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BRO > SEC Filings for BRO > Form 10-Q on 7-Aug-2014All Recent SEC Filings

Show all filings for BROWN & BROWN INC

Form 10-Q for BROWN & BROWN INC


7-Aug-2014

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 DECEMBER 31, 2013, AND THE TWO DISCUSSIONS SHOULD BE READ TOGETHER.

GENERAL

We are a diversified insurance agency, wholesale brokerage, insurance programs and services organization headquartered in Daytona Beach, 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, our focus on net new business growth and acquisitions.

We attempt to foster a strong, decentralized sales culture with a goal of consistent, sustained profitable growth over the long term.

We increased revenues every year from 1993 to 2013, with the exception of 2009, when our revenues dropped 1.0%. Our revenues grew from $95.6 million in 1993 to $1.4 billion in 2013, reflecting a compound annual growth rate of 14.2%. In the same 20-year period, we increased net income from $8.0 million to $217.1 million in 2013, 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 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. The continued declining exposure units during 2010 and 2011 had a greater negative impact on our commissions and fees revenues 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 exposure units subsequently began to gradually increase during the year. With certain limited exceptions, these trends have continued through 2013 and the second quarter of 2014.

For the three and six-month periods ended June 30, 2014, our consolidated internal revenue growth rates were 3.1% and 0.8%, respectively, but excluding the impact of revenues associated with Hurricane Sandy, our consolidated internal growth rates for the three and six month periods ended June 30, 2014 were 3.8% and 3.9% respectively. Additionally, each of our four divisions recorded positive internal revenue growth for each quarter of 2014. In the event that the gradual increases in insurance premium rates and insurable exposure units that occurred in 2013 and in the first half of 2014 continue for the remainder of 2014, we believe we will continue to see positive quarterly internal revenue growth rates for the remaining six months of 2014.


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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 4.4% 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 Condensed Consolidated Statement of Income in the year received. The term "core commissions and fees" excludes profit-sharing contingent commissions and guaranteed supplemental commissions, 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" are reported in this manner in order 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 attributable to (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 are determined for each of our customers. 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.

Beginning a few years ago, five to six national insurance companies replaced their loss-ratio based profit-sharing contingent commission agreements with new guaranteed fixed-base agreements, referred to as "Guaranteed Supplemental Commissions" ("GSCs"). For 2013, only four national insurance companies still used GSCs in lieu of loss-ratio based profit-sharing contingent commissions. 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, 2013, we accrued and earned $8.3 million of GSCs during 2013, most of which were collected in the first quarter of 2014. For the three-month periods ended June 30, 2014 and 2013, we earned $2.1 million and $1.7 million, respectively, from GSCs. For the six-month periods ended June 30, 2014 and 2013, we earned $5.0 million and $3.9 million, respectively, from GSCs.

Fee revenues relate to fees negotiated in lieu of commissions, which are recognized as services are rendered. Fee revenues have historically been 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. However, in conjunction with our July 1, 2013 acquisition of Beecher Carlson, which has a focus on large customers that generally pay us fees directly, the fee revenues in our Retail Division for 2014 have increased by nearly $39.5 million to $53.8 million. Fee revenues, on a consolidated basis, as a percentage of our total commissions and fees, represented 23.1% in 2013, 21.7% in 2012 and 16.4% in 2011.

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 and since that time we have invested in both interest bearing and non-interest-bearing checking accounts. Investment income also includes gains and losses realized from the sale of investments. Other income primarily reflects net gains on sales of customer accounts and fixed assets, but also includes sub-rental income, legal settlements and other miscellaneous income.


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Company Overview - Second Quarter of 2014

We continued the trend that began in the first quarter of 2012, of achieving a quarterly positive growth rate of our core organic commissions and fees in the second quarter of 2014. When the revenues associated with Hurricane Sandy reported by our Colonial Claims business in our Services Division in the second quarter of 2013 are excluded, we produced a positive growth rate of 3.8% for the second quarter of 2014. This accounted for $11.9 million of new core organic commissions and fees.

