filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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General
The following discussion should be read in conjunction with our Consolidated Financial Statements and the related Notes to those Consolidated Financial Statements included elsewhere in this Annual Report.
We are a diversified insurance agency, wholesale brokerage, insurance programs and services organization headquartered in Daytona Beach and Tampa, Florida. As an insurance intermediary, our principal sources of revenue are commissions paid by insurance companies and, to a lesser extent, fees paid directly by customers. Commission revenues generally represent a percentage of the premium paid by an insured and are materially affected by fluctuations in both premium rate levels charged by insurance companies and the insureds’ underlying “insurable exposure units,” which are units that insurance companies use to measure or express insurance exposed to risk (such as property values, sales and payroll levels) to determine what premium to charge the insured. Insurance companies establish these premium rates based upon many factors, including reinsurance rates paid by such insurance companies, none of which we control.
The volume of business from new and existing customers, fluctuations in insurable exposure units and changes in general economic and competitive conditions all affect our revenues. For example, level rates of inflation or a continuing general decline in economic activity could limit increases in the values of insurable exposure units. Conversely, the increasing costs of litigation settlements and awards have caused some customers to seek higher levels of insurance coverage. Historically, our revenues have typically grown as a result of an intense focus on net new business growth and acquisitions.
We foster a strong, decentralized sales culture with a goal of consistent, sustained growth over the long term. As of January 2011, our senior leadership group included eight executive officers with regional responsibility for oversight of designated operations within the Company. In July 2010, J. Scott Penny was promoted to the position of Regional President, and in January 2011, he was named Chief Acquisitions Officer. Also in January, 2011, Linda S. Downs and Charles H. Lydecker were promoted to be Regional Presidents As previously announced, Jim W. Henderson, Vice Chairman and Chief Operating Officer, retired from the Company in August 2010, and Kenneth D. Kirk, Regional President, and Thomas E. Riley, Regional President and Chief Acquisitions Officer, ceased employment with the Company in January 2011.
We increased revenues every year from 1993 to 2008. In 2009, our revenue dropped to $967.9 million, then increased 0.6% to $973.5 million in 2010. Our revenues grew from $95.6 million in 1993 to $973.5 million in 2010, reflecting a compound annual growth rate of 14.6%. In the same period, we increased net income from $8.0 million to $161.8 million in 2010, a compound annual growth rate of 19.3%.
The past four years have posed significant challenges for us and for our industry in the form of a prevailing decline in insurance premium rates, commonly referred to as a “soft market;” increased significant governmental involvement in the Florida insurance marketplace since 2007, resulting in a substantial loss of revenue for us; and, beginning in the second half of 2008 and throughout 2010, increased pressure on the values of insurable exposure units as the consequence of the general weakening of the economy in the United States.
Beginning in the first quarter of 2007 through the fourth quarter of 2010 we experienced negative internal revenue growth each quarter. This was due primarily to the “soft market,” and, beginning in the second half of 2008 and throughout 2010, the decline in insurable exposure units, which further reduced our commissions and fees revenue. Part of the decline in 2007 was the result of the increased governmental involvement in the Florida insurance marketplace, as described below in “The Florida Insurance Overview.” One industry segment that was hit especially hard during these years was the home-building industry in southern California and, to a lesser extent in Nevada, Arizona and Florida. We have a wholesale brokerage operation that focuses on placing property and casualty insurance products for that home-building segment. The revenues from this operation were significantly adversely impacted during 2007 through 2009 by these national economic trends, and by 2010 these revenues were insignificant.
While insurance premium rates continued to decline for most lines of coverage during 2010, the rate of decline appeared to be slowing. In 2009 and 2010, continued declining exposure units had a greater negative impact on our commissions and fees revenue than declining insurance premium rates. Although we do not anticipate any significant changes to the insurance premium rates during 2011, there appears to be a very gradual improvement in the rate of decline of exposure units which we expect will continue into 2011.
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We also earn “profit-sharing contingent commissions,” which are profit-sharing commissions based primarily on underwriting results, but may also reflect considerations for volume, growth and/or retention. These commissions are primarily received in the first and second quarters of each year, based on the aforementioned considerations for the prior year(s). Over the last three years, profit-sharing contingent commissions have averaged approximately 5.6% of the previous year’s total commissions and fees revenue. Profit-sharing contingent commissions are typically included in our total commissions and fees in the Consolidated Statements of Income in the year received. The term “core commissions and fees” excludes profit-sharing contingent commissions and therefore represents the revenues earned directly from specific insurance policies sold, and specific fee-based services rendered. In recent years, five national insurance companies have replaced the loss-ratio based profit-sharing contingent commission calculation with a guaranteed fixed-base methodology, referred to as “Guaranteed Supplemental Commissions” (“GSCs”). Since these GSCs are not subject to the uncertainty of loss ratios, they are accrued throughout the year based on actual premiums written. As of December 31, 2010, we earned $13.4 million from GSCs during 2010. Most of this total will not be collected until the first quarter of 2011. For the twelve-month periods ended December 31, 2009 and 2008, we earned $15.9 million and $13.4 million, respectively, from GSCs.
Fee revenues relate to fees negotiated in lieu of commissions, which are recognized as services are rendered. Fee revenues are generated primarily by: (1) our Services Division, 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, and Social Security disability and Medicare benefits advocacy services, and (2) our National Programs and Wholesale Brokerage Divisions, which earn fees primarily for the issuance of insurance policies on behalf of insurance companies. These services are provided over a period of time, typically one year. Fee revenues, as a percentage of our total commissions and fees, represented 14.6% in 2010, 13.3% in 2009 and 13.7% in 2008.
Historically, investment income has consisted primarily of interest earnings on premiums and advance premiums collected and held in a fiduciary capacity before being remitted to insurance companies. Our policy is to invest available funds in high-quality, short-term fixed income investment securities. As a result of the bank liquidity and solvency issues in the United States in the last quarter of 2008, we moved substantial amounts of our cash into non-interest bearing checking accounts so that they would be fully insured by the Federal Depository Insurance Corporation (“FDIC”) or into money-market investment funds (a portion of which is FDIC insured) of SunTrust and Wells Fargo, two large national banks. Investment income also includes gains and losses realized from the sale of investments.
Florida Insurance Overview
Many states have established “Residual Markets,” which are governmental or quasi-governmental insurance facilities that provide coverage to individuals and/or businesses that cannot buy insurance in the private marketplace, i.e., “insurers of last resort.” These facilities can be designed to cover any type of risk or exposure; however, the exposures most commonly subject to such facilities are automobile or high-risk property exposures. Residual Markets can also be referred to as FAIR Plans, Windstorm Pools, Joint Underwriting Associations, or may even be given names styled after the private sector like “Citizens Property Insurance Corporation” in Florida.
In August 2002, the Florida Legislature created “Citizens Property Insurance Corporation” (“Citizens”), to be the “insurer of last resort” in Florida. Initially, Citizens charged insurance rates that were higher than those generally prevailing in the private insurance marketplace. In each of 2004 and 2005, four major hurricanes made landfall in Florida. As a result of the ensuing significant insurance property losses, Florida property insurance rates increased in 2006. To counter the higher property insurance rates, the State of Florida instructed Citizens to significantly reduce its property insurance rates beginning in January 2007. By state law, Citizens guaranteed these rates through January 1, 2010. As a result, Citizens became one of the most, if not the most, competitive risk-bearers for a large percentage of Florida’s commercial habitational coastal property exposures, such as condominiums, apartments, and certain assisted living facilities. Additionally, Citizens became the only insurance market for certain homeowner policies throughout Florida. Today, Citizens is one of the largest underwriters of coastal property exposures in Florida. Effective January 1, 2010, Citizens raised its insurance rates, on average, 10% for properties with values of less than $10 million, and more than 10% for properties with values in excess of $10 million. It is expected that Citizens will continue to increase its insurance rates during 2011 and, as a result, the impact of Citizens should continue to lessen in 2011.
