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.
General
The following discussion should be read in conjunction with our Consolidated Financial Statements and the related Notes to those Financial Statements included elsewhere in this Annual Report on Form 10-K. In addition, please see “Information Regarding Non-GAAP Measures” below, regarding important information on non-GAAP financial measures contained in our discussion and analysis.
We are a diversified insurance agency, wholesale brokerage, insurance programs and services organization headquartered in Daytona Beach, 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 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, or sales and payroll levels) to determine what premium to charge the insured. Insurance companies establish these premium rates based upon many factors, including loss experience, risk profile and reinsurance rates paid by such insurance companies, none of which we control.
We have increased revenues every year from 1993 to 2017, with the exception of 2009, when our revenues dropped 1.0%. Our revenues grew from $95.6 million in 1993 to $1.9 billion in 2017, reflecting a compound annual growth rate of 13.2%. In the same 24-year period, we increased net income from $8.1 million to $399.6 million in 2017, a compound annual growth rate of 17.6%.
The volume of business from new and existing customers, fluctuations in insurable exposure units, changes in premium rate levels, and changes in general economic and competitive conditions all affect our revenues. For example, level rates of inflation or a general decline in economic activity could limit increases in the values of insurable exposure units. Conversely, increasing costs of litigation settlements and awards could cause some customers to seek higher levels of insurance coverage. Historically, our revenues have typically grown as a result of our focus on net new business growth and acquisitions. We foster a strong, decentralized sales and service culture with the goal of consistent, sustained growth over the long-term.
The term “Organic Revenue”, a non-GAAP measure, is our core commissions and fees less (i) the core commissions and fees earned for the first twelve months by newly-acquired operations and (ii) divested business (core commissions and fees generated from offices, books of business or niches sold or terminated during the comparable period). The term “core commissions and fees” excludes profit-sharing contingent commissions and guaranteed supplemental commissions, and therefore represents the revenues earned directly from specific insurance policies sold, and specific fee-based services rendered. “Organic Revenue” is reported in this manner in order to express the current year’s core commissions and fees on a comparable basis with the prior year’s core commissions and fees. The resulting net change reflects the aggregate changes attributable to (i) net new and lost accounts, (ii) net changes in our customers’ exposure units, (iii) net changes in insurance premium rates or the commission rate paid to us by our carrier partners, and (iv) the net change in fees paid to us by our customers. Organic Revenue is reported in the “Results of Operations - Segment Information” of this Form 10-K.
We also earn “profit-sharing contingent commissions,” which are profit-sharing commissions based primarily on underwriting results, but which 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 upon the aforementioned considerations for the prior year(s). Over the last three years, profit-sharing contingent commissions have averaged approximately 3.2% of the previous year’s total commissions and fees. Profit-sharing contingent commissions are included in our total commissions and fees in the Consolidated Statement of Income in the year received.
Certain insurance companies offer guaranteed fixed-base agreements, referred to as “Guaranteed Supplemental Commissions” (“GSCs”) in lieu of profit-sharing contingent commissions. Since GSCs are not subject to the uncertainty of loss ratios, they are accrued throughout the year based upon actual premiums written. For the year ended December 31, 2017, we had earned $10.4 million of GSCs, of which $8.5 million remained accrued at December 31, 2017 as most of this will be collected in the first quarter of 2018. For the years ended December 31, 2017, 2016, and 2015, we earned $10.4 million, $11.5 million and $10.0 million, respectively, from GSCs.
Fee revenues relate to fees negotiated in lieu of commissions, which are recognized as services are rendered. Fee revenues have historically been generated primarily by: (1) our Services Segment, which provides insurance-related services, including third-party claims administration and comprehensive medical utilization management services in both the workers’ compensation and all-lines liability arenas, as well as Medicare Set-aside services, Social Security disability and Medicare benefits advocacy services, and claims adjusting services, (2) our National Programs and Wholesale Brokerage Segments, which earn fees primarily for the issuance of insurance policies on behalf of insurance companies and to a lesser extent (3) our Retail Segment in our large-account customer base. Our services are provided over a period of time, which is typically one year. Fee revenues as a percentage of our total commissions and fees, represented 31.5% in 2017, 31.3% in 2016 and 30.6% in 2015.
Additionally, our profit-sharing contingent commissions and GSCs for the year ended December 31, 2017 decreased by $2.9 million over 2016 primarily as a result of a decrease in profit-sharing contingent commissions and GSCs in the Retail and Wholesale Brokerage Segments as a result of increased loss ratios and lower premium rates, partially offset by an increase in profit-sharing contingent commissions and GSCs in the National Programs Segment. Other income increased by $20.1 million primarily as a result of a legal settlement recognized in the first quarter of 2017.
