We lease our executive offices, which are located at 220 South Ridgewood Avenue, Daytona Beach, Florida 32114. We lease offices at each of our 311 locations. Our operating leases expire on various dates and generally contain renewal options and rent escalation clauses based upon increases in the lessors’ operating expenses and other charges. We expect that most leases will be renewed or replaced upon expiration. We own several contiguous parcels of land totaling over thirteen acres in Daytona Beach, Florida, located approximately a mile from our current executive offices, on which we have initiated a project to build a new office tower to hold our executive offices and certain other business operations with capacity for up to 1,000 employees and room for additional expansion through construction of additional office space at this location. We believe that our facilities are suitable and adequate for present purposes, and that the productive capacity in such facilities is substantially being utilized. From time to time, we may have unused space and seek to sublet such space to third parties, depending on the demand for office space in the locations involved. In the future, we may need to purchase, build or lease additional facilities to meet the requirements projected in our long-term business plan. See Note 15 to the Consolidated Financial Statements for additional information on our lease commitments.
Certain insurance companies offer guaranteed fixed-base agreements, referred to as “Guaranteed Supplemental Commissions” (“GSCs”) in lieu of profit-sharing contingent commissions. GSCs are accrued throughout the year based upon actual premiums written. For the year ended December 31, 2019, we had earned $23.1 million of GSCs, of which $12.7 million remained accrued at December 31, 2019 and most of this will be collected over the first and second quarters of 2020. For the years ended December 31, 2019 and 2018, we earned $23.1 million and $10.0 million, respectively, from GSCs.
Combined, our profit-sharing contingent commissions and GSCs for the year ended December 31, 2019 increased by $16.4 million over 2018. The net increase of $16.4 million was mainly driven by: (i) a GSC of approximately $9 million recorded in the second quarter of 2019 for the National Programs Segment that will not recur in the future as the associated multi-year contract has ended and (ii) to a lesser extent growth associated with acquisitions completed over the last 12 months.
large-account customer base, where we primarily earn fees for securing insurance for our customers, and in our automobile dealer services (“F&I”) businesses where we primarily earn fees for assisting our customers with selling warranty and service programs. Fee revenues as a percentage of our total commissions and fees, represented 27.1% in 2019 and 26.3% in 2018.
Part of our business strategy is to attract high-quality insurance intermediaries and service organizations to join our operations. From 1993 through the fourth quarter of 2019, we acquired 536 insurance intermediary operations, excluding acquired books of business (customer accounts).
On November 15, 2018, we completed the acquisition of certain assets and assumption of certain liabilities of Hays. At closing, we delivered a payment of $705 million, consisting of $605 million in cash and the issuance to certain key owners of Hays of 3,376,103 shares of our common stock for a total value of $100.0 million. In addition, the Company may pay additional consideration to Hays in the form of earn-out payments in the aggregate amount of up to $25.0 million in cash over three years, which is subject to certain conditions and the successful achievement of average annual EBITDA targets for the acquired business during 2019, 2020 and 2021. This transaction was initially funded through utilization of the Company’s revolving line of credit within our credit facility, details of which can be found in “Management’s Discussion and Analysis of Financial Condition”, “Results of Operations” and Note 9 “Long-Term Debt” in the “Notes to Consolidated Financial Statements”.
We believe that of our significant accounting and reporting policies, the more critical policies include our accounting for revenue recognition, business combinations and purchase price allocations, intangible asset impairments, non-cash stock-based compensation and reserves for litigation. In particular, the accounting for these areas requires significant use of judgment to be made by management. Different assumptions in the application of these policies could result in material changes in our consolidated financial position or consolidated results of operations. Refer to Note 1 “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” for a discussion of the impacts for adopting Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” and No. 2016-02, “Leases (Topic 842)”.
Acquisition purchase prices are typically based upon a multiple of average EBITDA, annual operating profit and/or core revenue earned over a one to three-year period within a minimum and maximum price range. The recorded purchase prices for all acquisitions include an estimation of the fair value of liabilities associated with any potential earn-out provisions, where an earn-out is part of the negotiated transaction. Subsequent changes in the fair value of earn-out obligations are recorded in the Consolidated Statement of Income when changes to the expected performance of the associated business are realized.
The fair value of 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. In determining fair value, the acquired business’s future performance is estimated using financial projections developed by management for the acquired business, and this estimate reflects market participant assumptions regarding revenue growth and/or profitability. The expected future payments are estimated on the basis of the earn-out formula and performance targets specified in each purchase agreement compared to the associated financial projections. These estimates are then discounted to a present value using a risk-adjusted rate that takes into consideration the likelihood that the forecasted earn-out payments will be made.
Management assesses the recoverability of our goodwill and our amortizable intangibles and other long-lived assets annually and whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Any of the following factors, if present, may trigger an impairment review: (i) a significant underperformance relative to historical or projected future operating results, (ii) a significant negative industry or economic trend, and (iii) a significant decline in our market capitalization. If the recoverability of these assets is unlikely because of the existence of one or more of the above-referenced factors, an impairment analysis is performed. Management must make assumptions regarding estimated future cash flows and other factors to determine the fair value of these assets. If these estimates or related assumptions change in the future, we may be required to revise the assessment and, if appropriate, record an impairment charge. We completed our most recent evaluation of impairment for goodwill as of November 30, 2019 and determined that the fair value of goodwill exceeded the carrying value of such assets. Additionally, there have been no impairments recorded for amortizable intangible assets for the years ended December 31, 2019 and 2018.
