The following discussion should be read in conjunction with our Consolidated Financial Statements and the related Notes to those Financial Statements included elsewhere in this Annual Report on Form 10-K. In addition, please see “Information Regarding Non-GAAP Measures” below, regarding important information on non-GAAP financial measures contained in our discussion and analysis.
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 with the goal of consistent, sustained growth over the long-term.
(3) our Retail Segment in our large-account customer base. Fee revenues as a percentage of our total commissions and fees, represented 19.8% in 2018, 31.5% in 2017 and 31.3% in 2016.
Part of our business strategy is to attract high-quality insurance intermediaries to join our operations. From 1993 through the fourth quarter of 2018, we acquired 513 insurance intermediary operations, excluding acquired books of business (customer accounts). During the year ended December 31, 2018, the Company acquired the assets and assumed certain liabilities of twenty insurance intermediaries, all of the stock of three insurance intermediaries and one book of business (customer accounts). Collectively, these acquired businesses had annualized revenues of approximately $323.2 million.
Acquisition purchase prices are typically based upon a multiple of average 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
During the first quarter of 2018, the performance conditions for 260,344 shares of the Company’s common stock granted under the Company’s Stock Incentive Plan were determined by the Compensation Committee to have been satisfied relative to performance-based grants issued in 2013. These grants had a performance measurement period that concluded on December 31, 2017. The vesting condition for these grants requires continuous employment for a period of up to ten years from the January 2013 grant date in order for the awarded shares to become fully vested and nonforfeitable. During the third quarter of 2018, the performance conditions for 2,229,561 shares of the Company’s common stock granted under the Company’s Stock Incentive Plan were determined by the Compensation Committee to have been satisfied relative to performance-based grants issued in July 2013. These grants had a performance measurement period that concluded on June 30, 2018. The vesting condition for these grants requires continuous employment for a period of up to seven years from the July 2013 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 in diluted net income per share where the net income attributable to unvested awarded stock plans is excluded from the total net income attributable to common shares.
During the first quarter of 2019, the performance conditions for approximately 2.0 million shares of the Company’s common stock granted under the Company’s Stock Incentive Plan 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 2018, increased $152.6 million to $2,009.9 million, or 8.2% over 2017. Core commissions and fees in 2018 increased $149.3 million, of which $91.2 million represented core commissions and fees from acquisitions that had no comparable revenues in 2017; approximately $43.5 million represented net new and renewal business; approximately $16.1 million related to the impact of the adoption of the New Revenue Standard; which was offset by $1.5 million related to commissions and fees revenue from businesses divested in 2017 and 2018, which reflected an Organic Revenue growth rate of 2.4%. Profit-sharing contingent commissions and GSCs for 2018 increased by $3.3 million, or 5.2%, compared to the same period in 2017. The net increase of $3.3 million was mainly driven by an increase in profit-sharing contingent commissions and GSCs in the National Programs Segment.
Commissions and fees, including profit-sharing contingent commissions and GSCs for 2017, increased $94.5 million to $1,857.3 million, or 5.4% over 2016. Core commissions and fees in 2017 increased $97.4 million, of which approximately $27.7 million represented core commissions and fees from agencies acquired since 2016 that had no comparable revenues. After accounting for divested business of $4.9 million, the remaining net increase of $74.6 million represented net new business, which reflected an Organic Revenue growth rate of 4.4% for core commissions and fees. Profit-sharing contingent commissions and GSCs for 2017 decreased by $2.9 million, or 4.5%, compared to the same period in 2016. The net decrease of $2.9 million was mainly driven by a decrease in profit-sharing contingent commissions and GSCs in the Retail and Wholesale Brokerage Segments, as a result of increased loss ratios and lower premium rates, which was partially offset by an increase in profit-sharing contingent commissions and GSCs in the National Programs Segment.
The Company recognized gains on disposal of $2.2 million in 2018 and 2017 and $1.3 million in 2016. The change in the gain on disposal was due to activity associated with book of business sales. Although we are not in the business of selling customer accounts, we periodically sell an office or a book of business (one or more customer accounts) that we believe does not produce reasonable margins or demonstrate a potential for growth, or because doing so is in the Company’s best interest.
