Why did Brown & Brown's organic revenue decline in 2007 despite strong reported growth?

Core commissions and fees fell 3.4% on an internal basis, a $27.9 million net loss. About $23.0 million of that came from Florida operations hit by Citizens Property Insurance, which the state required to cut rates roughly in half beginning in January 2007, and $6.2 million came from a southern California home-building program. Reported growth was driven by acquisitions rather than same-store performance.

How much of 2007 earnings came from one-time or non-recurring items?

The filing identifies an $18.7 million pre-tax gain on the sale of the Rock-Tenn investment and about $13.5 million to $13.7 million of gains from selling customer accounts (books of business). Together these are roughly $32 million pre-tax, about $30.9 million on a cash flow statement basis. Management says these gains are not indicative of future trends.

What is management's outlook for Florida and the company's pricing environment in 2008?

Management expects Citizens' 2008 rates to be similar to 2007 levels, which should make the year-over-year impact less severe. Florida casualty rates, which fell as much as 20% to 25% compared with 2006, are expected to remain competitive for at least the first half of 2008. The company also noted that Citizens' rates are guaranteed through January 1, 2009.

What regulatory and legal risks could affect the company's profit-sharing commissions?

Multiple state attorneys general and insurance departments are investigating compensation practices, and a derivative demand was previously received. The Florida matter was settled for $5.8 million with no admission of wrongdoing or prohibition on profit-sharing. Management says it cannot predict the outcome of ongoing inquiries and that adverse resolutions could reduce profit-sharing contingent commissions, which averaged about 5.8% of prior-year commissions and fees.

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

01—Abstract

Summary

Summary of the 10-K/A filed March 20, 2008. Cited figures are marked; the original filing is the authoritative source.

Brown & Brown, Inc. (NYSE: BRO) closed 2007 with total revenues of $959.7 million^a (up 9.3%) and net income of $191.0 million (up 10.8%), with diluted EPS of $1.35 versus $1.22 in 2006.

Growth was almost entirely acquisition-driven: the company completed 41 acquisitions with roughly $108.3 million^b of estimated annual revenue, while core commissions and fees fell 3.4% on an internal basis, the first negative internal growth year since the company began tracking it in 1997. The decline was concentrated in Florida, where state-backed Citizens Property Insurance cut rates roughly in half and captured market share, and in the home-building-exposed wholesale operations in southern California. Reported earnings were also flattered by one-time items, including an $18.7 million gain on the sale of its Rock-Tenn stake and $13.5 million (per the MD&A, $13.7 million in the Retail discussion) from sales of customer accounts.

Balance sheet and cash flow remain solid. Operating cash flow was $215.3 million^c, funding $212.3 million of acquisitions and $35.1 million of dividends, and goodwill and intangibles together reached roughly $1.29 billion of the $1.96 billion asset base, so future impairment risk is a relevant consideration. Management guides that Citizens' 2008 rates will be similar to 2007 and that competitive Florida casualty pricing (down as much as 20-25%) will persist into at least the first half of 2008.

Investors should weigh the strong acquisition-led compounding record against the organic growth slowdown and the concentration of revenue in a few states and two insurance carriers, which together account for roughly 10.6%^d of total revenues. The filing also flags ongoing state investigations into contingent commission practices and an unresolved derivative demand. Management states that no material liability is expected, but it acknowledges that outcomes could affect profit-sharing contingent commissions, which represented about 5.8% of prior-year revenues on average over the last three years.

02—Key points

Key Highlights

Total revenues rose 9.3% to $959.7 million and net income rose 10.8% to $191.0 million; diluted EPS was $1.35, up from $1.22.
Core commissions and fees posted a net internal growth rate of (3.4)%, the first negative year since internal growth tracking began in 1997, driven by Florida Citizens competition and weakness in California home-building programs.
Acquisition spending was heavy: 41 acquisitions in 2007 with about $108.3 million of estimated annual revenue, and $212.3 million of cash paid for acquisitions.
Reported 2007 results include one-time gains of $18.7 million from the sale of Rock-Tenn stock and about $13.5 million to $13.7 million from sales of customer accounts, which management says are not indicative of future trends.
Operating cash flow was $215.3 million, and the company paid $35.1 million in dividends; the Board has signaled continued quarterly dividends, with the 2007 quarterly rate raised to $0.07 in Q4.
Concentration risk is significant: about 74.1% of commissions and fees come from nine states, and two insurers each contribute about 5.3% of total revenues.
Goodwill of $846.4 million and amortizable intangibles of $443.2 million make up a large share of total assets, leaving the balance sheet sensitive to any future impairment or slowdown in acquired-business performance.

03—Questions

Frequently Asked Questions

Why did Brown & Brown's organic revenue decline in 2007 despite strong reported growth?
Core commissions and fees fell 3.4% on an internal basis, a $27.9 million net loss. About $23.0 million of that came from Florida operations hit by Citizens Property Insurance, which the state required to cut rates roughly in half beginning in January 2007, and $6.2 million came from a southern California home-building program. Reported growth was driven by acquisitions rather than same-store performance.
How much of 2007 earnings came from one-time or non-recurring items?
The filing identifies an $18.7 million pre-tax gain on the sale of the Rock-Tenn investment and about $13.5 million to $13.7 million of gains from selling customer accounts (books of business). Together these are roughly $32 million pre-tax, about $30.9 million on a cash flow statement basis. Management says these gains are not indicative of future trends.
What is management's outlook for Florida and the company's pricing environment in 2008?
Management expects Citizens' 2008 rates to be similar to 2007 levels, which should make the year-over-year impact less severe. Florida casualty rates, which fell as much as 20% to 25% compared with 2006, are expected to remain competitive for at least the first half of 2008. The company also noted that Citizens' rates are guaranteed through January 1, 2009.
What regulatory and legal risks could affect the company's profit-sharing commissions?
Multiple state attorneys general and insurance departments are investigating compensation practices, and a derivative demand was previously received. The Florida matter was settled for $5.8 million with no admission of wrongdoing or prohibition on profit-sharing. Management says it cannot predict the outcome of ongoing inquiries and that adverse resolutions could reduce profit-sharing contingent commissions, which averaged about 5.8% of prior-year commissions and fees.

04—Continue

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