Brown & Brown, Inc. — Q3 2017 Form 10-Q Summary
Business context and reporting period
Brown & Brown is a diversified insurance intermediary operating through Retail, National Programs, Wholesale Brokerage, and Services segments. The company markets insurance products and provides related brokerage, managing general agency, claims administration, and other services. This unaudited Form 10-Q covers the three and nine months ended September 30, 2017, compared with the corresponding 2016 periods.
Financial performance and key metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Total revenues | $475.6 million | $462.3 million | $1.407 billion | $1.333 billion |
| Income before income taxes | $124.4 million | $117.0 million | $343.4 million | $328.6 million |
| Net income | $75.9 million | $71.5 million | $212.1 million | $199.9 million |
| Diluted EPS | $0.53 | $0.50 | $1.49 | $1.41 |
| Operating cash flow | Not separately provided | Not separately provided | $313.6 million | $319.1 million |
| Total debt | $980.7 million at September 30 | Not directly comparable | $980.7 million at September 30 | $1.074 billion at December 31, 2016 |
- Q3 revenue increased 2.9%, pretax income increased 6.4%, and net income increased 6.3% year over year. For the first nine months, revenue increased 5.6%, pretax income 4.5%, and net income 6.2%.
- Q3 diluted EPS increased 6.0%; nine-month diluted EPS increased 5.7%.
- Approximate net margins were 16.0% in Q3 2017 versus 15.5% in Q3 2016, and 15.1% for the first nine months versus 15.0% in the prior-year period.
- Organic revenue growth, a non-GAAP measure, was 3.4% in Q3 and 2.8% for the first nine months. Q3 organic growth was 2.5% in Retail, 2.9% in National Programs, 6.1% in Wholesale Brokerage, and 4.8% in Services.
- Cash and cash equivalents were $546.5 million, while restricted cash and investments were $276.7 million at September 30, 2017. Cash and cash equivalents inclusive of restricted cash totaled $823.2 million.
- Nine-month cash flow from operations was $313.6 million. Investing activities used $40.5 million, including $26.5 million for acquisitions, and financing activities used $231.1 million, including debt repayments, share repurchases, and dividends.
- Dividends declared were $0.14 per share in Q3 and $0.41 per share for the first nine months, compared with $0.12 and $0.37, respectively, in 2016.
Material changes versus the prior comparable period
- Core commissions and fees increased 4.0% in Q3 and 4.4% for the first nine months. However, profit-sharing contingent commissions and guaranteed supplemental commissions declined by $5.2 million in Q3 and by $1.9 million for the first nine months, primarily reflecting carrier loss experience.
- Nine-month other income increased to $22.0 million from $2.2 million, primarily because of a $20.0 million legal settlement received in March 2017 and recorded in other income.
- Employee compensation and benefits increased 3.5% in Q3 and 6.3% for the first nine months. Compensation ratios rose to 51.7% and 52.3% of revenue, respectively, partly due to salary inflation, higher producer commissions, acquisitions, and a new Retail performance incentive plan.
- Other operating expense increased 6.9% in Q3 and 6.6% for the first nine months, reflecting investments in information technology and consulting, among other factors.
- Debt declined $93.1 million from December 31, 2016, primarily from scheduled and other principal repayments. The June 2017 amended credit agreement extended the $800.0 million revolving facility and $400.0 million term loans to June 2022; no revolving borrowings were outstanding at September 30.
- The company completed six insurance intermediary acquisitions during the first nine months, paying $26.5 million in cash. Acquired businesses contributed $3.2 million of Q3 revenue and $3.6 million of nine-month revenue.
- The company repurchased 1.1 million shares during Q3, including a $50.0 million accelerated share repurchase agreement. Following completion of the transaction, $302.4 million remained available under the repurchase authorization.
- Total assets increased to $7.414 billion from $5.263 billion at December 31, 2016, largely because of the Wright Flood reinsurance balances. Reinsurance recoverable and the corresponding losses and loss adjustment reserve were each $2.160 billion at September 30.
Guidance, outlook, commentary, risks, and unusual items
- Management stated that, if gradual increases in insurable exposure units continue through 2017 and premium rate changes remain similar to 2016, it expects positive quarterly organic revenue growth for the remainder of 2017. No formal earnings guidance was provided.
- Management believes existing cash, investments, operating cash flow, and available credit will satisfy normal liquidity needs, including debt payments, for at least the next twelve months. Contractual cash obligations totaled $1.512 billion, including $990.0 million of long-term debt, $200.3 million of operating leases, and $81.5 million of maximum future acquisition contingency payments.
- Key operating pressures include declining property insurance rates in catastrophe-prone areas, carrier risk-appetite changes, insurance premium and exposure-unit volatility, carrier loss experience affecting contingent commissions, competition, acquisition integration, and personnel retention.
- Wright Flood remains primarily liable to policyholders for ceded policies if reinsurers fail to perform. At September 30, 2017, it had $2.160 billion of reinsurance recoverables and $2.160 billion of related loss reserves. Statutory capital and surplus was $26.7 million, above the $7.5 million required minimum.
- Topic 606 revenue recognition was scheduled to become effective January 1, 2018. The company expected to use the modified retrospective method and did not expect a material full-year impact, although quarterly revenue and expense timing could change.
- The company early adopted the restricted-cash cash-flow presentation standard retrospectively and adopted the employee share-based payment standard prospectively in 2017. The nine-month 2016 operating cash-flow figure was consequently presented as $319.1 million rather than the previously reported $270.6 million.
- Management reported no material changes in previously disclosed risk factors, no material new legal proceedings during the quarter, and effective disclosure controls as of September 30, 2017.
Most important facts for investors to verify
- Whether organic revenue growth remains positive and whether premium-rate pressure, especially in property and catastrophe-exposed business, intensifies.
- The sustainability of contingent commissions, which declined materially in Q3 because of carrier loss experience.
- The effect of the $20.0 million legal settlement on year-over-year earnings comparisons and the absence of similar unusual income in future periods.
- Wright Flood’s reinsurance recoverability, reserve position, statutory capital, and exposure to reinsurer or regulatory developments.
- Debt repayment requirements, including the $100.0 million Series E notes due in 2018 and scheduled term-loan amortization, versus available liquidity and cash generation.
- The impact of Topic 606 and related contract-cost guidance on revenue and expense timing after adoption in 2018.
- Acquisition performance, earn-out obligations, integration results, and the company’s ability to deploy remaining share-repurchase authorization without constraining strategic liquidity.