We have increased revenues every year from 1993 to 2019, with the exception of 2009, when our revenues declined 1.0%. Our revenues grew from $95.6 million in 1993 to $2.4 billion in 2019, reflecting a compound annual growth rate of 13.2%. In the same 26-year period, we increased net income from $8.1 million to $398.5 million in 2019, a compound annual growth rate of 16.2%.
The volume of business from new and existing customers, fluctuations in insurable exposure units, changes in premium rate levels, changes in general economic and competitive conditions, and the occurrence of catastrophic weather events all affect our revenues. For example, level rates of inflation or a general decline in economic activity could limit increases in the values of insurable exposure units. Conversely, increasing costs of litigation settlements and awards could cause some customers to seek higher levels of insurance coverage. Historically, our revenues have typically grown as a result of our focus on net new business growth and acquisitions. We foster a strong, decentralized sales and service culture that leverages the broad capabilities and scale of our organization, with the goal of consistent, sustained growth over the long-term.
The term “Organic Revenue,” a non-GAAP measure, is our core commissions and fees less: (i) the core commissions and fees earned for the first 12 months by newly-acquired operations and (ii) divested business (core commissions and fees generated from offices, books of business or niches sold or terminated during the comparable period), and for the calculation of Organic Revenue growth in 2018 only (iii) the impact of the adoption of Accounting Standards Update No.2014-09, “Revenue from Contracts with Customers (Topic 606)” and Accounting Standards Codification Topic 340 - Other Assets and Deferred Cost (the “New Revenue Standard”) in order to be on a comparable basis with 2017. The term “core commissions and fees” excludes profit-sharing contingent commissions and guaranteed supplemental commissions, and therefore represents the revenues earned directly from specific insurance policies sold, and specific fee-based services rendered. “Organic Revenue” is reported in this manner in order to express the current year’s core commissions and fees on a comparable basis with the prior year’s core commissions and fees. The resulting net change reflects the aggregate changes attributable to: (i) net new and lost accounts, (ii) net changes in our customers’ exposure units, (iii) net changes in insurance premium rates or the commission rate paid to us by our carrier partners, and (iv) the net change in fees paid to us by our customers. Organic Revenue is reported in “Results of Operations” and in “Results of Operations - Segment Information” of this Annual Report on Form 10-K.
We also earn “profit-sharing contingent commissions,” which are commissions based primarily on underwriting results, but which may also reflect considerations for volume, growth and/or retention. These commissions, which are included in our commissions and fees in the Consolidated Statement of Income, are accrued throughout the year based on actual premiums written and are primarily received in the first and second quarters of each year, based upon the aforementioned considerations for the prior year(s). Prior to the adoption of the New Revenue Standard, these commissions were recorded to income when received. As a result of our adoption of the New Revenue Standard these commissions are now accrued based upon the placement of policies during the year and the expected payments to be received. Over the last three years, profit-sharing contingent commissions have averaged approximately 3.0% of commissions and fees revenue.
Fee revenues primarily relate to services other than securing coverage for our customers, as well as fees negotiated in lieu of commissions, and are recognized as performance obligations are satisfied. Fee revenues have historically been generated primarily by: (1) our Services Segment, which provides insurance-related services, including third-party claims administration and comprehensive medical utilization management services in both the workers’ compensation and all-lines liability arenas, as well as Medicare Set-aside services, Social Security disability and Medicare benefits advocacy services, and claims adjusting services; (2) our National Programs and Wholesale Brokerage Segments, which earn fees primarily for the issuance of insurance policies on behalf of insurance companies; and (3) our Retail Segment in our
For the years ended December 31, 2019 and 2018, our commissions and fees growth rate was 18.7% and 8.2%, respectively, and our consolidated Organic Revenue growth rate was 3.6% and 2.4%, respectively. In the event that the gradual increases in insurable exposure units that occurred in the past few years continues through 2020 and premium rate changes are similar with 2019, we believe we will continue to see positive quarterly Organic Revenue growth rates in 2020.
Historically, investment income has consisted primarily of interest earnings on operating cash, and where permitted, on premiums and advance premiums collected and held in a fiduciary capacity before being remitted to insurance companies. Our policy is to invest available funds in high-quality, short-term fixed income investment securities. Investment income also includes gains and losses realized from the sale of investments. Other income primarily reflects legal settlements and other miscellaneous income.
Income before income taxes for the year ended December 31, 2019 increased over 2018 by $63.5 million, primarily as a result of net new business and acquisitions completed since 2018 in addition to leveraging expenses, partially offset by additional interest expense and amortization associated with the acquisitions over the past two years, with the largest being our acquisition of The Hays Group, Inc. and certain of its affiliates (“Hays”).
The majority of our revenue is commissions derived from our performance as agents and brokers, acting on behalf of insurance carriers to sell products to customers that are seeking to transfer risk, and conversely, acting on behalf of those customers in negotiating with insurance carriers seeking to acquire risk in exchange for premiums. In these arrangements our performance obligation is complete upon the effective date of the bound policy, as such, that is when the associated revenue is recognized. Where the Company’s performance obligations have been completed, but the final amount of compensation is unknown due to variable factors, we estimate the amount of such compensation. We recognize subsequent commission adjustments upon our receipt of additional information or final settlement, whichever occurs first.