Depreciation expense increased $0.1 million, or 0.6%, in 2018, and increased $1.7 million, or 8.1% in 2017 as compared to 2016. These increases are due primarily to the addition of fixed assets resulting from capital projects related to our multi-year technology investment program and other business initiatives.
As of December 31, 2018, 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, 2018, 2017 and 2016 were as follows:
For the years ended December 31, 2018, 2017 and 2016, the fair value of estimated earn-out payables was re-evaluated and increased by $0.6 million, $6.9 million and $6.3 million, respectively, which resulted in charges to the Consolidated Statement of Income.
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. As of December 31, 2017, the estimated acquisition earn-out payables equaled $36.2 million, of which $25.1 million was recorded as accounts payable and $11.1 million was recorded as other non-current liability.
As discussed in Note 16 “Segment Information” of the Notes to Consolidated Financial Statements, we operate four reportable segments: Retail, National Programs, Wholesale Brokerage and Services. On a segmented basis, changes in amortization, depreciation and interest expenses generally result from activity associated with acquisitions. Likewise, other income in each segment reflects net gains primarily from legal settlements and miscellaneous income. As such, in evaluating the operational efficiency of a segment, management focuses on the Organic Revenue growth rate of core commissions and fees, the ratio of total employee compensation and benefits to total revenues, and the ratio of other operating expenses to total revenues.
The reconciliation of total commissions and fees to Organic Revenue for the year ended December 31, 2018, by Segment, are as follows:
The reconciliation of total commissions and fees, included in the Consolidated Statement of Income, to Organic Revenue for the years ended December 31, 2017 and 2016, is as follows:
The reconciliation of total commissions and fees to Organic Revenue for the year ended December 31, 2017, by Segment, are as follows:
The reconciliation of total commissions and fees, included in the Consolidated Statement of Income, to Organic Revenue for the years ended December 31, 2016 and 2015, is as follows:
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, 2017, is as follows:
The Retail Segment’s total revenues in 2018 increased 10.5%, or $99.3 million, over the same period in 2017, to $1,042.8 million. The $98.9 million increase in core commissions and fees was driven by the following: (i) approximately $73.4 million related to the core commissions and fees from acquisitions that had no comparable revenues in the same period of 2017; (ii) $28.1 million related to net new and renewal business; offset by (iii) $1.3 million related to the impact of adopting the New Revenue Standard; and (iv) a decrease of $1.3 million related to commissions and fees from businesses divested in 2017 and 2018. Profit-sharing contingent commissions and GSCs in 2018 increased 1.7%, or $0.6 million, over 2017, to $33.1 million. The Retail Segment’s growth rate for total commissions and fees was 10.6% and the Organic Revenue growth rate was 3.0% for 2018. The Organic Revenue growth rate was driven by increased new business and higher retention across most lines of business the preceding twelve months.
Income before income taxes for 2017 increased 4.6%, or $8.6 million, over the same period in 2016, to $196.6 million. The primary factors affecting this increase were: (i) the net increase in revenue as described above, which was offset by (ii) a 6.0%, or $29.2 million, increase in employee compensation and benefits, due primarily to the year-on-year impact of salary inflation, additional teammates to support revenue growth and the incremental investment in our performance incentive plan, (iii) an increase in operating expenses by $0.8 million, or 0.5%, primarily due to our multi-year technology investment program and increased value-added consulting services to support our customers; offset by (iv) a reduction in the change in estimated acquisition earn-out payables of $2.2 million, or 21.1%, to $8.1 million, and (v) a combined decrease in amortization, depreciation and intercompany interest expense of $9.3 million.
The National Programs Segment manages over 40 programs supported by approximately one hundred 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 are generally distributed through a nationwide network of independent agents and Brown & Brown retail agents, and offer targeted products and services designed for specific industries, trade groups, professions, public entities and market niches. 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.
acquisitions, strong growth in our earthquake programs, increased profit-sharing contingent commissions and a non-recurring adjustment of approximately $8.0 million relating to the New Revenue Standard with an offset for the lower weather-related claims revenue. The Organic Revenue growth rate decline was driven substantially by lower flood claims revenue as compared to the prior year.
