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BRO > SEC Filings for BRO > Form 10-Q on 2-Aug-2013All Recent SEC Filings

Show all filings for BROWN & BROWN INC

Form 10-Q for BROWN & BROWN INC


2-Aug-2013

Quarterly Report


ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

THE FOLLOWING DISCUSSION UPDATES THE MD&A CONTAINED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED IN 2012, AND THE TWO DISCUSSIONS SHOULD BE READ TOGETHER.

GENERAL

We are a diversified insurance agency, insurance programs, wholesale brokerage and services organization headquartered in Daytona Beach and Tampa, Florida. As an insurance intermediary, our principal sources of revenue are commissions paid by insurance companies and, to a lesser extent, fees paid directly by customers. Commission revenues generally represent a percentage of the premium paid by an insured and are materially affected by fluctuations in both premium rate levels charged by insurance companies and the insureds' underlying "insurable exposure units," which are units that insurance companies use to measure or express insurance exposed to risk (such as property values, or sales and payroll levels) to determine what premium to charge the insured. Insurance companies establish these premium rates based upon many factors, including reinsurance rates paid by such insurance companies, none of which we control.

The volume of business from new and existing customers, fluctuations in insurable exposure units and changes in general economic and competitive conditions all affect our revenues. For example, level rates of inflation or a general decline in economic activity could limit increases in the values of insurable exposure units. Conversely, the increasing costs of litigation settlements and awards have caused some customers to seek higher levels of insurance coverage. Historically, our revenues have typically grown as a result of, among other things, a concentrated focus on net new business growth and acquisitions.

We attempt to foster a strong, decentralized sales culture with a goal of consistent, sustained growth over the long term. As of July 1, 2013, our senior leadership group included eight executive officers with regional responsibility for oversight of designated operations within the Company, and six regional vice presidents in our Retail Division and one regional vice president in our Wholesale Brokerage Division, each of whom reports directly to one of our executive officers. Among the regional vice presidents in our Retail Division, the Company announced that P. Barrett Brown and Steve Denton had been named regional vice presidents as of July 1, 2013.

We increased revenues every year from 1993 to 2012, with the exception of 2009, when our revenues dropped 1.0%. Our annual revenues grew from $95.6 million in 1993 to $1.2 billion in 2012, reflecting a compound annual growth rate of 14.2%. In the same 19 year period, we increased annual net income from $8.0 million to $184.0 million in 2012, a compound annual growth rate of 17.9%.

The years 2007 through 2011 posed significant challenges for us and for our industry in the form of a prevailing decline in insurance premium rates, commonly referred to as a "soft market" and increased significant governmental involvement in the Florida insurance marketplace which resulted in a substantial loss of revenues for us. Additionally, beginning in the second half of 2008 and continuing throughout 2011, there was a general decline in insurable exposure units as the consequence of the general weakening of the economy in the United States. As a result, from the first quarter of 2007 through the fourth quarter of 2011 we experienced negative internal revenue growth each quarter. Part of the decline in 2007 was the result of the increased governmental involvement in the Florida insurance marketplace, as described below in "The Florida Insurance Overview." In 2010 and 2011, continued declining exposure units had a greater negative impact on our commissions and fees revenue than declining insurance premium rates.

Beginning in the first quarter of 2012, many insurance premium rates began to slightly increase. Additionally, in the second quarter of 2012, the general declines in insurable exposure units started to flatten and these exposures units subsequently began to gradually increase during the year. As a result, we recorded positive internal revenue growth for each quarter of 2012 for each of our four divisions with two exceptions; the first quarter for the Retail Division and the third quarter for the National Programs Division, in which declines of 0.7% and 3.3%, respectively, were experienced. For 2012, our consolidated internal revenue growth rate was 2.6%.

The growth trend has continued into 2013. For the three and six-month periods ended June 30, 2013, our consolidated internal revenue growth rates were 7.4% and 8.8%, respectively. Additionally, each of our four divisions recorded positive internal revenue growth for each quarter in 2013. In the event that the gradual increases in insurance premium rates and insurable exposure units that occurred in 2012 and in the first half of 2013 continue for the remainder of 2013, we expect to see continued positive quarterly internal revenue growth rates for the remaining six months of 2013, excluding the impact relating to our Colonial Claims operation. In the fourth quarter of 2012, Colonial Claims earned claims fees of $7.4 million as a direct result of the significant claims activity from Superstorm Sandy. Absent another major flooding event, we estimate Colonial Claims revenues for each of the 2013 third and fourth quarters to be between $1.5 million and $2.0 million.