During the first quarter of 2019, the performance conditions for 1,954,983 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 2014 and 2016. These grants had a performance measurement period that concluded on December 31, 2018. The vesting condition for these grants requires continuous employment for a period of up to seven years from the 2014 grant date and five years from the 2016 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.
Commissions and fees, including profit-sharing contingent commissions and GSCs for 2019, increased $374.9 million to $2,384.7 million, or 18.7% over 2018. Core commissions and fees in 2019 increased $358.5 million, of which $298.3 million represented core commissions and fees from acquisitions that had no comparable revenues in 2018; approximately $70.0 million represented net new and renewal business; which was offset by $9.8 million related to commissions and fees revenue from businesses divested in 2018 and 2019, which reflected an Organic Revenue growth rate of 3.6%. Profit-sharing contingent commissions and GSCs for 2019 increased by $16.4 million, or 24.9%, compared to the same period in 2018. The net increase of $16.4 million was mainly driven by: (i) a GSC of approximately $9 million recorded in the second quarter of 2019 for the National Programs Segment that will not recur in the future as the associated multi-year contract has ended and (ii) the remainder primarily from growth associated with acquisitions completed over the last 12 months.
Amortization expense for 2019 increased $18.8 million to $105.3 million, or 21.7% over 2018. The increase reflects the amortization of new intangible assets from recently acquired businesses, partially offset by certain intangible assets becoming fully amortized.
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 net changes, as well as the interest expense accretion on the estimated acquisition earn-out payables, for the years ended December 31, 2019 and 2018 were as follows:
As of December 31, 2019, the estimated acquisition earn-out payables equaled $161.5 million, of which $17.9 million was recorded as accounts payable and $143.6 million was recorded as other non-current liability. As of December 31, 2018, the estimated acquisition earn-out payables equaled $89.9 million, of which $21.1 million was recorded as accounts payable and $68.8 million was recorded as other non-current liability.
The reconciliation of total commissions and fees to Organic Revenue for the year ended December 31, 2019, by Segment, are as follows:
The Retail Segment’s total revenues in 2019 increased 31.1%, or $324.5 million, over the same period in 2018, to $1,367.3 million. The $312.2 million increase in core commissions and fees was driven by the following: (i) approximately $272.4 million related to the core commissions and fees from acquisitions that had no comparable revenues in the same period of 2018; (ii) $47.4 million related to net new and renewal business; offset by (iii) a decrease of $7.7 million related to commissions and fees from businesses or books of business divested in 2018 and 2019. Profit-sharing contingent commissions and GSCs in 2019 increased 36.8%, or $12.2 million, over 2018, to $45.2 million primarily from acquisitions completed in 2018 and 2019. The Retail Segment’s growth rate for total commissions and fees was 31.1% and the Organic Revenue growth rate was 4.7% for 2019. The Organic Revenue growth rate was driven by increased new business, higher customer retention and increasing premium rates across most lines of business over the preceding 12 months.
estimated acquisition earn-out payables of $6.9 million, to $8.0 million; partially offset by, (vi) an increase in the gain on disposal associated with the sale of certain books of business.
The National Programs Segment manages over 40 programs supported by approximately 100 well-capitalized carrier partners. In most cases, the insurance carriers that support the programs have delegated underwriting and, in many instances, claims-handling authority to our programs operations. These programs offer targeted products and services designed for specific industries, trade groups, professions, public entities and market niches and are generally distributed through a nationwide network of independent agents and Brown & Brown retail agents. The National Programs Segment operations can be grouped into five broad categories: Professional Programs, Personal Lines Programs, Commercial Programs, Public Entity-Related Programs and the National Flood Program. The National Programs Segment’s revenue is primarily commission based.
The National Programs Segment’s total revenues in 2019 increased 4.8%, or $23.9 million, over 2018, to a total $518.4 million. The $18.9 million increase in core commissions and fees was driven by the following: (i) $14.0 million related to net new and renewal business; (ii) an increase of approximately $5.7 million related to core commissions and fees from acquisitions that had no comparable revenues in 2018; offset by (iii) a decrease of $0.8 million related to commissions and fees recorded in 2018 from businesses since divested. Profit-sharing contingent commissions and GSCs were $28.1 million in 2019, which was an increase of $4.1 million over 2018, which was primarily driven by a non-recurring GSC received from one of our partners in the second quarter of 2019.
The National Programs Segment’s growth rate for total commissions and fees was 4.7% and the Organic Revenue growth rate was 3.0% for 2019. The total commissions and fees growth was mainly due to a new acquisition, strong growth in our earthquake programs, sports and entertainment program, wind programs and a non-recurring GSC received from one of our partners in the second quarter of 2019. The Organic Revenue growth rate increase was driven by net new business, growth in renewals and higher premium rates in a number of our programs compared to the prior year.
The Wholesale Brokerage Segment’s total revenues for 2019 increased 8.0%, or $23.1 million, over 2018, to $310.1 million. The $22.9 million increase in core commissions and fees was driven by the following: (i) $20.6 million related to net new and renewal business; (ii) $3.6 million related to the core commissions and fees from acquisitions that had no comparable revenues in 2018; which was offset by (iii) a decrease of $1.3 million related to commissions and fees recorded in 2018 from businesses since divested. Profit-sharing contingent commissions and GSCs for 2019 increased $0.1 million over 2018, to $8.9 million. The Wholesale Brokerage Segment’s growth rate for total commissions and fees was 8.1%, and the Organic Revenue growth rate was 7.4% for 2019. The Organic Revenue growth rate was driven by net new business, a modest increase in exposure units, as well as increased rates seen across most lines of business.
