Business Context and Reporting Period
Brown & Brown, Inc. is a diversified insurance intermediary providing retail brokerage, national programs, wholesale brokerage and insurance-related services. This unaudited Form 10-Q covers the three months ended March 31, 2018, compared with March 31, 2017.
The company adopted ASC Topic 606 and related ASC Topic 340 guidance on January 1, 2018 using the modified retrospective method. Accordingly, 2017 amounts were not restated and certain quarterly comparisons are affected by revenue-recognition timing.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total revenue | $501.5 million | $465.1 million | 7.8% |
| Core commissions and fees | $485.7 million | $411.9 million | 17.9% |
| Income before taxes | $118.4 million | $111.0 million | 6.7% |
| Income before tax margin | 23.6% | 23.9% | Down 30 bps |
| Net income | $90.8 million | $70.1 million | 29.6% |
| Diluted earnings per share | $0.32 | $0.25 | 28.0% |
| EBITDAC | $156.7 million | $152.4 million | 2.8% |
| EBITDAC margin | 31.2% | 32.8% | Down 160 bps |
| Operating cash flow | $79.5 million | $90.0 million | Down $10.5 million |
Net income benefited from a lower effective tax rate of 23.3%, compared with 36.8% in the prior-year quarter, primarily reflecting the lower U.S. federal corporate tax rate under the 2017 Tax Cuts and Jobs Act.
Cash and cash equivalents were $558.2 million at March 31, 2018. Including restricted cash, cash and cash equivalents totaled $826.4 million. Total assets were $5.6 billion.
Total debt was $971.5 million, net of unamortized discount and debt issuance costs, down from $976.1 million at December 31, 2017. The company had $380.0 million outstanding under its term loan, no revolving-loan borrowings, and $800.0 million of revolving credit capacity. The company reported compliance with its debt covenants.
Quarterly cash uses included $42.8 million for investing activities, including $33.6 million for acquisitions, and $34.4 million for financing activities. The company paid $20.7 million in dividends and repurchased shares. The declared quarterly dividend was $0.08 per share after giving effect to the two-for-one stock split.
Material Changes Versus the Prior Comparable Period
- Total commissions and fees increased 12.5%, but profit-sharing contingent commissions fell $18.3 million, primarily because ASC 606 changed the timing of recognition.
- Organic revenue growth was 5.7%, compared with 3.5% in the first quarter of 2017. By segment, organic growth was 2.0% for Retail, 12.5% for National Programs, 6.1% for Wholesale Brokerage and 8.3% for Services.
- ASC 606 increased reported first-quarter commissions and fees by $27.4 million versus the prior accounting method and increased reported net income by $11.1 million. The company stated that the full-year impact is not expected to be significant, although quarterly timing will be affected.
- Revenue from the 2018 acquisitions contributed $0.9 million during the quarter. Brown & Brown completed two insurance-intermediary acquisitions and recorded $31.4 million of additional goodwill.
- Other income declined to $0.5 million from $20.3 million because the prior-year period included a $20.0 million legal settlement with AssuredPartners.
- Employee compensation and benefits increased 10.2% and other operating expenses increased 14.0%. Their ratios to revenue rose to 54.0% and 15.2%, respectively.
- Retail, National Programs and Services reported higher pretax income, while Wholesale Brokerage pretax income declined 25.4% to $11.4 million, partly due to lower contingent commissions, higher compensation and increased earn-out expense.
- Retained earnings increased to $2.64 billion, including the $117.5 million cumulative increase recorded upon adoption of the new revenue standard.
Guidance, Outlook, Risks and Unusual Items
Management did not provide formal numerical earnings guidance. It stated that if exposure-unit growth continues and premium-rate changes remain similar to 2017, positive quarterly organic revenue growth is expected for the remainder of 2018.
Management believes cash, investments, operating cash flow and available credit will satisfy normal liquidity needs, including debt maturities, for at least the next twelve months. Contractual cash obligations totaled approximately $1.50 billion, including $980.0 million of scheduled debt payments, $199.6 million of operating lease obligations, $179.1 million of interest obligations and up to $84.2 million of acquisition-related contingent payments.
- Insurance commissions are affected by premium rates, customer exposure units, policy cancellations, renewal terms, catastrophe events and general economic conditions.
- Competition, technological disintermediation, regulatory changes, personnel retention and the integration of acquired businesses could affect results.
- The company remains exposed to legal proceedings and governmental investigations in the ordinary course of business. Management reported no proceeding expected to have a material adverse effect based on current information, but unfavorable developments could affect earnings, cash flow or liquidity.
- Estimated acquisition earn-out payables were $40.6 million at March 31, 2018, with maximum future acquisition contingency payments of $84.2 million. Changes in fair value generated a $2.5 million first-quarter expense.
- Wright Flood remains primarily liable to policyholders despite substantial reinsurance. Reinsurance recoverables were $146.8 million and prepaid reinsurance premiums were $292.2 million at quarter-end.
- The accounting for certain 2017 Tax Reform Act effects remained provisional and may be adjusted within the permitted measurement period.
- The company adopted ASU 2016-15 with no cash-flow statement impact and expects the new lease standard, effective for the company in 2019, to add right-of-use assets and lease liabilities. Undiscounted remaining lease payments were $199.6 million.
The company effected a two-for-one stock split on March 28, 2018. It completed a $75.0 million accelerated share repurchase program and retained authorization to repurchase up to $227.5 million of additional common stock.
Investor Verification Checklist
- Verify the effect of ASC 606 and ASC 340 on quarterly revenue, expenses, contract assets and liabilities, and comparability with 2017.
- Assess whether 5.7% organic revenue growth is sustained after excluding accounting-timing effects, acquisitions and divestitures.
- Monitor contingent commission trends, particularly the timing of recognition and the effect on seasonal cash receipts.
- Review debt maturities, the September 2018 maturity of the $100.0 million Series E notes, floating-rate term-loan exposure and covenant compliance.
- Evaluate acquisition integration, goodwill of $2.75 billion, intangible amortization and the $84.2 million maximum acquisition earn-out exposure.
- Track litigation, reinsurance recoverability and Wright Flood’s regulatory capital and dividend restrictions.
- Confirm the eventual resolution of provisional tax accounting and the balance-sheet impact of adopting the lease standard in 2019.