We also earn "profit-sharing contingent commissions," which are profit-sharing commissions based primarily on underwriting results, but which may also reflect considerations for volume, growth and/or retention. These commissions are primarily received in the first and second quarters of each year, based on the aforementioned considerations for the prior year(s). Over the last three years, profit-sharing contingent commissions have averaged approximately 4.8% of the previous year's total commissions and fees revenue. Profit-sharing contingent commissions are typically included in our total commissions and fees in the Consolidated Statements of Income in the year received. The term "core commissions and fees" excludes profit-sharing contingent commissions and GSCs (as defined below),


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and therefore represents the revenues earned directly from specific insurance policies sold, and specific fee-based services rendered. In contrast, the term "core organic commissions and fees" is our core commissions and fees less
(i) the core commissions and fees earned for the first twelve months by newly-acquired operations and (ii) divested business (core commissions and fees generated from offices, books of business or niches sold or terminated during the comparable period). Core organic commissions and fees attempts to express the current year's core commissions and fees on a comparable basis with the prior year's core commissions and fees. The resulting net change reflects the aggregate changes from (i) net new and lost accounts, (ii) net changes in our clients' exposure units, and (iii) net changes in insurance premium rates. The net changes in each of these three components can be determined for each of our customers. However, because our agency management accounting systems do not aggregate such data, it is not reportable. Core organic commissions and fees can reflect either "positive" growth with a net increase in revenues, or "negative" growth with a net decrease in revenues.

In recent years, five national insurance companies have replaced the loss-ratio based profit-sharing contingent commission calculation with a guaranteed fixed-base methodology, referred to as "Guaranteed Supplemental Commissions" ("GSCs"). Since GSCs are not subject to the uncertainty of loss ratios, they are accrued throughout the year based on actual premiums written. As of December 31, 2012, we accrued and earned $9.1 million from GSCs during 2012, most of which was collected in the first quarter of 2013. For the three-month periods ended June 30, 2013 and 2012, we earned $1.7 million and $2.3 million, respectively, from GSCs. For the six-month periods ended June 30, 2013 and 2012, we earned $3.9 million and $4.9 million, respectively, from GSCs.

Fee revenues relate to fees negotiated in lieu of commissions, which are recognized as services are rendered. Fee revenues are generated primarily by:
(1) our Services Division, which provides insurance-related services, including third-party claims administration and comprehensive medical utilization management services in both the workers' compensation and all-lines liability arenas, as well as Medicare set-aside services, Social Security disability and Medicare benefits advocacy services, and catastrophe claims adjusting services, and (2) our National Programs and Wholesale Brokerage Divisions, which earn fees primarily for the issuance of insurance policies on behalf of insurance companies. These services are provided over a period of time, typically one year. Fee revenues, as a percentage of our total commissions and fees as of the three months ended June 30, 2013 and 2012 represented 20.7% and 19.1%, respectively. Fee revenues, as a percentage of our total commissions and fees as of the six months ended June 30, 2013 and 2012 represented 26.4% and 18.4%, respectively. Fee revenues, as a percentage of our total commissions and fees, represented 21.7% in 2012, 16.4% in 2011 and 14.6% in 2010.

Historically, investment income has consisted primarily of interest earnings on premiums and advance premiums collected and held in a fiduciary capacity before being remitted to insurance companies. Our policy is to invest available funds in high-quality, short-term fixed income investment securities. As a result of the bank liquidity and solvency issues in the United States in the last quarter of 2008, we moved substantial amounts of our cash into non-interest bearing checking accounts so that they would be fully insured by the Federal Deposit Insurance Corporation ("FDIC") or into money-market investment funds (a portion of which is FDIC insured) of SunTrust and Wells Fargo, two large national banks. Effective January 1, 2013, the FDIC ceased providing insurance guarantees on non-interest bearing checking accounts. Investment income also includes gains and losses realized from the sale of investments.

