Brown & Brown, Inc. — 2016 Q2 Form 10-Q Summary
Business Context and Reporting Period
Brown & Brown is a diversified insurance intermediary providing retail insurance, national programs, wholesale brokerage, and insurance-related services. The filing covers the three and six months ended June 30, 2016, compared with the corresponding 2015 periods. Financial statements are unaudited and prepared under U.S. GAAP.
Financial Performance and Key Metrics
| Metric | Q2 2016 | Q2 2015 | Change | Six Months 2016 | Six Months 2015 | Change |
|---|---|---|---|---|---|---|
| Total revenues | $446.5 million | $419.4 million | 6.5% | $870.7 million | $823.7 million | 5.7% |
| Commissions and fees | $445.7 million | $417.2 million | 6.8% | $868.0 million | $821.0 million | 5.7% |
| Income before taxes | $109.1 million | $100.9 million | 8.1% | $211.6 million | $194.7 million | 8.7% |
| Net income | $66.3 million | $61.0 million | 8.6% | $128.3 million | $118.0 million | 8.8% |
| Diluted EPS | $0.47 | $0.43 | 9.3% | $0.91 | $0.82 | 11.0% |
| Net margin | 14.8% | 14.5% | 30 bps | 14.7% | 14.3% | 40 bps |
| Pre-tax margin | 24.4% | 24.1% | 30 bps | 24.3% | 23.6% | 70 bps |
Core organic commissions and fees grew 2.6% in the second quarter and 2.0% in the first six months. All four reportable segments recorded positive internal revenue growth for both periods.
- Retail revenue increased 5.3% in Q2 and 5.8% year to date; pre-tax income increased 1.4% and 4.3%, respectively.
- National Programs revenue increased 5.6% in Q2 and 3.6% year to date; pre-tax income increased 61.1% and 54.8%, benefiting from expense management, premium-tax credits, and lower intercompany interest charges.
- Wholesale Brokerage revenue increased 10.6% in Q2 and 7.0% year to date, while pre-tax income was essentially flat due to higher compensation and operating expenses.
- Services revenue increased 8.8% in Q2 and 7.1% year to date; pre-tax income increased 24.7% and 19.1%, aided by weather-related claims activity and operating efficiency.
Cash Flow, Balance Sheet, Debt, and Liquidity
- Cash flow from operations was $190.8 million for the six months ended June 30, 2016, versus $227.4 million in the prior-year period.
- Investing cash use was $120.0 million, including $107.3 million for acquisitions and $8.9 million for capital expenditures.
- Financing cash use was $60.3 million, including $20.6 million of debt repayments, $34.1 million of dividends, and $11.3 million of treasury-stock purchases, partially offset by $11.3 million received from settlement of an accelerated share repurchase program.
- Cash and cash equivalents increased to $453.9 million from $443.4 million at December 31, 2015. Restricted cash and investments were $277.6 million, and short-term investments were $16.1 million.
- Total assets were $5.21 billion, including $2.67 billion of goodwill and $745.4 million of amortizable intangible assets. Shareholders’ equity was $2.25 billion.
- Total debt was $1.13 billion, down from $1.14 billion at December 31, 2015. The company had $508.8 million outstanding under its term loan and no revolving-credit borrowings.
- The company retained up to $800 million of available capacity under its revolving credit facility and stated that cash, investments, operating cash flow, and available credit should meet normal liquidity needs for at least the next twelve months.
- Debt covenants were satisfied as of June 30, 2016. The Wells Fargo $25 million revolver was terminated on March 14, 2016 without fees.
Material Changes, Acquisitions, and Unusual Items
- The company completed five acquisitions during the first six months, including Social Security Advocates for the Disabled and Morstan General Agency. Cash paid for acquisitions was $109.4 million.
- Acquisitions contributed $6.3 million of Q2 revenue and $8.9 million of first-half revenue. Acquisition-related goodwill increased by $78.7 million.
- Estimated acquisition earn-out liabilities totaled $73.5 million at June 30, 2016. The related income-statement charge was $4.1 million in Q2 and $3.2 million year to date, versus $0.4 million and $1.7 million in the comparable periods.
- Profit-sharing contingent commissions and guaranteed supplemental commissions increased by $4.4 million in Q2 and $5.2 million year to date, supporting revenue growth.
- Other income declined because the prior-year periods included a legal settlement and, for the first half, a company-owned life insurance benefit.
- The company repurchased 136,386 shares during Q2 through employee equity-plan share surrenders and tax withholding; no shares were purchased under the public repurchase program during the quarter. Approximately $375 million remained authorized for repurchases at June 30, 2016.
- The company adopted debt-issuance-cost presentation guidance retrospectively, reclassifying $8.3 million from other assets to long-term debt. No material impairment of goodwill was identified in the latest annual assessment.
Guidance, Outlook, Risks, and Contingencies
Management did not provide formal numerical earnings guidance. It stated that, if exposure-unit growth continues and premium-rate changes remain similar to 2015, positive quarterly internal revenue growth is expected during 2016.
- Revenue is sensitive to insurance premium rates, exposure units, customer retention, policy cancellations, competition, economic conditions, and regulatory developments.
- Management highlighted continued reductions in property insurance rates, particularly in catastrophe-prone areas, and the uncertainty of carrier-set premium rates.
- Acquisition execution and integration remain important risks, including elevated valuations caused by consolidation and private-equity participation.
- Pending litigation and regulatory matters arise in the ordinary course. Management believes no current proceedings are materially adverse, but unfavorable developments could affect results, cash flow, and liquidity.
- Wright Flood remains primarily liable to policyholders despite extensive reinsurance. Its statutory capital and surplus was $20.7 million, and ordinary dividends without prior approval were limited to $4.1 million in 2016.
- The company had $1.75 billion of contractual cash obligations, including $1.13 billion of debt, $204.3 million of operating leases, $208.6 million of interest obligations, and $131.6 million of maximum future acquisition contingency payments.
- A 10% hypothetical change in interest rates or foreign-exchange rates was not expected to have a material effect on the financial statements, although the $508.8 million floating-rate term loan remains exposed to LIBOR changes.
- Management concluded that disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Investor Verification Checklist
- Verify whether organic growth, premium-rate trends, and exposure-unit growth support management’s expectation of positive internal revenue growth for the remainder of 2016.
- Assess the sustainability of higher contingent commissions and the extent to which Q2 earnings benefited from unusual premium-tax credits and other non-recurring items.
- Monitor acquisition integration, goodwill and intangible-asset balances, and the $73.5 million earn-out liability for future remeasurement charges.
- Review debt maturities and required payments, including the $25 million senior-note maturity in December 2016 and scheduled term-loan repayments.
- Evaluate cash conversion, since operating cash flow declined despite higher net income, and distinguish fiduciary or restricted premium funds from freely available liquidity.
- Monitor litigation, reinsurance recoverables, Wright Flood statutory capital, and dividend restrictions.