EBITDAC for 2018 decreased 2.2%, or $4.0 million, from the same period in 2017, to $175.9 million. EBITDAC Margin for 2018 decreased to 35.6% from 37.5% in the same period in 2017. The decrease in EBITDAC Margin was related to (i) increased employee compensation and benefits primarily driven by the investment in our core commercial program; (ii) a decrease in weather-related claims revenue compared to the prior year which has a margin higher than the average margin of the National Programs Segment; partially offset by (iii) the total revenue growth.
The National Programs Segment’s growth rate for total commissions and fees was 7.0% and the Organic Revenue growth rate was 6.1% for 2017. This Organic Revenue growth rate was mainly due to increased flood claims revenues and our new core commercial program with QBE. Growth in these businesses was partially offset by certain programs that have been affected by certain carriers changing their risk appetite for new or existing programs or lower premium rates for certain lines of business.
Income before income taxes for 2017 increased 19.8%, or $18.2 million, from the same period in 2016, to $110.0 million. The increase was the result of a lower intercompany interest charge of $10.2 million, along with leveraging revenue growth of $31.3 million.
The Wholesale Brokerage Segment’s total revenues for 2018 increased 5.6%, or $15.3 million, over 2017, to $287.0 million. The $16.3 million increase in core commissions and fees was driven by the following: (i) $14.9 million related to net new and renewal business; (ii) $2.5 million related to the core commissions and fees from acquisitions that had no comparable revenues in 2017; which was offset by (iii) a decrease of $0.9 million related to the impact of adopting the New Revenue Standard; and (iv) a decrease of $0.1 million related to commissions and fees recorded in 2017 from businesses since divested. Profit-sharing contingent commissions and GSCs for 2018 decreased $1.1 million over 2017, to $8.8 million. This decrease was driven by higher loss ratios experienced for several carriers due to losses associated with 2017 weather-related events. The Wholesale Brokerage Segment’s growth rate for total commissions and fees was 5.6%, and the Organic Revenue growth rate was 5.7% for 2018. The Organic Revenue growth rate was driven by net new business and modest increases in exposure units that were partially offset by slightly decreasing rates.
million increase in operating expenses, primarily related to intercompany technology charges that had no comparable expenses in the same period of 2017.
The Wholesale Brokerage Segment’s total revenues for 2017 increased 11.8%, or $28.6 million, over 2016, to $271.7 million. The $31.6 million net increase in core commissions and fees was driven by the following: (i) $16.5 million related to the core commissions and fees from acquisitions that had no comparable revenues in 2016; and (ii) $15.1 million related to net new business. Profit-sharing contingent commissions and GSCs for 2017 decreased $3.2 million over 2016, to $9.9 million. This decrease was driven by higher loss ratios experienced for several carriers, and partially offset by profit-sharing contingent commissions received from acquisitions that had no comparable profit-sharing contingent commissions in 2016. The Wholesale Brokerage Segment’s growth rate for total commissions and fees was 11.7%, and the Organic Revenue growth rate was 6.6% for 2017, which were driven by net new business and modest increases in exposure units that were partially offset by significant contraction in insurance premium rates for catastrophe-prone properties during the first half of the year, which moderated in the latter part of the year.
Income before income taxes for 2017, increased 9.9%, or $6.2 million, over 2016, to $68.8 million, primarily due to the following: (i) the net increase in revenue as described above, offset by (ii) an increase in employee compensation and benefits of $16.4 million, of which $10.4 million was related to acquisitions that had no comparable compensation and benefits in the same period of 2016, with the remainder related to additional teammates to support increased transaction volumes and compensation increases for existing teammates, (iii) a decrease in profit from lower profit-sharing contingent commissions and GSCs, (iv) a net $2.5 million increase in operating expenses, of which $3.1 million was related to acquisitions that had no comparable expenses in the same period of 2016 and (v) higher intercompany interest charges related to acquisitions completed in the previous year.
EBITDAC for 2017 increased 12.2%, or $9.7 million, from the same period in 2016, to $88.8 million. EBITDAC Margin for 2017 increased to 32.7% from 32.5% in the same period in 2016. The increase in EBITDAC Margin was primarily driven by: (i) growth of core commissions and fees of 13.7%; and (ii) improving the EBITDAC Margin of a business acquired in 2016, which were partially offset by (iii) the net decrease in profit-sharing contingent commissions as a result of higher loss ratios.