In 2007, Citizens became the principal direct competitor of the insurance companies that underwrite the condominium program administered by one of our indirect subsidiaries, Florida Intracoastal Underwriters, Limited Company (“FIU”), and the excess and surplus lines insurers represented by our wholesale brokers such as Hull & Company, Inc., another of our subsidiaries. Consequently, these operations lost significant amounts of revenue to Citizens. From 2008 through 2010, Citizens’ impact was not as dramatic as it had been in 2007; FIU’s core revenues decreased 9.2% in this period. Citizens continued to be competitive against the excess and surplus lines insurers, and therefore Citizens negatively affected the revenues of our Florida-based wholesale brokerage operations, such as Hull & Company, Inc., from 2007 through 2010, although the impact is decreasing from year to year.
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Citizens’ impact on our Florida Retail Division was less severe than on our National Programs and Wholesale Brokerage Divisions, because our retail offices have the ability to place business with Citizens, although at slightly lower commission rates and with greater difficulty than is the case with other insurance companies.
Current Year Company Overview
For the fourth consecutive year, we experienced negative internal growth of our commissions and fees revenue as a direct result of the general weakness of the economy since the second half of 2008 and the continuing “soft market.” Our total commissions and fees revenue excluding the effect of recent acquisitions, profit-sharing contingencies and sales of books of business over the last twelve months reflected a negative internal growth rate of (4.7)%. However, including the revenues from new acquisitions, increased profit-sharing contingencies, and the increase in other income, total revenues in 2010 increased 0.6% over 2009.
Income before income taxes in 2010 increased over 2009 by 4.5%, or $11.3 million, to $266.1 million. Of the $11.3 million increase, $5.6 million related to increased revenues with the remaining increase attributable to improved cost efficiencies, primarily in the area of rent expense and legal costs.
Acquisitions
Approximately 37,500 independent insurance agencies are estimated to be operating currently in the United States. Part of our continuing business strategy is to attract high-quality insurance intermediaries to join our operations. From 1993 through 2010, we acquired 367 insurance intermediary operations, including acquired books of business (customer accounts). Acquisition activity slowed in 2009 in part because potential sellers were unhappy with reduced agency valuations that were the consequence of lower revenues and operating profits due to the continuing “soft market” and decreasing exposure units, and therefore opted to defer the sales of their insurance agencies. The economic outlook in 2010 improved slightly over 2009 and as a result, certain sellers viewed 2010 as a better time in which to join our organization, and consequently, we were able to close a greater number of acquisitions.
A summary of our acquisitions over the last three years is as follows (in millions, except for number of acquisitions):
| Number of Acquisitions | Estimated Annual Revenues | Net Cash Paid | Notes Issued | Liabilities Assumed | Recorded Earn-out Payable | Aggregate Purchase Price | ||||||||||||||||||||||||||
| Asset | Stock | |||||||||||||||||||||||||||||||
| 2010 | 33 | — | $ | 70.6 | $ | 158.6 | $ | 0.8 | $ | 2.3 | $ | 25.1 | $ | 186.8 | ||||||||||||||||||
| 2009 | 11 | — | $ | 26.5 | $ | 40.4 | $ | 6.9 | $ | 1.8 | $ | 7.2 | $ | 56.3 | ||||||||||||||||||
| 2008 | 43 | 2 | $ | 120.2 | $ | 255.8 | $ | 8.3 | $ | 14.6 | $ | — | $ | 278.7 |
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RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008
The following discussion and analysis regarding results of operations and liquidity and capital resources should be considered in conjunction with the accompanying Consolidated Financial Statements and related Notes.
Financial information relating to our Consolidated Financial Results is as follows (in thousands, except percentages):
| 2010 | Percent Change | 2009 | Percent Change | 2008 | ||||||||||||||||
| REVENUES | ||||||||||||||||||||
| Core commissions and fees | $ | 912,185 | (0.5 | )% | $ | 917,226 | 0.8 | % | $ | 909,564 | ||||||||||
| Profit-sharing contingent commissions | 54,732 | 14.9 | % | 47,637 | (15.6 | )% | 56,419 | |||||||||||||
| Investment income | 1,326 | 14.2 | % | 1,161 | (80.9 | )% | 6,079 | |||||||||||||
| Other income, net | 5,249 | 183.3 | % | 1,853 | (66.3 | )% | 5,492 | |||||||||||||
| Total revenues | 973,492 | 0.6 | % | 967,877 | (1.0 | )% | 977,554 | |||||||||||||
| EXPENSES | ||||||||||||||||||||
| Employee compensation and benefits | 487,820 | 0.6 | % | 484,680 | (0.2 | )% | 485,783 | |||||||||||||
| Non-cash stock-based compensation | 6,845 | (7.0 | )% | 7,358 | 0.6 | % | 7,314 | |||||||||||||
| Other operating expenses | 135,851 | (5.3 | )% | 143,389 | 4.4 | % | 137,352 | |||||||||||||
| Amortization | 51,442 | 3.2 | % | 49,857 | 6.9 | % | 46,631 | |||||||||||||
| Depreciation | 12,639 | (4.5 | )% | 13,240 | (0.3 | )% | 13,286 | |||||||||||||
| Interest | 14,471 | (0.9 | )% | 14,599 | (0.6 | )% | 14,690 | |||||||||||||
| Change in estimated acquisition earn-out payables | (1,674 | ) | — | % | — | — | % | — | ||||||||||||
| Total expenses | 707,394 | (0.8 | )% | 713,123 | 1.1 | % | 705,056 | |||||||||||||
| Income before income taxes | $ | 266,098 | 4.5 | % | $ | 254,754 | (6.5 | )% | $ | 272,498 | ||||||||||
| Net internal growth rate — core commissions and fees | (4.7 | )% | (5.1 | )% | (5.5 | )% | ||||||||||||||
| Employee compensation and benefits ratio | 50.1 | % | 50.1 | % | 49.7 | % | ||||||||||||||
| Other operating expenses ratio | 14.0 | % | 14.8 | % | 14.1 | % | ||||||||||||||
| Capital expenditures | $ | 10,454 | $ | 11,310 | $ | 14,115 | ||||||||||||||
| Total assets at December 31 | $ | 2,400,814 | $ | 2,224,226 | $ | 2,119,580 |
Commissions and Fees
Commissions and fees revenue, including profit-sharing contingent commissions, increased 0.2% in 2010, but decreased 0.1% in 2009 after a 5.6% increase in 2008. Profit-sharing contingent commissions increased $7.1 million to $54.7 million in 2010, with the increase primarily due to the performance of our National Programs Division. Profit-sharing contingent commissions decreased $8.8 million to $47.6 million in 2009 primarily due to higher loss ratios, and therefore, lower profitability for insurance carriers. Core commissions and fees are our commissions and fees, less (i) profit-sharing contingent commissions and (ii) divested business (commissions and fees generated from offices, books of business or niches sold or terminated). Core commissions and fees revenue decreased 4.7% in 2010, 5.1% in 2009 and 5.5% in 2008. The 2010 decrease of (4.7)% represents $42.7 million of net lost core commissions and fees revenue, of which $7.6 million was attributable to our retail, wholesale brokerage and services operations based in Florida, while $21.8 million related to our non-Florida retail, wholesale brokerage and services operations. The remaining $13.3 million of net lost core commissions and fees revenue related to our National Programs Division, of which $10.7 million represented net lost business at Proctor Financial, Inc., our subsidiary which provides lender-placed insurance (“Proctor”).
The 2009 decrease of (5.1)% represented $46.5 million of net lost core commissions and fees revenue, of which $22.4 million was attributable to our retail, wholesale brokerage and services operations based in Florida. The decrease in our non-Florida retail and wholesale brokerage operations in 2009 was $35.1 million, but that was substantially offset by Proctor’s strong revenue growth of $13.4 million.
Investment Income
Investment income increased slightly to $1.3 million in 2010, compared with $1.2 million in 2009 and $6.1 million in 2008. The $4.9 million decrease in 2009 from 2008 was primarily due to substantially lower investment yields in 2009, even though the average daily invested balance was higher in 2009 than in 2008.
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Other Income, Net
Other income for 2010 reflected income of $5.2 million, compared with $1.9 million in 2009 and $5.5 million in 2008. Other income consists primarily of gains and losses from the sale and disposition of assets. However, for 2010, other income also included $1.5 million paid to us in accordance with judgments rendered in our favor in litigation against former employees for violation of restrictive covenants contained in their employment agreements with us. Also in 2010, we recognized gains of $1.2 million from sales of books of business (customer accounts). Although we are not in the business of selling books of business, we periodically will sell an office or a book of business because it does not produce reasonable margins or demonstrate a potential for growth, or for other reasons related to the particular assets in question.