Additionally, our profit-sharing contingent commissions and GSCs for the three months ended June 30, 2014 decreased by $4.7 million compared to the second quarter of 2013. A material portion of this decrease was related to reporting the contingent revenues within our FIU business in our Programs Division in the first quarter of the current year versus the second quarter of 2013. Other income increased by $1.5 million primarily as a result of gains on book of business sales.

Income before income taxes in the three month period ended June 30, 2014 increased from the second quarter of 2013 by $15.6 million, primarily as a result of new acquisitions and net new business.

Acquisitions

Approximately 38,500 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 2014, we acquired 455 insurance intermediary operations, excluding acquired books of business (customer accounts). In the second quarter of 2014, we acquired a flood insurance carrier with business consisting of flood policies written through the National Flood Insurance Program administered by FEMA. For excess flood insurance policies, all exposure is reinsured with a reinsurance carrier.

A summary of our acquisitions and related adjustments to the purchase price of prior acquisitions for the six months ended June 30, 2014 and 2013 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
2014           5                 1     $     154.8     $ 720.1     $      -      $     0.1      $       407.0     $     13.2     $  1,140.4
2013           2                -      $       6.0     $  14.4     $      -      $    (0.3 )    $         0.9     $      1.8     $     16.8

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, 2013 on file with the Securities and Exchange Commission ("SEC") for details regarding our critical and significant accounting policies.

RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2014 AND 2013

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.


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Financial information relating to our Condensed Consolidated Financial Results for the three and six months ended June 30, 2014 and 2013 is as follows (in thousands, except percentages):

                                            For the three months                           For the six months
                                               ended June 30,                                ended June 30,
                                                                     %                                               %
                                      2014           2013         Change           2014             2013          Change
REVENUES
Core commissions and fees           $ 389,850      $ 314,571         23.9 %     $   717,177      $   621,103         15.5 %
Profit-sharing contingent
commissions                             2,756          7,879        (65.0 )%         34,504           32,918          4.8 %
Guaranteed supplemental
commissions                             2,084          1,700         22.6 %           5,016            3,922         27.9 %
Investment income                         194            239        (18.8 )%            297              425        (30.1 )%
Other income, net                       2,880          1,403        105.3 %           4,364            2,436         79.1 %

Total revenues                        397,764        325,792         22.1 %         761,358          660,804         15.2 %

EXPENSES
Employee compensation and
benefits                              196,397        163,514         20.1 %         380,507          323,012         17.8 %
Non-cash stock-based compensation       5,994          3,623         65.4 %          13,509            7,473         80.8 %
Other operating expenses               60,546         47,397         27.7 %         113,007           93,736         20.6 %
Amortization                           20,623         16,121         27.9 %          38,499           32,282         19.3 %
Depreciation                            5,242          4,263         23.0 %           9,882            8,430         17.2 %
Interest                                7,004          3,997         75.2 %          11,076            7,981         38.8 %
Change in estimated acquisition
earn-out payables                         177            656        (73.0 )%          6,260            2,178          NMF (1)

Total expenses                        295,983        239,571         23.5 %         572,740          475,092         20.6 %

Income before income taxes            101,781         86,221         18.0 %         188,618          185,712          1.6 %

Income taxes                           40,026         34,214         17.0 %          74,448           73,574          1.2 %


NET INCOME                          $  61,755      $  52,007         18.7 %     $   114,170      $   112,138          1.8 %


Net internal growth rate - core
organic commissions and fees              3.1 %          7.4 %                          0.8 %            8.8 %
Employee compensation and
benefits ratio                           49.4 %         50.2 %                         50.0 %           48.9 %
Other operating expenses ratio           15.2 %         14.5 %                         14.8 %           14.2 %

Capital expenditures                $   7,850      $   4,176                    $    12,577      $     7,123
Total assets at June 30, 2014 and
2013                                                                            $ 4,930,472      $ 3,326,320

