled with more cautious investment parameters, negatively impacted this business in the quarter. We remain committed to this business as we continue to believe that it is an expanding growth market that makes life insurance a more attractive product for consumers by providing them with more options. Our joint venture with Goldman Sachs and Genworth, coupled with NFPs distribution reach, positions us well for long-term growth in the settlements market. Doug will discuss this in more detail in his comment.

In retail life insurance, we are seeing tighter underwriting standards and a longer underwriting process in the high net worth older age market. This is likely due to carriers' desire to identify and limit the acceptance of certain type of premium financing and structured transactions. In addition, the instability in the credit markets is impacting a portion of this business as well, as funding available for carrier approved finance program is limited.

That said, demands for life insurance among our firms' clients remain strong. The older age population is growing and over the long term, wealth in United States will continue to increase. Our firms report that clients are increasingly interested in using life insurance as a fundamental asset class for state and wealth transfer, and business liquidity planning. Based on an extensive business review with certain of our large firm principals, our life insurance pipeline is rising consistently as the attractive IRRs of life insurance are particularly appealing in today's volatile markets. As always though, predicting when and which life cases will close remains difficult.

Our executive benefits business also declined during the quarter due economic factors which have led to lower deferrals and reduced headcounts. This is a smaller part of our business, but we like the long-term prospects and our firms are focused on adding new clients. Year-to-date executive benefits has accounted for 3% to 5% of total revenue.

Turning to the expense side, this is an area of focus at both the corporate and owned firms level. We have built a strong infrastructure, now it's time to leverage that infrastructure. As a result, we are reducing the expense growth target for corporate and our Austin-based facilities and Doug is going to provide you with more details.

Moving to the help of our firms using trailing 12-month results, 56% of base acquired for longer than a year is operating in excess of target compared with 68% a year ago, 67% of base acquired for the longer than a year is operating within 85% of target compared with 77% a year ago, 21% of base acquired is in the base deficit compared with 13% in the second quarter of 2007. By number of firms, approximately 60% of our firms are operating above target, 70% of our firms are within 85% of target, and 15% are below base. These declines are in line with the slowdown we saw in the life settlement brokerage, retail life and executive benefits businesses and we expect our firm's performance relative to base and target to improve as growth resumes. The increase in firms in the base deficit relates to a few firms that are just below base on a trailing four quarters basis and we believe a significant portion of this base acquired should move above base by year-end. In other words, a significant portion of the shortfall is just timing related.

Moving on to capital management, the strong after-tax annual cash flow that NFP generates allows us to balance acquisitions with dividends and opportunistic share repurchases. On the acquisition front, we have acquired $2.9 million in base earnings related to five transactions since the first quarter earnings announcement. The largest of which is $2.5 million in base. This firm is a significant ancillary group benefits firm that is highly focused on the large corporate market. Consistent with our strategy of growing existing NFP firms and enhancing our operating leverage, this firm will be integrated into one of our existing executive benefits firm. Year to date we have acquired $16.3 million in base earnings.

We remain on target to achieve $20 million in base earnings for the year and our acquisition pipeline remained healthy. Mindful of the economic environment and our stock price, we are balancing acquisitions without our capital uses. We continue to focus on strategic acquisitions that increase recurring revenue and further support our distribution network through the expansion of our offerings.

Year to date we had spent about $22 million on share repurchases and have approximately $23 million remaining under our current authorization. Yesterday, our Board declared a quarterly dividend of $0.21 per share. Based on this amount, NFP pays an annualized dividend of $0.84 a year. Our dividend has grown from an annual rate of $0.40 per share right after going public to $0.84 per share currently. Our dividend yield is around 4%.

We are also very pleased to announce that after an exhausted search that encompass candidates from many financial services companies, we have hired Donna Blank as our new Chief Financial Officer. We issued a press release announcing this key management hire concurrent with our earnings last night. Donna will begin on September 1. She brings over 20 years of financial and management experience, including over 10 years at FGIC which was formerly part of General Electric, including 5 years as the company's CFO. We look forward to her joining our team. We expect she will enhance our ability to manage growth, optimize our capital structure, support our owned firms, assess our financial analysis capabilities, review in detail our expense structure and create lasting value for our shareholders. This hire is included in our G&A forecast.

At this time, I would also like to recognize Marc for his nearly 10 years of service as Chief Financial Officer and we are looking forward to his continuing contributions. As you know, the final liquidity date for our pre-IPO shareholders is the 5th anniversary of the IPO in September. It is unlikely that we will execute a secondary offering at that time. We believe that the appetite of our restricted holders to sell it for our prices is not large enough to justify the expense of an offering.