Employee Compensation and Benefits
Employee compensation and benefits expense increased, on a net basis, approximately 0.6% or $3.1 million in 2010. However, that net increase included $10.6 million of new compensation costs related to new acquisitions that were stand-alone offices, and therefore, employee compensation and benefits from those offices that existed in same time periods of 2010 and 2009 (including the new acquisitions that “folded in” to those offices) decreased by $7.4 million. The employee compensation and benefit reductions from these offices were primarily related to reductions in staff and management salaries and bonuses of $12.6 million, off-set by an increase in compensation of new producers of $3.2 million for new salaried producers and $0.8 million for new commissioned producers, and an increase of $1.1 million in group health insurance costs.
Employee compensation and benefits decreased, on a net basis, approximately (0.2)% or $1.1 million in 2009. However, that net decrease included $17.3 million of new compensation costs related to new acquisitions that were stand-alone offices, and therefore, employee compensation and benefits from those offices that existed in same time periods of 2009 and 2008 (including the new acquisitions that “folded in” to those offices) decreased by $18.4 million. The employee compensation and benefit reductions from these offices were primarily related to reductions in producer commissions, staff salaries and bonuses of $15.9 million, off-set by an increase in compensation of new salaried producers of $1.1 million.
Employee compensation and benefits expense as a percentage of total revenues remained flat at 50.1% for both 2010 and 2009, but was 49.7% in 2008. The increase in the percentage in 2009 from 2008 was the result of the continued reduction of compensation expense due to headcount reductions. We had 5,286 full-time equivalent employees at December 31, 2010, compared with 5,206 at December 31, 2009 and 5,398 at December 31, 2008. Of the net increase of 80 full-time equivalent employees at December 31, 2010 over the prior year-end, an increase of 226 was attributable to acquisitions that continued as stand-alone offices, thus reflecting a net reduction of 146 employees in the offices existing at both year-ends.
Non-Cash Stock-Based Compensation
The Company has an employee stock purchase plan, and grants stock options and non-vested stock awards to its employees. Compensation expense for all share-based awards is recognized in the financial statements based upon the grant-date fair value of those awards.
For 2010, 2009 and 2008, the non-cash stock-based compensation expense incorporates the costs related to each of our four stock-based plans as explained in Note 11 of the Notes to the Consolidated Financial Statements.
Non-cash stock-based compensation decreased 7.0% or $0.5 million in 2010 as a result of headcount reductions. Effective January 2011, we issued new grants under our Stock Incentive Plan (SIP) that will vest in six to ten years, subject to the achievement of certain performance criteria by grantees, and the achievement of consolidated EPS growth at certain levels by the Company, over a five-year measurement period ending December 31, 2015. We estimate that the incremental cost of these new SIP grants in 2011 will be approximately $5.1 million.
Other Operating Expenses
As a percentage of total revenues, other operating expenses represented 14.0% in 2010, 14.8% in 2009 and 14.1% in 2008. Other operating expenses in 2010 decreased $7.5 million from 2009, of which $2.4 million was related to acquisitions that joined as stand-alone offices. Therefore, other operating expenses from those offices that existed in the same periods in both 2010 and 2009 (including the new acquisitions that “folded in” to those offices) decreased by $9.9 million. Of the $9.9 million decrease, $3.2 million related to reduced net legal fees, $2.5 million related to reductions in office rent expense, and the remaining $4.2 million related to broad-based reductions relating to travel and entertainment expenses, bad debt expenses, supplies, and postage and delivery expenses. Of the $3.2 million reduction in net legal fees, $3.8 million related to a reimbursement by an insurance carrier of previously incurred legal costs.
Other operating expenses in 2009 increased $6.0 million over 2008, of which $4.6 million was related to acquisitions that joined as stand-alone offices. Therefore, other operating expenses from those offices that existed in the same periods in both 2009 and 2008 (including the new acquisitions that “folded in” to those offices) increased by $1.4 million. Of the $1.4 million increase, $3.0 million resulted from additional legal fees, but those costs were partially offset by broad-based reductions relating to travel and entertainment expenses, supplies, and postage and delivery expenses.
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Amortization
Amortization expense increased $1.6 million, or 3.2%, in 2010, $3.2 million, or 6.9%, in 2009, and $6.2 million, or 15.3%, in 2008. The increases in 2010 and 2009 were due to the amortization of additional intangible assets as a result of acquisitions completed in those years.
Depreciation
Depreciation decreased (4.5)% in 2010 and (0.3)% in 2009 but increased 4.1% in 2008. The decreases in 2010 and 2009 were primarily due to reduced acquisition activity. The increase in 2008 was primarily due to the purchase of new computers, related equipment and software, corporate aircraft and the depreciation of fixed assets associated with acquisitions completed that year.
Interest Expense
Interest expense decreased $0.1 million, or (0.9)%, in 2010 and $0.1 million, or (0.6)%, in 2009 primarily as a result of principal payments during those years. Interest expense increased $0.9 million, or 6.4%, in 2008 over 2007 primarily as a result of the additional $25.0 million that was borrowed in February 2008.
Change in estimated acquisition earn-out payables
For acquisitions consummated after January 1, 2009, $32.3 million was initially recorded as estimated acquisition earn-out payables. During 2010, the fair value of the estimated acquisition earn-out payables was re-evaluated on a quarterly basis and reduced, in aggregate, by $1.7 million, which resulted in a credit to the Consolidated Statement of Income. Additionally, the interest expense accretion to the Consolidated Statement of Income for 2010 and 2009 was $0.9 million and $0.1 million, respectively.
Income Taxes
The effective tax rate on income from operations was 39.2% in 2010, 39.8% in 2009 and 39.0% in 2008. The lower effective annual tax rate in 2010 compared with 2009 was primarily the result of lower average effective state income tax rates. The higher effective annual tax rate in 2009 compared with 2008 was primarily the result of reduced benefits from tax-exempt interest income, and increased amounts of business conducted in states having higher state tax rates.
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RESULTS OF OPERATIONS — SEGMENT INFORMATION
As discussed in Note 15 of the Notes to Consolidated Financial Statements, we operate four reportable segments or divisions: the Retail, National Programs, Wholesale Brokerage, and Services Divisions. On a divisional basis, increases in amortization, depreciation and interest expenses result from completed acquisitions within a given division in a particular year. Likewise, other income in each division primarily reflects net gains on sales of customer accounts and fixed assets. As such, in evaluating the operational efficiency of a division, management emphasizes the net internal growth rate of core commissions and fees revenue, the gradual improvement of the ratio of total employee compensation and benefits to total revenues, and the gradual improvement of the ratio of other operating expenses to total revenues.
Total core commissions and fees are our total commissions and fees less (i) profit-sharing contingent commissions (revenue derived from special revenue-sharing commissions from insurance companies based upon the volume and the growth and/or profitability of the business placed with such companies during the prior year), and (ii) divested business (commissions and fees generated from offices, books of business or niches sold by the Company or terminated).
