Brown & Brown, Inc. — FY2012 Form 10-K Summary
Business context and reporting period
Annual report for the fiscal year ended December 31, 2012, filed March 1, 2013. Brown & Brown is a diversified insurance agency, wholesale broker, insurance-program administrator and insurance-services provider. It operates through Retail, National Programs, Wholesale Brokerage and Services divisions, with 218 locations in 37 states and one London office, and had 6,438 full-time-equivalent employees at year-end.
Revenue is derived primarily from commissions paid by insurers and fees paid by customers. The company does not assume underwriting risk. Insurance pricing and customer exposure units began improving during 2012 after several years of declines.
Financial performance and key metrics
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Total revenue | $1,200.0 million | $1,013.5 million | 18.4% |
| Commissions and fees | $1,189.1 million | $1,006.0 million | 18.2% |
| Core commissions and fees | $1,136.3 million | $950.7 million | 19.5% |
| Income before income taxes | $304.8 million | $270.5 million | 12.7% |
| Net income | $184.0 million | $164.0 million | 12.2% |
| Diluted EPS | $1.26 | $1.13 | 11.5% |
| Operating cash flow | $220.3 million | $237.5 million | Down $17.2 million |
| Capital expenditures | $24.0 million | $13.6 million | Up $10.4 million |
| Cash and cash equivalents | $219.8 million | $286.3 million | Down $66.5 million |
| Total debt | $450.1 million | $251.3 million | Up $198.8 million |
| Shareholders’ equity | $1,807.3 million | $1,644.0 million | Up 10.0% |
Calculated margins were approximately 25.4% for income before taxes and 15.3% for net income in 2012, compared with approximately 26.7% and 16.2%, respectively, in 2011. The effective tax rate was 39.6%, versus 39.4% in 2011.
Core organic commissions and fees increased 2.6%, or $24.9 million, marking the first positive internal growth since 2006. Fee revenue represented 21.7% of commissions and fees, compared with 16.4% in 2011. Profit-sharing contingent commissions were $43.7 million and guaranteed supplemental commissions were $9.1 million, together representing $52.8 million of revenue.
Segment performance
| Division | 2012 revenue | Revenue change | Pre-tax income | Internal growth |
|---|---|---|---|---|
| Retail | $644.4 million | 6.1% | $145.2 million | 1.5% |
| National Programs | $252.9 million | 53.8% | $51.5 million | 0.8% |
| Wholesale Brokerage | $183.6 million | 5.4% | $43.4 million | 6.1% |
| Services | $116.7 million | 76.9% | $16.8 million | 8.6% |
National Programs and Services growth was driven predominantly by acquisitions, particularly Arrowhead. Wholesale Brokerage benefited from new business and higher premiums, especially in coastal property. Retail growth was supported by acquisitions, stabilizing exposure units and modestly higher insurance rates.
Material changes versus prior comparable period
- Completed 20 acquisitions in 2012, including the January 9, 2012 acquisition of Arrowhead for a cash purchase price of approximately $395.0 million. Aggregate 2012 acquisition purchase price was $667.6 million, including $483.9 million of cash consideration.
- Acquisitions contributed approximately $171.4 million of the increase in core commissions and fees, before divested business. Acquired operations generated $129.5 million of 2012 revenue and $0.9 million of pre-tax income during the post-acquisition period included in the statements.
- Employee count increased by 881 to 6,438, with 759 of the increase attributable to acquisitions. Employee compensation and benefits rose 19.6% and increased to 50.7% of revenue from 50.2%.
- Interest expense increased 13.9% to $16.1 million because of debt used to finance Arrowhead. Total debt rose to $450.1 million from $251.3 million.
- Goodwill increased to $1.712 billion from $1.323 billion, principally from acquisitions. No goodwill or amortizable-intangible impairment was recorded.
- Dividends declared increased to $0.345 per share from $0.325. The company did not repurchase shares under its announced repurchase plan; 586,138 shares were withheld during the fourth quarter to fund employee tax obligations.
