BROWN & BROWN, INC. quarterly report, Q2 FY2018

Brown & Brown, Inc. — Form 10-Q Summary

Reporting period: Three and six months ended June 30, 2018; filed August 7, 2018. The unaudited statements cover a diversified insurance agency, wholesale brokerage, insurance programs and services organization operating through Retail, National Programs, Wholesale Brokerage and Services segments.

Financial Performance and Position

Metric	Three months ended June 30	Six months ended June 30
Total revenues	$473.2 million, up 1.5%	$974.6 million, up 4.6%
Income before income taxes	$100.9 million, down 6.6%	$219.4 million, up 0.2%
Net income	$73.9 million, up 11.8%	$164.8 million, up 21.0%
Diluted earnings per share	$0.26 versus $0.23	$0.58 versus $0.48
Income before-tax margin	21.3% versus 23.2%	22.5% versus 23.5%
EBITDAC margin	29.1% versus 32.3%	30.2% versus 32.5%

Core commissions and fees increased 1.3% in the second quarter and 9.2% year to date. Organic Revenue growth was 5.2% and 5.4%, respectively, on a non-GAAP basis.
Operating cash flow was $277.4 million for the first six months, compared with $270.1 million in the prior-year period.
Investing cash outflow was $150.8 million, including $141.8 million for businesses acquired. Financing cash outflow was $163.5 million, including debt repayments, dividends and share repurchases.
Cash and cash equivalents were $477.9 million at June 30, 2018; cash and restricted cash totaled $787.2 million, compared with $824.1 million at December 31, 2017.
Total assets were $5.70 billion and shareholders’ equity was $2.83 billion at June 30, 2018.
Total debt was $867.0 million, down $109.2 million from year-end 2017. The company had $375.0 million outstanding under its term loan and no revolving-loan borrowings; the revolving facility provides up to $800.0 million of capacity.
The company reported compliance with its debt covenants and believes available cash, investments, operating cash flow and borrowing capacity will satisfy normal liquidity needs for at least the next twelve months.

Material Changes Versus Prior Comparable Period

Revenue recognition: The company adopted ASC Topic 606 and related ASC 340 guidance on January 1, 2018 using the modified retrospective method. Opening retained earnings increased by $117.5 million. The adoption changed the timing of commission, fee, contingent-commission and contract-cost recognition and makes quarterly comparisons less directly comparable.
For the six months, Topic 606 increased base and incentive commission revenue by $14.8 million, reduced profit-sharing contingent commission revenue by $17.0 million and increased fee revenue by $2.4 million compared with the former accounting policies. Reported six-month net income was $1.8 million lower than it would have been under the former policies.
Other income declined to $0.9 million from $21.5 million for the first six months, primarily because the prior-year period included a $20.0 million AssuredPartners legal settlement.
The effective tax rate declined to 26.7% from 38.8% for the quarter and to 24.9% from 37.8% year to date, principally because of the lower U.S. federal corporate tax rate under the 2017 Tax Cuts and Jobs Act.
Brown & Brown completed eight acquisitions during the first six months, paying approximately $150.0 million in cash. Acquisitions added $7.9 million of revenue and $1.0 million of pretax income during the period; goodwill increased by $129.8 million.
Other operating expenses rose 17.4% in the quarter and 15.8% year to date, reflecting technology and consulting investments. Employee compensation as a percentage of revenue also increased.
The company paid the $100.0 million Series E Senior Notes in May 2018 and made scheduled term-loan repayments. It also completed settlement of a $75.0 million accelerated share repurchase program and retained authorization to repurchase up to $227.5 million of common stock.
A two-for-one stock split became effective March 28, 2018; historical share and per-share data were adjusted accordingly.

Outlook, Commentary, Risks and Unusual Items

Management expected positive quarterly Organic Revenue growth for the remainder of 2018 if exposure-unit growth continued and premium-rate changes remained similar to 2017. This is conditional commentary, not formal quantitative guidance.
Management cited net new business, acquisitions, exposure-unit growth and selected commercial auto, employee-benefit and catastrophe-exposed property rate increases as revenue drivers. Workers’ compensation rate reductions remained a headwind in parts of the Retail business.
The National Programs segment benefited from flood-claims processing related to Hurricanes Harvey and Irma and continued investment in a new core commercial program; these investments reduced segment margins.
Key risks include insurance premium-rate and exposure-unit volatility, catastrophic weather, economic and regulatory conditions, competition and technology-driven disintermediation, acquisition integration and valuation, personnel retention, policy cancellations, litigation, tax-law changes, liquidity forecasting and foreign-exchange exposure.
The company remains exposed to reinsurance-counterparty risk through Wright National Flood Insurance Company, although management stated that it remains primarily liable to policyholders and did not identify a substantial current insurer non-performance risk.
Maximum future acquisition contingency payments were $106.1 million, including approximately $52.5 million of recorded earn-out payables. Total contractual cash obligations were $1.40 billion, including debt, leases, interest and acquisition contingencies.
Management stated that no material changes occurred in previously disclosed risk factors and that no pending legal proceeding was expected, based on current information, to have a material adverse effect. Unfavorable litigation outcomes could nevertheless materially affect future results, cash flows or liquidity.
The company is evaluating the lease standard effective for public companies in 2019. Undiscounted remaining operating-lease payments were $191.8 million at June 30, 2018.

Investor Verification Priorities

Reconcile reported revenue, margins and earnings with the effects of ASC 606/ASC 340, particularly the timing of contingent commissions and contract costs.
Assess the sustainability of 5.4% year-to-date Organic Revenue growth after separating acquisitions, divestitures and accounting changes.
Monitor segment margin pressure from technology spending, compensation, the new core commercial program and changes in contingent commissions.
Review acquisition integration, goodwill growth, the $52.5 million recorded earn-out liability and $106.1 million maximum future acquisition contingencies.
Verify debt repayment capacity, floating-rate exposure on the $375.0 million term loan, lease obligations and continued availability under the $800.0 million revolving facility.
Evaluate the provisional tax accounting under the 2017 Tax Reform Act and the potential effect of future adjustments.
Monitor catastrophe, reinsurance, regulatory and litigation developments, particularly those affecting Wright Flood and the company’s concentrated operating states.