Moving on to our future outlooks, as you know, it is very difficult to determine the length of the economic slowdown or challenging under writing environment, but NFP is well positioned in the current market environment and over the long term for three primary reasons. First, NFP's business is 100% distribution. We take no asset quality risk, no underwriting risk, and limited market risk. Our business is simple. Our firms sell a product or provide a service, receive a cash commission or build a client, then pay their expenses. NFP shows the profit with the principal and pays for necessary corporate G&A expense. The remainder is available for acquisitions, dividends and share repurchases. Our acquisition structure provides significant downside protection since NFP retains the priority position in the earnings capitalized.

On an annual basis, our after-tax cash earning equates approximately to operating cash flow which was over $100 million in 2007. This cash flow is sufficient to self finance our acquisition budget. Our cash earnings return on equity for 2007 which excludes the management agreement buyout was 15%, a number which we are very proud.

Second, the long-term demographic trends in the markets we serve are strong. There is significant need for state planning and wealth transfer in the high net worth market. Wealth in America will continue to grow over the long term and life insurance is a product that people are receptive to in volatile times. Medical inflation which drives revenue growth in the benefits area continues to rise. And despite current conditions, the financial markets do produce positive returns over the long term and today's market enforce the need for advice that our firms give.

Third, NFP provides the scale and resources to independent financial services entrepreneurs that allows them to grow faster over the long term than they could have as a standalone entity. The value of consolidation and NFP's reputation enhances the competitive position of our firms. Based on these three drivers, we continue to target high single-digit same store revenue growth over the long term. And at this time, I would like to turn the call over to Doug Hammond, our Chief Operating Officer. Doug?

Doug Hammond

Thank you, Jessica. I will provide more details about revenue trends, then discuss expenses and our business development and planning initiative. Looking at the second quarter firm level business mix, including both same store firms and new firms, retail life insurance was 25% of firm level business during the second quarter, up from 24% in the prior period. Wholesale life brokerage which includes life settlements brokerage was 27% of firm level business, down from 30% in the prior period. In total, life insurance was 52% of firm level business during the quarter, down from 54% in the prior year period. Benefits which includes group and executive benefits was 38% of firm level business, up from 36% in the prior year period. Financial advisory remained stable at 10% of firm level business. As a percentage of firm level business year-to-date, retail life was 24%, wholesale life brokerage was 28%, benefits was 38%, and financial advisory was 10%.

As Jessica touched on, a good way to look at the trends in our various revenue product areas is to categorize our firms by the single product that constitutes the bulk of their revenue. For purposes of this analysis, we group our firms into one of the six categories Jessica referenced, based on the source of 70% or more of their revenue. Using this method, our wholesale life brokerage firms grew revenue in the high single-digits. Our employee benefits and financial advisory firms grew revenue in the low single-digits. Our life settlements brokerage firms experienced a significant decline of approximately 40%. Executive benefits firms had a low double-digit decline and retail life firms had a high single-digit decline.

I'd like to provide additional detail concerning our life settlements and retail life businesses. We believe that the factors that drove the slowdown in both categories are somewhat similar. Several factors impacted our life settlements business in this quarter.

First, as expected, there has been margin compression in the business driven by heightened transparency and regulatory initiatives. Margin compression appears to have stabilized and we feel this is consistent with the maturation of this market. Second, concerns over the risks associated with the purchase of non-traditional premium finance policies have caused many investors to implement a more rigorous diligence process. This had slowed the closing process and in some cases, reduced the settlement value or precluded a settlement altogether of such policies.

Finally, turmoil in the credit market has impacted the ability of certain investors to deploy capital at the same levels as prior periods. Despite the current market environment, there is significant opportunity in the settlement’s market. To put things in context, last year, between $8 billion and $10 billion of debt benefit was settled. According to industry sources, there was over $10 trillion of life insurance in force. Of that, the vast majority of universal life policies lapsed.

We are well positioned to participate in this growth market through our distribution network as well as our life settlement joint venture with Goldman Sachs and Genworth. Our joint venture, Institutional Life Services, addresses many of the challenges in the market today. The JV provides a platform where stable sources of capital will offer competitive pricing for policies that are originated through a comprehensive diligence process. The JV will be the only market alternative that permanently protects the insurer's identity, which we believe will allay consumer concerns and extend the market.