Florida Insurance Overview

Many states have established "Residual Markets," which are governmental or quasi-governmental insurance facilities that are intended to provide coverage to individuals and/or businesses that cannot buy insurance in the private marketplace, i.e., "insurers of last resort." These facilities can be designed to cover any type of risk or exposure; however, the exposures most commonly subject to such facilities are automobile or high-risk property exposures. Residual Markets can also be referred to as FAIR Plans, Windstorm Pools, Joint Underwriting Associations, or may even be given names styled after the private sector like "Citizens Property Insurance Corporation" ("Citizens") in Florida.

In August 2002, the Florida Legislature created Citizens, to be the "insurer of last resort" in Florida. Initially, Citizens charged insurance rates that were higher than those generally prevailing in the private insurance marketplace. In each of 2004 and 2005, four major hurricanes made landfall in Florida. As a result of the ensuing significant insurance property losses, Florida property insurance rates increased in 2006. To counter the higher property insurance rates, the State of Florida instructed Citizens to significantly reduce its property insurance rates beginning in January 2007. By state law, Citizens guaranteed these rates through January 1, 2010. As a result, Citizens became one of the most, if not the most, competitive risk-bearers for a large percentage of Florida's commercial habitational coastal property exposures, such as condominiums, apartments, and certain assisted living facilities. Additionally, Citizens became the only insurance market for certain homeowner policies throughout Florida. Today, Citizens is one of the largest underwriters of coastal property exposures in Florida.

In 2007, Citizens became the principal direct competitor of the insurance companies that underwrite the condominium program administered by one of our indirect subsidiaries, Florida Intracoastal Underwriters, Limited Company ("FIU"), and the excess and surplus lines insurers represented by wholesale brokers such as Hull & Company, Inc., another of our subsidiaries. Consequently, these operations lost significant amounts of revenue to Citizens. From 2008 through 2012, Citizens' impact was not as dramatic as it


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had been in 2007; FIU's core commissions and fees decreased 19.7% during this four-year period. Citizens continued to be competitive against the excess and surplus lines insurers, and therefore Citizens has negatively affected the revenues of our Florida-based wholesale brokerage operations, such as Hull & Company, Inc. since 2007, although the impact has been decreasing each year.

Citizens' impact on our Florida retail offices was less severe than on our National Programs and Wholesale Brokerage Division operations because our retail offices have the ability to place business with Citizens, although at slightly lower commission rates and with greater difficulty than with other insurance companies.

Effective January 1, 2010, Citizens raised its insurance rates, on average, 10% for properties with values of less than $10 million, and more than 10% for properties with values in excess of $10 million. Citizens raised its insurance rates again in 2011, 2012, and 2013. Our commission revenues from Citizens for 2012, 2011 and 2010 were approximately $6.4 million, $7.8 million, and $8.3 million, respectively. If, as expected, Citizens continues to attempt to reduce its insured exposures, the financial impact of Citizens on our business should continue to be reduced in the second half of 2013.

Company Overview - Second Quarter of 2013

We continued the trend that began in the first quarter of 2012, by achieving a quarterly positive growth rate of our core organic commissions and fees in the second quarter of 2013. This positive growth rate of 7.4% for the second quarter of 2013 accounted for $21.1 million of new core organic commissions and fees, which was generally broad-based across all four Divisions. Of the $21.1 million of new core organic commissions and fees, $7.1 million related to a new automobile aftermarket program in our National Programs Division, and $2.4 million was generated by our Colonial Claims operation in our Services Division as a result of the slowing claims activity related to the 2012 Superstorm Sandy.

Additionally, our profit-sharing contingent commissions and GSCs for the three months ended June 30, 2013 increased by $6.3 million over the second quarter of 2012.

Income before income taxes in the three-month period ended June 30, 2013 increased over the same period in 2012 by 21.2%, or $15.1 million, to $86.2 million, primarily due to net new business.

Acquisitions

Approximately 37,500 independent insurance agencies are estimated to be operating currently in the United States. Part of our continuing business strategy is to attract high-quality insurance intermediaries to join our operations. From 1993 through the second quarter of 2013, we acquired 442 insurance intermediary operations, excluding acquired books of business (customer accounts).