We have acquired significant intangible assets through acquisitions of businesses. These assets generally consist of purchased customer accounts, non-compete agreements, and the excess of purchase prices over the fair value of identifiable net assets acquired (goodwill). The determination of estimated useful lives and the allocation of purchase price to intangible assets requires significant judgment and affects the amount of future amortization and possible impairment charges.
All of our business combinations initiated after June 30, 2001 have been accounted for using the acquisition method. In connection with these acquisitions, we record the estimated value of the net tangible assets purchased and the value of the identifiable intangible assets purchased, which typically consist of purchased customer accounts and non-compete agreements. Purchased customer accounts include the physical records and files obtained from acquired businesses that contain information about insurance policies, customers and other matters essential to policy renewals of delivery of services. However, they primarily represent the present value of the underlying cash flows expected to be received over the estimated future renewal periods of the insurance policies comprising those purchased customer accounts. The valuation of purchased customer accounts involves significant estimates and assumptions concerning matters such as cancellation frequency, expenses and discount rates. Any change in these assumptions could affect the carrying value of purchased customer accounts. Non-compete agreements are valued based upon their duration and any unique features of the particular agreements. Purchased customer accounts and non-compete agreements are amortized on a straight-line basis over the related estimated lives and contract periods, which range from 3 to 15 years. The excess of the purchase price of an acquisition over the fair value of the identifiable tangible and intangible assets is assigned to goodwill and is not amortized.
We grant non-vested stock awards to our employees, with the related compensation expense recognized in the financial statements over the associated service period based upon the grant-date fair value of those awards. During the performance measurement period, we review the probable outcome of the performance conditions associated with our performance awards and align the expense accruals with the expected performance outcome.
During the first quarter of 2020, the performance conditions for approximately 1.9 million shares of the Company’s common stock granted under the Company’s 2010 SIP were determined by the Compensation Committee to have been satisfied relative to performance-based grants issued in 2015 and 2017. These grants had a performance measurement period that concluded on December 31, 2019. The vesting condition for these grants requires continuous employment for a period of up to seven years from the 2015 grant date and five years from the 2017 grant date in order for the awarded shares to become fully vested and nonforfeitable. As a result of the awarding of these shares, the grantees will be eligible to receive payments of dividends and exercise voting privileges after the awarding date, and the awarded shares will be included as issued and outstanding common stock shares and included in the calculation of basic and diluted net income per share.
The following discussion and analysis regarding results of operations and liquidity and capital resources should be considered in conjunction with the accompanying Consolidated Financial Statements and related Notes. For a comparison of our results of operations and liquidity and capital resources for the years ended December 31, 2018 and 2017, please see Part II, Item 7 of our Annual Report on Form 10-K filed with the SEC on February 26, 2019.
Other income for 2019 was $1.7 million, compared with $1.6 million in 2018. Other income consists primarily of legal settlements and other miscellaneous income.
Employee compensation and benefits expense increased 22.4%, or $239.3 million, in 2019 compared to 2018. This increase included $164.4 million of compensation costs related to stand-alone acquisitions that had no comparable costs in the same period of 2018. Therefore, employee compensation and benefits expense attributable to those offices that existed in the same time periods of 2019 and 2018 increased by $74.8 million or 7.2%. This underlying employee compensation and benefits expense increase was primarily related to (i) an increase in teammates for certain of our higher growth businesses; (ii) an increase in bonus expense driven by the attainment of various revenue and profit targets within our businesses; (ii) increased producer commissions due to higher revenue; (iii) an increase in staff salaries attributable to salary inflation; (iv) the increase in the value of deferred compensation liabilities driven by changes in the market prices of our employees' investment elections, which was substantially offset by other operating expenses; and (v) an increase in non-cash stock-based compensation expense due to the better-than-expected Company performance related to our equity compensation plan and teammate retention. Employee compensation and benefits expense as a percentage of total revenues was 54.7% for 2019 as compared to 53.1% for the year ended December 31, 2018.
Depreciation expense for 2019 increased $0.6 million to $23.4 million, or 2.6% over 2018. The increase was due primarily to the addition of fixed assets resulting from capital projects related to our multi-year technology investment program and other business initiatives, net additions of fixed assets resulting from recent acquisitions, partially offset by fixed assets which became fully depreciated.
Interest expense for 2019 increased $23.1 million to $63.7 million, or 56.9%, over 2018. The increase was due to the debt issued as a result of acquisitions over the past two years, with the largest being our acquisition of Hays, and to a lesser extent a rise in interest rates associated with our outstanding floating rate debt balances.
For the years ended December 31, 2019 and 2018, the fair value of estimated earn-out payables was re-evaluated and decreased by $7.3 million for 2019 and increased by $0.6 million for 2018, which resulted in a credit, net of interest expense accretion, to the Consolidated Statement of Income for 2019 and net charges for 2018.