Income before income taxes for 2019 increased 17.9%, or $12.6 million, over 2018, to $82.7 million, primarily due to the following: (i) the net increase in revenue as described above, (ii) a decrease in intercompany interest expense, (iii) a decrease in change in estimated acquisition earn-out payables, which was offset by (iv) an increase in employee compensation and benefits of $10.4 million, related to additional teammates to support increased transaction volumes, compensation increases for existing teammates, and additional non-cash stock-based compensation expense; and (iii) a net $1.6 million increase in other operating expenses, primarily related intercompany technology charges.
Income before income taxes for 2019 increased 16.9%, or $5.8 million, over 2018, to $40.3 million due to a combination of: (i) the change in estimated acquisition earn-out payables partially offset by (ii) higher intercompany interest charges due to businesses acquired during 2019 and (iii) a decline in other operating expenses driven by management of our costs.
EBITDAC for 2019 decreased 2.5%, or $1.1 million, over the same period in 2018, to $42.8 million. EBITDAC Margin for 2019 decreased to 22.1% from 23.2% in the same period in 2018. The decrease in EBITDAC Margin was due the decline in Organic Revenue.
Our cash and cash equivalents of $439.0 million at December 31, 2018 reflected a decrease of $134.4 million from the $573.4 million balance at December 31, 2017. During 2018, $567.5 million of cash was generated from operating activities, representing an increase of 28.4%. During this period, $923.9 million of cash was used for new acquisitions, $26.6 million was used for acquisition earn-out payments, $41.5 million was used to purchase additional fixed assets, $84.7 million was used for payment of dividends, $100.0 million was used for share repurchases and $120.0 million was used to pay outstanding principal balances owed on long-term debt.
Our ratio of current assets to current liabilities (the “current ratio”) was 1.22 at both December 31, 2019 and 2018.
As of December 31, 2019, our contractual cash obligations were as follows:
Total debt at December 31, 2019 was $1,555.3 million net of unamortized discount and debt issuance costs, which was an increase of $48.4 million compared to December 31, 2018. The increase includes (i) a drawdown on the Revolving Credit Facility of $100.0 million on August 9, 2019 in connection with the acquisition of CKP Insurance, LLC and various other acquisitions closed in the third quarter of 2019, (ii) the repayment of principal of $50.0 million for scheduled principal amortization balances related to our various existing floating rate debt term notes, (iii) amortization of discounted debt related to our various unsecured Senior Notes, and debt issuance cost amortization of $2.1 million, offset by (iv) additional discount to par and aggregate debt issuance costs of $3.7 million related to the issuance of the Company's 4.500% Senior Notes due 2029 as of December 31, 2019.
On May 10, 2018, the Company elected to prepay in full the principal balance of $100.0 million from the Series E Senior Notes, which were issued on September 15, 2011 in connection with the December 22, 2006 Master Shelf and Note Purchase Agreement with a national insurance company. Along with accrued interest of $0.7 million and a prepayment premium of $0.7 million as the notes were to mature on September 15, 2018. This resulted in a net interest expense savings of $0.8 million after deducting the pro-rated interest expense and prepayment premiums paid when compared to holding the note to maturity paying the full semi-annual coupon interest expense of $2.3 million.
Consolidated Statements of Income for the years ended December 31, 2019, 2018 and 2017
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2019, 2018 and 2017
Brown & Brown, Inc., a Florida corporation, and its subsidiaries (collectively, “Brown & Brown” or the “Company”) is a diversified insurance agency, wholesale brokerage, insurance programs and service organization that markets and sells insurance products and services, primarily in the property, casualty and employee benefits areas. Brown & Brown’s business is divided into four reportable segments. 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. The National Programs Segment, which acts as a managing general agent (“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 a nationwide network of independent agents, including Brown & Brown retail agents. The Wholesale Brokerage Segment markets and sells excess and surplus commercial and personal lines insurance, primarily through independent agents and brokers, as well as Brown & Brown retail agents. 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, as well as Medicare Set-aside services, Social Security disability and Medicare benefits advocacy services and claims adjusting services.
In January 2017, the FASB issued ASU No. 2017-04, “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” The new guidance eliminates Step 2 of the goodwill impairment test. The updated guidance requires an entity to perform its annual or interim goodwill impairment test by comparing the fair value of the reporting unit to its carrying value, and recognizing a non-cash impairment charge for the amount by which the carrying value exceeds the reporting unit’s fair value with the loss not exceeding the total amount of goodwill allocated to that reporting unit. ASU 2017-04 will take effect for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 and will be applied prospectively. The Company is currently evaluating the impact of this guidance on future interim or annual goodwill impairment tests performed.
In March 2016, the FASB issued ASU 2016-08, “Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net)” (“ASU 2016-08”) to clarify certain aspects of the principal-versus-agent guidance included in the new revenue standard ASU 2014-09 “Revenue from Contracts with Customers” (“ASU 2014-09”). The FASB issued the ASU in response to concerns identified by stakeholders, including those related to (1) determining the appropriate unit of account under the revenue standard’s principal-versus-agent guidance and (2) applying the indicators of whether an entity is a principal or an agent in accordance with the revenue standard’s control principle. The Company adopted ASU 2016-08 effective contemporaneously with ASU 2014-09 beginning January 1, 2018. The impact of ASU 2016-08 was limited to the claims administering activities of one of our businesses within our Services Segment and therefore was not material to the net income of the Company.