A summary of our acquisitions and related adjustments to the purchase price of prior acquisitions for the six months ended June 30, 2013 and 2012 are as follows (in millions, except for number of acquisitions):

                                        Estimated                                                                  Recorded       Aggregate
         Number of Acquisitions          Annual         Cash         Note          Other         Liabilities       Earn-Out       Purchase
         Asset              Stock       Revenues        Paid        Payable       Payable          Assumed         Payable          Price
2013           2                -      $       6.0     $  14.4     $      -      $    (0.3 )    $         0.9     $      1.8     $      16.8
2012           7                 1     $     123.1     $ 428.6     $     0.1     $    23.6      $       133.9     $     12.9     $     599.1

Critical Accounting Policies

Our Condensed Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We continually evaluate our estimates, which are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. These estimates form the basis for our judgments about the carrying values of our assets and liabilities, which values are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe that of our significant accounting and reporting policies, the more critical policies include our accounting for revenue recognition, business acquisitions and purchase price allocations, intangible asset impairments and reserves for litigation. In particular, the accounting for these areas requires significant judgments to be made by management. Different assumptions in the application of these policies could result in material changes in our consolidated financial position or consolidated results of operations. Refer to Note 1 in the "Notes to Consolidated Financial Statements" in our Annual Report on Form 10-K for the year ended December 31, 2012 on file with the Securities and Exchange Commission ("SEC") for details regarding our critical and significant accounting policies.


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RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2013 AND 2012

The following discussion and analysis regarding results of operations and liquidity and capital resources should be considered in conjunction with the accompanying Condensed Consolidated Financial Statements and related Notes.

Financial information relating to our Condensed Consolidated Financial Results for the three and six months ended June 30, 2013 and 2012, is as follows (in thousands, except percentages):

                                             For the three months                            For the six months
                                                ended June 30,                                 ended June 30,
                                                                      %                                                %
                                       2013           2012         Change            2013             2012          Change
REVENUES
Core commissions and fees            $ 314,571      $ 286,641          9.7 %      $   621,103      $   556,361         11.6 %
Profit-sharing contingent
commissions                              7,879          1,043        655.4 %           32,918           25,264         30.3 %
Guaranteed supplemental
commissions                              1,700          2,258        (24.7 )%           3,922            4,850        (19.1 )%
Investment income                          239            187         27.8 %              425              322         32.0 %
Other income, net                        1,403            787         78.3 %            2,436            6,605        (63.1 )%

Total revenues                         325,792        290,916         12.0 %          660,804          593,402         11.4 %

EXPENSES
Employee compensation and benefits     163,514        150,752          8.5 %          323,012          300,348          7.5 %
Non-cash stock-based compensation        3,623          3,738         (3.1 )%           7,473            7,485         (0.2 )%
Other operating expenses                47,397         42,220         12.3 %           93,736           85,620          9.5 %
Amortization                            16,121         15,881          1.5 %           32,282           31,494          2.5 %
Depreciation                             4,263          3,784         12.7 %            8,430            7,425         13.5 %
Interest                                 3,997          4,000         (0.1 )%           7,981            8,087         (1.3 )%
Change in estimated acquisition
earn-out payables                          656           (604 )        NMF (1)          2,178             (992 )        NMF (1)

Total expenses                         239,571        219,771          9.0 %          475,092          439,467          8.1 %

Income before income taxes              86,221         71,145         21.2 %          185,712          153,935         20.6 %

Income taxes                            34,214         28,674         19.3 %           73,574           62,031         18.6 %


NET INCOME                           $  52,007      $  42,471         22.5 %      $   112,138      $    91,904         22.0 %


Net internal growth rate - core
organic commissions and fees               7.4 %          3.2 %                           8.8 %            2.1 %
Employee compensation and benefits
ratio                                     50.2 %         51.8 %                          48.9 %           50.6 %
Other operating expenses ratio            14.5 %         14.5 %                          14.2 %           14.4 %

Capital expenditures                 $   4,176      $   6,772                     $     7,123      $    12,677
Total assets at June 30, 2013 and
2012                                                                              $ 3,326,320      $ 3,097,291

(1) NMF = Not a meaningful figure

Commissions and Fees

Commissions and fees, including profit-sharing contingent commissions and GSCs, for the second quarter of 2013 increased $34.2 million, or 11.8%, over the same period in 2012. Profit-sharing contingent commissions and GSCs for the second quarter of 2013 increased $6.3 million, or 190.2%, over the second quarter of 2012, to $9.6 million, due primarily to $5.6 million and $0.8 million increases in profit-sharing contingent commissions and GSCs in our National Programs and Wholesale Brokerage Divisions, respectively. Core organic commissions and fees are our core commissions and fees, less (i) the core commissions and fees


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earned for the first twelve months by newly acquired operations and
(ii) divested business (core commissions and fees generated from sold or terminated offices, books of business or niches). Core commissions and fees revenue for the second quarter of 2013 increased $27.9 million on a net basis, of which approximately $8.5 million represented core commissions and fees from agencies acquired since the third quarter of 2012. After divested business of $1.7 million, the remaining net increase of $21.1 million represented net new business, which reflects a 7.4% internal growth rate for core organic commissions and fees.

