NATIONAL FINANCIAL PARTNERS CORP – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Consolidated Financial Statements (Unaudited) of the Company and the related notes contained elsewhere in this report. In addition to historical information, this discussion includes forward-looking information that involves risks and assumptions, which could cause actual results to differ materially from management's expectations. See "Forward-Looking Statements" included elsewhere in this report.

NFP's principal and executive offices are located at 340 Madison Avenue, New York, New York, 10173 and the telephone number is (212) 301-4000. On NFP's Web site, www.nfp.com, NFP posts the following filings as soon as reasonably practicable after they are electronically filed or furnished with the SEC: NFP's annual reports on Form 10-K, NFP's quarterly reports on Form 10-Q, NFP's current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All such filings on NFP's Web site are available free of charge. Information on NFP's Web site does not constitute part of this report.

Executive Overview

NFP and its benefits, insurance and wealth management businesses provide a full range of advisory and brokerage services to the Company's clients. NFP serves corporate and high net worth individual clients throughout the United States and in Canada, with a focus on the middle market and entrepreneurs.

Founded in 1998, the Company has grown organically and through acquisitions, operating in the independent distribution channel. This distribution channel offers independent advisors the flexibility to sell products and services from multiple non-affiliated providers to deliver objective, comprehensive solutions. The number of products and services available to independent advisors is large and can lead to a fragmented marketplace. NFP facilitates the efficient sale of products and services in this marketplace by using its scale and market position to contract with leading product providers. These relationships foster access to a broad array of insurance and financial products and services as well as better underwriting support and operational services. In addition, the Company is able to operate effectively in this distribution channel by leveraging financial and intellectual capital, technology solutions, the diversification of product and service offerings, and regulatory compliance support across the Company. The Company's marketing and wholesale organizations also provide an independent distribution channel for benefits, insurance and wealth management products and services, serving both third-party affiliates as well as member NFP businesses.

NFP has organized its businesses into three reportable segments: the Corporate Client Group (the "CCG"), the Individual Client Group (the "ICG") and the Advisor Services Group (the "ASG"). The CCG is one of the leading corporate benefits advisors in the middle market, offering independent solutions for health and welfare, retirement planning, executive benefits, and property and casualty insurance. The ICG is a leader in the delivery of independent life insurance, wealth management annuities, long-term care and wealth transfer solutions for high net worth individuals and includes wholesale life brokerage and retail life services. The ASG, including NFP Securities, Inc. ("NFPSI"), a leading independent broker-dealer and corporate registered investment advisor, serves independent financial advisors whose clients are high net worth individuals and companies by offering broker-dealer and asset management products and services. NFP promotes collaboration among its business lines to provide its clients the advantages of a single coordinated resource to address their corporate and individual benefits, insurance and wealth management planning needs.

NFP enhances its competitive position by offering its clients a broad array of insurance and financial solutions. NFP's continued investments in marketing, compliance and product support provide its independent advisors with the resources to deliver strong client service. NFP believes its operating structure allows its businesses to effectively and objectively serve clients at the local level while having access to the resources of a national company. NFP's senior management team is composed of experienced insurance and financial services leaders. The Company's employees and principals who manage the day-to-day operations of NFP's businesses are professionals who are well positioned to understand client needs.

On April 14, 2013, NFP entered into the Merger Agreement with Parent and Merger Sub, providing for the merger of Merger Sub with and into NFP, with NFP surviving the Merger as a wholly owned subsidiary of Parent. Parent and Merger Sub are beneficially owned by affiliates of Madison Dearborn. See "Note 12-Subsequent Events-Agreement and Plan of Merger" to the Company's Consolidated Financial Statements (Unaudited) contained in this report. In connection with this Merger, the Company has incurred $0.7 million of transaction related costs during the three months ended March 31, 2013.

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  Table of Contents  Reportable Segments  Corporate Client Group

The CCG is one of the leading corporate benefits advisors in the middle market, offering independent solutions for health and welfare, retirement planning, executive benefits and property and casualty insurance. The CCG serves corporate clients by providing advisory and brokerage services related to the planning and administration of benefits plans that take into account the overall business profile and needs of the corporate client. The CCG accounted for approximately 46.6% and 44.1% of NFP's revenue for the three months ended March 31, 2013 and 2012, respectively. The CCG has organized its operations by region in order to facilitate the sharing of resources and investments among its advisors to address clients' needs.