The Services Segment’s total revenues for 2018 increased 14.4%, or $23.9 million, over 2017, to $189.2 million. The $24.0 million increase in core commissions and fees was driven primarily by the following: (i) $10.3 million related to the impact of adopting the New Revenue Standard; (ii) $8.0 million related to the core commissions and fees from acquisitions that had no comparable revenues in the same period of 2017; and (iii) $5.7 million related to net new and renewal business. The Services Segment’s growth rate for total commissions and fees was 14.5%, and the Organic Revenue growth rate was 3.4% for 2018. The Organic Revenue growth rate was driven by growth across multiple businesses.
Income before income taxes for 2018 increased 13.1%, or $4.0 million, over 2017, to $34.5 million due to a combination of: (i) Organic Revenue growth; and (ii) lower intercompany interest charges, which were partially offset by (iii) the growth in other operating expenses associated with the New Revenue Standard and professional fees to support Organic Revenue growth.
Income before income taxes for 2017 increased 25.3%, or $6.2 million, over 2016, to $30.5 million due to a combination of: (i) new business realized across most of our businesses, (ii) our claims offices that handled catastrophe claims, (iii) the continued efficient operation of our businesses, and (iv) lower intercompany interest charges.
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 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.
We hold approximately $19.8 million in cash outside of the U.S., which we currently have no plans to repatriate in the near future.
Our ratio of current assets to current liabilities (the “current ratio”) was 1.22 and 1.13 at December 31, 2018 and 2017, respectively.
Total debt at December 31, 2018 was $1,507.0 million net of unamortized discount and debt issuance costs, which was an increase of $530.8 million compared to December 31, 2017. The increase reflects the addition of $650.0 million in principal balances, total debt repayments of $120.0 million, net of the amortization of discounted debt related to our Senior Notes due 2024, with a fixed interest rate of 4.200% per year and debt issuance cost amortization of $1.6 million. The Company also added $0.8 million in debt issuance costs related to the Term Loan Credit Agreement (as defined below) that was executed in December 2018.
See accompanying notes to Consolidated Financial Statements. Refer to Note 13 for reconciliation of cash and cash equivalents inclusive of restricted cash.
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 services organization that markets and sells to its customers, 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 entities, professional and individual customers; the National Programs Segment, acting 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 insurance, primarily through a nationwide network of independent agents and brokers, as well as Brown & Brown Retail offices; and 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 November 2016, the Financial Accountings Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-18, “Statement of Cash Flows (Topic 230)”: Restricted Cash (“ASU 2016-18”), which requires that the Statement of Cash Flows explain the changes during the period of cash and cash equivalents inclusive of amounts categorized as restricted cash. ASU 2016-18 is effective for periods beginning after December 15, 2017. However, the Company elected to early adopt for the reporting period beginning January 1, 2017 under the full retrospective approach for all periods presented. With the adoption of ASU 2016-18, the change in restricted cash is no longer reflected as a change in operating assets and liabilities, and the Statement of Cash Flows details the changes in the balance of cash and cash equivalents inclusive of restricted cash. Net cash provided by operating activities for the year ended December 31, 2016 were previously reported as $375.2 million. With the retrospective adoption, the net cash provided by operating activities for the year ended December 31, 2016 is now reported as $411.0 million. The Company reflects cash collected from customers that is payable to insurance companies as restricted cash if segregation of this cash is required by the state of domicile for the office conducting this transaction or if required by contract with the relevant insurance company providing coverage. Cash collected from customers that is payable to insurance companies is reported in cash and cash equivalents if no such restriction is required.
The following areas are impacted by the adoption of Topic 606:
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 client, 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 twelve months. For the year ended December 31, 2018, the adoption of Topic 606 increased base and incentive commissions
Fee revenues - The Company earns fee revenue related to services other than securing insurance coverage, which are predominantly in the Company’s National Programs and Services Segments, and to a lesser extent in the large accounts businesses within the Company’s Retail Segment, where the Company receives negotiated fees in lieu of a commission. In accordance with Topic 606, fee revenue from fee agreements are recognized in earlier periods and others in later periods as compared to our previous accounting treatment depending on when the services within the contract are satisfied and when we have transferred control of the related services to the customer. The overall impact of these changes is not significant on a full-year basis, but the timing of recognizing fees revenue will impact our fiscal quarters when compared to prior years. For the year ended December 31, 2018, the adoption of Topic 606 increased fees revenue by $6.2 million compared to what would have been recognized under our previous accounting policies, including a one-time $10.5 million increase for revenues within our Services Segment. Excluding this increase, fee revenues would have decreased by $4.3 million.