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” (“Topic 842”), which provides guidance for accounting for leases. Under Topic 842, all leases are required to be recorded on the balance sheet and are classified as either operating leases or finance leases. Effective as of January 1, 2019, the Company adopted Topic 842, and all related amendments, which established Accounting Standards Codification (“ASC”) Topic 842. The Company adopted these standards by the recognition of right-of-use assets and related lease liabilities on the balance sheet. As permitted by Topic 842, the Company elected the transition practical expedient to adopt as of January 1, 2019, the date of initial application under the modified retrospective approach for leases existing at that date, with an adjustment to retained earnings. As a result, the Consolidated Balance Sheets at December 31, 2018 was not restated and continues to be reported under ASC Topic 840 (“Topic 840”) which did not require the recognition of operating lease liabilities on the balance sheet, and thus is not comparative. For the year ended December 31, 2019, all of the Company’s leases are classified as operating leases, which are primarily real estate leases for office space. The expense recognition for operating leases under Topic 842 is substantially consistent with Topic 840, where operating lease charges are recorded entirely in operating expenses. As a result, there is no significant difference in the Company’s results of operations presented in the Company’s Condensed Consolidated Statements of Income for each period presented.
Leases are classified as either finance leases or operating leases. A lease is classified as a finance lease if any one of the following criteria are met: the lease transfers ownership of the asset by the end of the lease term, the lease contains an option to purchase the asset that is reasonably certain to be exercised, or the lease term is for a major part of the remaining useful life of the asset or the present value of the lease payments equals or exceeds substantially all of the fair value of the asset. A lease is classified as an operating lease if it does not meet any one of these criteria. None of the Company’s real estate leases for office space meet the definition of a finance lease. The Company’s policy is to own, rather than lease, equipment.
Lease payments included in the measurement of the lease liability comprise the following: the fixed noncancelable lease payments, payments for optional renewal periods where it is reasonably certain the renewal period will be exercised, and payments for early termination options unless it is reasonably certain the lease will not be terminated early. Some of the Company’s real estate leases contain variable lease payments, including payments based on an index or rate. Variable lease payments based on an index or rate are initially measured using the index or rate in effect at lease commencement and based on the minimum amount stated in the lease. Lease components are included in the measurement of the initial lease liability. 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. Lease modifications result in remeasurement of the right-of-use assets and the lease liability.
The Company elected not to recognize right-of-use assets and lease liabilities for short-term leases that have a total term of 12 months or less. The effect of short-term leases on the Company’s right-of-use asset and lease liability would not be significant.
The Company earns commissions and fees paid by insurance carriers for the binding of insurance coverage. These commissions and fees are earned at a point in time upon the effective date of bound insurance coverage, as no performance obligation exists after coverage is bound. If there are other services within the contract, the Company estimates the stand-alone selling price for each separate performance obligation, and the corresponding apportioned revenue is recognized over the period of time in which the customer receives the service, and as the performance obligations are fulfilled and the Company is entitled to that portion of revenue using the output method for the services. In situations where multiple performance obligations exist within a contract, the use of estimates is required to allocate the transaction price on a relative stand-alone selling price basis to each separate performance obligation.
Commission revenues - Prior to the adoption of Topic 606, commission revenues, including those billed on an installment basis, were recognized on the latter of the policy effective date or the date that the premium was billed to the customer, with the exception of the Company’s Arrowhead businesses, which followed a policy of recognizing these revenues on the latter of the policy effective date or processed date in our systems. As a result of the adoption of Topic 606, commission revenues associated with the issuance of policies are now recognized upon the effective date of the associated policy. The overall impact of these changes are not significant on a full-year basis, but the timing of recognizing revenue has impacted our fiscal quarters when compared to prior years. These commission revenues, including those billed on an installment basis, are now recognized earlier than they had been previously. Revenue is now accrued based upon the completion of the performance obligation, thereby creating a current asset for the unbilled revenue, until such time as an invoice is generated, which typically does not exceed 12 months. For the year ended December 31, 2018, the adoption of Topic 606 increased base and incentive commissions revenue, as defined in Note 2, by $9.9 million compared to what would have been recognized under the Company’s previous accounting policies. Incentive commissions represent a form of variable consideration which includes additional commissions over base commissions received from insurance carriers based on predetermined production levels mutually agreed upon by both parties.
In connection with the implementation of Topic 606 and ASC 340, we modified, and in some instances instituted, additional accounting procedures, processes and internal controls. While the relative impacts of these standards to our revenue and expense streams are significant during a calendar year, we do not view these modifications and additions as a material change in our internal controls over financial reporting on a full year basis.
receivable. The $8.7 million adjustment to accounts payable and the $22.8 million adjustment to accrued expenses and other liabilities consists of commissions payable and deferred revenue, respectively.
The Company earns commissions paid by insurance carriers for the binding of insurance coverage. Commissions are earned at a point in time upon the effective date of bound insurance coverage, as no performance obligation exists after coverage is bound. If there are other services within the contract, the Company estimates the stand-alone selling price for each separate performance obligation, and the corresponding apportioned revenue is recognized over a period of time as the performance obligations are fulfilled. The Company earns fee revenue by receiving negotiated fees in lieu of a commission and from services other than securing insurance coverage. Fee revenues from certain agreements are recognized depending on when the services within the contract are satisfied and when we have transferred control of the related services to the customer. In situations where multiple performance obligations exist within a fee contract, the use of estimates is required to allocate the transaction price on a relative stand-alone selling price basis to each separate performance obligation. Incentive commissions represent a form of variable consideration which includes additional commissions over base commissions received from insurance carriers based on predetermined production levels mutually agreed upon by both parties. Profit-sharing contingent commissions represent a form of variable consideration associated with the placement of coverage, for which we earn commissions. Profit-sharing contingent commissions and incentive commissions are estimated with a constraint applied and accrued relative to the recognition of the corresponding core commissions based on the amount of consideration that will be received in the coming year such that a significant reversal of revenue is not probable. Guaranteed supplemental commissions, a form of variable consideration, represent guaranteed fixed-base agreements in lieu of profit-sharing contingent commissions.