Moreover, the life settlements market makes life insurance a far more attractive product, providing potential liquidity at a level above cash or under [ph] value which we believe will increase long-term demand for life insurance. The joint venture began a limited acceptance of policies on July 1st. We expect it to be profitable in 2009.

Similar to our settlements business, our retail life business which is concentrated in the high net worth older age market has been impacted by a slower and more conservative life underwriting process. Life settlements funders [ph] the carriers' concerns over certain premium financed and structured life insurance transactions have resulted in additional underwriting scrutiny, particularly in areas such as financial underwriting and the review of legal documents related to the transactions such as trusts.

While our life insurance pipeline is healthy and client demand is strong, the underwriting process has been slow and closing cases has been challenging. These increased underwriting requirements have also created backlogs which have impacted the service level at certain carriers. As one of the largest independent distributors of life insurance in the United States, NFP in a unique position to work with carriers as their underwriting standards evolves.

While the current underwriting environment maybe challenging, our firms are equipped with the resources that allow them to execute on business more quickly and efficiently than their competitors. We are also working with carriers on initiatives to expedite the medical and financial underwriting process through various NFP channels.

Let me turn now to expenses. NFP’s expenses fall into two general categories. First, the expected NFP directly controls at the corporate offices and the Austin utilities. Second, expenses at the owned firm level which are dictated by the decisions the principals make as they manage the day-to-day operations of their businesses.

For the corporate level and Austin expenses that we directly control, we’re balancing the resources and services our firms require and the infrastructure needed to run a public company with disciplined expense management. After several years of investment in these areas, we are now carefully reviewing what we have built to determine how we can execute more efficiently. In this regard, we’ve identified opportunities to lower our previously reduced 2008 expense growth goals for both corporate and Austin.

Last quarter, we reduced our 2008 corporate G&A growth goal from our initial 10% to 11% to 5% to 6%. We are again reducing this goal to 4%. This excludes the corporate office move which added $3.3 million to G&A in the first half of 2008 and is expected to impact G&A by approximately $3.4 million in the second half of 2008.

For the quarter, excluding the move, G&A expense is down 3.4% at corporate. At the Austin level, we are reducing our expense growth from 6% to 8% to 2% to 4%. For the quarter, expense growth at the Austin level was less than 1%.

Even with these reductions, we continue to build in key areas. This includes the cost of new hires, including our business development officer and new CFO, our business planning effort, and continued strategic investment at the Austin level to support our owned and member firms.

We continue to review opportunities to streamline our operations with an eye towards greater efficiency and expense reductions. At the firm level, the growth in operating expenses is also an area of focus. We are increasing our efforts to help our firms maximize revenue and manage expense growth by partnering with them in a more proactive strategic growth and planning process.

Examining firm level expenses for the quarter, the most significant areas of growth related to new business initiatives across our markets, efforts by retail life firms to diversify into businesses with more recurring revenue, and our group benefits clients demand for more services such as employee call centers, COBRA and other administration services, and legal, and compliance support.

Operating expenses at the firm level can also fluctuate based on production related payments to employees. While such diversification and client retention expenses are positive and should yield future dividends, our firms' expense growth can certainly be planned more effectively and with an eye towards greater operating leverage where appropriate.

The financial alignment, the NFP model, creates ensures that a significant portion of investments made at the firm level are borne by the principals. This motivates the firms to make spending decisions that will drive the long-term earnings growth of their businesses. Part of our job is to offer resources that maximize the benefit of this financial alignment and assist our firm principals to make decisions that will yield the greatest return. We are rolling out an initiative to partner with our firms to provide a comprehensive strategic growth and business planning resource designed to run parallel to our firms' earn out and incentive plan cycles.

The planning process will leverage the NFP resources available to our firms and facilitate greater operating profitability. We're on the process of organizing our internal resources to support a rollout of this initiative throughout the remainder of this year. Our front principals are welcoming this process as it fully appreciates the right to manage the day to day operations of their firms while enhancing their ability to earn more.

We have begun the planning process with three firms that have above average expenses and the results have been positive. At the three firms reviewed, we identified significant opportunities to increase profitability by streamlining operations and reducing expenses. These efforts will result in approximately $1.2 million in savings in the second half of 2008 and approximately $3.1 million in savings in 2009. While we would not expect the savings of this magnitude across all of our firms, our initial efforts do show that the economic alignment that our model creates motivates the principals to work with us to optimize their financial results. The ultimate revenue growth and expense savings are difficult to quantify, but a comprehensive business planning and development process should maximize the profits of our firm.

At this time, I'd like to turn the call over to Marc.