Management determines the policy cancellation reserve based upon historical cancellation experience adjusted for any known circumstances.
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 Sheet. Realized gains and losses are reported on the Consolidated Statement of Income, with the cost of securities sold determined on a specific identification basis.
Amortizable intangible assets are stated at cost, less accumulated amortization, and consist of purchased customer accounts and non-compete 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. Purchased customer accounts primarily consist of records and files that contain information about insurance policies and the related insured parties that are essential to policy renewals.
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, 2018 and determined that the fair value of goodwill significantly exceeded the carrying value of such assets. In addition, as of December 31, 2018, there are no accumulated impairment losses.
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 2016 and 2017 reflect 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, 2018 and 2017, 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, 2018 and 2017 as our fixed-rate borrowings of $499.1 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 $1,015.0 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.
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.
Other income consists primarily of legal settlements and other miscellaneous income.
The balances of contract assets and contract liabilities arising from contracts with customers as of December 31, 2018 and 2017 were as follows:
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 to be recognized beyond one year. As of December 31, 2017, deferred revenue consisted of $44.5 million as current portion to be recognized within one year and $6.7 million in long-term deferred revenue to be recognized beyond one year.
During the twelve months ended December 31, 2018, the amount of revenue recognized related to performance obligations satisfied in a previous period, inclusive of changes due to estimates, was approximately $8.9 million.
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, 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. These measurement period adjustments have been reflected as current period adjustments for the year ended December 31, 2018 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 $934.9 million and $41.5 million in the years ended December 31, 2018 and 2017, respectively. We completed twenty-three acquisitions (excluding book of business purchases) during the year ended December 31, 2018. We completed eleven acquisitions (excluding book of business purchases) during the year ended December 31, 2017.
The following table summarizes the purchase price allocations made as of the date of each acquisition for current year acquisitions and adjustments made during the measurement period for prior year acquisitions. During the measurement periods, the Company will adjust assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date. These adjustments are made in the period in which the amounts are determined and the current period income effect of such adjustments will be calculated as if the adjustments had been completed as of the acquisition date.
The following table summarizes the estimated fair values of the aggregate assets and liabilities acquired as of the date of each acquisition and adjustments made during the measurement period of the prior year acquisitions.
During the year ended December 31, 2017, the Company acquired the assets and assumed certain liabilities of eleven 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 twelve months as permitted by ASC 805. Such adjustments are presented in the “Other” category within the following two tables.
The following table summarizes the estimated fair values of the aggregate assets and liabilities acquired as of the date of each acquisition.
For the acquisitions completed during 2017, 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, 2017 included in the Consolidated Statement of Income for the year ended December 31, 2017 were $7.8 million. The income before income taxes, including the intercompany cost of capital charge, from the acquisitions completed through December 31, 2017 included in the Consolidated Statement of Income for the year ended December 31, 2017 was $2.4 million. 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.
During the year ended December 31, 2016, the Company acquired the assets and assumed certain liabilities of seven insurance intermediaries, all of the stock of one insurance intermediary and three books of business (customer accounts). Additionally, miscellaneous adjustments were recorded to the purchase price allocation of certain prior acquisitions completed within the last twelve months as permitted by ASC 805. Such adjustments are presented in the “Other” category within the following two tables.
As of December 31, 2018, the maximum future contingency payments related to all acquisitions totaled $198.6 million, all of which relates to acquisitions consummated subsequent to January 1, 2009.
As of December 31, 2018, 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, 2018, 2017 and 2016 were as follows:
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 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 $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. Of the $63.8 million of estimated acquisition earn-out payables as of December 31, 2016, $31.8 million was recorded as accounts payable, and $32.0 million was recorded as other non-current liabilities.
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, 2018:
The amortized cost and estimated fair value of the fixed maturity securities at December 31, 2018 by contractual maturity are set forth below:
Proceeds from the sales and maturity of the Company’s investment in fixed maturity securities were $5.8 million for the year ended December 31, 2017. This along with maturing time deposits yielded total cash proceeds from the sale of investments of $9.6 million in the period of January 1, 2017 to December 31, 2017. These proceeds were used to purchase additional fixed- maturity securities. The gains and losses realized on those sales for the period from January 1, 2017 to December 31, 2017 were insignificant.