The reconciliation of income before incomes taxes, included in the Consolidated Statement of Income, to EBITDAC, a non-GAAP measure, and Income Before Income Taxes Margin to EBITDAC Margin, a non-GAAP measure, for the year ended December 31, 2018, is as follows:
The Retail Segment provides a broad range of insurance products and services to commercial, public and quasi-public, professional and individual insured customers, and non-insurance risk-mitigating products through our automobile dealer services (“F&I”) businesses. Approximately 81.7% of the Retail Segment’s commissions and fees revenue is commission based. Because most of our other operating expenses are not correlated to changes in commissions on insurance premiums, a significant portion of any fluctuation in the commissions we receive, net of related producer compensation and cost to fulfill expense deferrals and releases as required by the New Revenue Standard, will result in a similar fluctuation in our income before income taxes, unless we make incremental investments or modifications to the costs in the organization.
Income before income taxes for 2019 increased 2.3%, or $5.0 million, over the same period in 2018, to $222.9 million. The primary factors affecting this increase were: (i) the net increase in revenue as described above, (ii) offset by a 33.3%, or $190.0 million, increase in employee compensation and benefits, due primarily to the year-on-year impact of acquisitions, salary inflation and additional teammates to support revenue growth, (iii) a combined increase in amortization, depreciation and intercompany interest expense of $72.2 million resulting from our acquisition activity in 2019 and 2018; (iv) other operating expenses which increased by $59.2 million, or 35.0%, due to the impact of our multi-year technology investment program and increased professional services to support our customers and acquisitions; (v) an increase in the change in
EBITDAC for 2019 increased 27.6%, or $84.1 million, from the same period in 2018, to $388.7 million. EBITDAC Margin for 2019 decreased to 28.4% from 29.2% in the same period in 2018. The decrease in EBITDAC Margin was primarily driven by: (i) the acquisition of Hays, which had a lower operating margin than the segmental average; partially offset by, (ii) the net increase in revenue excluding Hays; (iii) higher profit-sharing contingent commissions and supplemental commissions; and (iv) an increase in the gain on disposal associated with the sale of certain books of business.
EBITDAC for 2019 increased 9.1%, or $16.1 million, from the same period in 2018, to $191.9 million. EBITDAC Margin for 2019 increased to 37.0% from 35.6% in the same period in 2018. The increase in EBITDAC Margin was related to (i) growth in a number or our programs; and (ii) a non-recurring GSC received from one of our partners in the second quarter of 2019.
EBITDAC for 2019 increased 12.4%, or $11.1 million, from the same period in 2018, to $100.4 million. EBITDAC Margin for 2019 increased to 32.4% from 31.1% in the same period in 2018. The increase in EBITDAC Margin was primarily driven by Organic Revenue growth as described above. This was partially offset by the intercompany technology charges and increased employee compensation and non-cash stock-based compensation costs.
The Services Segment provides insurance-related services, including third-party claims administration and comprehensive medical utilization management services in both the workers’ compensation and all-lines liability arenas. The Services Segment also provides Medicare Set-aside account services, Social Security disability and Medicare benefits advocacy services, and claims adjusting services.
The Company seeks to maintain a conservative balance sheet and liquidity profile. Our capital requirements to operate as an insurance intermediary are low and we have been able to grow and invest in our business principally through cash that has been generated from operations. We have the ability to utilize our revolving credit facility (the “Revolving Credit Facility”), which currently provides access to up to $700.0 million in available cash, and we believe that we have access to additional funds, if needed, through the capital markets to obtain further debt financing under the current market conditions. The Company believes that its existing cash, cash equivalents, short-term investment portfolio and funds generated from operations, together with the funds available under the Revolving Credit Facility, will be sufficient to satisfy our normal liquidity needs, including principal payments on our long-term debt, for at least the next 12 months.
We hold approximately $21.3 million in cash outside of the U.S., which we currently have no plans to repatriate in the near future.
On March 11, 2019, the Company completed the issuance of $350.0 million aggregate principal amount of the Company's 4.500% Senior Notes due 2029. The Senior Notes were given investment grade ratings of BBB-/Baa3 with a stable outlook. The notes are subject to certain covenant restrictions which are customary for credit-rated obligations. At the time of funding, the proceeds were offered at a discount to the notional amount which also excluded an underwriting fee discount. The net proceeds received from the issuance were used to repay a portion of the outstanding balance of $350.0 million on the Revolving Credit Facility, utilized in connection with financing related to our acquisition of Hays, and for other general corporate purposes. As of December 31, 2019, there was an outstanding debt balance of $350.0 million exclusive of the associated discount balance.
On December 21, 2018, the Company borrowed $300.0 million under a term loan credit agreement with Wells Fargo Bank, National Association, as administrative agent, Bank of America, N.A., BMO Harris Bank N.A. and SunTrust Bank as co-syndication agents, and Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, BMO Capital Markets Corp. and SunTrust Robinson Humphrey, Inc. as joint lead arrangers and joint bookrunners (the “Term Loan Credit Agreement”). The Term Loan Credit Agreement provides for an unsecured term loan in the initial amount of $300.0 million, which may, subject to lenders’ discretion, potentially be increased up to an aggregate amount of $450.0 million (the “Term Loan”). The Term Loan is repayable over the five-year term from the effective date of the Term Loan Credit Agreement, which was December 21, 2018. Based on the Company’s net debt leverage ratio or a non-credit enhanced senior unsecured long-term debt rating as determined by Moody’s Investor Service and Standard & Poor’s Rating Service, the current rate of interest on the Term Loan is 1.25% above the adjusted 1-Month London Interbank Offered Rate (“LIBOR”). The Company used $250.0 million of the borrowings to reduce indebtedness under the Revolving Credit Facility.