In our capacity as an insurance agent or broker, the Company typically collects premiums from insureds and, after deducting the authorized commissions, remits the net premiums to the appropriate insurance company or companies. Accordingly, as reported in the Consolidated Balance Sheets, premiums are receivable from insureds. Unremitted net insurance premiums are held in a fiduciary capacity until the Company disburses them. Where allowed by law, the Company invests these unremitted funds only in cash, money market accounts, tax-free variable-rate demand bonds and commercial paper held for a short-term. In certain states in which the Company operates, the use and investment alternatives for these funds are regulated and restricted by various state laws and agencies. These restricted funds are reported as restricted cash and investments on the Consolidated Balance Sheets. The interest income earned on these unremitted funds, where allowed by state law, is reported as investment income in the Consolidated Statement of Income.
Certificates of deposit, and other securities, having maturities of more than three months when purchased are reported at cost and are adjusted for other-than-temporary market value declines. The Company’s investment holdings include U.S. Government securities, municipal bonds, domestic corporate and foreign corporate bonds as well as short-duration fixed income funds. Investments within the portfolio or funds are held as available-for-sale and are carried at their fair value. Any gain/loss applicable from the fair value change is recorded, net of tax, as other comprehensive income within the equity section of the Consolidated Balance Sheets. Realized gains and losses are reported on the Consolidated Statement of Income, with the cost of securities sold determined on a specific identification basis.
All of our business combinations initiated after June 30, 2001 are accounted for using the acquisition method. Acquisition purchase prices are typically based upon a multiple of average annual EBITDA, operating profit and/or core revenue earned over a period of 3 years within a minimum and maximum price range. The recorded purchase prices for all acquisitions consummated after January 1, 2009 include an estimation of the fair value of liabilities associated with any potential earn-out provisions. Subsequent changes in the fair value of earn-out obligations are recorded in the Consolidated Statement of Income when incurred.
Basic net income per share is computed based on the weighted average number of common shares (including participating securities) issued and outstanding during the period. Diluted net income per share is computed based on the weighted average number of common shares issued and outstanding plus equivalent shares, assuming the exercise of stock options. The dilutive effect of stock options is computed by application of the treasury-stock method. The weighted average number of common shares outstanding for 2017 reflects the 2-for-1 stock split that occurred on March 28, 2018.
(1)The weighted average number of common shares outstanding for 2017 reflects the 2-for-1 stock split that occurred on March 28, 2018.
The carrying amounts of the Company’s financial assets and liabilities, including cash and cash equivalents; restricted cash and short-term investments; investments; premiums, commissions and fees receivable; reinsurance recoverable; prepaid reinsurance premiums; premiums payable to insurance companies; losses and loss adjustment reserve; unearned premium; premium deposits and credits due customers and accounts payable, at December 31, 2019 and 2018, approximate fair value because of the short-term maturity of these instruments. The carrying amount of the Company’s long-term debt approximates fair value at December 31, 2019 and 2018 as our fixed-rate borrowings of $848.7 million approximate their values using market quotes of notes with the similar terms as ours, which we deem a close approximation of current market rates. The estimated fair value of the $715.0 million currently outstanding approximates the carrying value due to the variable interest rate based upon adjusted LIBOR. See Note 3 to our Consolidated Financial Statements for the fair values related to the establishment of intangible assets and the establishment and adjustment of earn-out payables. See Note 6 for information on the fair value of investments and Note 9 for information on the fair value of long-term debt.
The Company protects itself from claims-related losses by reinsuring all claims risk exposure. The only line of insurance in which the Company acts in a risk-bearing capacity is flood insurance associated with the Wright National Flood Insurance Company (“WNFIC”), which is part of our National Programs Segment. However, all exposure is reinsured with the Federal Emergency Management Agency (“FEMA”) for basic admitted policies conforming to the National Flood Insurance Program. For excess flood insurance policies, all exposure is reinsured with a reinsurance carrier with an AM Best Company rating of “A” or better. Reinsurance does not legally discharge the ceding insurer from the primary liability for the full amount due under the reinsured policies. Reinsurance premiums, commissions, expense reimbursement and reserves related to ceded business are accounted for on a basis consistent with the accounting for the original policies issued and the terms of reinsurance contracts. Premiums earned and losses and loss adjustment expenses incurred are reported net of reinsurance amounts. Other underwriting expenses are shown net of earned ceding commission income. The liabilities for unpaid losses and loss adjustment expenses and unearned premiums are reported gross of ceded reinsurance recoverable.
Unpaid losses and loss adjustment reserve include amounts determined on individual claims and other estimates based upon the past experience of WNFIC and the policyholders for IBNR claims, less anticipated salvage and subrogation recoverable. The methods of making such estimates and for establishing the resulting reserves are continually reviewed and updated, and any adjustments resulting therefrom are reflected in operations currently.
Profit-sharing contingent commissions are based primarily on underwriting results, but may also reflect considerations for volume, growth and/or retention.
Guaranteed supplemental commissions represent guaranteed fixed-base agreements in lieu of profit-sharing contingent commissions.
