Why did Brown & Brown's core organic growth turn negative in 2007?

Core commissions and fees fell 3.4% on a net internal basis, equal to $27.9 million of lost revenue. About $23.0 million of that came from Florida operations hurt by Citizens Property Insurance, which cut rates roughly in half starting January 2007. Another $6.2 million came from the home-building wholesale operation in Southern California. Soft premium rates in most other U.S. regions also contributed.

How much of 2007's earnings growth came from one-time items?

The $18.7 million Rock-Tenn gain and roughly $13.5 to $13.7 million of gains from selling customer accounts were non-recurring. Management stated that the customer account sales were 'not indicative of any expected trends.' Combined, these items added around $30.9 million in pre-tax gains, which is a significant portion of the $311.5 million pre-tax income, so underlying growth was lower than headline figures suggest.

What is the company's acquisition strategy and how much has it spent?

Brown & Brown acquired 278 intermediary operations from 1993 through 2007. In 2007 alone it completed 41 acquisitions for $241.4 million in aggregate purchase price, including $207.9 million in cash. Early 2008 saw another $71.1 million of acquisitions through February 29. The company also has up to $226.2 million in maximum future acquisition contingency payments, so acquisition spending is a major use of cash.

What are the main risks to future commission revenue?

Commission revenue depends on insurer premium rates, which the company does not control and which have been declining in most regions. Insurers are also moving to Guaranteed Supplemental Commissions and may reduce commission rates. Profit-sharing contingent commissions (about 5.8% of prior-year revenue) are under scrutiny from state regulators, and the company has not chosen to discontinue them. Concentration is also a risk: 74.1% of commissions and fees came from nine states, and two insurers each supplied about 5.3% of revenue.

Does the company plan to expand beyond the United States?

Yes. The 10-K states that Brown & Brown plans to expand into the United Kingdom, which would be its first operations outside the U.S., and it intends to evaluate further international opportunities. The filing notes that international expansion carries risks including staffing challenges, regulatory changes, currency-transfer restrictions, and the need for more management time and expense to reach profitability.

BRO 10-K FY2007 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed February 29, 2008. Cited figures are marked; the original filing is the authoritative source.

Brown & Brown, Inc. (NYSE: BRO) closed 2007 with total commissions and fees of $914.7 million^a (up 5.8%) and total revenues of $959.7 million (up 9.3%), while net income rose 10.8% to $191.0 million and diluted EPS reached $1.35, up from $1.22.

Headline growth, however, was flattered by acquisitions and one-time gains. The company made 41 acquisitions in 2007 with estimated annual revenues of $108.3 million^b, and it booked an $18.7 million gain on the sale of its Rock-Tenn Company stake plus $13.5 million to $13.7 million of gains from selling customer accounts. Core organic performance deteriorated sharply: the net internal growth rate of core commissions and fees was (3.4)%, the first negative year since tracking began in 1997.

Management attributed this to a soft property and casualty pricing market, Florida's state-run insurer Citizens cutting rates roughly in half, and weakness in the Southern California home-building segment. Profitability held up better than organic growth suggests. The employee compensation ratio rose modestly to 46.3%^c, while the other operating expense ratio improved to 13.7%, and the effective tax rate was 38.7%.

Operating cash flow was $215.3 million^d, and capital expenditures were $30.6 million. Shareholders' equity grew to $1.10 billion, with a book value per share of $7.80, and long-term debt was about $228 million. Management expects Citizens' 2008 rates to be similar to 2007, so the year-over-year headwind should ease, though casualty pricing pressure in Florida (rates down as much as 20%-25%) is expected to persist for at least the first half of 2008.

Brown & Brown also plans its first international expansion, into the United Kingdom. For investors, the central question is whether the acquisition-driven growth model can offset negative organic growth. Continued acquisition spending ($212.3 million in 2007, with another $71.1 million of deals closed in January and February 2008) and the company's dependence on profit-sharing contingent commissions remain key variables, along with the unresolved state investigations into broker compensation practices.

02—Key points

Key Highlights

Total commissions and fees rose 5.8% to $914.7 million, and total revenues rose 9.3% to $959.7 million, driven largely by 41 acquisitions with $108.3 million of estimated annual revenues.
Net internal (organic) growth in core commissions and fees was (3.4)%, the first negative full year since tracking began in 1997, reflecting soft pricing, Citizens' Florida rate cuts, and weakness in Southern California home-building.
Net income increased 10.8% to $191.0 million, and diluted EPS rose 10.7% to $1.35, helped by an $18.7 million gain on the sale of Rock-Tenn Company stock and roughly $13.7 million in gains on customer account sales.
Florida casualty rates fell as much as 20%-25% versus 2006, and Citizens' 2008 rates are expected to be similar to 2007, which should moderate the year-over-year headwind.
Operating cash flow was $215.3 million; cash used for acquisitions was $212.3 million, and dividends paid were $35.1 million (quarterly dividend raised to $0.07 in Q4 2007).
Shareholders' equity grew to $1.10 billion (book value $7.80 per share), with total assets of $1.96 billion, and long-term debt of $227.7 million; a $25 million Series D note was issued in February 2008.
Ongoing risks include state investigations into contingent commission practices, a 74.1% revenue concentration in nine states, and two insurers each contributing about 5.3% of revenues.

03—Questions

Frequently Asked Questions

Why did Brown & Brown's core organic growth turn negative in 2007?
Core commissions and fees fell 3.4% on a net internal basis, equal to $27.9 million of lost revenue. About $23.0 million of that came from Florida operations hurt by Citizens Property Insurance, which cut rates roughly in half starting January 2007. Another $6.2 million came from the home-building wholesale operation in Southern California. Soft premium rates in most other U.S. regions also contributed.
How much of 2007's earnings growth came from one-time items?
The $18.7 million Rock-Tenn gain and roughly $13.5 to $13.7 million of gains from selling customer accounts were non-recurring. Management stated that the customer account sales were 'not indicative of any expected trends.' Combined, these items added around $30.9 million in pre-tax gains, which is a significant portion of the $311.5 million pre-tax income, so underlying growth was lower than headline figures suggest.
What is the company's acquisition strategy and how much has it spent?
Brown & Brown acquired 278 intermediary operations from 1993 through 2007. In 2007 alone it completed 41 acquisitions for $241.4 million in aggregate purchase price, including $207.9 million in cash. Early 2008 saw another $71.1 million of acquisitions through February 29. The company also has up to $226.2 million in maximum future acquisition contingency payments, so acquisition spending is a major use of cash.
What are the main risks to future commission revenue?
Commission revenue depends on insurer premium rates, which the company does not control and which have been declining in most regions. Insurers are also moving to Guaranteed Supplemental Commissions and may reduce commission rates. Profit-sharing contingent commissions (about 5.8% of prior-year revenue) are under scrutiny from state regulators, and the company has not chosen to discontinue them. Concentration is also a risk: 74.1% of commissions and fees came from nine states, and two insurers each supplied about 5.3% of revenue.
Does the company plan to expand beyond the United States?
Yes. The 10-K states that Brown & Brown plans to expand into the United Kingdom, which would be its first operations outside the U.S., and it intends to evaluate further international opportunities. The filing notes that international expansion carries risks including staffing challenges, regulatory changes, currency-transfer restrictions, and the need for more management time and expense to reach profitability.

04—Continue

← View all 10-K filings