The internal growth rates for our core commissions and fees for the three years ended December 31, 2010, 2009 and 2008, by divisional units are as follows (in thousands, except percentages):
| 2010 | For the years ended December 31, | Total Net Change | Total Net Growth % | Less Acquisition Revenues | Internal Net Growth $ | Internal Net Growth % | ||||||||||||||||||||||
| 2010 | 2009 | |||||||||||||||||||||||||||
| Florida Retail | $ | 151,113 | $ | 155,928 | $ | (4,815 | ) | (3.1 | )% | $ | 1,509 | $ | (6,324 | ) | (4.1 | )% | ||||||||||||
| National Retail | 314,330 | 308,461 | 5,869 | 1.9 | % | 15,895 | (10,026 | ) | (3.3 | )% | ||||||||||||||||||
| Western Retail | 93,876 | 98,249 | (4,373 | ) | (4.5 | )% | 6,200 | (10,573 | ) | (10.8 | )% | |||||||||||||||||
| Total Retail(1) | 559,319 | 562,638 | (3,319 | ) | (0.6 | )% | 23,604 | (26,923 | ) | (4.8 | )% | |||||||||||||||||
| Professional Programs | 41,686 | 44,588 | (2,902 | ) | (6.5 | )% | — | (2,902 | ) | (6.5 | )% | |||||||||||||||||
| Special Programs | 124,089 | 133,704 | (9,615 | ) | (7.2 | )% | 740 | (10,355 | ) | (7.7 | )% | |||||||||||||||||
| Total National Programs | 165,775 | 178,292 | (12,517 | ) | (7.0 | )% | 740 | (13,257 | ) | (7.4 | )% | |||||||||||||||||
| Wholesale Brokerage | 140,755 | 142,069 | (1,314 | ) | (0.9 | )% | 1,094 | (2,408 | ) | (1.7 | )% | |||||||||||||||||
| Services | 46,336 | 32,689 | 13,647 | 41.7 | % | 13,716 | (69 | ) | (0.2 | )% | ||||||||||||||||||
| Total Core Commissions and Fees | $ | 912,185 | $ | 915,688 | $ | (3,503 | ) | (0.4 | )% | $ | 39,154 | $ | (42,657 | ) | (4.7 | )% | ||||||||||||
The reconciliation of the above internal growth schedule to the total Commissions and Fees included in the Consolidated Statements of Income for the years ended December 31, 2010 and 2009 is as follows (in thousands):
| For the years ended December 31, | ||||||||
| 2010 | 2009 | |||||||
| Total core commissions and fees | $ | 912,185 | $ | 915,688 | ||||
| Profit-sharing contingent commissions | 54,732 | 47,637 | ||||||
| Divested business | — | 1,538 | ||||||
| Total commission & fees | $ | 966,917 | $ | 964,863 | ||||
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| 2009 | For the years ended December 31, | Total Net Change | Total Net Growth % | Less Acquisition Revenues | Internal Net Growth $ | Internal Net Growth % | ||||||||||||||||||||||
| 2009 | 2008 | |||||||||||||||||||||||||||
| Florida Retail | $ | 155,817 | $ | 167,508 | $ | (11,691 | ) | (7.0 | )% | $ | 6,203 | $ | (17,894 | ) | (10.7 | )% | ||||||||||||
| National Retail | 309,386 | 293,748 | 15,638 | 5.3 | % | 32,713 | (17,075 | ) | (5.8 | )% | ||||||||||||||||||
| Western Retail | 98,888 | 96,155 | 2,733 | 2.8 | % | 16,302 | (13,569 | ) | (14.1 | )% | ||||||||||||||||||
| Total Retail(1) | 564,091 | 557,411 | 6,680 | 1.2 | % | 55,218 | (48,538 | ) | (8.7 | )% | ||||||||||||||||||
| Professional Programs | 44,588 | 43,881 | 707 | 1.6 | % | — | 707 | 1.6 | % | |||||||||||||||||||
| Special Programs | 133,768 | 121,833 | 11,935 | 9.8 | % | 1,719 | 10,216 | 8.4 | % | |||||||||||||||||||
| Total National Programs | 178,356 | 165,714 | 12,642 | 7.6 | % | 1,719 | 10,923 | 6.6 | % | |||||||||||||||||||
| Wholesale Brokerage | 142,090 | 149,895 | (7,805 | ) | (5.2 | )% | 1,602 | (9,407 | ) | (6.3 | )% | |||||||||||||||||
| Services | 32,689 | 32,137 | 552 | 1.7 | % | — | 552 | 1.7 | % | |||||||||||||||||||
| Total Core Commissions and Fees | $ | 917,226 | $ | 905,157 | $ | 12,069 | 1.3 | % | $ | 58,539 | $ | (46,470 | ) | (5.1 | )% | |||||||||||||
The reconciliation of the above internal growth schedule to the total Commissions and Fees included in the Consolidated Statements of Income for the years ended December 31, 2009 and 2008 is as follows (in thousands):
| For the years ended December 31, | ||||||||
| 2009 | 2008 | |||||||
| Total core commissions and fees | $ | 917,226 | $ | 905,157 | ||||
| Profit-sharing contingent commissions | 47,637 | 56,419 | ||||||
| Divested business | — | 4,407 | ||||||
| Total commission & fees | $ | 964,863 | $ | 965,983 | ||||
| 2008 | For the years ended December 31, | Total Net Change | Total Net Growth % | Less Acquisition Revenues | Internal Net Growth $ | Internal Net Growth % | ||||||||||||||||||||||
| 2008 | 2007 | |||||||||||||||||||||||||||
| Florida Retail | $ | 168,576 | $ | 174,744 | $ | (6,168 | ) | (3.5 | )% | $ | 12,490 | $ | (18,658 | ) | (10.7 | )% | ||||||||||||
| National Retail | 294,563 | 238,017 | 56,546 | 23.8 | % | 64,337 | (7,791 | ) | (3.3 | )% | ||||||||||||||||||
| Western Retail | 98,307 | 91,234 | 7,073 | 7.8 | % | 15,321 | (8,248 | ) | (9.0 | )% | ||||||||||||||||||
| Total Retail(1) | 561,446 | 503,995 | 57,451 | 11.4 | % | 92,148 | (34,697 | ) | (6.9 | )% | ||||||||||||||||||
| Professional Programs | 43,401 | 42,185 | 1,216 | 2.9 | % | — | 1,216 | 2.9 | % | |||||||||||||||||||
| Special Programs | 122,532 | 108,747 | 13,785 | 12.7 | % | 674 | 13,111 | 12.1 | % | |||||||||||||||||||
| Total National Programs | 165,933 | 150,932 | 15,001 | 9.9 | % | 674 | 14,327 | 9.5 | % | |||||||||||||||||||
| Wholesale Brokerage | 150,048 | 156,790 | (6,742 | ) | (4.3 | )% | 16,192 | (22,934 | ) | (14.6 | )% | |||||||||||||||||
| Services | 32,137 | 35,505 | (3,368 | ) | (9.5 | )% | — | (3,368 | ) | (9.5 | )% | |||||||||||||||||
| Total Core Commissions and Fees | $ | 909,564 | $ | 847,222 | $ | 62,342 | 7.4 | % | $ | 109,014 | $ | (46,672 | ) | (5.5 | )% | |||||||||||||
The reconciliation of the above internal growth schedule to the total Commissions and Fees included in the Consolidated Statements of Income for the years ended December 31, 2008 and 2007 is as follows (in thousands):
| For the years ended December 31, | ||||||||
| 2008 | 2007 | |||||||
| Total core commissions and fees | $ | 909,564 | $ | 847,222 | ||||
| Profit-sharing contingent commissions | 56,419 | 57,623 | ||||||
| Divested business | — | 9,805 | ||||||
| Total commission & fees | $ | 965,983 | $ | 914,650 | ||||
| (1) | The Retail Division includes commissions and fees reported in the “Other” column of the Segment Information in Note 15 of the Notes to the Consolidated Financial Statements, which includes corporate and consolidation items. |
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Retail Division
The Retail Division provides a broad range of insurance products and services to commercial, public and quasi-public, professional and individual insured customers. Approximately 96.2% of the Retail Division’s commissions and fees revenue is commission-based. Because most of our other operating expenses do not change as premiums fluctuate, we believe that most of any fluctuation in the commissions, net of related compensation, which we receive will be reflected in our pre-tax income.