In August 2018, the FASB issued ASU 2018-15, “Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract,” which provides guidance for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 will take effect for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The impact of ASU 2018-15 is not expected to be material to the Company.
In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230)”: Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force) (“ASU 2016-15”), which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified and applies to all entities, including both business entities and not-for-profit entities that are required to present a statement of cash flows under Topic 230. ASU 2016-15 became effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017 with early adoption permitted. The Company adopted ASU 2016-15 effective January 1, 2018 and has determined there is no impact on the Company’s Statement of Cash Flows. The Company already presented cash paid on contingent consideration in business combination as prescribed by ASU 2016-15 and does not, at this time, engage in the other activities being addressed in this ASU.
The impact of the adoption of Topic 842 on the balance sheet at January 1, 2019 was (in thousands):
For contracts entered into on or after the January 1, 2019, at the inception of a contract the Company assesses whether the contract is, or contains, a lease. This assessment is based on: (1) whether the contract involves the use of a distinct identified asset, (2) whether the Company obtains the right to substantially all the economic benefit from the use of the asset throughout the period, and (3) whether the Company has the right to direct the use of the asset. Leases entered into prior to January 1, 2019 are accounted for under Topic 840 and were not reassessed. For real estate leases that contain both lease and non-lease components, the Company elected to account the lease components together with non-lease components (e.g., common-area maintenance).
For leases at the lease commencement date, a right-of-use asset and a lease liability are recognized. The right-of-use asset represents the right to use the leased asset for the lease term. The right-of-use asset is initially measured at cost, which primarily comprises the initial amount of the lease liability, plus any initial direct costs incurred, less any lease incentives received. The lease liability is initially measured at the present value of the lease payments under the lease. For the Company’s operating leases, the lease payments are discounted using an incremental borrowing rate, which approximates the rate of interest that would be paid on a secured borrowing in an amount equal to the lease payments for the underlying asset under similar terms.
Incremental cost to obtain - The adoption of ASC 340 resulted in the Company deferring certain costs to obtain customer contracts primarily as they relate to commission-based compensation plans in the Retail Segment, in which the Company pays an incremental amount of compensation on new business. These incremental costs are deferred and amortized over a 15-year period, which is consistent with the analysis performed on acquired customer accounts and referenced in Note 5 to the Company’s consolidated financial statements. For incremental costs with an amortization period of less than 12 months, the costs are expensed as incurred. For the year ended December 31, 2018, the Company deferred $13.7 million of incremental cost to obtain customer contracts. The Company expensed $0.5 million of the incremental cost to obtain customer contracts for the year ended December 31, 2018.
The $52.7 million adjustment to other current assets reflects the deferral of certain cost to fulfill contracts. The $12.1 million adjustment to premiums payable to insurance companies reflects the estimated amount payable to outside brokers on unbilled premiums, commissions and fees
Fixed assets, including leasehold improvements, are carried at cost, less accumulated depreciation and amortization. Expenditures for improvements are capitalized, and expenditures for maintenance and repairs are expensed to operations as incurred. Upon sale or retirement, the cost and related accumulated depreciation and amortization are removed from the accounts and the resulting gain or loss, if any, is reflected in other income. Depreciation has been determined using the straight-line method over the estimated useful lives of the related assets, which range from 3 to 15 years. Leasehold improvements are amortized on the straight-line method over the shorter of the useful life of the improvement or the term of the related lease.
The excess of the purchase price of an acquisition over the fair value of the identifiable tangible and amortizable intangible assets is assigned to goodwill. While goodwill is not amortizable, it is subject to assessment at least annually, and more frequently in the presence of certain circumstances, for impairment by application of a fair value-based test. The Company compares the fair value of each reporting unit with its carrying amount to determine if there is potential impairment of goodwill. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the fair value of the goodwill within the reporting unit is less than its carrying value. Fair value is estimated based upon multiples of earnings before interest, income taxes, depreciation, amortization and change in estimated acquisition earn-out payables (“EBITDAC”), or on a discounted cash flow basis. The Company completed its most recent annual assessment as of November 30, 2019 and determined that the fair value of goodwill significantly exceeded the carrying value of such assets. In addition, as of December 31, 2019, there are no accumulated impairment losses.
The carrying value of amortizable intangible assets attributable to each business or asset group comprising the Company is periodically reviewed by management to determine if there are events or changes in circumstances that would indicate that its carrying amount may not be recoverable. Accordingly, if there are any such changes in circumstances during the year, the Company assesses the carrying value of its amortizable intangible assets by considering the estimated future undiscounted cash flows generated by the corresponding business or asset group. Any impairment identified through this assessment may require that the carrying value of related amortizable intangible assets be adjusted. There were no impairments recorded for the years ended December 31, 2019, 2018 and 2017.
The following is a reconciliation between basic and diluted weighted average shares outstanding for the years ended December 31:
Balances due from reinsurers on unpaid losses and loss adjustment expenses, including an estimate of such recoverables related to reserves for incurred but not reported (“IBNR”) losses, are reported as assets and are included in reinsurance recoverable even though amounts due on unpaid loss and loss adjustment expense are not recoverable from the reinsurer until such losses are paid. The Company does not believe it is exposed to any material credit risk through its reinsurance as the reinsurer is FEMA for basic admitted flood policies and national reinsurance carriers for private flood policies, which has an AM Best Company rating of “A” or better. Historically, no amounts due from reinsurance carriers have been written off as uncollectible.