As of December 31, 2019, deferred revenue consisted of $41.2 million as current portion to be recognized within one year and $16.9 million in long-term to be recognized beyond one year. As of December 31, 2018, deferred revenue consisted of $37.0 million as current portion to be recognized within one year and $16.5 million in long-term deferred revenue to be recognized beyond one year.
Contract assets and contract liabilities arising from acquisitions in 2019 were approximately $6.5 million and $9.3 million, respectively. Contract assets and contract liabilities arising from acquisitions in 2018 were approximately $34.3 million and $3.3 million, respectively.
Incremental cost to obtain - The Company defers 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. The cost to obtain balance within the Other Assets caption in the Company’s Condensed Consolidated Balance Sheets was $26.9 million and $13.2 million as of December 31, 2019 and December 31, 2018, respectively. For the 12 months ended December 31, 2019, the Company deferred $15.1 million of incremental cost to obtain customer contracts. The Company expensed $1.4 million and $0.5 million of the incremental cost to obtain customer contracts for the 12 months ended December 31, 2019 and December 31, 2018, respectively.
During the year ended December 31, 2019, the Company acquired the assets and assumed certain liabilities of 22 insurance intermediaries, all the stock of one insurance intermediary and 4 books of businesses (customer accounts). Additionally, miscellaneous adjustments were recorded to the purchase price allocation of certain prior acquisitions completed within the last 12 months as permitted by ASC Topic 805 - Business Combinations (“ASC 805”). Such adjustments are presented in the “Other” category within the following two tables. The recorded purchase price for all acquisitions includes an estimation of the fair value of liabilities associated with any potential earn-out provisions. Subsequent changes in the fair value of earn-out obligations will be recorded in the Consolidated Statement of Income when incurred.
Based upon the acquisition date and the complexity of the underlying valuation work, certain amounts included in the Company’s Consolidated Financial Statements may be provisional and thus subject to further adjustments within the permitted measurement period, as defined in ASC 805. For the year ended December 31, 2019, adjustments were made within the permitted measurement period that resulted in a decrease in the aggregate purchase price of the affected acquisitions of $4.1 million relating to the assumption of certain liabilities. These measurement period adjustments have been reflected as current period adjustments for the year ended December 31, 2019 in accordance with the guidance in ASU 2015-16 “Business Combinations.” The measurement period adjustments impacted goodwill, with no effect on earnings or cash in the current period.
Cash paid for acquisitions was $356.3 million and $934.9 million in the years ended December 31, 2019 and 2018, respectively. We completed 23 acquisitions (excluding book of business purchases) during the year ended December 31, 2019. We completed 23 acquisitions (excluding book of business purchases) during the year ended December 31, 2018.
Goodwill of $328.5 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 $302.6 million, $0.1 million, $6.5 million and $19.3 million, respectively. Of the total goodwill of $328.5 million, the amount currently deductible for income tax purposes is $245.6 million and the remaining $82.9 million relates to the recorded earn-out payables and will not be deductible until it is earned and paid.
During the year ended December 31, 2018, the Company acquired the assets and assumed certain liabilities of 20 insurance intermediaries, all the stock of three insurance intermediaries and one book of business (customer accounts). Additionally, miscellaneous adjustments were recorded to the purchase price allocation of certain prior acquisitions completed within the last 12 months as permitted by ASC 805. Such adjustments are presented in the “Other” category within the following two tables.
For the year ended December 31, 2018, several adjustments were made within the permitted measurement period that resulted in an increase in the aggregate purchase price of the affected acquisitions of $21.4 thousand, relating to the assumption of certain liabilities.
During the year ended December 31, 2017, the Company acquired the assets and assumed certain liabilities of 11 insurance intermediaries and one book of business (customer accounts). Additionally, miscellaneous adjustments were recorded to the purchase price allocation of certain prior acquisitions completed within the last 12 months as permitted by ASC 805. Such adjustments are presented in the “Other” category within the following two tables.
Of the $161.5 million of estimated acquisition earn-out payables as of December 31, 2019, $17.9 million was recorded as accounts payable, and $143.6 million was recorded as another non-current liability. Included within additions to estimated acquisition earn-out payables are any adjustments to opening balance sheet items prior to the one-year anniversary date of the acquisition and may therefore differ from previously reported amounts. Of the $89.9 million of estimated acquisition earn-out payables as of December 31, 2018, $21.1 million was recorded as accounts payable, and $68.8 million was recorded as other non-current liabilities. Of the $36.2 million of estimated acquisition earn-out payables as of December 31, 2017, $25.1 million was recorded as accounts payable, and $11.1 million was recorded as other non-current liabilities.
Amortizable intangible assets at December 31, 2019 and 2018 consisted of the following:
Amortization expense for amortizable intangible assets for the years ending December 31, 2020, 2021, 2022, 2023 and 2024 is estimated to be $101.2 million, $97.6 million, $93.1 million, $86.2 million and $82.3 million, respectively.
At December 31, 2019, the Company’s amortized cost and fair values of fixed maturity securities are summarized as follows:
At December 31, 2019, the Company held $26.6 million in fixed income securities composed of U.S Treasury securities, securities issued by U.S. Government agencies and municipalities, and $5.4 million issued by corporations with investment-grade ratings. Of the total, $4.6 million is classified as short-term investments on the Consolidated Balance Sheets as maturities are less than one year in duration. Additionally, the Company holds $7.7 million in short-term investments, which are related to time deposits held with various financial institutions.