Commissions and fees, including profit-sharing contingent commissions and GSCs, for the six months ended June 30, 2013 increased $71.5 million, or 12.2%, over the same period in 2012. Profit-sharing contingent commissions and GSCs for the six months ended June 30, 2013 increased $6.7 million or 22.3%, from the first half of 2012, to $36.8 million, due primarily to $3.3 million, $1.8 million, and $1.4 million increase in profit-sharing contingent commissions and GSCs in our Retail, National Program and Wholesales Brokerage Divisions, respectively. Core commissions and fees revenue for the six months ended June 30, 2013 increased $64.7 million on a net basis, of which approximately $20.0 million represented core commissions and fees from agencies acquired since the third quarter of 2012. After divested business of $3.7 million, the remaining net increase of $48.4 million represented net new business, which reflects a 8.8% internal growth rate for core organic commissions and fees.

Investment Income

Investment income for the three months ended June 30, 2013, increased $0.1 million, or 27.8%, from the same period in 2012. Investment income for the six months ended June 30, 2013, increased $0.1 million, or 32.0%, from the same period in 2012. These increases are the result of larger average invested balances in 2013, primarily as a result of lower acquisition activity.

Other Income, net

Other income for the three months ended June 30, 2013, reflected income of $1.4 million, compared with $0.8 million in the same period in 2012. Other income for the six months ended June 30, 2013, reflected income of $2.4 million, compared with $6.6 million in the same period in 2012. Other income consists primarily of gains and losses from the sale and disposition of assets. Although we are not in the business of selling customer accounts, we periodically will sell an office or a book of business (one or more customer accounts) that we believe does not produce reasonable margins or demonstrate a potential for growth, or when doing so is otherwise in the Company's interest. The $0.6 million increase for the three months ended June 30, 2013 over the comparable period of 2012 is primarily due to a sale of a book of business. Of the $4.2 million decrease for the six months ended June 30, 2013 from the comparable period of 2012, $1.3 million represented gains on the sale of books of business in 2012, and $3.1 million related to a legal settlement that we received on the enforcement of non-piracy covenants in our employment agreements.

Employee Compensation and Benefits

Employee compensation and benefits expense as a percentage of total revenues decreased to 50.2% for the three months ended June 30, 2013, from 51.8% for the three months ended June 30, 2012. Employee compensation and benefits for the second quarter of 2013 increased, on a net basis, approximately 8.5%, or $12.8 million, over the same period in 2012. However, that net increase included $1.7 million of new compensation costs related to new acquisitions that were stand-alone offices. Therefore, employee compensation and benefits expense attributable to those offices that existed in the same three-month period ended June 30, 2013 and 2012 (including the new acquisitions that combined with, or "folded into" those offices) increased by $11.0 million. The employee compensation and benefits expense increases in these offices were primarily related to an increase in staff salaries ($5.6 million), an increase in profit center and other incentive bonuses ($2.1 million), an increase in producer salaries due to our hiring of new producer trainees ($1.0 million), an increase in commissioned producer compensation due to increased commissions and fees revenues ($1.6 million), and an increase in related payroll taxes ($1.1 million).

Employee compensation and benefits expense as a percentage of total revenues decreased to 48.9% for the six months ended June 30, 2013, from the 50.6% for the six months ended June 30, 2012. Employee compensation and benefits for the six months ended June 30, 2013 increased, on a net basis, approximately 7.5%, or $22.7 million, over the same period in 2012. However, that net increase included $3.9 million of new compensation costs related to new acquisitions that were stand-alone offices. Therefore, employee compensation and benefits expense attributable to those offices that existed in the same six-month period ended June 30, 2013 and 2012 (including the new acquisitions that combined with, or . . .

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