Fee revenues relate to fees for services other than securing coverage for our customers, fees negotiated in lieu of commissions, and automotive finance and insurance products (“F&I”).
The balances of contract assets and contract liabilities arising from contracts with customers as of December 31, 2019 and 2018 were as follows:
During the twelve months ended December 31, 2019 and 2018, the amount of revenue recognized related to performance obligations satisfied in a previous period, inclusive of changes due to estimates, was approximately $17.2 million and $8.9 million, respectively.
Cost to fulfill - The Company defers certain costs to fulfill contracts and recognizes these costs as the associated performance obligations are fulfilled. The cost to fulfill balance within the other current assets caption in the Company's Condensed Consolidated Balance Sheets was $73.3 million and $69.8 million as of December 31, 2019 and December 31, 2018, respectively. For the 12 months ended December 31, 2019, the Company had a net deferral of $1.0 million related to current year deferrals for costs incurred that relate to performance obligations yet to be fulfilled, net of the expense of previously deferred contract fulfillment costs associated with performance obligations that were satisfied in the period.
For the acquisitions completed during 2019, the results of operations since the acquisition dates have been combined with those of the Company. The total revenues from the acquisitions completed through December 31, 2019 included in the Consolidated Statement of Income for the year ended December 31, 2019 were $49.1 million. The income before income taxes, including the intercompany cost of capital charge, from the acquisitions completed through December 31, 2019 included in the Consolidated Statement of Income for the year ended December 31, 2019 was $3.4 million, excluding one acquisition from the third quarter of 2019 which recognizes primarily all of its revenues in the first quarter of each year. If the acquisitions had occurred as of the beginning of the respective periods, the Company’s results of operations would be as shown in the following table. These unaudited pro forma results are not necessarily indicative of the actual results of operations that would have occurred had the acquisitions actually been made at the beginning of the respective periods.
Goodwill of $717.7 million, which is net of any opening balance sheet adjustments within the allowable measurement period, was allocated to the Retail, National Programs, Wholesale Brokerage and Services Segments in the amounts of $676.9 million, $18.7 million, $5.5 million and $16.5 million, respectively. Of the total goodwill of $717.7 million, the amount currently deductible for income tax purposes is $640.3 million and the remaining $77.4 million relates to the recorded earn-out payables and will not be deductible until it is earned and paid.
For the year ended December 31, 2017, several adjustments were made within the permitted measurement period that resulted in a decrease in the aggregate purchase price of the affected acquisitions of $1.5 million, relating to the assumption of certain liabilities.
As of December 31, 2019, the maximum future contingency payments related to all acquisitions totaled $328.7 million, all of which relates to acquisitions consummated subsequent to January 1, 2009.
As of December 31, 2019, the fair values of the estimated acquisition earn-out payables were re-evaluated and measured at fair value on a recurring basis using unobservable inputs (Level 3) as defined in ASC 820-Fair Value Measurement. The resulting additions, payments and net changes, as well as the interest expense accretion on the estimated acquisition earn-out payables, for the years ended December 31, 2019, 2018 and 2017 were as follows:
For securities in a loss position, the following table shows the investments’ gross unrealized loss and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2019:
At December 31, 2018, the Company’s amortized cost and fair values of fixed maturity securities are summarized as follows:
Proceeds from the sales and maturity of the Company’s investment in fixed maturity securities were $5.8 million. This along with maturing time deposits yielded total cash proceeds from the sale of investments of $8.5 million in the period of January 1, 2019 to December 31, 2019. These proceeds, along with other sources of cash were used to purchase an additional $17.5 million of fixed maturity securities and to fund certain general corporate purposes. The gains and losses realized on those sales for the period from January 1, 2019 to December 31, 2019 were insignificant.
Construction in progress reflects expenditures related to the construction of the new headquarters in Daytona Beach, Florida.
On June 28, 2017, the Company entered into an amended and restated credit agreement (the “Amended and Restated Credit Agreement”) with the lenders named therein, JPMorgan Chase Bank, N.A. as administrative agent and certain other banks as co-syndication agents and co-documentation agents. The Amended and Restated Credit Agreement amended and restated the credit agreement dated April 17, 2014, among such parties (the “Original Credit Agreement”). The Amended and Restated Credit Agreement extends the applicable maturity date of the existing revolving credit facility (the “Revolving Credit Facility”) of $800.0 million to June 28, 2022 and re-evidences unsecured term loans at $400.0 million while also extending the applicable maturity date to June 28, 2022. The quarterly term loan principal amortization schedule was reset. At the time of the execution of the Amended and Restated Credit Agreement, $67.5 million of principal from the original unsecured term loans was repaid using operating cash balances, and the Company added an additional $2.8 million in debt issuance costs related to the Revolving Credit Facility to the Condensed Consolidated Balance Sheets. The Company also expensed to the Condensed Consolidated Statements of Income $0.2 million of debt issuance costs related to the Original Credit Agreement due to certain lenders exiting prior to execution of the Amended and Restated Credit Agreement. The Company also carried forward $1.6 million on the Condensed Consolidated Balance Sheets the remaining unamortized portion of the Original Credit Agreement debt issuance costs, which will be amortized over the term of the Amended and Restated Credit Agreement. On December 31, 2019, the Company made a scheduled principal payment of $10.0 million per the terms of the Amended and Restated Credit Agreement. As of December 31, 2019, there was an outstanding debt balance issued under the term loan of the Amended and Restated Credit Agreement of $330.0 million and $100.0 million borrowings outstanding against the Revolving Credit Facility. As of December 31, 2018, there was an outstanding debt balance issued under the term loan of the Amended and Restated Credit Agreement of $365.0 million with $350.0 million in borrowings outstanding against the Revolving Credit Facility. The Company had borrowed approximately $600.0 million under its Revolving Credit Facility on November 15, 2018 in connection with the closing of the acquisition of certain assets and assumption of certain liabilities of The Hays Group, Inc. and certain of its affiliates. Per the terms of the Amended and Restated Credit Agreement, a scheduled principal payment of $10.0 million is due March 31, 2020.
