How much of Brown & Brown's 2006 growth came from organic versus acquired business?

Core commissions and fees grew 11.6% in total, but only 4.0% after removing acquisition revenue, so the bulk of growth came from acquisitions. Total commissions and fees rose 11.5% including $41.0M of profit-sharing contingent commissions. The Retail Division's internal growth was just 2.5%, while National Programs grew 8.9% and Wholesale Brokerage 3.9%.

Is Brown & Brown's profit-sharing contingent commission income reliable?

Not fully. These commissions depend on insurer loss ratios and are received mainly in the first and second quarters, so they are hard to forecast. The 10-K also notes that two national carriers are moving to fixed-based methods, and that regulatory investigations could reduce or end these payments. The company has chosen not to discontinue receiving them.

What legal and regulatory risks does the company face?

Brown & Brown is a defendant in consolidated antitrust class actions in New Jersey involving contingent commissions and bid-rigging allegations, and a shareholder demand letter has been received. Governmental inquiries are ongoing in about 20 states. The company settled with Florida agencies in December 2006 for $5.8M total, with no fines or prohibition on profit-sharing. Management says it cannot estimate the range of possible loss in the antitrust matters.

How strong is the balance sheet and how is cash being deployed?

Shareholders' equity increased to $929.3M and the current ratio is 1.10. Long-term debt is $226.3M, and the company was in compliance with its covenants. Cash went to acquisitions and dividends, and the company repaid $87.4M of debt. A $200M shelf facility and about $90M of the universal shelf registration remain available, giving management flexibility to fund further acquisitions.

What should investors watch for in 2007?

Key items include the expected sharp decline in FIU revenue after Florida regulatory changes, the pace of organic growth in a softening premium-rate environment, the outcome of the antitrust litigation, and whether profit-sharing commission structures change under new carrier methodologies. The company also plans to sell its remaining 284,970 Rock-Tenn shares, worth about $9.9M, which could produce further gains.

BRO 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 1, 2007. Cited figures are marked; the original filing is the authoritative source.

Brown & Brown, Inc. (NYSE: BRO) closed fiscal 2006 with record results: total revenues rose 11.7% to $878.0 million^a, net income grew 14.5% to $172.4 million, and diluted EPS reached $1.22 versus $1.08 in 2005.

Growth was driven by a mix of net new business, acquisitions (32 agency operations acquired in 2006 with about $56.4 million^b of annualized revenue), and profit-sharing contingent commissions, which rose 17.4% to $41.0 million. Core commissions and fees grew an internal 4.0%, a modest organic rate that management attributes to softening premium rates in most U.S. regions, partly offset by coastal property rate increases in the Southeast. Margin discipline held up: the pre-tax margin was about 31.9%, and employee compensation fell to 46.1% of revenue from 47.7%.

The balance sheet strengthened, with shareholders' equity up 21.6% to $929.3 million^c, though goodwill and intangibles now make up roughly 60% of total assets. Operating cash flow was $225.2 million, funding $143.7 million of acquisitions and $29.3 million of dividends, and the company repaid $87.4 million of debt. Management reports a current ratio of 1.10 and says liquidity is sufficient through at least 2007.

The company also placed $25 million^d of new 5.66% Series C senior notes and reduced its revolver commitment from $75 million to $20 million. Key risks for investors include the cyclical, hard-to-forecast nature of commission revenue; regulatory scrutiny of contingent commissions and related antitrust class actions, which management says cannot yet be estimated; geographic concentration, with about 71% of commissions and fees from eight states; and reliance on two insurance carriers for roughly 10% of total revenue. Florida's early-2007 regulatory changes are expected to substantially reduce FIU (condominium program) revenue in 2007.

02—Key points

Key Highlights

Total revenues up 11.7% to $878.0M; net income up 14.5% to $172.4M; diluted EPS $1.22 (vs. $1.08 in 2005)
Internal core commissions and fees growth of only 4.0%, with acquisitions (32 agencies, ~$56.4M annualized revenue) supplying much of the top-line growth
Profit-sharing contingent commissions rose 17.4% to $41.0M, though these are volatile and under regulatory pressure
Employee compensation ratio improved to 46.1% of revenue (47.7% in 2005); return on beginning equity was 23%
Operating cash flow of $225.2M funded $143.7M of acquisitions and $29.3M of dividends; $87.4M of debt was repaid
Goodwill and intangibles exceed $1.08B, about 60% of total assets, creating impairment and amortization sensitivity
Concentration risk: about 71% of commissions and fees from eight states; two carriers contribute about 10% of total revenue; FIU revenue expected to fall sharply in 2007 after Florida changes

03—Questions

Frequently Asked Questions

How much of Brown & Brown's 2006 growth came from organic versus acquired business?
Core commissions and fees grew 11.6% in total, but only 4.0% after removing acquisition revenue, so the bulk of growth came from acquisitions. Total commissions and fees rose 11.5% including $41.0M of profit-sharing contingent commissions. The Retail Division's internal growth was just 2.5%, while National Programs grew 8.9% and Wholesale Brokerage 3.9%.
Is Brown & Brown's profit-sharing contingent commission income reliable?
Not fully. These commissions depend on insurer loss ratios and are received mainly in the first and second quarters, so they are hard to forecast. The 10-K also notes that two national carriers are moving to fixed-based methods, and that regulatory investigations could reduce or end these payments. The company has chosen not to discontinue receiving them.
What legal and regulatory risks does the company face?
Brown & Brown is a defendant in consolidated antitrust class actions in New Jersey involving contingent commissions and bid-rigging allegations, and a shareholder demand letter has been received. Governmental inquiries are ongoing in about 20 states. The company settled with Florida agencies in December 2006 for $5.8M total, with no fines or prohibition on profit-sharing. Management says it cannot estimate the range of possible loss in the antitrust matters.
How strong is the balance sheet and how is cash being deployed?
Shareholders' equity increased to $929.3M and the current ratio is 1.10. Long-term debt is $226.3M, and the company was in compliance with its covenants. Cash went to acquisitions and dividends, and the company repaid $87.4M of debt. A $200M shelf facility and about $90M of the universal shelf registration remain available, giving management flexibility to fund further acquisitions.
What should investors watch for in 2007?
Key items include the expected sharp decline in FIU revenue after Florida regulatory changes, the pace of organic growth in a softening premium-rate environment, the outcome of the antitrust litigation, and whether profit-sharing commission structures change under new carrier methodologies. The company also plans to sell its remaining 284,970 Rock-Tenn shares, worth about $9.9M, which could produce further gains.

04—Continue

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