Financial information relating to Brown & Brown’s Retail Division is as follows (in thousands, except percentages):
| 2010 | Percent Change | 2009 | Percent Change | 2008 | ||||||||||||||||
| REVENUES | ||||||||||||||||||||
| Core commissions and fees | $ | 558,535 | (0.7 | )% | $ | 562,619 | 0.4 | % | $ | 560,311 | ||||||||||
| Profit-sharing contingent commissions | 15,274 | (23.1 | )% | 19,853 | (23.3 | )% | 25,884 | |||||||||||||
| Investment income | 170 | (39.7 | )% | 282 | (71.8 | )% | 999 | |||||||||||||
| Other income, net | 1,082 | 74.5 | % | 620 | (79.6 | )% | 3,044 | |||||||||||||
| Total revenues | 575,061 | (1.4 | )% | 583,374 | (1.2 | )% | 590,238 | |||||||||||||
| EXPENSES | ||||||||||||||||||||
| Employee compensation and benefits | 288,957 | (0.9 | )% | 291,675 | 0.1 | % | 291,486 | |||||||||||||
| Non-cash stock-based compensation | 3,514 | (25.1 | )% | 4,692 | 30.0 | % | 3,610 | |||||||||||||
| Other operating expenses | 93,184 | (4.6 | )% | 97,639 | 4.6 | % | 93,372 | |||||||||||||
| Amortization | 30,725 | 2.6 | % | 29,943 | 11.6 | % | 26,827 | |||||||||||||
| Depreciation | 5,349 | (11.7 | )% | 6,060 | — | % | 6,061 | |||||||||||||
| Interest | 27,037 | (14.4 | )% | 31,596 | 4.3 | % | 30,287 | |||||||||||||
| Change in estimated acquisition earn-out payables | (1,731 | ) | — | % | — | — | % | — | ||||||||||||
| Total expenses | 447,035 | (3.2 | )% | 461,605 | 2.2 | % | 451,643 | |||||||||||||
| Income before income taxes | $ | 128,026 | 5.1 | % | $ | 121,769 | (12.1 | )% | $ | 138,595 | ||||||||||
| Net internal growth rate — core commissions and fees | (4.8 | )% | (8.7 | )% | (6.9 | )% | ||||||||||||||
| Employee compensation and benefits ratio | 50.2 | % | 50.0 | % | 49.4 | % | ||||||||||||||
| Other operating expenses ratio | 16.2 | % | 16.7 | % | 15.8 | % | ||||||||||||||
| Capital expenditures | $ | 4,852 | $ | 3,459 | $ | 4,152 | ||||||||||||||
| Total assets at December 31 | $ | 1,914,587 | $ | 1,764,249 | $ | 1,687,137 |
The Retail Division’s total revenues in 2010 decreased (1.4)%, or $8.3 million, from the same period in 2009, to $575.1 million. Profit-sharing contingent commissions in 2010 decreased $4.6 million, or (23.1)%, from 2009, primarily due to increased loss ratios resulting in lower profitability for insurance companies in 2009. The $4.1 million net decrease in commissions and fees revenue resulted from the following factors: (i) an increase of approximately $23.6 million related to the core commissions and fees revenue from acquisitions that had no comparable revenues in 2009, (ii) a decrease of $1.5 million related to commissions and fees revenue recorded in 2009 from business divested during 2010, and (iii) the remaining net decrease of $26.9 million was primarily attributable to net lost business. The Retail Division’s negative internal growth rate for core commissions and fees revenue was (4.8)% for 2010, and was driven by lower property insurance rates and reduced insurable exposure units in most areas of the United States.
Income before income taxes for 2010 increased 5.1%, or $6.3 million, over the same period in 2009, to $128.0 million. Even though total revenues were down $8.3 million, total expenses were reduced by $14.6 million. Employee compensation and benefits expense was reduced $2.7 million primarily due to lower salaries and bonuses, non-cash stock-based compensation was reduced by $1.2 million as a result of lower participation in the employee stock purchase plan and certain forfeitures of performance stock plan shares, other operating expenses were reduced by $4.5 million due to broad-based expense reductions, a lower inter-company interest allocation of $4.5 million resulting from reduced acquisition activity and a $1.7 million credit resulted from changes in the estimated acquisition earn-out payables. Additionally, interest expenses of this Division for prior acquisitions decreased by $4.6 million, primarily due to the 1.0% annual reduction in the cost of capital interest rate charged against the total purchase price of the Division’s prior acquisitions.
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The Retail Division’s total revenues in 2009 decreased $6.9 million to $583.4 million, a (1.2)% decrease from 2008. Profit-sharing contingent commissions in 2009 decreased $6.0 million from 2008, primarily due to increased loss ratios resulting in lower profitability for insurance companies in 2008. Approximately $2.3 million of the change in the Retail Division’s total revenues was due to net growth in core commissions and fees; however, $55.2 million was from acquisitions for which there were no comparable revenues in 2008. Therefore, excluding revenues from acquisitions, $48.5 million was lost on a “same-store sales” basis, resulting in a negative internal growth rate of (8.7)%. Most of the negative internal growth resulted from continued reductions in insurable exposure units caused by the significant slowdown in the middle-market economy during 2009. Additionally, insurance pricing continued to be competitive, primarily in Florida and in the western United States.
Income before income taxes in 2009 decreased $16.8 million from 2008, of which $6.0 million was due to reduced profit- sharing contingent commissions and $3.1 million was due to reduced investment and other income. The remaining decrease of $7.7 million was due to reduced earnings from core commissions and fees, offset by earnings from acquisitions.
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National Programs Division
The National Programs Division is comprised of two units: Professional Programs, which provides professional liability and related package products for certain professionals delivered through nationwide networks of independent agents; and Special Programs, which markets targeted products and services designated for specific industries, trade groups, public and quasi-public entities and market niches. Like the Retail Division and the Wholesale Brokerage Division, the National Programs Division’s revenues are primarily commission-based.
Financial information relating to our National Programs Division is as follows (in thousands, except percentages):
| 2010 | Percent Change | 2009 | Percent Change | 2008 | ||||||||||||||||
| REVENUES | ||||||||||||||||||||
| Core commissions and fees | $ | 165,775 | (7.1 | )% | $ | 178,356 | 7.5 | % | $ | 165,933 | ||||||||||
| Profit-sharing contingent commissions | 23,169 | 89.7 | % | 12,216 | 1.8 | % | 11,997 | |||||||||||||
| Investment income | 1 | (66.7 | )% | 3 | (99.1 | )% | 327 | |||||||||||||
| Other income, net | 220 | NMF | (1) | 18 | (37.9 | )% | 29 | |||||||||||||
| Total revenues | 189,165 | (0.7 | )% | 190,593 | 6.9 | % | 178,286 | |||||||||||||
| EXPENSES | ||||||||||||||||||||
| Employee compensation and benefits | 72,529 | (0.8 | )% | 73,142 | 7.4 | % | 68,116 | |||||||||||||
| Non-cash stock-based compensation | 811 | (21.2 | )% | 1,029 | 28.6 | % | 800 | |||||||||||||
| Other operating expenses | 25,359 | (11.7 | )% | 28,721 | 7.3 | % | 26,761 | |||||||||||||
| Amortization | 9,213 | 0.4 | % | 9,175 | 0.8 | % | 9,098 | |||||||||||||
| Depreciation | 3,049 | 11.9 | % | 2,725 | 1.2 | % | 2,693 | |||||||||||||
| Interest | 3,242 | (39.6 | )% | 5,365 | (28.8 | )% | 7,531 | |||||||||||||
| Change in estimated acquisition earn-out payables | 21 | — | % | — | — | % | — | |||||||||||||
| Total expenses | 114,224 | (4.9 | )% | 120,157 | 4.5 | % | 114,999 | |||||||||||||
| Income before income taxes | $ | 74,941 | 6.4 | % | $ | 70,436 | 11.3 | % | $ | 63,287 | ||||||||||
| Net internal growth rate — core commissions and fees | (7.4 | )% | 6.6 | % | 9.5 | % | ||||||||||||||
| Employee compensation and benefits ratio | 38.3 | % | 38.4 | % | 38.2 | % | ||||||||||||||
| Other operating expenses ratio | 13.4 | % | 15.1 | % | 15.0 | % | ||||||||||||||
| Capital expenditures | $ | 2,432 | $ | 4,318 | $ | 2,867 | ||||||||||||||
| Total assets at December 31 | $ | 667,123 | $ | 627,392 | $ | 607,599 |
| (1) | NMF = Not a meaningful figure |
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The National Programs Division’s total revenues in 2010 decreased $1.4 million to $189.2 million, a (0.7)% decrease from 2009. Profit-sharing contingent commissions in 2010 increased $11.0 million over 2009, of which $5.8 million of that increase related to our condominium program at FIU, and $3.8 million related to Proctor Financial, Inc., our subsidiary that provides lender-placed insurance (“Proctor”). FIU’s increased profit-sharing contingent commissions were principally attributable to the lack of hurricane activity in Florida during 2010 and 2009. Proctor’s increased profit-sharing contingent commissions were the direct result of the substantial premium growth generated by Proctor in 2009. Of the $12.6 million net decrease in commissions and fees for National Programs: (i) an increase of approximately $0.7 million related to the core commissions and fees revenue from acquisitions that had no comparable revenues in the same period of 2009; and (ii) the remaining net decrease of $13.3 million was primarily related to net lost business. Therefore, the National Programs Division’s negative internal growth rate for core commissions and fees revenue was (7.4)% for 2010. Of the $13.3 million of net lost business, $10.7 million related to Proctor, and was primarily the result of its loss of two large customers, $1.9 million related to the Lawyer’s Protector Plan® and $0.9 million related to FIU.