At December 31, 2018, 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 $22.8 million in 2018, $22.7 million in 2017 and $21.0 million in 2016.
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 1.00% to 1.75%, 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 Company’s Amended and Restated Credit Agreement, dated June 28, 2017, 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 “Revolving Credit Facility”). As of December 31, 2018, there was an outstanding debt balance issued under the term loan of the Term Loan Credit Agreement 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, 2019.
The Master Agreement, Amended and Restated Credit Agreement and the 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, 2018 and 2017.
The 30-day Adjusted LIBOR Rate for the term loan and Revolving Credit Facility of the Amended and Restated Credit Agreement and Term Loan Credit Agreement as of December 31, 2018 was 2.563%, 2.288%, and 2.500%, respectively.
Interest paid in 2018, 2017 and 2016 was $38.0 million, $36.2 million, and $37.7 million, respectively.
At December 31, 2018, maturities of long-term debt were $50.0 million in 2019, $55.0 million in 2020, $70.0 million in 2021, $630.0 million in 2022, $210.0 million in 2023 and $500.0 million in 2024.
Significant components of the Company’s net deferred tax liabilities as of December 31 are as follows:
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of December 31, 2018, 2017 and 2016 the Company had $197,205, $228,608 and $86,191 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 $1.6 million as of December 31, 2018, $1.7 million as of December 31, 2017 and $0.8 million as of December 31, 2016. The Company does not expect its unrecognized tax benefits to change significantly over the next 12 months.
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 2018, $19.6 million in 2017 and $19.3 million in 2016.
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 “SIP”).
On April 28, 2010, the shareholders of the Company, Inc. approved the Stock Incentive Plan (“SIP”) that provides for the granting of stock options, stock, restricted stock units, and/or stock appreciation rights to employees and directors contingent on criteria established by the Compensation Committee of the Company’s Board of Directors. The principal purpose of the SIP is to attract, incentivize and retain key employees by offering those persons an opportunity to acquire or increase a direct proprietary interest in the Company’s operations and future success. The SIP includes a sub-plan applicable to Decus Insurance Brokers Limited (“Decus”) which, is a subsidiary of Decus Holdings (U.K.) Limited. The shares of stock reserved for issuance under the SIP are any shares that are authorized for issuance under the PSP and not already subject to grants under the PSP, and that were outstanding as of April 28, 2010, the date of suspension of the PSP, together with PSP shares and SIP shares forfeited after that date. As of April 28, 2010, 12,093,536 shares were available for issuance under the PSP, which were then transferred to the SIP. In addition, in May 2016 and May 2017 our shareholders approved amendments to the SIP to increase the shares available for issuance by an additional 2,400,000 and 2,600,000, respectively.
Non-employee members of the Board of Directors received shares annually issued pursuant to the SIP as part of their annual compensation. A total of 33,720 shares were issued in January 2016, 22,700 shares were issued in January 2017 and 26,620 shares were issued in January 2018.
The Company uses the closing stock price on the day prior to the grant date to determine the fair value of SIP grants 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.
Of the 1,151,578 shares of performance-based restricted stock granted in 2017, the payout for 641,652 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%.
Of the 1,578,892 shares of performance-based restricted stock granted in 2016, the payout for 706,264 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 Company has a shareholder-approved Employee Stock Purchase Plan (“ESPP”) with a total of 34,000,000 authorized shares of which 7,316,901 were available for future subscriptions as of December 31, 2018. 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 2018 was $5.88. The fair values of an ESPP share option as of the Subscription Periods beginning in August 2017 and 2016, were $4.32 and $3.81, respectively.
For the ESPP plan years ended July 31, 2018, 2017 and 2016, the Company issued 985,601, 1,058,024 and 1,029,330 shares of common stock, respectively. These shares were issued at an aggregate purchase price of $18.7 million, or $18.96 per share, in 2018, $16.4 million, or $15.52 per share, in 2017, and $15.0 million, or $14.62 per share, in 2016.