The unrealized losses from corporate issuers were caused by interest rate increases. At December 31, 2019, the Company had 10 securities in an unrealized loss position. The corporate securities are highly rated securities with no indicators of potential impairment. Based upon the
ability and intent of the Company to hold these investments until recovery of fair value, which may be maturity, the bonds were not considered to be other-than-temporarily impaired at December 31, 2019.
Proceeds from the sales and maturity of the Company’s investment in fixed maturity securities were $17.1 million for the year ended December 31, 2018. This along with maturing time deposits yielded total cash proceeds from the sale of investments of $17.9 million in the period of January 1, 2018 to December 31, 2018. These proceeds were used to purchase an additional $9.3 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, 2018 to December 31, 2018 were insignificant.
At December 31, 2019, investments with a fair value of approximately $4.1 million were on deposit with state insurance departments to satisfy regulatory requirements.
Depreciation and amortization expense for fixed assets amounted to $23.4 million in 2019, $22.8 million in 2018 and $22.7 million in 2017.
The Lease liability is the current portion of the Operating lease liabilities as reflected in the Consolidated Balance Sheets as of December 31, 2019. The accrued rent previously deferred under Topic 840 was reclassified to Operating lease assets upon the adoption of Topic 842 as described in Note 1 “Summary of Significant Accounting Policies”.
On September 18, 2014, the Company issued $500.0 million of 4.200% unsecured Senior Notes due in 2024. The Senior Notes were given investment grade ratings of BBB-/Baa3 with a stable outlook. The notes are subject to certain covenant restrictions and regulations which are customary for credit rated obligations. At the time of funding, the proceeds were offered at a discount of the original note amount which also
On December 21, 2018, the Company entered into a term loan credit agreement (the “Term Loan Credit Agreement”) with the lenders named therein, Wells Fargo Bank, National Association, as administrative agent, and certain other banks as co-syndication agents and as joint lead arrangers and joint bookrunners. 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 rates of interest charged on the term loan are 1.000% to 1.750%, above the adjusted 1-Month LIBOR rate. On December 21, 2018, the Company borrowed $300.0 million under the Term Loan Credit Agreement and used $250.0 million of the proceeds to reduce indebtedness under the Revolving Credit Facility. As of December 31, 2019, there was an outstanding debt balance issued under the Term Loan of $285.0 million. As of December 31, 2018, there was an outstanding debt balance issued under the Term Loan of $300.0 million. Per the terms of the Term Loan Credit Agreement, a scheduled principal payment of $3.8 million is due March 31, 2020.
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 of the original note 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 the 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.
The Amended and Restated Credit Agreement and Term Loan Credit Agreement require the Company to maintain certain financial ratios and comply with certain other covenants. The Company was in compliance with all such covenants as of December 31, 2019 and December 31, 2018.
On adoption of the new Lease Standard ASC 842, the Company has recorded the 2019 lease liabilities of $46.2 million and ROU assets total $52.2 million. In 2018, the accruals and reserves total of $10.5 million includes the net deferred tax assets associated with accrued leases of $3.9 million.
At December 31, 2019, the Company had net operating loss carryforwards of $0.1 million and $39.9 million for federal and state income tax reporting purposes, respectively, portions of which expire in the years 2020 through indefinite. The federal carryforward is derived from insurance operations acquired by the Company in 2001. The state carryforward amount is derived from the operating results of certain subsidiaries and from the 2013 stock acquisition of Beecher Carlson Holdings, Inc.
The Company has granted stock to our employees in the form of Restricted Stock Awards and Performance Stock Awards under the 2010 SIP and 2019 SIP. To date, a substantial majority of stock grants to employees under these plans vest in five to ten years. The Performance Stock
Non-employee members of the Board of Directors received shares annually issued pursuant to the 2010 SIP as part of their annual compensation. A total of 22,700 shares were issued in January 2017, 26,620 shares were issued in January 2018 and 27,885 shares were issued in April 2019.
A summary of 2010 SIP and 2019 SIP activity for the years ended December 31, 2019, 2018 and 2017 is as follows:
Of the 1,014,269 shares of performance-based restricted stock granted in 2019, the payout for 501,384 shares may be increased up to 200% of the target or decreased to zero, subject to the level of performance attained. The amount reflected in the table includes all restricted stock grants at a target payout of 100%.
The following table sets forth information as of December 31, 2019, 2018 and 2017, with respect to the number of time-based restricted shares granted and awarded, the number of performance-based restricted shares granted, and the number of performance-based restricted shares awarded under our Performance Stock Plan and 2010 Stock Incentive Plan:
At December 31, 2019, 9,515,603 shares were available for future grants under the 2019 SIP. This amount is calculated assuming the maximum payout for all restricted stock grants.
Our Restricted Cash balance is composed of funds held in separate premium trust accounts as required by state law or, in some cases, per agreement with our carrier partners. The following is a reconciliation of cash and cash equivalents inclusive of restricted cash as of December 31, 2019, 2018 and 2017.
The Company’s accruals for legal matters that were probable and estimable were not material at December 31, 2019 and 2018. We continue to assess certain litigation and claims to determine the amounts, if any, that management believes will be paid as a result of such claims and litigation and, therefore, additional losses may be accrued and paid in the future, which could adversely impact the Company’s operating results, cash flows and overall liquidity. The Company maintains third-party insurance policies to provide coverage for certain legal claims, in an effort to mitigate its overall exposure to unanticipated claims or adverse decisions. However, as (i) one or more of the Company’s insurance carriers could take the position that portions of these claims are not covered by the Company’s insurance, (ii) to the extent that payments are made to resolve claims and lawsuits, applicable insurance policy limits are eroded and (iii) the claims and lawsuits relating to these matters are continuing to develop, it is possible that future results of operations or cash flows for any particular quarterly or annual period could be materially affected by unfavorable resolutions of these matters. Based upon the AM Best Company ratings of these third-party insurers, management does not believe there is a substantial risk of an insurer’s material non-performance related to any current insured claims.