excluded an underwriting fee discount. The net proceeds received from the issuance were used to repay the outstanding balance of $475.0 million on the Revolving Credit Facility and for other general corporate purposes. As of December 31, 2019 and December 31, 2018, there was an outstanding debt balance of $500.0 million exclusive of the associated discount balance.
Interest paid in 2019, 2018 and 2017 was $58.3 million, $38.0 million, and $36.2 million, respectively.
At December 31, 2019, maturities of long-term debt were $55.0 million in 2020, $70.0 million in 2021, $380.0 million in 2022, $210.0 million in 2023, $500.0 million in 2024 and $350.0 million in 2029.
For 2017, we made a reasonable estimate of the impact of the Tax Reform Act and recorded a one-time credit in our 2017 income tax expense of $120.9 million, which reflects an estimated reduction in our deferred income tax liabilities of $124.2 million as a result of the maximum federal rate decreasing to 21.0% from 35.0%, which was partially offset by an estimated increase in income tax payable in the amount of $3.3 million as a result of the transition tax on cash and cash equivalent balances related to untaxed accumulated earnings associated with our international operations. During 2018, we made a credit adjustment to the transition tax on untaxed international operations in the amount of $1.6 million. This adjustment was a reduction of income tax expense for 2018 as a result of updated calculations based on the Company’s tax filings for the 2017 year end. As of December 31, 2019, management does not expect any further changes to the amounts previously recorded and adjusted under SAB 118.
Income taxes paid in 2019, 2018 and 2017 were $110.0 million, $110.6 million and $152.0 million, respectively.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of December 31, 2019, 2018 and 2017 the Company had $217,635, $197,205 and $228,608 of accrued interest and penalties related to uncertain tax positions, respectively.
The total amount of unrecognized tax benefits that would affect the Company’s effective tax rate if recognized was $1.1 million as of December 31, 2019, $1.6 million as of December 31, 2018 and $1.7 million as of December 31, 2017. The Company does not expect its unrecognized tax benefits to change significantly over the next 12 months.
As a result of a 2006 Internal Revenue Service (“IRS”) audit, the Company agreed to accrue at each December 31, for tax purposes only, a known amount of profit-sharing contingent commissions represented by the actual amount of profit-sharing contingent commissions received in the first quarter of the related year, with a true-up adjustment to the actual amount received by the end of the following March. Since this method for tax purposes differed from the method used for book purposes, it resulted in a current deferred tax asset as of December 31, 2017. As of January 1, 2018, pursuant to ASU 606, Revenue Recognition, the deferred tax asset was removed and was included in the Company’s overall beginning retained earnings adjustment per ASC 606. The Company will now follow book treatment for accrued profit-sharing contingent commissions.
The Company is subject to taxation in the United States and various state jurisdictions. The Company is also subject to taxation in the United Kingdom and Canada. In the United States, federal returns for fiscal years 2016 through 2019 remain open and subject to examination by the IRS. The Company files and remits state income taxes in various states where the Company has determined it is required to file state income taxes. The Company’s filings with those states remain open for audit for the fiscal years 2015 through 2019. In the United Kingdom, the Company’s filings remain open for audit for the fiscal years 2018 and 2019. In Canada, the Company’s filings remain open for audit for the fiscal years 2016 through 2019.
During 2019, the Company settled the previously disclosed State of Colorado income tax audit for the fiscal years 2013-2016, the State of Kansas income tax audit for the fiscal years 2014-2016, and the State of New York income tax audit for the fiscal years 2015-2017. In addition, the Company is currently under audit in the states of California, Illinois, and Massachusetts for the fiscal years 2015 through 2017.
In general, it is our practice and intention to reinvest the earnings of our non-U.S. subsidiaries in those operations.
The Company has an Employee Savings Plan (401(k)) in which substantially all employees with more than 30 days of service are eligible to participate. Under this plan, the Company makes matching contributions of up to 4.0% of each participant’s annual compensation. Prior to 2014, the Company’s matching contribution was up to 2.5% of each participant’s annual compensation with an additional discretionary profit-sharing contribution each year, which equaled 1.5% of each eligible employee’s compensation. The Company’s contribution expense to the plan totaled $22.8 million in 2019, $22.8 million in 2018 and $19.6 million in 2017.