The corporate benefits business line accounted for approximately 79.4% and 77.0% of the CCG's revenue for the three months ended March 31, 2013 and 2012, respectively. Generally, corporate benefits are available to a broad base of employees within an organization and include products and services such as group medical and disability insurance, group life insurance and retirement planning. The corporate benefits business line consists of both retail and wholesale benefits operations. These businesses have access to tools, resources and comprehensive support services which are provided through NFP Benefits Partners. NFP Benefits Partners is a division of NFP Insurance Services, Inc. ("NFPISI"), a licensed insurance agency and an insurance marketing organization owned by NFP.

The executive benefits business line accounted for approximately 9.6% and 13.1% of the CCG's revenue for the three months ended March 31, 2013 and 2012, respectively. Executive benefits products and services provide employers with the ability to establish plans that create or reinstate benefits for highly-compensated employees, typically through non-qualified plans or disability plans. Clients may utilize a corporate-owned life insurance funding strategy to finance future compensation due under these plans. The executive benefits business line consists of NFP businesses and other entities that pay membership fees for membership in one of NFP's marketing and wholesale organizations.

The property and casualty business line accounted for approximately 11.0% and 9.9% of the CCG's revenue for the three months ended March 31, 2013 and 2012, respectively. Property and casualty products and services provide risk management capabilities to businesses and individuals by protecting against property damage, the associated interruption of business and related expenses, or against other damages incurred in the normal course of operations. In addition to managing their own operations, NFP's property and casualty resources are positioned to serve NFP's businesses and members of NFP's marketing and wholesale organizations with commercial, personal and surety line capabilities.

The CCG earns commissions on the sale of insurance policies and fees for the development, implementation and administration of corporate and executive benefits programs and property and casualty products and services. In the corporate benefits business line, commissions and fees are generally paid each year as long as the client continues to use the product and maintains its broker of record relationship. Commissions are based on a percentage of insurance premium or are based on a fee per plan participant. In some cases, such as for the administration of retirement-focused products like 401(k) plans, fees earned are based on the value of assets under administration or advisement. Generally, in the executive benefits business line, consulting fees are earned relative to the completion of specific client engagements, administration fees are earned throughout the year on policies, and commissions are earned as a calculated percentage of the premium in the year that the policy is originated and during subsequent renewal years, as applicable. Through the property and casualty business line, the CCG offers property and casualty insurance brokerage and consulting services for which it earns commissions and fees. These fees are paid each year as long as the client continues to use the product and maintains its broker of record relationship.

NFP believes that the corporate benefits business line and the property and casualty business line provides a relatively consistent source of revenue to NFP because recurring revenue is earned each year a policy or service remains in effect. NFP believes that the CCG has a high rate of client retention. NFP estimates that the majority of revenue from the executive benefits business line is recurring revenue while the remainder is concentrated in the year of sale. Historically, revenue earned by the CCG is weighted towards the fourth quarter.

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Individual Client Group

The ICG is a leader in the delivery of independent life insurance, annuities, long-term care and wealth transfer solutions for high net worth individuals. In evaluating their clients' near-term and long-term financial goals, the ICG's advisors serve wealth accumulation, preservation and transfer needs, including estate planning, business succession, charitable giving and financial advisory services. The ICG accounted for 28.9% and 31.7% of NFP's revenue for the three months ended March 31, 2013 and 2012, respectively. The ICG operates through its marketing organization, PartnersFinancial, and wholesale life brokerage businesses as well as through its retail life and wealth management business lines.

Revenue generated by the marketing organization and wholesale life brokerage and retail life business lines tends to be concentrated in the year that the policy is originated. Historically, revenue earned by the marketing organization and wholesale life brokerage and retail life business lines is weighted towards the fourth quarter as clients finalize tax planning decisions at year-end. Long-term wealth management strategies continue to evolve, although some certainty was achieved with the passage of the American Taxpayer Relief Act of 2012, which established an estate tax rate of 40% with an exclusion of $5 million, to be adjusted annually for inflation. Revenue generated by the ICG's wealth management business line is generally recurring given high client retention rates and is influenced by the performance of the financial markets and the economy, as well as asset allocation decisions, if fees are based on assets under management.

The marketing organization and wholesale life brokerage business line accounted for approximately 51.6% and 52.1% of the ICG's revenue for the three months ended March 31, 2013 and 2012, respectively. Annual fees are paid for membership in PartnersFinancial, which develops relationships and contracts with selected preferred insurance carriers, earning override commissions when those contracts are used. The ICG is supported by shared service technology investments, a product management department, an advanced case design team, underwriting advocacy specialists, training and marketing services. The Company's wholesale life brokerage businesses operate through a brokerage general agency model that provides brokers, typically either independent life insurance advisors or institutions, support as needed. The independent life insurance advisors or institutions then distribute life insurance products and services directly to individual clients. The support provided by the wholesale life brokerage businesses may include underwriting, marketing, point of sale, case management, advanced case design, compliance or technical support.