Substantially all of the Company's operating lease right-of-use assets and operating lease liabilities represent real estate leases for office space used to conduct the Company's business that expire on various dates through 2043. Leases generally contain renewal options and escalation clauses based upon increases in the lessors’ operating expenses and other charges. The Company anticipates that most of these leases will be renewed or replaced upon expiration.
The Company assess at inception of a contract if it 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.
As of December 31, 2019, the Company has entered into future lease agreements expected to commence in 2020 and 2021 consisting of undiscounted lease liabilities of $5.1 million and $0.6 million, respectively.
The components of lease cost for operating leases for the 12 months ended December 31, 2019 were:
Maturities of the operating lease liabilities by fiscal year at December 31, 2019 for the Company's operating leases are as follows:
All premiums written by WNFIC under the National Flood Insurance Program are 100.0% ceded to FEMA, for which WNFIC received a 30.0% expense allowance from January 1, 2019 through September 30, 2019 and a 30.1% expense allowance from October 1, 2019 through December 31, 2019. As of December 31, 2019 and 2018, the Company ceded $694.9 million and $617.2 million of written premiums, respectively.
As of December 31, 2019, the Consolidated Balance Sheets contained Reinsurance recoverable of $58.5 million and Prepaid reinsurance premiums of $366.0 million. As of December 31, 2018, the Consolidated Balance Sheets contained reinsurance recoverable of $65.4 million and prepaid reinsurance premiums of $337.9 million. There was no net activity in the reserve for losses and loss adjustment expense for the year ended December 31, 2019, and $0.2 million net activity in the reserve for losses and loss adjustment expense for the year ended December 31, 2018, as WNFIC’s direct premiums written were 100.0% ceded to two reinsurers. The balance of the reserve for losses and loss adjustment expense, excluding related reinsurance recoverables was $58.5 million as of December 31, 2019 and $65.4 million as of December 31, 2018.
WNFIC maintains capital in excess of minimum statutory amount of $7.5 million as required by regulatory authorities. The statutory capital and surplus of WNFIC was $29.6 million as of December 31, 2019 and $19.4 million as of December 31, 2018. As of December 31, 2019 and 2018, WNFIC generated statutory net income of $8.1 million and $4.5 million, respectively. The maximum amount of ordinary dividends that WNFIC can pay to shareholders in a rolling 12 month period is limited to the greater of 10.0% of statutory adjusted capital and surplus of 100.0% of adjusted net income. There was no dividend payout in 2018 and 2019 and the maximum dividend payout that may be made in 2020 without prior approval is $8.1 million.
To the shareholders and the Board of Directors of Brown & Brown, Inc.
We have audited the accompanying consolidated balance sheets of Brown & Brown, Inc. and subsidiaries (the "Company") as of December 31, 2019 and 2018, the related consolidated statements of income, shareholders' equity, and cash flows, for each of the three years in the period ended December 31, 2019, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), 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 and our report dated February 24, 2020, expressed an unqualified opinion on the Company's internal control over financial reporting.
As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for leases on January 1, 2019, on a modified retrospective basis due to the adoption of Financial Accounting Standards Board Accounting Standards Codification 842, Leases, and related amendments.
In determining fair value of the earn-out obligation, the acquired business’s future performance is estimated using financial projections of future earnings developed by management that are discounted to a present value using a risk-adjusted rate that takes into consideration the likelihood that the forecasted earn-out obligation will be paid. The earn-out obligation balance was $161.5 million as of December 31, 2019 and the potential maximum earn-out obligation was $328.7 million. Of the total earn-out obligation balance, $17.9 million is recorded as accounts payable and $143.6 million is recorded as other non-current liability.
We read any post acquisition asset/stock purchase agreements and associated addenda modifications for any additional terms to evaluate the completeness and reasonableness of the models utilized to calculate the earn-out obligation.
We evaluated management’s ability to accurately forecast future earnings by comparing actual results to management’s historical forecast and forecasted growth rates to that of the overall industry and comparable companies.
To the shareholders and the board of directors of Brown & Brown, Inc.
The management of Brown & Brown, Inc. and its subsidiaries (“Brown & Brown”) is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Securities Exchange Act Rule 13a-15(f). Under the supervision and with the participation of management, including Brown & Brown’s principal executive officer and principal financial officer, Brown & Brown conducted an evaluation of the effectiveness of internal control over financial reporting based upon the framework in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
In conducting Brown & Brown’s evaluation of the effectiveness of its internal control over financial reporting, Brown & Brown has excluded the following acquisitions completed by Brown & Brown during 2019: 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. (collectively the “2019 Excluded Acquisitions”), which were acquired during 2019 and whose financial statements constitute approximately (0.26%) and 5.20% of net and total assets, respectively, 1.13% of revenues, and (1.39%) of net income of the consolidated financial statement amounts as of and for the year ended December 31, 2019. Refer to Note 3 to the Consolidated Financial Statements for further discussion of these acquisitions and their impact on Brown & Brown’s Consolidated Financial Statements.
Based upon Brown & Brown’s evaluation under the framework in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, management concluded that internal control over financial reporting was effective as of December 31, 2019. Management’s internal control over financial reporting as of December 31, 2019 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which is included herein.