In 1996, the Company adopted and the shareholders approved a performance stock plan, under which until the suspension of the plan in 2010, up to 28,800,000 Performance Stock Plan (“PSP”) shares could be granted to key employees contingent on the employees’ future years of
service with the Company and other performance-based criteria established by the Compensation Committee of the Company’s Board of Directors. Before participants may take full title to Performance Stock, two vesting conditions must be met. Of the grants currently outstanding, specified portions satisfied the first condition for vesting based upon 20% incremental increases in the 20-trading-day average stock price of Brown & Brown’s common stock from the price on the business day prior to date of grant. Performance Stock that has satisfied the first vesting condition is considered “awarded shares.” Awarded shares are included as issued and outstanding common stock shares and are included in the calculation of basic and diluted net income per share. Dividends are paid on awarded shares and participants may exercise voting privileges on such shares. Awarded shares satisfy the second condition for vesting on the earlier of a participant’s: (i) 15 years of continuous employment with Brown & Brown from the date shares are granted to the participants (or, in the case of the July 2009 grant to Powell Brown, 20 years), (ii) attainment of age 64 (on a prorated basis corresponding to the number of years since the date of grant), or (iii) death or disability. On April 28, 2010, the PSP was suspended and any remaining authorized, but unissued shares, as well as any shares forfeited in the future, will be reserved for issuance under the 2010 Stock Incentive Plan (the “2010 SIP”).
At December 31, 2019, 10,239,624 shares had been granted, net of forfeitures, under the PSP. As of December 31, 2019, 1,051,292 shares had met the first condition of vesting and had been awarded, and 9,188,332 shares had satisfied both conditions of vesting and had been distributed to participants. Of the shares that have not vested as of December 31, 2019, the initial stock prices ranged from $8.30 to $12.84.
A summary of PSP activity for the years ended December 31, 2019, 2018 and 2017 is as follows:
The total fair value of PSP grants that vested during each of the years ended December 31, 2019, 2018 and 2017 was $3.5 million, $11.9 million and $6.3 million, respectively.
Awards are subject to the achievement of certain performance criteria by grantees, which may include growth in a defined book of business, Organic Revenue growth and operating profit growth of a profit center, Organic Revenue growth of the Company and consolidated diluted net income per share growth at certain levels of the Company. The performance measurement period ranges from three to five years. Beginning in 2016, certain Performance Stock Awards have a payout range between 0% to 200% depending on the achievement against the stated performance target. Prior to 2016, the majority of the grants had a binary performance measurement criteria that only allowed for 0% or 100% payout.
The Company uses the closing stock price on the day prior to the grant date to determine the fair value of grants under the 2010 SIP and 2019 SIP and then applies an estimated forfeiture factor to estimate the annual expense. Additionally, the Company uses the path-dependent lattice model to estimate the fair value of grants with PSP-type vesting conditions as of the grant date. SIP shares that satisfied the first vesting condition for PSP-type grants or the established performance criteria are considered awarded shares. Awarded shares are included as issued and outstanding common stock shares and are included in the calculation of basic and diluted net income per share.
The Company has a shareholder-approved Employee Stock Purchase Plan (“ESPP”) with a total of 34,000,000 authorized shares of which 6,340,598 were available for future subscriptions as of December 31, 2019. Employees of the Company who regularly work 20 hours or more per week are eligible to participate in the ESPP. Participants, through payroll deductions, may allot up to 10% of their compensation towards the purchase of a maximum of $25,000 worth of Company stock between August 1st of each year and the following July 31st (the “Subscription Period”) at a cost of 85% of the lower of the stock price as of the beginning or end of the Subscription Period.
The Company estimates the fair value of an ESPP share option as of the beginning of the Subscription Period as the sum of: (1) 15% of the quoted market price of the Company’s stock on the day prior to the beginning of the Subscription Period, and (2) 85% of the value of a one-year stock option on the Company stock using the Black-Scholes option-pricing model. The estimated fair value of an ESPP share option as of the Subscription Period beginning in August 2019 was $7.46. The fair values of an ESPP share option as of the Subscription Periods beginning in August 2018 and 2017, were $5.88 and $4.32, respectively.
For the five months ended December 31, 2019, 2018 and 2017 (portions of the 2019-2020, 2018-2019 and 2017-2018 plan years), 419,446, 402,349 and 435,027 shares of common stock (from authorized but unissued shares), respectively, were subscribed to by ESPP participants for proceeds of approximately $12.8 million, $9.9 million and $8.2 million, respectively.
As of December 31, 2019, the Company estimates there to be $109.7 million of unamortized compensation expense related to all non-vested stock-based compensation arrangements granted under the Company’s stock-based compensation plans, based upon current projections of grant measurement against performance criteria. That expense is expected to be recognized over a weighted average period of 3.27 years.
NOTE 13 Supplemental Disclosures of Cash Flow Information and Non-Cash Financing and Investing Activities
Variable lease cost is lease payments that are based on an index or similar rate. They are initially measured using the index or rate in effect at lease commencement and are based on the minimum payments stated in the lease. Additional payments based on the change in an index or rate, or payments based on a change in the Company's portion of the operating expenses, including real estate taxes and insurance, are recorded as a period expense when incurred.