Income before income taxes for 2010 increased 6.4%, or $4.5 million, over the same period in 2009, to $74.9 million. Even though total revenues decreased $1.4 million, total expenses were reduced by $5.9 million. Employee compensation and benefits expense was reduced $0.6 million primarily due to lower salaries and producer commission expense, other operating expenses were reduced by $3.4 million due to broad-based expense reductions, and inter-company interest allocation was reduced by $2.1 million as a result of reduced acquisition activity. Additionally, interest expenses to this Division for prior acquisitions decreased by $2.1 million, primarily due to the 1.0% annual reduction in the cost of capital interest rate charged against the total purchase price of the Division’s prior acquisitions.
The National Programs Division’s total revenues in 2009 increased $12.3 million to $190.6 million, a 6.9% increase over 2008. Profit-sharing contingent commissions in 2009 increased $0.2 million over 2008, primarily due to the improved profitability of the insurance carriers during calendar year 2008. Of the $12.4 million increase in core commissions and fees revenues, only approximately $1.7 million related to core commissions and fees revenue from acquisitions for which there were no comparable revenues in 2008. The National Programs Division’s net internal growth rate for core commissions and fees revenue was 6.6%, excluding core commissions and fees revenues recognized in 2009 from new acquisitions. The majority of the internally generated growth in core commissions and fees revenues was primarily related to $13.4 million of net new business written by Proctor. Additionally, our professional liability programs generated net new business of approximately $0.9 million, our condominium program at FIU was down slightly by $0.3 million, and our public entity business lost approximately $0.9 million of core commissions and fees revenue, mainly due to premium rate reductions.
Income before income taxes in 2009 increased $7.1 million to $70.4 million, an 11.3% increase over 2008. Most of this increase resulted from net new business generated by Proctor.
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Wholesale Brokerage Division
The Wholesale Brokerage Division markets and sells excess and surplus commercial and personal lines insurance and reinsurance, primarily through independent agents and brokers. Like the Retail and National Programs Divisions, the Wholesale Brokerage Division’s revenues are primarily commission-based.
Financial information relating to our Wholesale Brokerage Division is as follows (in thousands, except percentages):
| 2010 | Percent Change | 2009 | Percent Change | 2008 | ||||||||||||||||
| REVENUES | ||||||||||||||||||||
| Core commissions and fees | $ | 140,755 | (0.9 | )% | $ | 142,090 | (5.3 | )% | $ | 150,048 | ||||||||||
| Profit-sharing contingent commissions | 16,289 | 4.6 | % | 15,568 | (16.0 | )% | 18,538 | |||||||||||||
| Investment income | 29 | (53.2 | )% | 62 | (95.6 | )% | 1,414 | |||||||||||||
| Other income, net | 1,626 | 161.8 | % | 621 | (3.7 | )% | 645 | |||||||||||||
| Total revenues | 158,699 | 0.2 | % | 158,341 | (7.2 | )% | 170,645 | |||||||||||||
| EXPENSES | ||||||||||||||||||||
| Employee compensation and benefits | 78,945 | (2.0 | )% | 80,561 | (7.7 | )% | 87,297 | |||||||||||||
| Non-cash stock-based compensation | 687 | (30.3 | )% | 985 | 21.6 | % | 810 | |||||||||||||
| Other operating expenses | 30,413 | (6.0 | )% | 32,343 | (4.4 | )% | 33,815 | |||||||||||||
| Amortization | 10,201 | (0.4 | )% | 10,239 | 0.3 | % | 10,205 | |||||||||||||
| Depreciation | 2,695 | (6.9 | )% | 2,894 | 0.1 | % | 2,892 | |||||||||||||
| Interest | 10,770 | (24.6 | )% | 14,289 | (20.8 | )% | 18,033 | |||||||||||||
| Change in estimated acquisition earn-out payables | (246 | ) | — | % | — | — | % | — | ||||||||||||
| Total expenses | 133,465 | (5.6 | )% | 141,311 | (7.7 | )% | 153,052 | |||||||||||||
| Income before income taxes | $ | 25,234 | 48.2 | % | $ | 17,030 | (3.2 | )% | $ | 17,593 | ||||||||||
| Net internal growth rate — core commissions and fees | (1.7 | )% | (6.3 | )% | (14.6 | )% | ||||||||||||||
| Employee compensation and benefits ratio | 49.7 | % | 50.9 | % | 51.2 | % | ||||||||||||||
| Other operating expenses ratio | 19.2 | % | 20.4 | % | 19.8 | % | ||||||||||||||
| Capital expenditures | $ | 1,838 | $ | 3,201 | $ | 4,794 | ||||||||||||||
| Total assets at December 31 | $ | 631,344 | $ | 618,704 | $ | 618,662 |
The Wholesale Brokerage Division’s total revenues in 2010 increased $0.4 million over 2009, of which $0.7 million was attributable to higher profit-sharing contingent commissions, and $1.0 million was attributable to an increase in other income and this increase was partially offset by a $1.3 million reduction in core commissions and fees revenue. Of the $1.3 million net decrease in commissions and fees revenue: (i) an increase of approximately $1.1 million related to core commissions and fees revenue from acquisitions that had no comparable revenues in the same period of 2009; and (ii) the remaining net decrease of $2.4 million was primarily due to net lost business. As such, the Wholesale Brokerage Division’s negative internal growth rate for core commissions and fees revenue for 2010 was (1.7)%. Even though the internal growth rate in 2010 remained negative, the substantial reduction in the negative growth rates as compared to 2009 and 2008 reflects gradual continuation of the stabilization of coastal property insurance rates and the fact that excess and surplus lines insurance products continue to be more competitive against the standard lines carriers, including, especially, Citizens Property Insurance Corporation in Florida.
Income before income taxes for 2010 increased 48.2%, or $8.2 million, over the same period in 2009, to $25.2 million. Even though total revenues increased by only $0.4 million, total expenses were reduced by $7.8 million. Employee compensation and benefits expense was reduced $1.6 million primarily due to lower management and staff salaries and bonuses, and other operating expenses were reduced by $1.9 million, primarily in the areas of postage, supplies, telephone, and office rent costs. Additionally, interest expenses for this Division for prior acquisitions decreased by $3.5 million, primarily due to the 1.0% annual reduction in the cost of capital interest rate charged against the total purchase price of the Division’s prior acquisitions.
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The Wholesale Brokerage Division’s total revenues in 2009 decreased $12.3 million from 2008, of which $8.0 million was attributable to the reduction in core commissions and fees revenue, $3.0 million was the result of lower profit-sharing contingent commissions, and $1.4 million was due to a reduction in investment income. Of the $8.0 million net decrease in core commissions and fees, only $1.6 million related to core commissions and fees revenue from acquisitions for which there were no comparable revenues in 2008. The net internal growth rate for core commissions and fees revenue in 2009 was (6.3)%, or $9.4 million less in revenues than in 2008, excluding core commissions and fees revenue recognized in 2009 from new acquisitions. The 2009 internal growth rate of (6.3)% was an improvement over the 2008 internal growth rate of (14.6)% and represented $13.5 million less of lost revenues. This improvement was reflective of the stabilization of coastal property insurance rates and the fact that excess and surplus lines insurance products have become more competitive against the standard lines carriers, including, especially, Citizens.
Income before income taxes in 2009 decreased by only $0.6 million to $17.0 million, a 3.2% decrease from 2008, even though total revenues decreased $12.3 million from 2008. This improvement in pre-tax margin was primarily the result of specific headcount reductions at several of our wholesale brokerage operations, which also resulted in a $6.7 million reduction in employee compensation and benefits. Additionally we reduced other operating expenses by $1.5 million, primarily in the areas of travel and entertainment expenses, bad debt expense and occupancy costs. Interest expenses for this Division for prior acquisitions decreased by $3.7 million, primarily due to the 1.0% annual reduction in the cost of capital interest rate charged against the total purchase price of the Division’s prior acquisitions.