The ICG's retail life business line accounted for 25.9% and 27.3% of the ICG's revenue for the three months ended March 31, 2013 and 2012, respectively. The retail life business line provides individual clients with life insurance products and services and consists of NFP-owned businesses.

The ICG's wealth management business line accounted for 22.5% and 20.6% of the ICG's revenue for the three months ended March 31, 2013 and 2012, respectively. The ICG's wealth management business line provides retail financial services to individual clients. This business line consists of NFP-owned businesses.

The ICG's clients are generally high net worth individuals who the ICG accesses both directly through its retail life and wealth management business lines and indirectly through its marketing organization and wholesale life brokerage business line.

Commissions paid by insurance companies are based on a percentage of the premium that the insurance company charges to the policyholder. In the marketing organization and wholesale life brokerage business line, the ICG generally receives commissions paid by the insurance carrier for facilitating the placement of the product. Wholesale life brokerage revenue also includes amounts received by NFP's life brokerage entities, which assist advisors with the placement and sale of life insurance. In the retail life business line, commissions are generally calculated as a percentage of premiums, generally paid in the first year. The ICG receives renewal commissions for a period following the first year. The ICG's wealth management business line earns fees for offering financial advisory and related services. These fees are generally based on a percentage of assets under management and are paid quarterly. In addition, the ICG may earn commissions related to the sale of securities and certain investment-related insurance products.

Most of the advisors within the wealth management business line of the ICG conduct securities or wealth management business through NFPSI. Like the other business lines in the ICG, the wealth management business line generally targets high net worth individuals as clients. In contrast, the ASG's primary clients are independent investment advisors, who in turn serve high net worth individuals and companies. The ICG's wealth management business line is composed of NFP businesses. In contrast, the ASG serves independent financial advisors associated with both NFP and other businesses. When independent financial advisors associated with NFP businesses place business through NFPSI, NFPSI receives a commission and the independent financial advisor associated with the NFP business receives the remaining commission. When independent financial advisors associated with non-owned businesses place business through NFPSI, NFPSI receives a commission and the independent financial advisor associated with the other business receives the remaining commission. See also "-Advisor Services Group."

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Advisor Services Group

The ASG serves independent financial advisors whose clients are high net worth individuals and companies by offering broker-dealer and asset management products and services through NFPSI, NFP's corporate registered investment advisor and independent broker-dealer. The ASG attracts financial advisors seeking to provide clients with sophisticated resources and an open choice of products. The ASG accounted for 24.5% and 24.2% of NFP's revenue for the three months ended March 31, 2013 and 2012, respectively.

The ASG accesses high net worth individuals through retail investment and insurance planners, corporate benefits advisors who distribute qualified plans or COLI/BOLI and wholesale life insurance advisors who utilize the ASG's capabilities. The ASG derives a significant portion of revenue from members of NFP's marketing and wholesale organizations.

The ASG earns fees for providing the platform for financial advisors to offer financial advice and execute financial planning strategies. These fees are based on a percentage of assets under management and are generally paid quarterly. The ASG may also earn fees for the development of a financial plan or annual fees for advising clients on asset allocation. The ASG also earns commissions related to the sale of securities and certain investment-related insurance products. Such commission income and related expenses are recorded on a trade date basis. Transaction-based fees, including incentive fees, are recognized when all contractual obligations have been satisfied. Most NFP businesses and members of NFP's marketing and wholesale organizations conduct securities or investment advisory business through NFPSI.

Independent broker-dealers/corporate registered investment advisors, such as NFPSI, tend to offer extensive product and financial planning services and heavily emphasize investment advisory platforms and packaged products and services such as mutual funds, variable annuities and wrap fee programs. NFP believes that broker-dealers serving the independent channel tend to be more responsive to the product and service requirements of their registered representatives than wire houses or regional brokerage firms. Advisors using the ASG benefit from a compliance program in place at NFPSI, as broker-dealers are subject to regulations which cover all aspects of the securities business.

Revenue generated by the ASG based on assets under management and the volume of securities transactions is influenced by the performance of the financial markets and the economy.

Acquisitions

In executing on its acquisition strategy, NFP focuses on businesses that provide high levels of recurring revenue and strategically complement its existing businesses. Businesses that supplement the Company's geographic reach and improve product capabilities across business lines are of particular interest to NFP.