(1) NMF = Not a meaningful figure

Commissions and Fees

Commissions and fees, including profit-sharing contingent commissions and GSCs, for the second quarter of 2014 increased $70.5 million to $394.7 million, or 21.8%, over the same period in 2013. Profit-sharing contingent commissions and GSCs for the second quarter of 2014 decreased $4.7 million, or 49.5%, over the second quarter of 2013. The net decrease of $4.7 million in the second quarter was due largely to timing of certain profit sharing commissions which were recognized in the first quarter of 2014 as compared to the second quarter of 2013. Core commissions and fees revenue for the second quarter of 2014 increased $75.3 million on a net basis, of which approximately $67.2 million represented core commissions and fees from agencies acquired since the second quarter of 2013. After divested business of $1.7 million, the remaining net increase of $9.8 million represented net new business, which reflects an internal growth rate of 3.1% for core organic commissions and fees. The internal growth rate for core organic commissions and fees after adjusting for Colonial Claims' revenue related to Hurricane Sandy in the second quarter of 2013 was 3.8%.

For the six months ended June 30, 2014 commissions and fees increased $98.8 million to $756.7 million, or 15.0% over the same period in 2013. Profit-sharing contingent commissions and GSCs for the six months ended June 30, 2014 increased $2.7 million, or 7.3%, over the same period in 2013. The net increase of $2.7 million was largely due to activity from acquired businesses. Core commissions and fees revenue for the six months ended June 30, 2014 increased $96.1 million to $717.2 million or 15.5% over the same period in 2013. After net acquired business of $94.7 million and divested business of $ 3.5 million, the remaining increase of $4.9 million represents 0.8% organic growth in core commissions and fees. The internal growth rate for core organic commissions and fees after adjusting for Colonial Claims' revenue related to Hurricane Sandy in 2013 was 3.9% for the six month period ended June 30, 2014.


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Investment Income

Investment income for the three months ended June 30, 2014, was essentially flat from the same period in 2013. Investment income for the six months ended June 30, 2014, decreased $0.1 million, or 30.1%, from the same period in 2013. This decrease is the result of lower average invested balances in 2014, primarily as a result of increased acquisition activity.

Other Income, net

Other income for the three months ended June 30, 2014, reflected income of $2.9 million, compared with $1.4 million in the same period in 2013. Other income for the six months ended June 30, 2014, reflected income of $4.4 million, compared with $2.4 million in the same period in 2013. 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 because doing so is otherwise in the Company's best interest. The $1.5 million increase for the three months ended June 30, 2014 and the $2.0 million increase for the six months ended June 30, 2014 over the comparable periods of 2013 are primarily due to additional book of business sales.

Employee Compensation and Benefits

Employee compensation and benefits expense as a percentage of total revenues decreased to 49.4% for the three months ended June 30, 2014, from 50.2% for the three months ended June 30, 2013. Employee compensation and benefits for the second quarter of 2014 increased, on a net basis, approximately 20.1%, or $32.9 million, over the same period in 2013. However, that net increase included $29.8 million of compensation costs related to new acquisitions. Therefore, employee compensation and benefits expense attributable to those offices that existed in the same three-month period ended June 30, 2014 and 2013 increased by $3.1 million or 1.9%. The employee compensation and benefits expense increases in these offices were primarily related to an increase in staff salaries.

For the six months ended June 30, 2014 employee compensation and benefits expense as a percentage of total revenues was 50.0% as compared to 48.9% in the same period for 2013. The increase of $57.5 million over the same period in 2013 is principally attributable to new team mates from acquisitions. Employee compensation and benefits expense attributable to those offices that existed in the same six-month period ended June 30, 2014 and 2013 (including the new acquisitions that combined with, or "folded into" those offices) increased 3.3% with approximately $1.0 million of costs incurred in the first quarter of 2014 related to the retirement of the previous CFO as well as additional costs incurred in hiring the new CFO.