Marc Gordon

Thank you, Doug. I would like to spend a few minutes going over some of the financial details that Jessica and Doug have not yet covered.

First, I would like to point out that our quarterly financial supplement we have included additional detail related to management fee expense and income taxes. So some of the detail I have historically included in my remarks has been shifted to this supplement. Revenue trends have been discussed by Jessica and Doug, so let me begin my discussion with the factors effecting gross margin.

Commission and fees as a percentage of revenue increase from 31.3% to 32.7% for the quarter. This was largely due to a greater contribution to gross revenue by our broker/dealer which has payouts in the 80% to 90% range. The broker/dealer's revenue grew during the quarter due to the addition of new representatives. In addition, net same store revenue growth or same store revenue less commission and fees was negative 4.4% compared to same store revenue growth of negative 3.7% due to the payouts at same store firms increasing slightly. Due to the seasonally stronger second half of the year in our retail life operations, which have lower payouts than our other businesses, we continue to expect full year commission and fee percentage to be between 31.5% and 32.5% of revenue. This estimate 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 and faster growth at the broker/dealer. We will provide updates to this estimate throughout the year as appropriate.

Operating expenses, which include the firms and Austin, were up 14.4% year-over-year. As a percentage of revenue, expenses were 34.9% in the quarter, up from 31% a year ago. As Doug mentioned, this is an area of focus. I would like to point out that operating expenses did decline from the first quarter of this year to the second and the year-over-year growth rate in rate in the second quarter was below the first quarter. Management fee percentage decreased in the quarter from 45% to 43.8%, largely as a result of an increased economic ownership percentage in our firms, partially offset by a slight increase in incentive accrual from $2.4 million to $2.6 million. The incentive approval increase was primarily due to the accrual of cash elections at Highland Capital Brokerage, which finished an incentive cycle in the first quarter. The Highland principals elected to receive 75% of the incentive payment in stock, for which NFP pays an additional cash gross up. Highland principals were the last who could elect between 0% and 100% in stock. Going forward, all firms earning incentives will be able to elect between 30% and 50% in stock and we accrue for 30%, so our exposure to cash gross ups for stock collections will be greatly reduced.

Looking toward the remainder of the year, our current estimate for 2008 management fee percentage is 46% to 49%, which is slightly down from the 47% to 50%. As you may recall, the management fee percentage tends to be higher in the latter portion of the year due to seasonally stronger earnings. As a percentage of revenue, management fees were 14.2% in the second quarter versus 17% a year ago. Gross margin was 18.2% of revenue in the second quarter versus 20.7% a year ago and 17.3% in the first quarter.

While Doug discussed our G&A outlook, I want to remind you that the impact of the move in the second half of the year should be one-third of the impact in the first half of the year. Specifically, we will likely have G&A expense of approximately $3.4 million, offset by approximately $1.5 million of other income from the sublet of our old space. These amounts will impact the third and fourth quarters equally. The additional rent was also included in the fourth quarter of 2007, so the impact on G&A growth in the fourth quarter should be even lower.

Impairments during the quarter of $2.8 million were related to one firm. I would like to reiterate that we review all firms on a quarterly basis for impairments. We expand our review for firms that have operated below base for five consecutive quarters or have experienced other significant events, which warrant further review. We compare the carrying value of the firms to their estimated fair value. To estimate fair value, we use a discounted cash flow model. Note that these intangibles have relatively long lives, so a few quarters of performance below base is generally not enough to trigger an impairment.

Moving on to taxes, excluding the impact of the gain on sale in the first quarter, the year-to-date tax rate was 46.7% versus a full-year 2007 tax rate of 46.1%. The increase is a result of 75% of the expected full-year FIN 48 expense occurring in the first half of the year. FIN 48 expenses in the second half are expected to be approximately $300,000 versus $900,000 in the first half. Due to the seasonality of the FIN 48 expense, we continue to target a full-year tax rate of 45% to 45.5%. However, our tax rates during the remainder of the year may be impacted by additional non-deductible expenses, impairments dispositions, and the overall level of taxable income.

I would also like to note that net interest and other was impacted by an approximate $400,000 expense in the quarter and approximately $700,000 expense in the first half of the year related to our portion of the startup expenses for the life settlements joint venture. The impact on second half results could be slightly higher than in the first half. Also, SFAS 141R relating to business combinations and FASB staff position APB 14-1 relating to convertible debt instruments will impact our financials in 2009. We will likely discuss the impact of both of these rules during the third or fourth quarter conference calls.

