Brown & Brown, Inc. — Q1 2012 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. Operations are reported through Retail, National Programs, Wholesale Brokerage, and Services divisions. This unaudited report covers the three months ended March 31, 2012, compared with the three months ended March 31, 2011.
Financial performance and key metrics
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Total revenues | $302.5 million | $262.2 million | 15.4% |
| Commissions and fees | $296.5 million | $261.5 million | 13.4% |
| Income before income taxes | $82.8 million | $76.7 million | 8.0% |
| Net income | $49.4 million | $46.3 million | 6.8% |
| Diluted EPS | $0.34 | $0.32 | 6.3% |
| Operating cash flow | $25.8 million | $51.6 million | Down $25.8 million |
- Net margin was approximately 16.3%, compared with 17.7% in the prior-year quarter; pretax margin was approximately 27.4%, compared with 29.2%.
- Core commissions and fees increased 17.6% to $269.7 million, including $41.5 million from acquisitions without comparable prior-year revenue. Core organic commissions and fees grew 0.9%, versus a 2.4% decline in Q1 2011.
- Profit-sharing contingent commissions and guaranteed supplemental commissions declined by $5.4 million, or 16.7%, to $26.8 million, primarily because of higher loss ratios and changes to certain commission arrangements.
- Other income increased to $5.8 million from $0.6 million, including $2.8 million of gains on customer-account sales and a $2.2 million legal settlement.
- Employee compensation and benefits increased 18.2%; the ratio to revenue rose to 49.5% from 48.3%. Other operating expenses increased 20.3%, and the ratio rose to 14.3% from 13.8%.
- Cash and cash equivalents were $155.7 million at March 31, 2012, compared with $286.3 million at December 31, 2011. The current ratio declined to 1.16 from 1.47.
- Cash used in investing activities was $343.5 million, primarily reflecting $341.8 million of acquisition payments. Capital expenditures were $5.9 million.
- Total debt was $450.6 million, compared with $251.3 million at December 31, 2011. The increase primarily funded the Arrowhead acquisition. Debt consisted predominantly of unsecured senior notes and acquisition-related term loans; no revolving credit borrowings were outstanding at quarter-end.
- Dividends declared increased to $0.085 per share from $0.08; cash dividends paid were $12.2 million.
Material changes versus the prior comparable period
- The January 2012 acquisition of Arrowhead General Insurance Agency Superholding Corporation and other intermediary acquisitions added $27.7 million of reported revenue and $0.4 million of pretax income during the quarter. Aggregate 2012 acquisition purchase price was $559.2 million, including $401.2 million of cash payments, $21.4 million of other payables, assumed liabilities, and earn-out obligations.
- Goodwill increased to $1.649 billion from $1.323 billion at year-end 2011, while amortizable intangible assets increased to $581.3 million from $496.2 million.
- National Programs revenue increased 38.7%, but pretax income declined 20.3% because of higher acquisition-related interest expense and lower contingent commissions. Services revenue increased 63.0% and pretax income increased 72.6%. Wholesale Brokerage pretax income increased 14.1%; Retail pretax income increased 8.3%.
- Operating cash flow fell because of working-capital changes, including a $59.0 million increase in restricted cash and investments and other liability movements.
Guidance, outlook, commentary, risks, and unusual items
- Management reported a modest increase in insurance premium rates, particularly for workers’ compensation and coastal property, and stated that middle-market exposure units appeared to stabilize. Management believed positive core organic commissions and fees growth could continue through the remainder of 2012, but no formal revenue or earnings guidance was provided.
- Two of six national insurance companies eliminated guaranteed supplemental commission contracts and returned to loss-ratio-based arrangements, delaying recognition of related contingent commissions until 2013.
- Management estimated the 2012 cost of a special producer production bonus at approximately $6 million to $8 million, with the bonus payable in the first quarter of 2013.
- As of March 31, 2012, maximum future acquisition contingency payments were $136.8 million, including $51.9 million of recorded acquisition earn-out payables. Earn-out valuations use significant management estimates and unobservable inputs.
- Management stated that existing cash, investments, operating cash flow, and available debt facilities should satisfy normal liquidity needs through at least the end of 2012. The company was in compliance with its debt covenants.
- Key risks include insurance premium-rate and exposure-unit volatility, competition, regulatory changes, geographic concentration, policy cancellations, acquisition integration and earn-out estimates, litigation, tax-rate changes, and general economic conditions. Management disclosed no material changes to previously reported risk factors.
- Pending and threatened legal proceedings arise in the ordinary course of business. Management does not expect a material adverse effect on consolidated financial position, but unfavorable resolutions could materially affect results or cash flow in a particular period.
Most important facts for investors to verify
- Whether the improvement in 0.9% core organic growth is sustained without relying on acquisitions.
- The performance and integration of Arrowhead, including acquisition-related earnings, leverage, amortization, and future earn-out payments.
- Whether contingent commissions recover after the decline in Q1 and after the 2012 contract changes.
- Cash conversion and liquidity following the $341.8 million acquisition cash outflow and the increase in debt to $450.6 million.
- The effect of the planned $6 million to $8 million producer bonus, higher compensation ratios, and increased interest expense on full-year margins.
- Progress in premium rates and customer exposure units, particularly in the Retail and Florida-related businesses.