For the five months ended December 31, 2018, 2017 and 2016 (portions of the 2018-2019, 2017-2018 and 2016-2017 plan years), 402,349, 435,027 and 494,046 shares of common stock (from authorized but unissued shares), respectively, were subscribed to by ESPP participants for proceeds of approximately $9.9 million, $8.2 million and $7.7 million, respectively.
As of December 31, 2018, the Company estimates there to be $97.1 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 3.29 years.
The Company’s cash paid during the period for interest and income taxes are summarized as follows:
Our Restricted Cash balance is comprised 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, 2018, 2017 and 2016.
The Company leases facilities and certain items of office equipment under non-cancelable operating lease arrangements expiring on various dates through 2042. The facility 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. At December 31, 2018, the aggregate future minimum lease payments under all non-cancelable lease agreements were as follows:
Rental expense in 2018, 2017 and 2016 for operating leases totaled $54.6 million, $51.0 million and $49.3 million, respectively.
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, (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.
All premiums written by WNFIC under the National Flood Insurance Program are 100% ceded to FEMA, for which WNFIC received a 30.9% expense allowance from January 1, 2018 through September 30, 2018. From October 1, 2018 through December 31, 2018 WNFIC received a 30.0% expense allowance. As of December 31, 2018 and 2017, the Company ceded $617.2 million and $602.9 million of written premiums, respectively.
Effective April 1, 2014, WNFIC is also a party to a quota share agreement whereby it cedes 100% of its gross private excess flood premiums, excluding fees, to Arch Reinsurance Company and receives a 30.5% commission. WNFIC ceded $2.0 million and $1.7 million for the years ended December 31, 2018 and 2017. As of December 31, 2018, WNFIC had $2.3 million in paid excess flood losses, $99,349 in loss adjustment expenses, case reserves of $0 and incurred but not reported of $0.1 million.
WNFIC also ceded 100%, of the Homeowners, Private Passenger Auto Liability, and Other Liability Occurrence to Stillwater Insurance Company, formerly known as Fidelity National Insurance Company. This business is in runoff. Therefore, only loss data still exists on this business. As of December 31, 2018, no ceded unpaid losses and loss adjustment expenses or incurred but not reported balance for Homeowners, Private Passenger Auto Liability and Other Liability Occurrence.
As of December 31, 2018, the Consolidated Balance Sheet contained Reinsurance recoverable of $65.4 million and Prepaid reinsurance premiums of $337.9 million. As of December 31, 2017, the Consolidated Balance Sheet contained reinsurance recoverable of $477.8 million and prepaid reinsurance premiums of $321.0 million. There was $0.2 million net activity in the reserve for losses and loss adjustment expense for the year ended December 31, 2018, and $1.1 million net activity in the reserve for losses and loss adjustment expense for the year ended December 31, 2017, as WNFIC’s direct premiums written were 100% ceded to two reinsurers. The balance of the reserve for losses and loss adjustment expense, excluding related reinsurance recoverables was $65.4 million as of December 31, 2018 and $477.8 million as of December 31, 2017.
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 $19.4 million as of December 31, 2018 and $28.7 million as of December 31, 2017. As of December 31, 2018 and 2017, WNFIC generated statutory net income of $4.5 million and $4.8 million, respectively.
On March 28, 2018, we effected a 2-for-1 stock split (the “Stock Split”). As a result of the Stock Split, every share of common stock outstanding as of close of business on March 14, 2018 received an additional share of common stock, increasing the number of outstanding shares of common stock from approximately 138 million shares to approximately 276 million shares. The number of authorized shares of our common stock increased from 280 million shares to 560 million shares. No fractional shares were issued in connection with the Stock Split. Par value of the Company’s common stock was unchanged as a result of the Stock Split remaining at $0.10 per share. The number of shares of common stock reserved or subject to outstanding grants, the exercise or purchase prices applicable to such outstanding grants and
subscriptions, and certain grant limitations under our 1990 Employee Stock Purchase Plan, Performance Stock Plan and 2010 Stock Incentive Plan were adjusted as a result of the Stock Split, as required under the terms of those plans. Treasury shares were not adjusted for the Stock Split. All other shares and per share data included within this Annual Report on Form 10-K, including our Consolidated Financial Statements and related footnotes, have been adjusted to account for the effect of the Stock Split.
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, 2018 and 2017, the related consolidated statements of income, shareholders' equity, and cash flows, for each of the three years in the period ended December 31, 2018, 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, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.