NFP historically utilized an acquisition model in which at the time of acquisition, the business, the principals (former owners), the Management Company and NFP entered into a management contract. Acquisition price was generally determined by first establishing a business's earnings before owners' compensation ("EBOC"). For purposes of determining the earnings split with the principals described below, the business's EBOC is also referred to as "target earnings." NFP would then capitalize a portion of the business's target earnings, referred to as "base earnings," and maintain a priority earnings position in base earnings on a yearly basis. The principals have a right to receive, in the form of fees to principals, the earnings of the business in excess of base earnings and up to target earnings. Earnings in excess of target earnings are typically shared between NFP and the principals in the same ratio as base earnings to target earnings. Additional earn-outs may be paid to the former owners of the business upon the satisfaction of certain compounded growth rate thresholds following the closing of the acquisition. The principals are subject to certain non-competition and non-solicitation covenants during the term of the management contract and for a period thereafter. Regarding this type of acquisition model, NFP has concluded and disclosed that it maintains the power criterion since the Company directs the activities that impact the underlying economics of the business (see "Note 2-Variable Interest Entities" in the 2012 10-K).

More recently, in acquiring businesses and transitioning away from a Management Company structure, NFP has completed acquisition transactions where the former owners of the acquired business become employees of the Company. In these transactions, NFP acquires all cash flows of the underlying business instead of acquiring a percentage of EBOC. The former owners of the acquired business are typically party to employment contracts, and are subject to certain non-competition and non-solicitation covenants during the term of the employment contract and for a period thereafter. Incentive compensation is also a component of the employment contract.

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Management contract buyouts are contemplated typically for businesses demonstrating higher levels of recurring revenue and consistent profitable performance. In management contract buyouts, NFP either purchases the Management Company or purchases a principal's economic interest in the management contract. In either scenario, NFP acquires a greater economic interest in the cash flows of the underlying business than it had prior to the management contract buyout. The principals who enter into the management contract buyouts with NFP generally become employees who are party to employment contracts, and are subject to certain non-competition and non-solicitation covenants during the term of the employment contract and for a period thereafter. Incentive compensation is also a component of the employment contract. Management contract buyouts result in an expense to NFP.

Role of NFP Common Stock in Acquisitions

While consideration for management contract buyouts and all acquisitions in 2011 and 2012 was paid in cash, NFP had historically required principals to receive a minimum portion of the acquisition price (typically at least 30%) in the form of NFP common stock. In transactions involving institutional sellers, the purchase price typically consisted of all cash. In recent acquisition transactions, the Company has required employees or principals to purchase shares of NFP common stock on the open market by the end of a certain period of time (the "Purchased Shares"). The Purchased Shares are subject to liquidity restrictions similar to those set forth in NFP's amended and restated stockholders agreement and lock-up agreement.

Restructures

In the course of NFP's operating history, certain businesses have required a change in the economic relationship between NFP and the principals. These restructures generally result in either temporary or permanent reductions in base and target earnings and/or changes in the ratio of base to target earnings. Restructures frequently involve business concessions by principals, such as the relinquishment of operational control. Several businesses in the ICG, particularly in the retail life business line, have been restructured such that NFP has a right to a lower amount of target earnings and a lower priority interest in such business's earnings. In some instances, NFP and the business essentially have a revenue sharing agreement regardless of the level of the business's earnings. NFP may restructure transactions in the future as the need arises.

Disposals

At times, NFP may dispose of businesses, certain divisions within a business or assets for one or more of the following reasons: non-performance, changes resulting in businesses no longer being part of the Company's core business, change in competitive environment, regulatory changes, the cultural incompatibility of a specific management team with the Company, change of business interests of a principal or other issues personal to a principal. In certain instances, NFP may sell the businesses back to the principal or principals. Principals generally buy back businesses by surrendering all of their NFP common stock and paying cash and/or issuing NFP a note. NFP may dispose of businesses in the future as it deems appropriate.

Regulation

The Company is subject to extensive regulation in the United States, certain United States territories and Canada. Failure to comply with applicable federal or state law or regulatory requirements could result in actions by regulators, potentially leading to fines and penalties, adverse publicity and damage to the Company's reputation. The interpretations of regulations by regulators may change and statutes may be enacted with retroactive impact. In extreme cases, revocation of a subsidiary's authority to do business in one or more jurisdictions could result from failure to comply with regulatory requirements. NFP could also face lawsuits by clients, insureds or other parties for alleged violations of laws and regulations.