For the years ended December 31, 2017 and 2016, our commissions and fees growth rate was 5.4% and 6.4%, respectively, and our consolidated organic revenue growth rate was 4.4% and 3.0%, respectively. Additionally, each of our four segments recorded positive organic revenue growth for the year ended December 31, 2017. In the event that the gradual increases in insurable exposure units that occurred in the past few years continues through 2018 and premium rate changes are similar with 2017, we believe we will continue to see positive quarterly organic revenue growth rates in 2018.
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. Investment income also includes gains and losses realized from the sale of investments. Other income primarily reflects legal settlements and other miscellaneous income.
Income before income taxes for the year ended December 31, 2017 increased over 2016 by $26.2 million, primarily as a result of a legal settlement recorded in the first quarter of 2017 and net new business and acquisitions completed in the past twelve months.
Information Regarding Non-GAAP Measures
In the discussion and analysis of our results of operations, in addition to reporting financial results in accordance with GAAP, we provide information regarding the following non-GAAP measures: Organic Revenue, organic revenue growth, and organic revenue growth rate. We view each of these non-GAAP measures as important indicators when assessing and evaluating our performance on a consolidated basis and for each of our segments because they allow us to determine a comparable, but non-GAAP, measurement of revenue growth that is associated with the revenue sources that were a part of our business in both the current and prior year and that are expected to continue in the future. These measures are not in accordance with, or an alternative to the GAAP information provided in this Annual Report on Form 10-K. We believe that presenting these non-GAAP measures allows readers of our financial statements to measure, analyze and compare our consolidated growth, the growth of each of our segments, and certain aspects of our operating performance from period to period in a meaningful and consistent manner that may not be otherwise apparent on a GAAP basis. Our industry peers may provide similar supplemental non-GAAP information with respect to one or more of these measures, although they may not use the same or comparable terminology and may not make identical adjustments. This supplemental financial information should be considered in addition to, not in lieu of, our Consolidated Financial Statements.
Tabular reconciliations of this supplemental non-GAAP financial information to our most comparable GAAP information are contained in this Annual Report on Form 10-K under “Results of Operation - Segment Information.”
Acquisitions
Part of our business strategy is to attract high-quality insurance intermediaries to join our operations. From 1993 through the fourth quarter of 2017, we acquired 490 insurance intermediary operations, excluding acquired books of business (customer accounts). During the year ended December 31, 2017, the Company acquired the assets and assumed certain liabilities of eleven insurance intermediaries and one book of business (customer accounts). Collectively, these acquired business that had annualized revenues of approximately $17.5 million.
Critical Accounting Policies
Our Consolidated Financial Statements are prepared in accordance with U.S. 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 upon 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, of which values are not readily apparent from other sources. Actual results may differ from these estimates.
We believe that of our significant accounting and reporting policies, the more critical policies include our accounting for revenue recognition, business combinations and purchase price allocations, intangible asset impairments, non-cash stock-based compensation and reserves for litigation. In particular, the accounting for these areas requires significant use of judgment to be made by management. Different assumptions in the application of these policies could result in material changes in our consolidated financial position or consolidated results of operations. Refer to Note 1 “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” for a discussion of the impacts for adopting Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers (Topic 606).
Revenue Recognition
Commission revenues are recognized as of the effective date of the insurance policy or the date on which the policy premium is processed into our systems and invoiced to the customer, whichever is later. Commission revenues related to installment billings are recognized on the later of the date effective or invoiced, with the exception of our Arrowhead business which follows a policy of recognizing on the later of the date effective or processed into our systems regardless of the billing arrangement. 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 from insurance companies concerning matters necessitating such adjustments. Profit-sharing contingent commissions are recognized when determinable, which is generally when such commissions are received from insurance
companies, or periodically when we receive formal notification of the amount of such payments. Fee revenues, and commissions for employee benefits coverages and workers’ compensation programs, are recognized as services are rendered. Please see Note 1 in the “Notes to Consolidated Financial Statements” for changes to our revenue recognition policies that are effective January 1, 2018 as prescribed by new accounting pronouncements.
Business Combinations and Purchase Price Allocations
We have acquired significant intangible assets through acquisitions of businesses. These assets generally 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 purchase price to 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 acquisition 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 upon their duration and any unique features of the 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 3 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 not amortized.