At this time, operator, we would like to open up the call for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from line of Andrew Kligerman with UBS. Please proceed.

Andrew Kligerman – UBS

Hey good morning.

Jessica Bibliowicz

Good morning, Andrew.

Andrew Kligerman – UBS

Maybe you can give a little more clarity, Doug, around the expenses. You mentioned a firm that – sort of your two firms you said where you are sort of heaviest expense related companies and you "streamlined operations and decreased expenses". Can you get a little more granular on how you save that $3.1 million that you mentioned or plan to save that in 2009, very specifically what do these firms do?

Doug Hammond

Yes. I'm having a little bit of trouble hearing your question, but I think I get the gist of it, Andrew. We are really focused as a matter of priority on several firms that had very high expenses, they're related to different items and we approach each one of the firms differently. But as a general matter, we looked at the operations, looked at the performance, noted that the expenses were extremely high, engaged the partners – the principals in an overall planning review of their business and looked at staffing operations, internal resources, what NFP's resources internally could provide rather than what they had internally and took action with the firm principles. And at the end of the process, I can tell you that the firm principals that were involved welcomed the process and are very engaged with management moving forward to operate more profitably.

Andrew Kligerman – UBS

And is this something that you'll do with all of your firms ultimately, is that the plan?

Doug Hammond

Yes. Our planning process, I mean, there are really several approaches to it. Every one of our firms is unique and not all firms will engage with us in the planning process because they are free into [ph] their agreements not to, but we have seen a very high demand as we roll out this initiative of firms that are lining up in queue and demanding to have the resource first. So, we will obviously allocate our resources internally based on where we think we can have the biggest impact so we're prioritizing what we're doing internally while at the same time rolling out our initiative on a much larger scale to provide the resource ultimately to all the firms.

Andrew Kligerman – UBS

And then, just on the life settlements area, it's amazing to hear that, I guess, the revenues from life settlements were down 40% year over year. Could you talk about the run rate of that? I mean, should we expect that sort of 40% year-over-year decline throughout the balance of the year and into part of next year? When does that sort of level out on a year-over-year basis?

Doug Hammond

Yes, I don't expect to see that level of decline. Obviously, I think that was very significant and it was a weak quarter. I think what we're seeing and we're seeing sort of an analogous situation with the life insurance companies is a much higher level of scrutiny associated with the types of transactions that the investors are gauging in and on the life side that the life underwriters are engaging in, and they're closely scrutinizing the underlying circumstances of the cases and that is slowing the process for many of the investors. And many of the investors that had previously had an appetite for finance business, non-traditionally financed business, no longer have an appetite. And again, the diligence parameters associated with their evaluation of policies for investment has increased considerably.

Andrew Kligerman – UBS

I see. So basically it's more of an environmental situation than say a commission related situation. Because I think in the past NFP has alluded to the fact that – I think you did on this call too – the fact that the commissions are down on a policy by policy basis, right?

Doug Hammond

Yes, we see the same level of margin compression. The margin compression has not gotten worst on the compensation front, that certainly has stabilized. But, I do think in terms of the volume of business, what we're seeing is a bit of a slowdown based on the environment. I also think you need to step back. I think a lot of folks get overemphasized the current market conditions. And when you think about the ultimate size of this market and where it can go and you think about the general sort of stage of very active high volume premium finance transactions in the grand scheme of life insurance in force, it's not significant. And what we're trying to do is look at this as a longer term opportunity and that's why we're positioning ourselves the way that we indicated.

Andrew Kligerman – UBS

Great, thanks a lot.

Jessica Bibliowicz

Thanks Andrew.

Doug Hammond

Thanks.

Operator

Your next question comes from the line of Eric Berg with Lehman Brothers. Please proceed.

Eric Berg – Lehman Brothers

Thanks very much and good morning to everybody. I wanted to build on Andrew's questions about life settlements and the discussion about retail life insurance. I guess I'm looking for more specifics, because candidly even those who follow NFP full time as we do and follow the life insurance business people full-time, this is quite abstract. What's going on at the underwriting level, what's going on at the trust level and all that? So it is abstract and I'm hoping we can move from the abstract to the concrete by getting answers to the following questions. What specifically is it that is giving investors pause to prevent them from buying policies? Why is that happening now? And I guess the same question about sort of a similar question in the retail brokerage area. What specifically is giving underwriters pause causing them to delay or delay the issuance policies to older wealthier people, and why is it happening now? There have been always old people. There have always been rich people. We have this issue about a year (inaudible). What specifically is happening? What specifically is their concern, the underwriters concern and the investor concerns and why is it happening now as this business has been – this business called life settlement has been around for years? Thank you.