Services Division
The Services Division provides insurance-related services, including third-party claims administration (“TPA”) and comprehensive medical utilization management services in both the workers’ compensation and all-lines liability arenas, as well as Medicare set-aside services and, effective in 2010, Social Security disability and Medicare benefits advocacy services.
Unlike our other segments, approximately 99.8% of the Services Division’s 2010 commissions and fees revenue is generated from fees, which are not significantly affected by fluctuations in general insurance premiums.
Financial information relating to our Services Division is as follows (in thousands, except percentages):
| 2010 | Percent Change | 2009 | Percent Change | 2008 | ||||||||||||||||
| REVENUES | ||||||||||||||||||||
| Core commissions and fees | $ | 46,336 | 41.7 | % | $ | 32,689 | 1.7 | % | $ | 32,137 | ||||||||||
| Profit-sharing contingent commissions | — | — | — | — | — | |||||||||||||||
| Investment income | 15 | (34.8 | )% | 23 | 76.9 | % | 13 | |||||||||||||
| Other (loss) income net | 96 | 209.7 | % | 31 | NMF | (1) | (6 | ) | ||||||||||||
| Total revenues | 46,447 | 41.9 | % | 32,743 | 1.9 | % | 32,144 | |||||||||||||
| EXPENSES | ||||||||||||||||||||
| Employee compensation and benefits | 26,443 | 38.4 | % | 19,106 | 4.4 | % | 18,293 | |||||||||||||
| Non-cash stock-based compensation | 87 | (46.6 | )% | 163 | 16.4 | % | 140 | |||||||||||||
| Other operating expenses | 7,734 | 54.2 | % | 5,015 | 1.8 | % | 4,924 | |||||||||||||
| Amortization | 1,264 | 173.6 | % | 462 | — | 462 | ||||||||||||||
| Depreciation | 352 | 5.7 | % | 333 | (20.9 | )% | 421 | |||||||||||||
| Interest | 2,592 | 288.0 | % | 668 | (11.1 | )% | 751 | |||||||||||||
| Change in estimated acquisition earn-out payables | 282 | — | — | — | — | |||||||||||||||
| Total expenses | 38,754 | 50.5 | % | 25,747 | 3.0 | % | 24,991 | |||||||||||||
| Income before income taxes | $ | 7,693 | 10.0 | % | $ | 6,996 | (2.2 | )% | $ | 7,153 | ||||||||||
| Net internal growth rate — core commissions and fees | (0.2 | )% | 1.7 | % | (9.5 | )% | ||||||||||||||
| Employee compensation and benefits ratio | 56.9 | % | 58.4 | % | 56.9 | % | ||||||||||||||
| Other operating expenses ratio | 16.7 | % | 15.3 | % | 15.3 | % | ||||||||||||||
| Capital expenditures | $ | 419 | $ | 160 | $ | 301 | ||||||||||||||
| Total assets at December 31 | $ | 145,321 | $ | 47,829 | $ | 45,360 |
| (1) | NMF = Not a meaningful figure |
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The Services Division’s total revenues in 2010 increased $13.7 million over 2009, almost exclusively due to acquired revenues attributable to our Medicare Secondary Payer statute (“MSP”) compliance-related services and our new Social Security disability and Medicare benefits advocacy services.
Income before income taxes in 2010 increased $0.7 million over 2009 due to the operations acquired in 2010. Additionally, interest expenses for this Division for the current year acquisitions increased by $1.9 million, primarily due to the interest rate charged against the total purchase price of the Division’s acquisitions.
The Services Division’s total revenues in 2009 increased $0.6 million from 2008, primarily due to net new business growth generated by our MSP compliance-related services and our workers’ compensation claims business. This net new business growth was offset by a $0.9 million reduction in commissions and fees at our public entity claims services, due to the continued drop in the Florida workers’ compensation rates.
Income before income taxes in 2009 decreased $0.2 million from 2008. Even though total revenues increased slightly in 2009, employee compensation and benefits increased $0.8 million, due to increased staffing associated with our MSP compliance-related services and our workers’ compensation claims business.
Other
As discussed in Note 15 of the Notes to Consolidated Financial Statements, the “Other” column in the Segment Information table includes any income and expenses not allocated to reportable segments, and corporate-related items, including the inter-company interest expense charges to reporting segments.
LIQUIDITY AND CAPITAL RESOURCES
Our cash and cash equivalents of $273.0 million at December 31, 2010 reflected an increase of $75.9 million from the $197.1 million balance at December 31, 2009. During 2010, $296.1 million of cash was provided from operating activities. Also during this period, $157.6 million of cash was used for acquisitions, $10.4 million was used for additions to fixed assets, $19.4 million was used for payments on long-term debt and $44.5 million was used for payment of dividends.
Our cash and cash equivalents of $197.1 million at December 31, 2009 reflected an increase of $118.6 million from the $78.6 million balance at December 31, 2008. During 2009, $221.6 million of cash was provided from operating activities. Also during this period, $44.7 million of cash was used for acquisitions, $11.3 million was used for additions to fixed assets, $15.1 million was used for payments on long-term debt and $42.9 million was used for payment of dividends.
Our cash and cash equivalents of $78.6 million at December 31, 2008 reflected an increase of $40.3 million from the $38.2 million balance at December 31, 2007. During 2008, $341.8 million of cash was provided from operating activities. Also during this period, $263.4 million of cash was used for acquisitions, $14.1 million was used for additions to fixed assets, $20.3 million was used for payments on long-term debt and $40.2 million was used for payment of dividends.
Our ratio of current assets to current liabilities (the “current ratio”) was 1.39 and 1.28 at December 31, 2010 and 2009, respectively.
Contractual Cash Obligations
As of December 31, 2010, our contractual cash obligations were as follows:
| (in thousands) | Total | Less Than 1 Year | 1-3 Years | 4-5 Years | After 5 Years | |||||||||||||||
| Long-term debt | $ | 251,729 | $ | 1,662 | $ | 67 | $ | 125,000 | $ | 125,000 | ||||||||||
| Other liabilities | 11,516 | 6,380 | 3,723 | 380 | 1,033 | |||||||||||||||
| Operating leases | 95,142 | 24,491 | 35,149 | 21,519 | 13,983 | |||||||||||||||
| Interest obligations | 39,368 | 12,790 | 17,675 | 7,522 | 1,381 | |||||||||||||||
| Unrecognized tax benefits | 656 | — | 656 | — | — | |||||||||||||||
| Maximum future acquisition contingency payments | 144,383 | 81,067 | 60,120 | 3,196 | — | |||||||||||||||
| Total contractual cash obligations | $ | 542,794 | $ | 126,390 | $ | 117,390 | $ | 157,617 | $ | 141,397 | ||||||||||
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Debt
In July 2004, we completed a private placement of $200.0 million of unsecured senior notes (the “Notes”). The $200.0 million is divided into two series: Series A, for $100.0 million due in 2011 and bearing interest at 5.57% per year; and Series B, for $100.0 million due in 2014 and bearing interest at 6.08% per year. The closing on the Series B Notes occurred on July 15, 2004. The closing on the Series A Notes occurred on September 15, 2004. We have used the proceeds from the Notes for general corporate purposes, including acquisitions and repayment of existing debt. As of December 31, 2010 and 2009, there was an outstanding balance of $200.0 million on the Notes.
On December 22, 2006, we entered into a Master Shelf and Note Purchase Agreement (the “Master Agreement”) with a national insurance company (the “Purchaser”). The Purchaser also purchased Notes issued by us in 2004. The Master Agreement provides for a $200.0 million private uncommitted “shelf” facility for the issuance of senior unsecured notes over a three-year period, with interest rates that may be fixed or floating and with such maturity dates, not to exceed ten years, as the parties may determine. The Master Agreement includes various covenants, limitations and events of default similar to the Notes issued in 2004. The initial issuance of notes under the Master Agreement occurred on December 22, 2006, through the issuance of $25.0 million in Series C Senior Notes due December 22, 2016, with a fixed interest rate of 5.66% per annum. On February 1, 2008, $25.0 million in Series D Senior Notes due January 15, 2015, with a fixed interest rate of 5.37% per annum were issued. As of December 31, 2010 and 2009, there was an outstanding balance of $50.0 million under the Master Agreement.
