Brown & Brown, Inc. — 2014 Q3 Form 10-Q Summary
Business context and reporting period
Brown & Brown is a diversified insurance agency, wholesale brokerage, insurance programs and services organization focused primarily on property and casualty products. Reported segments are Retail, National Programs, Wholesale Brokerage and Services. The unaudited filing covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods.
The May 2014 acquisition of The Wright Insurance Group added a flood insurance carrier and materially expanded the National Programs segment. Brown & Brown completed six acquisitions during the first nine months of 2014.
Key financial metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Total revenues | $421.4 million, up 17.3% | $1.183 billion, up 15.9% |
| Income before income taxes | $112.7 million, up 18.1% | $301.3 million, up 7.2% |
| Net income | $68.3 million, up 18.3% | $182.5 million, up 7.4% |
| Diluted EPS | $0.47, versus $0.39 | $1.24, versus $1.16 |
| Net income margin | 16.2%, versus 16.1% | 15.4%, versus 16.7% |
| Effective tax rate | 39.4%, versus 39.5% | 39.4%, versus 39.6% |
- Core commissions and fees increased 17.9% in the third quarter and 16.3% for the nine-month period. Internal organic growth was 2.9% and 1.5%, respectively; excluding Hurricane Sandy-related 2013 revenue, nine-month organic growth was 3.5%.
- Third-quarter segment revenue growth was 5.1% in Retail, 49.7% in National Programs, 12.5% in Wholesale Brokerage and 18.2% in Services. Nine-month Services revenue declined 0.2% and pretax income declined 43.1%, primarily because 2013 included Hurricane Sandy-related Colonial Claims revenue.
- Net cash provided by operating activities was $285.4 million for the first nine months, compared with $309.9 million in 2013. Cash used in investing activities was $711.7 million, including $694.8 million for acquisitions. Cash provided by financing activities was $605.5 million.
- Capital expenditures were $20.2 million, compared with $11.5 million in the prior-year period. Cash and cash equivalents totaled $382.1 million at September 30, 2014, versus $203.0 million at December 31, 2013.
- Total debt was $1.198 billion at September 30, 2014, versus $480.0 million at year-end 2013. Debt included $550.0 million outstanding under the new Credit Facility and $500.0 million of 4.200% senior notes due 2024.
- Employee compensation and benefits represented 48.2% of revenue in the third quarter and 49.3% for the nine-month period. Other operating expenses represented 15.4% and 15.0%, respectively, compared with 13.9% and 14.1% in the comparable periods.
Material changes versus the prior comparable period
- Revenue growth was driven primarily by acquisitions, especially Wright, rather than organic expansion. Acquired businesses contributed approximately $53.3 million of third-quarter core commissions and fees growth and $148.0 million of nine-month growth.
- The National Programs segment benefited substantially from Wright, with nine-month revenue increasing $66.4 million and pretax income increasing $4.0 million. Higher amortization, operating costs and allocated interest partially offset the acquisition contribution.
- Interest expense increased 76.5% in the quarter and 51.7% year to date due to acquisition-related borrowings, the new Credit Facility and the 2024 senior notes.
- Amortization increased 23.1% in the quarter and 20.6% year to date, reflecting additional acquired intangible assets. Goodwill increased from $2.006 billion at year-end 2013 to $2.513 billion at September 30, 2014.
- The nine-month increase in pretax income and net income was considerably below revenue growth because of acquisition-related expenses, higher interest, amortization, operating expenses and the absence of 2013 Hurricane Sandy-related Services revenue.
- The company repurchased 2.139 million shares during 2014 through September 30. The quarter included an accelerated share repurchase with an initial delivery of 1.294 million shares; $157.5 million remained available under the repurchase authorization at quarter-end.
Guidance, outlook, risks and unusual items
- Management expected positive quarterly internal revenue growth for the remainder of 2014 if gradual increases in insurable exposure units continued, although insurance rates were expected to moderate downward.
- Management stated that cash, investments, operating cash flow and available credit were sufficient for normal liquidity needs for at least the next twelve months. The filing identifies up to $825.0 million of available revolving credit capacity and $125.0 million of additional notes available under existing arrangements.
- Management reported compliance with debt covenants as of September 30, 2014. Contractual cash obligations totaled $1.872 billion, including $1.200 billion of long-term debt, $272.9 million of interest obligations, $182.4 million of operating leases and maximum future acquisition contingency payments of $150.6 million.
- Acquisition earn-out payables totaled $52.3 million at quarter-end, and changes in estimated earn-outs produced a $6.6 million expense for the nine-month period.
- Wright’s flood insurance carrier cedes substantially all written flood exposure to FEMA or other reinsurers. The company remains legally liable to policyholders, and reinsurance recoverables totaled $23.2 million. WNFIC’s statutory capital and surplus was $9.4 million and its statutory net income was $0.9 million for the period presented.
- Key risks include economic and regulatory changes, insurance premium rates and exposure units, competition, acquisition valuation and integration, personnel retention, policy cancellations, litigation and regulatory proceedings, technology and internal controls, and the company’s ability to forecast liquidity needs through at least the end of 2015.
- Pending legal matters arise in the ordinary course of business. Management did not expect them to have a material adverse effect on financial position, but unfavorable resolutions could materially affect results or cash flows in a particular period.
- The filing reported no material changes to previously disclosed risk factors, no new material legal proceedings, and effective disclosure controls as of September 30, 2014.
Important facts for investors to verify
- Whether Wright and other 2014 acquisitions deliver expected organic growth, margins and integration benefits after acquisition-related amortization and interest costs.
- The sustainability of organic growth, particularly the reported 1.5% nine-month rate and the 3.5% rate excluding Hurricane Sandy-related revenue.
- Debt reduction capacity, covenant headroom, refinancing requirements and the effect of variable-rate borrowings on future interest expense.
- The performance of the Services segment absent significant catastrophe activity and the potential volatility of contingent commissions.
- The adequacy of flood insurance reserves and reinsurance recoverables, including exposure to FEMA, reinsurer credit risk and conflicting state and NFIP requirements.
- Future acquisition earn-out payments, goodwill and intangible-asset impairment risk, and the remaining $157.5 million share-repurchase authorization.