Doug Hammond

Frankly, I think that there was an indication by the insurance companies early on which we had indicated a while ago that they were concerned about certain types of premium finance and other structured and life insurance transactions. In my view, what is happening recently is really sort of a progression of the life underwriters' sophistication in addressing these issues. And they are gearing up in a much more effective way internally to evaluate the risks for which they have concern. And I think we have seen that over the past several months more and more than we had seen previously. And I think the issues that they are concerned about are transactions, not just that they can see, but transactions that they may not be aware of because they're structured in a way to bypass their underwriting process. So they're very conservative in their approach, in their evaluation of these policies as they should be, and it is creating a slowdown in the process for our firms. And on the life settlement's side, I see sort of a very similar phenomenon. I think that there is heightened perception of risk among some investors in connection with the premium finance structures and the risks associated with those structures that gives them pause. And they are either discounting the value associated with them or they're not purchasing them at all.

Eric Berg – Lehman Brothers

But, if I could just follow up and then we'll go on to the next questioner, what is the specific fear or concern of the investor in connection with premium finance? What specifically are they concerned might be the outcome of these arrangement for them as investors, what specifically is on their mind worrying them?

Doug Hammond

And I think, in the most abusive cases involving these life insurance transactions, there has been a recent spate of litigation with respect to very aggressive structures and the insurance companies have attempted to rescind some of those transactions. And I think that activity in the marketplace and more awareness of the risks associated with that possible outcome is what's driving the diligence issues.

Jessica Bibliowicz

And just to reiterate a couple of things, I think NFP in its size and scale and distribution views itself as a partner, whether it's on the capacity side on the initiation of life or on investor side on the life settlements. As it relates to our carriers and working with them, we have been extremely diligent and proactive to help determine which kinds of programs they like, which kind of financing they like and make those available to our firms and to really give guidelines that are consistent with what the carriers want in terms of accepting capacities. So I think we're moving ahead there.

On the settlement side, I would just say that I think the work that Doug and folks from the joined venture are doing really are focused on the issues that are in the market and that's why Doug and his comments emphasize the due diligence approach, the provenance of the policies to make sure that there too the investors who are buying the policies are getting exactly the kind of policies that they want to have in their book and I think that why now was part of your question, Eric.

Eric Berg – Lehman Brothers

Yeah.

Jessica Bibliowicz

And I think you are just seeing an incredibly conservative environment. I think that capital being put out on any side has much more scrutiny to it than ever before and I think that the whole financed life insurance area was something that the world has never seen before and it continues to create its backlash.

Doug Hammond

And we talked a bit about our infrastructure build over the past several years. I mean a big part of that infrastructure is in our fixed insurance compliance area and I think because we have such a strong relationship with the life underwriters on compliance and we've been working with them to educate them on the different programs there in the marketplace, I think we'll be in a very good position to address these issues to streamline the underwriting process.

Eric Berg – Lehman Brothers

Thank you.

Jessica Bibliowicz

Thanks, Eric.

Doug Hammond

Thank you.

Operator

Your next question comes from the line of Ed Spehar with Merrill Lynch. Please proceed.

Ed Spehar – Merrill Lynch

Thank you, good morning.

Jessica Bibliowicz

Good morning, Ed.

Ed Spehar – Merrill Lynch

Hi, I have a few questions. First of all could you help me understand how you define life settlements for these six categories? Is this just policies that are being settled or is this policies that are being sold today where there is an expectation that they are going to be settled?

Jessica Bibliowicz

No, it is just our life settlements brokerage is only policies being sold, they are existing policies that are being settled in the marketplace.

Ed Spehar – Merrill Lynch

And what percent of revenue?

Jessica Bibliowicz

It's about somewhere between 5% to 8% of revenue.

Ed Spehar – Merrill Lynch

Okay. And then, another question I had was on the acquisitions side. I think when you do sub-acquisitions where it's less than 25% of the acquiring company's earnings or revenues or whatever that you don’t make an adjustment to the same store calculation, I haven’t done this math, but it seems like you've done more sub-acquisitions recently? Could you talk about what if any type of distortion we might be seeing in the same store numbers because of sub-acquisitions that are less than 25%?