Cash flow, liquidity and debt
Operating activities generated $220.3 million. Investing cash outflows were $435.5 million, principally $425.1 million for acquisitions and $24.0 million for fixed assets. Financing activities provided $148.7 million, including $200.0 million of new long-term debt, partly offset by $49.5 million of dividends and debt-related payments.
The current ratio declined to 1.34 from 1.47. Contractual cash obligations totaled $831.5 million, including $450.1 million of debt, $133.9 million of operating leases, $53.4 million of interest obligations and $146.9 million of maximum future acquisition-contingency payments.
Debt consisted primarily of unsecured senior notes and term loans. Principal maturities include $100.0 million in 2014, $25.0 million in 2015, $225.0 million in 2016 and $100.0 million in 2018 and beyond. Management stated that existing cash, investments and operating cash flow were sufficient for normal liquidity needs through at least the end of 2013. The company was in compliance with debt covenants at December 31, 2012.
Guidance, outlook, commentary and unusual items
- Management expected insurance premium rates and insurable exposure units to continue modestly increasing during 2013, supporting positive internal growth if the trend continued.
- Management characterized 2012 as a transition year from a prolonged soft market and economic weakness to positive organic growth.
- Other income included $4.3 million of gains on sales of books of business, $3.6 million from litigation settlements involving former employees and $2.3 million of other non-recurring gains, rental income and software-service revenue.
- A special one-time producer bonus program increased 2012 compensation expense by approximately $6.8 million. Changes in acquisition earn-out estimates produced a $1.4 million expense in 2012, compared with a $2.2 million benefit in 2011.
- Profit-sharing contingent commissions remain uncertain and generally depend on insurer underwriting results, volume, growth and retention. The company cannot reliably forecast these amounts.
- Quarterly results are subject to seasonality from policy renewals, acquisition timing and receipt of contingent commissions. Fourth-quarter 2012 revenue was $302.8 million and net income was $42.6 million, compared with fourth-quarter 2011 revenue of $244.1 million and net income of $36.5 million.
Principal risks and contingencies
- Revenue depends on insurer premium rates, commission rates, customer exposure units, policy retention and new business, all of which are difficult to predict.
- Acquisition integration, employee retention, earn-out estimates and the ability to realize expected acquisition benefits may materially affect results.
- Goodwill totaled $1.712 billion. A sustained decline in market capitalization, expected cash flows or industry conditions could require a material impairment charge.
- The business is concentrated in ten states that generated $933.2 million, or 78.5%, of 2012 commissions and fees, increasing exposure to regional economic, regulatory and catastrophe risks.
- Potential adverse changes to contingent-commission practices, insurance regulation, litigation, errors-and-omissions claims, insurer credit quality, cybersecurity, information-technology disruptions and healthcare-benefit costs could affect profitability or liquidity.
- Legal accruals for probable and estimable matters were not material at year-end, and management stated that no current legal proceeding was expected to have a material adverse effect; however, future claims and unfavorable resolutions could materially affect results.
- Internal-control audits were unqualified, but management and the auditors excluded certain 2012 acquisitions from the internal-control assessment. Those acquisitions represented 19.0% of total assets, 10.1% of revenue and 10.4% of net income.
Important facts for investors to verify
- Whether positive organic growth persists independently of acquisitions and whether insurance pricing and exposure-unit trends continue in 2013.
- Arrowhead’s operating performance, integration progress and contribution relative to the debt incurred and goodwill recorded.
- Cash conversion, acquisition spending, debt maturities and compliance with financial covenants.
- The sustainability and predictability of contingent commissions and guaranteed supplemental commissions.
- Goodwill valuation assumptions and sensitivity to lower growth, cash flow or market capitalization.
- Exposure to concentrated states, insurer counterparties, litigation, regulatory changes and catastrophe events.
- The effect of higher compensation, amortization, interest expense and other acquisition-related costs on future margins.