Non-Cash Stock-Based Compensation

The Company has an employee stock purchase plan, and grants stock options and non-vested stock awards under other equity-based plans to its employees. Compensation expense for all share-based awards is recognized in the financial statements based upon the grant-date fair value of those awards. Non-cash stock-based compensation expense for the three months ended June 30, 2014 increased $2.4 million, or 65.4%, over the same period in 2013. Non-cash stock-based compensation expense for the six months ended June 30, 2014 increased $6.0 million, or 80.8%, over the same period in 2013. These increases were the result of new non-vested stock awards granted on July 1, 2013 and smaller grants that are issued periodically when approved by the Board of Directors, primarily to a broad-based group of producers, profit center leaders, and senior leaders. Non-cash stock-based compensation will fluctuate based upon actual participation within the plans.

Other Operating Expenses

As a percentage of total revenues, other operating expenses represented 15.2% in the second quarter of 2014, an increase over the 14.5% reported in the second quarter of 2013. The adjusted 2014 and 2013 percentages were 14.2% and 14.6% respectively, after disregarding the effect of new acquisitions that were stand-alone offices (including the Beecher Carlson large accounts business whose revenues are cyclical in nature and whose expense base is relatively stable) and the effect of Colonial Claims due to the effects of Hurricane Sandy on the 2013 margins. Other operating expenses for the second quarter of 2014 increased $13.1 million, or 27.7%, over the same period of 2013, of which $13.5 million related to acquisitions that joined us as stand-alone offices since June 2013. Therefore, other operating expenses from those offices that existed in both the three-month periods ended June 30, 2014 and 2013 (including the new acquisitions that "folded into" those offices) decreased by $0.4 million.

Other operating expenses represented 14.8% of total revenues for the six months ended June 30, 2014, an increase from the 14.2% ratio for the six months ended June 30, 2013. Other operating expenses for the six months ended June 30, 2014 increased $19.3 million, or 20.6%, over the same period of 2013, of which $20.3 million related to acquisitions that joined us as stand-alone offices since the second quarter of 2013. Therefore, other operating expenses from those offices that existed in both the six-month periods ended June 30, 2014 and 2013 (including the new acquisitions that "folded into" those offices) decreased by $1.0 million. The other operating expense decreases in these offices were primarily related to lower E&O and insurance costs.


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Amortization

Amortization expense for the second quarter of 2014 increased $4.5 million, or 27.9%, over the second quarter of 2013. Amortization expense for the six months ended June 30, 2014, increased $6.2 million, or 19.3%, over the six months ended June 30, 2013. These increases are due primarily to the amortization of additional intangible assets as the result of recent acquisitions.

Depreciation

Depreciation expense for the second quarter of 2014 increased $1.0 million, or 23.0%, over the second quarter of 2013. Depreciation expense for the six months ended June 30, 2014, increased $1.5 million, or 17.2%, over the six months ended June 30, 2013. These increases are due primarily to the addition of fixed assets as a result of recent acquisitions.

Interest Expense

Interest expense for the second quarter of 2014 increased $3.0 million, or 75.2%, over the second quarter of 2013. Interest expense for the six months ended June 30, 2014 increased $3.1 million, or 38.8%, over the same period in 2013. These increases are due to the increased borrowings in 2014 associated with the establishment of our Credit Facility related to the Wright acquisition which provides increased financial flexibility and a lower effective interest rate.

Change in Estimated Acquisition Earn-out Payables

Accounting Standards Codification ("ASC") Topic 805-Business Combinations is the authoritative guidance requiring an acquirer to recognize 100% of the fair values of acquired assets, including goodwill, and assumed liabilities (with only limited exceptions) upon initially obtaining control of an acquired entity. Additionally, the fair value of contingent consideration arrangements (such as earn-out purchase arrangements) at the acquisition date must be included in the purchase price consideration. As a result, the recorded purchase prices for all acquisitions consummated after January 1, 2009 include an estimation of the fair value of liabilities associated with any potential earn-out provisions. Subsequent changes in these earn-out obligations are required to be recorded in . . .

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