Marc Gordon

Yes, thanks, that's a good question. The way to tell is, I mean, we did one big sub-acquisition which we did at the end of last year which was in the small group area combining with one of our firms in New England and that pushed the threshold and that one went into – when it goes into the excluded category, and to be honest the revenue there is about flat, not much different in the overall trend. In terms of the rest of the sub-acquisitions, what we're talking about is basically really small sub-acquisitions. They don't really move the needle as significant amount, because if they did, it will move them into the excluded category. So we don’t think it had a significant impact one way or the other on the same store. As Doug and Jessica said, when you look at the categories that are driving the same store, the big dollars, the big dollar changes are in the areas that has the biggest declines.

Ed Spehar – Merrill Lynch

Okay, and then just a two quick ones. Marc, can you just – I know you're not going to talk about the specifics of the two coming changes, but in terms of magnitude, could you give us a sense of which one you would anticipate would have a larger impact on earnings in 2009? The convertible or the acquisition related change?

Marc Gordon

Well, the larger impact will clearly be the convertible in the near term because you can figure out a market rate of interest on the $230 million of convertible debt with that portion of the debt – the portion of $230 million that is considered debt versus the acuity component. So, that's not that difficult to decide, it will be slightly above $10 million. The question that we have there is how is everybody affected by this going to treat the noncash charge and will they highlight it in how will you treat the noncash charge.

On the acquisition accounting, there are two issues there. One is kind of minor and that is that you can't capitalize acquisition related expenses anymore. Since we do most of our legal work internally and our due diligence work internally, our external acquisition related expenses are not big, maybe $1 million a year. The bigger issue is that you have to assign a contingent consideration to every deal upfront. In the past, you can do it when the contingency was resolved. So we have to look at some method of saying, okay, if our average deal grew 10% to 15%, then we have to assign that level of contingent consideration to every deal and then adjust it regularly based on both performance of the firm and since this is going to be an acuity component to the in and out payment changes in equity evaluation, and that's going to run through the income statement, and yet we are just going to have to identify that. It’s going to be a change in the volatility of the contingent consideration. But the interest expense, $11 million or so, will be visible next year but it will be non-cash.

Ed Spehar – Merrill Lynch

Okay, and then one final question. That's really helpful. One final question, Marc, when you're talking about the other, the sublet of the office space, you said $1.5 million. Was that per quarter or for the second half of the year?

Marc Gordon

For the quarter.

Ed Spehar – Merrill Lynch

So, that's a quarterly basis number?

Marc Gordon

I'm sorry? Other income. It's the second half, it's $750,000 a quarter. What it does is, I mean, basically we sublet this space. It is approximately the rent we are paying here. So that offsets half of the corporate space and then another piece is in firm operating expenses, which is offset if the firms moved in and gave up other space. So, basically the impact drops substantially on a net-net basis. The impact of the move becomes very, very small on a going-forward basis. And because we had two quarters of the higher expense this year with double rent, the actual expense related to the new occupancy will be lower next year than it is this year.

Ed Spehar – Merrill Lynch

Okay, thank you.

Jessica Bibliowicz

Thank you.

Operator

Your next question comes from line of Jukka Lipponen with KBW. Please proceed.

Jukka Lipponen – KBW

Good morning. First question, Marc, I didn't quite catch, you made a comment about the same store and I think you said something along the lines that same store growth was impacted by higher or increased payouts or did I miss that? Can you sort of go over that again?

Marc Gordon

No, what I've said specifically was that the commission expense at the same store level was slightly higher because same store net revenue fell a little faster than same store gross revenue. But the difference was less than 100 basis points. So, we think that movement right back can happen quarter to quarter and they are not material.

Jukka Lipponen – KBW

My second question is to Doug on the life settlement. You said that you don't expect the same magnitude of reduction in the second half in the revenues. But how does that happen? I mean, do you expect the market conditions to change or did you have a significant drop in the life settlement revenues in the second half of 2007 versus the first half of 2007?

Jessica Bibliowicz

The question is, well, let me just repeat the question you can make, so I have it right. The second part of it was, are your comparables for the second half of the year in settlements easier because it was lower than the second half of last year and why do you expect the decrease to happen?

Doug Hammond

Yes, I guess from what we're hearing and reviewing the business issues with the firms, the investors are actually getting, they're streamlining their parameters relative to the diligence. The fourth quarter of last year was a bit weaker so the comparables are easier, frankly. And on the process, we think that the investors are just getting better with the process. So as they finalize their underwriting process relative to the investment in life insurance policies, we think the closing process should be expedited.

Jukka Lipponen – KBW

And the expense reduction you sited with respect to the three firms, what percentage of their expenses was the reduction?