The right-of-use asset is initially measured at cost, which is primarily composed of the initial lease liability, plus any initial direct costs incurred, less any lease incentives received. The lease liability is initially measured at the present value of the minimum lease payments through the term of the lease. Minimum lease payments are discounted to present value using the incremental borrowing rate at the lease commencement date, which approximates the rate of interest the Company expects to be paid on a secured borrowing in an amount equal to the lease payments for the underlying asset under similar terms and economic conditions. The balances and classification of operating lease right-of-use assets and operating lease liabilities within the Condensed Consolidated Balance Sheets is as follows:
The weighted average remaining lease term and the weighted average discount rate for operating leases as of December 31, 2019 were:
Quarterly financial results are affected by seasonal variations. The timing of the insurance policy renewals sold by the Company and acquisitions may cause revenues, expenses and net income to vary significantly between quarters.
Brown & Brown’s business is divided into four reportable segments: (1) the Retail Segment, which provides a broad range of insurance products and services to commercial, public and quasi-public entities, and to professional and individual customers, and non-insurance risk-mitigating products through our automobile dealer services (“F&I”) businesses, (2) the National Programs Segment, which acts as an MGA, provides professional liability and related package products for certain professionals, a range of insurance products for individuals, flood coverage, and targeted products and services designated for specific industries, trade groups, governmental entities and market niches, all of which are delivered through nationwide networks of independent agents, and Brown & Brown retail agents, (3) the Wholesale Brokerage Segment, which markets and sells excess and surplus commercial and personal lines insurance, primarily through independent agents and brokers, as well as Brown & Brown retail agents, and (4) the Services Segment, which provides insurance-related services, including third-party claims administration and comprehensive medical utilization management services in both the workers’ compensation and all-lines liability arenas, as well as Medicare Set-aside services, Social Security disability and Medicare benefits advocacy services and claims adjusting services.
Brown & Brown conducts all of its operations within the United States of America, except for a wholesale brokerage operation based in London, England, retail operations in Bermuda and the Cayman Islands, and a national programs operation in Canada. These operations earned $17.7 million, $15.2 million and $15.9 million of total revenues for the years ended December 31, 2019, 2018 and 2017, respectively. Long-lived assets held outside of the United States during each of these three years were not material.
During 2017, the Company repurchased 2,883,349 shares at an average price of $48.51 for a total cost of $139.9 million under the current share repurchase authorization. During 2018, the Company entered into accelerated share repurchase agreement (“ASR”) with an investment bank to purchase an aggregate $100.0 million of the Company’s common stock. As part of the ASR, the company received an initial share delivery of 2,910,150 shares of the Company’s common stock with a fair market value of approximately $80.0 million in 2018. On May 17, 2019, this agreement was completed with the delivery of 566,599 shares of the Company’s common stock. In addition to the settlement of the ASR, during 2019, the Company made share repurchases in the open market of 1,087,914 shares at a total cost of $38.7 million, at an average price of $35.55 per share. At December 31, 2019, the remaining amount authorized by our Board of Directors for share repurchases was approximately $461.3 million. Under the authorized repurchase programs, the Company has repurchased a total of approximately 15.5 million shares for an aggregate cost of approximately $536.2 million between 2014 and 2019. The aforementioned share amounts have not been adjusted for the March 28, 2018 2-for-1 stock split, as treasury shares did not participate in this stock split transaction.
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
The Company’s acquisition purchase price for business combinations is typically based upon a multiple of average annual operating profit and/or revenue earned over a one to three-year period within a minimum and maximum price range. The recorded purchase prices for most acquisitions include an estimation of the fair value of liabilities associated with potential earn-out provisions, when an earn-out obligation is part of the negotiated transaction. The fair value of the earn-out obligations is based upon the present value of the expected future payments to be made to the sellers of the acquired businesses in accordance with the provisions contained in the respective purchase agreements. Subsequent changes in the fair value of the earn-out obligations are recorded in the consolidated statement of income when incurred.
Our audit procedures related to the forecasted future earnings assumptions used in determining the fair value of the earn-out obligation included the following, among others:
We read the asset/stock purchase agreements and associated addenda and agreed the provisions of the contracts to the earn-out obligation models.
We have audited the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2019, of the Company and our report dated February 24, 2020, expressed an unqualified opinion on those financial statements and included an explanatory paragraph regarding the Company’s adoption of Financial Accounting Standards Board Accounting Standards Codification 842, Leases, and related amendments.
As described in Management’s Annual Report on Internal Control Over Financial Reporting, management excluded from its assessment the internal control over financial reporting at CKP Insurance, LLC, Poole Professional Ltd. Insurance Agents and Brokers et al, Innovative Risk Solutions, Inc., Medval, LLC, Twinbrook Insurance Brokerage, Inc., VerHagen Glendenning & Walker LLP, United Development Systems, Inc., AGA Enterprises, LLC d/b/a Cossio Insurance Agency, West Ridge Insurance Agency, Inc. d/b/a Yozell Associates, and Izzo Insurance Services, Inc. which were acquired in 2019 and whose financial statements constitute approximately (0.26) and 5.20 percent of net and total assets, respectively, 1.13 percent of revenues, and (1.39) percent of net income of the consolidated financial statement amounts as of and for the year ended December 31, 2019. Accordingly, our audit did not include the internal control over financial reporting of these acquired entities.