On January 21, 2011, we entered into a Confirmation of Acceptance (the “Confirmation”) in connection with the Master Agreement in which we agreed to issue to the Purchaser and certain of the Purchaser’s affiliates an aggregate of $100.0 million principal amount of unsecured Series E Senior Notes due September 15, 2018, with a fixed interest rate of 4.5% per year. The closing and funding date for the unsecured Series E Senior Notes is identified as September 15, 2011 in order to correspond with maturity date of the Series A Notes. In accordance with ASC Topic 470 – Debt, the Company has classified the related principal balance as long-term debt as of December 31, 2010, as the Company has both the intent and ability to refinance the obligation on a long-term basis, as evidenced by the Confirmation.
On June 12, 2008, we entered into an Amended and Restated Revolving Loan Agreement (the “Loan Agreement”), dated as of June 3, 2008, with a national banking institution, amending and restating the existing Revolving Loan Agreement dated September 29, 2003, as amended (the “Revolving Agreement”), in order to increase the lending commitment to $50.0 million (subject to potential increases up to $100.0 million) and to extend the maturity date from December 20, 2011 to June 3, 2013. The Revolving Agreement initially provided for a revolving credit facility in the maximum principal amount of $75.0 million. After a series of amendments that provided covenant exceptions for the notes issued or to be issued under the Master Agreement and relaxed or deleted certain other covenants, the maximum principal amount was reduced to $20.0 million. The calculation of interest and fees is generally based on our quarterly ratio of funded debt to earnings before interest, taxes, depreciation, amortization, and non-cash stock-based compensation. Interest is charged at a rate equal to 0.50% to 1.00% above the London Interbank Offering Rate (“LIBOR”) or 1.00% below the base rate, each as more fully defined in the Loan Agreement. Fees include an upfront fee, an availability fee of 0.10% to 0.20%, and a letter of credit usage fee of 0.50% to 1.00%. The Loan Agreement contains various covenants, limitations, and events of default customary for similar facilities for similar borrowers. The 90-day LIBOR was 0.300% and 0.251% as of December 31, 2010 and 2009, respectively. There were no borrowings against this facility at December 31, 2010 or 2009.
All three of these credit agreements require that we maintain certain financial ratios and comply with certain other covenants. We were in compliance with all such covenants as of December 31, 2010 and 2009.
Neither we nor our subsidiaries has ever incurred off-balance sheet obligations through the use of, or investment in, off-balance sheet derivative financial instruments or structured finance or special purpose entities organized as corporations, partnerships or limited liability companies or trusts.
We believe that our existing cash, cash equivalents, short-term investment portfolio and funds generated from operations, together with our Master Agreement and the Loan Agreement described above, will be sufficient to satisfy our normal liquidity needs through at least the end of 2011. Additionally, we believe that funds generated from future operations will be sufficient to satisfy our normal liquidity needs, including the required annual principal payments on our long-term debt.
Historically, much of our cash has been used for acquisitions. If additional acquisition opportunities should become available that exceed our current cash flow, we believe that given our relatively low debt-to-total-capitalization ratio, we would be able to raise additional capital through either the private or public debt markets.
For further discussion of our cash management and risk management policies, see “Quantitative and Qualitative Disclosures About Market Risk.”
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In addition, we currently have a shelf registration statement with the SEC registering the potential sale of an indeterminate amount of debt and equity securities in the future, from time to time, to augment our liquidity and capital resources.
Critical Accounting Policies
Our Consolidated Financial Statements are prepared in accordance GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We continually evaluate our estimates, which are based on historical experience and on assumptions that we believe to be reasonable under the circumstances. These estimates form the basis for our judgments about the carrying values of our assets and liabilities, which values are not readily apparent from other sources. Actual results may differ from these estimates.
We believe that, of our significant accounting policies (see “Note 1—Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements), the following critical accounting policies may involve a higher degree of judgment and complexity.
Revenue Recognition
Commission revenues are recognized as of the effective date of the insurance policy or the date on which the policy premium is billed to the customer, whichever is later. At that date, the earnings process has been completed, and we can reliably estimate the impact of policy cancellations for refunds and establish reserves accordingly. Management determines the policy cancellation reserve based upon historical cancellation experience adjusted in accordance with known circumstances. Subsequent commission adjustments are recognized upon our receipt of notification concerning matters necessitating such adjustments from the insurance companies. Profit-sharing contingent commissions are recognized when determinable, which is when such commissions are received from insurance companies, or when we receive formal notification of the amount of such payments. Fee revenues are recognized as services are rendered.
Business Combinations and Purchase Price Allocations
We have acquired significant intangible assets through business acquisitions. These assets consist of purchased customer accounts, non-compete agreements, and the excess of purchase prices over the fair value of identifiable net assets acquired (Goodwill). The determination of estimated useful lives and the allocation of the purchase price to the intangible assets requires significant judgment and affects the amount of future amortization and possible impairment charges.
All of our business combinations initiated after June 30, 2001 have been accounted for using the purchase method. In connection with these acquisitions, we record the estimated value of the net tangible assets purchased and the value of the identifiable intangible assets purchased, which typically consist of purchased customer accounts and non-compete agreements. Purchased customer accounts include the physical records and files obtained from acquired businesses that contain information about insurance policies, customers and other matters essential to policy renewals. However, they primarily represent the present value of the underlying cash flows expected to be received over the estimated future renewal periods of the insurance policies comprising those purchased customer accounts. The valuation of purchased customer accounts involves significant estimates and assumptions concerning matters such as cancellation frequency, expenses and discount rates. Any change in these assumptions could affect the carrying value of purchased customer accounts. Non-compete agreements are valued based on their duration and any unique features of particular 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 five to 15 years. The excess of the purchase price of an acquisition over the fair value of the identifiable tangible and intangible assets is assigned to goodwill and is no longer amortized.
Acquisition purchase prices are typically based on a multiple of average annual operating profit earned over a one- to three-year period within a minimum and maximum price range. The recorded purchase price for all acquisitions consummated after January 1, 2009 included 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.
The fair value of earn-out obligations is based on the present value of the expected future payments to be made to the sellers of the acquired businesses in accordance with the provisions outlined 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 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 payments are then discounted to present value using a risk-adjusted rate that takes into consideration the likelihood that the forecasted earn-out payments will be made.
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Intangible Assets Impairment
Goodwill is subject to at least an annual assessment for impairment by applying a fair-value-based test. Amortizable intangible assets are amortized over their useful lives and are subject to an impairment review based on an estimate of the undiscounted future cash flows resulting from the use of the asset. To determine if there is potential impairment of goodwill, we compare the fair value of each reporting unit with its carrying value. If the fair value of the reporting unit is less than its carrying value, an impairment loss would be 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 on multiples of earnings before interest, income taxes, depreciation and amortization (“EBITDA”).
Management assesses the recoverability of our goodwill on an annual basis, and assesses the recoverability of our amortizable intangibles and other long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. The following factors, if present, may trigger an impairment review: (i) significant underperformance relative to historical or projected future operating results; (ii) significant negative industry or economic trends; (iii) significant decline in our stock price for a sustained period; and (iv) 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, 2010 and identified no impairment as a result of the evaluation.
Non-Cash Stock-Based Compensation
The Company grants stock options and non-vested stock awards to its employees, which requires that the related compensation expense be recognized in the financial statements based upon the grant-date fair value of those awards.
Litigation Claims
We are subject to numerous litigation claims that arise in the ordinary course of business. If it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of the loss is estimable, an accrual for the costs to resolve these claims is recorded in accrued expenses in the accompanying Consolidated Balance Sheets. Professional fees related to these claims are included in other operating expenses in the accompanying Consolidated Statements of Income. Management, with the assistance of in-house and outside counsel, determines whether it is probable that a liability has been incurred and estimates the amount of loss based upon analysis of individual issues. New developments or changes in settlement strategy in dealing with these matters may significantly affect the required reserves and affect our net income.
New Accounting Pronouncements
See Note 1 of the Notes to Consolidated Financial Statements for a discussion of the effects of the adoption of new accounting standards.
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