Jessica Bibliowicz

I don’t know the answer to that, I'll ask (inaudible) we would have to circle around –

Doug Hammond

Yes, we can get the information and get back to you on it.

Jukka Lipponen – KBW

Okay, thank you.

Operator

Your next question comes from the line of John Nadel with Sterne Agee. Please proceed.

John Nadel – Sterne Agee

Hi, good morning. So, I guess trying to beat the life settlements issue further to death. I guess I wanted to get at sort of similar issues that I think Andrew and Jukka were trying to get at, and that is this, maybe to simplify it, if we took the life settlements out of organic in both last year and this year, how much of an improvement from the minus 3.7% would we have seen? And Jessica you said that settlements was between 5% to 8% of revenues. I mean that's a reasonably wide range especially considering that it fell by 40% year over year.

Jessica Bibliowicz

Right.

Marc Gordon

Yes, I think John, I mean we don’t have the numbers for last year in front of us. Remember, we're not talking about all settlements. When we did the segments that Doug spoke about, that was only settlements brokerage, if not settlements activity done at our individual firms, at our retail firms. But at the brokerage level, I can tell you that for the first half of the year, gross same store would be flat.

John Nadel – Sterne Agee

I'm sorry, the gross same store would be – well you had, and so that's taking life settlements brokerage out of the entire first half.

Marc Gordon

For the second quarter. I'm sorry, I don’t have the first half.

John Nadel – Sterne Agee

Okay, that's what confused me, because your first quarter was actually positive.

Marc Gordon

Yes, I'm sorry. I was looking at – I'm looking at second quarter and the second quarter ex the settlements brokerage would be flat.

John Nadel – Sterne Agee

Okay, that's interesting. And then, so Marc, you mentioned also that's just a brokerage piece related to life settlements. And obviously early on, you guys talked about that the retail life, not the wholesale, but the retail life piece of your firms was down sort of high single digits year over year. How much of that would you say is reflective of a lack of production related to future life settlements?

Jessica Bibliowicz

Well, it would be related to current life settlements, right, that would be on settlement.

John Nadel – Sterne Agee

Well, selling a new policy that would ultimately be sold, right?

Doug Hammond

John, we don’t think that it is related to – we think that even on a relative basis.

Jessica Bibliowicz

I think the majority is retail life.

John Nadel – Sterne Agee

The majority is just weakness overall in retail life.

Doug Hammond

Yes.

John Nadel – Sterne Agee

Okay. And then I think this is probably on everybody's mind, it's a little touchy but I'll ask it anyway. Given the performance of the stock and given some of the issues over the last several quarters, especially some of the sort of external attacks, can you ascribe any of that as a meaningful driver of weakness overall in organic growth?

Jessica Bibliowicz

No, I think that it is very fair to say that the firms are unhappy and disappointed in the stock performance, but I think in general, our firms are working hard. They are engaged in their business. They are focused on their clients and they are focused on the right thing. I think it is like any company where you have large equity participations when your stock becomes dislocated from your company. It clearly will be a destruction, but we are doing everything possible and working with the firms to keep them engaged in their business and their current cash flow. And I think that just one of the interesting things of the survey that we referenced in our comments where we really hit a very large number of firms in terms of their business and what they were thinking and their future prospects, and I thought that was incredibly engaging and it really indicated how hard they are working to see their businesses continue to serve their clients. So it is a much more difficult environment to operate on with the stock price where it is, but our firms are engaged in their businesses for the most parts.

Marc Gordon

I think the other thing is John, in answer to your question, I addressed it a bit with the stock collections on the ongoing incentive plans that we saw in the middle of the second quarter.

Jessica Bibliowicz

Right. I mean the Highland taking 75% of the stock collection was I think a very nice growth.

John Nadel – Sterne Agee

And that sort of would have gotten me to my last, it's a good segue to my last question, just specifically how much does that cost in terms of the management fee true up in the second quarter?

Marc Gordon

It's a little over $1 million in total. About $1.2 million in total of all the gross ups for incremental stock collections and the vast majority was related to Highland.

John Nadel – Sterne Agee

Okay. And that's almost entirely or entirely above any accrual you could run, right?

Marc Gordon

Yes. Because the first they have the 0 to 100, we could accrue nothing.

John Nadel – Sterne Agee

That's right okay. Alright, understood, thank you very much.

Operator

Ladies and gentleman, this concludes the call. I would like to now turn the presentation over to Jessica Bibliowicz. Please proceed.

Jessica Bibliowicz

Great, thank you all very much, I hope you have a great day and we appreciate your attention on the call. Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. U.S.ERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!