The insurance industry continues to be subject to a significant level of scrutiny by various regulatory bodies, including state attorneys general and insurance departments, concerning certain practices within the insurance industry. These practices include, without limitation, conducting stranger-owned life insurance sales in which the policy purchaser may not have a sufficient insurable interest as required by some states' laws or regulations, the receipt of contingent commissions by insurance brokers and agents from insurance companies and the extent to which such compensation has been disclosed, bid rigging and related matters. From time to time, NFP's subsidiaries receive subpoenas and other informational requests from regulatory bodies relating to these or other matters.

Employees

As of March 31, 2013, the Company had approximately 2,950 employees. NFP believes that its relations with the Company's employees are generally satisfactory. None of the Company's employees are represented by a union.

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Results of Operations

The Company earns revenue that consists primarily of commissions and fees earned from the sale of benefits, insurance and wealth management products and services to its clients. The Company also incurs commissions and fees expense and compensation and non-compensation expense in the course of earning revenue. The Company refers to revenue earned by the Company's businesses less the operating expenses of its businesses and allocated shared expenses associated with shared corporate resources as income (loss) from operations. The Company's operating expenses include commissions and fees, compensation expense-employees, fees to principals, non-compensation expense, amortization of intangibles, depreciation, impairment of goodwill and intangible assets, (gain) loss on sale of businesses, net, change in estimated acquisition earn-out payables and management contract buyout.

Information with respect to all sources of revenue, income from operations and Adjusted EBITDA by reportable segment for the three months ended March 31, 2013 and 2012 is presented below (in thousands).

                                                 Three Months Ended                                       March 31, 2013       March 31, 2012             Revenue            Commissions and fees            Corporate Client Group    $        122,628$        112,089            Individual Client Group             76,174               80,593            Advisor Services Group              64,669               61,449             Total                     $        263,471$        254,131             Income from operations            Corporate Client Group    $          7,380     $          6,648            Individual Client Group                774                1,182            Advisor Services Group               2,963                2,175             Total                     $         11,117     $         10,005             Adjusted EBITDA            Corporate Client Group    $         24,988     $         24,531            Individual Client Group              3,743                4,711            Advisor Services Group               3,977                2,882             Total                     $         32,708     $         32,124    Adjusted EBITDA  

The Company reports its financial results in accordance with U.S. GAAP; however, management believes that the evaluation of the Company's ongoing operating results may be enhanced by a presentation of Adjusted EBITDA, which is a non-GAAP financial measure. Adjusted EBITDA is defined as net income excluding income tax expense; interest income; interest expense; gain on early extinguishment of debt; other, net; amortization of intangibles; depreciation; impairment of goodwill and intangible assets; (gain) loss on sale of businesses, net; the accelerated vesting of, or reversal of previously-recognized expenses related to, certain RSUs; any change in estimated acquisition earn-out payables recorded in accordance with purchase accounting that have been subsequently adjusted and recorded in the consolidated statements of income; the expense related to management contract buyouts and minority interest (income) loss.

Management believes that the presentation of Adjusted EBITDA provides useful information to investors because Adjusted EBITDA reflects the underlying performance and profitability of the Company's business by excluding items that generally do not have a current cash impact and are therefore not representative of the Company's current operating performance. Additionally, Adjusted EBITDA excludes certain items that are not necessarily comparable from period to period because they are dependent on the outcome of specific transactions. The Company uses Adjusted EBITDA as a measure of operating performance (on an individual business line, segment and consolidated basis); for planning purposes, including the preparation of budgets and forecasts; as the basis for allocating resources to enhance the performance of the Company; to evaluate the effectiveness of its business strategies; as a factor in shaping the Company's acquisition activity; and as a factor in determining compensation and incentives to employees.

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The Company believes that the use of Adjusted EBITDA provides an additional meaningful method of evaluating certain aspects of the Company's operating performance from period to period on a basis that may not be otherwise apparent under U.S. GAAP when used in addition to, and not in lieu of, U.S. GAAP measures.

A reconciliation of Adjusted EBITDA to its U.S. GAAP counterpart on a consolidated and segment basis for the three months ended March 31, 2013 and March 31, 2012 is provided in the tables below. The reconciliation of Adjusted EBITDA per reportable segment does not include the following items, which are not allocated to any of the Company's reportable segments: income tax expense; interest income; interest expense; gain on early extinguishment of debt and other, net. These items are included in the reconciliation of Adjusted EBITDA to net income on a consolidated basis.