Acquisition purchase prices are typically based upon a multiple of average annual operating profit or core revenue earned over a one to three-year period within a minimum and maximum price range. The recorded purchase prices for all acquisitions consummated after January 1, 2009 include 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 are recorded in the Consolidated Statement of Income when changes to the expected performance of the associated business are realized.
The fair value of earn-out obligations is based upon the present value of the expected future payments to be made to the sellers of the acquired businesses in accordance with the provisions contained in the respective purchase agreements. In determining fair value, the acquired business’s future performance is estimated using financial projections developed by management for the acquired business, and this estimate 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 estimates are then discounted to a present value using a risk-adjusted rate that takes into consideration the likelihood that the forecasted earn-out payments will be made.
Intangible Assets Impairment
Goodwill is subject to at least an annual assessment for impairment measured by a fair-value-based test. Amortizable intangible assets are amortized over their useful lives and are subject to an impairment review based upon an estimate of the undiscounted future cash flows resulting from the use of the assets. 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 upon multiples of earnings before interest, income taxes, depreciation, amortization and change in estimated acquisition earn-out payables (“EBITDAC”), or on a discounted cash flow basis.
Management assesses the recoverability of our goodwill and our amortizable intangibles and other long-lived assets annually and whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Any of the following factors, if present, may trigger an impairment review: (i) a significant underperformance relative to historical or projected future operating results, (ii) a significant negative industry or economic trend, and (iii) a 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, 2017 and determined that the fair value of goodwill exceeded the carrying value of such assets. Additionally, there have been no impairments recorded for amortizable intangible assets for the years ended December 31, 2017, 2016 and 2015.
Non-Cash Stock-Based Compensation
We grant non-vested stock awards, and to a lesser extent, stock options to our employees, with the related compensation expense recognized in the financial statements over the associated service period based upon the grant-date fair value of those awards.
During the first quarter of 2016, the performance conditions for approximately 1.4 million shares of the Company’s common stock granted under the Company’s Stock Incentive Plan were determined by the Compensation Committee to have been satisfied relative to performance-based grants issued in 2011. These grants had a performance measurement period that concluded on December 31, 2015. The vesting condition for these grants requires continuous employment for a period of up to ten years from the January 2011 grant date in order for the awarded shares to become fully vested and nonforfeitable. As a result of the awarding of these shares, the grantees became eligible to receive payments of dividends and exercise voting privileges after the awarding date.
During the first quarter of 2017, the performance conditions for approximately 169,000 shares of the Company’s common stock granted under the Company’s Stock Incentive Plan were determined by the Compensation Committee to have been satisfied relative to performance-based grants issued in 2012. These grants had a performance measurement period that concluded on December 31, 2016. The vesting condition for these grants requires continuous employment for a period of up to ten years from the January 2012 grant date in order for the awarded shares to become fully vested and nonforfeitable. As a result of the awarding of these shares, the grantees will be eligible to receive payments of dividends and exercise voting privileges after the awarding date, and the awarded shares will be included as issued and outstanding common stock shares and included in the calculation of basic and diluted EPS.
During the first quarter of 2018, the performance conditions for 130,172 shares of the Company’s common stock granted under the Company’s Stock Incentive Plan were determined by the Compensation Committee to have been satisfied relative to performance-based grants issued in 2013. These grants had a performance measurement period that concluded on December 31, 2017. The vesting condition for these grants requires continuous employment for a period of up to ten years from the January 2013 grant date in order for the awarded shares to become fully vested and nonforfeitable. As a result of the awarding of these shares, the grantees will be eligible to receive payments of dividends and exercise voting privileges after the awarding date, and the awarded shares will be included as issued and outstanding common stock shares and included in the calculation of basic and diluted EPS.
Litigation and Claims
We are subject to numerous litigation claims that arise in the ordinary course of business. If it is probable that 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 Financial Statements. Professional fees related to these claims are included in other operating expenses in the accompanying Consolidated Statement of Income as incurred. 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.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2017**,** 2016 AND 2015
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) | 2017 | % Change | 2016 | % Change | 2015 | ||||||||||||
| REVENUES | |||||||||||||||||
| Core commissions and fees | $ | 1,794,714 | 5.7 | % | $ | 1,697,308 | 6.4 | % | $ | 1,595,218 | |||||||
| Profit-sharing contingent commissions | 52,186 | (3.4 | )% | 54,000 | 4.4 | % | 51,707 | ||||||||||
| Guaranteed supplemental commissions | 10,370 | (9.7 | )% | 11,479 | 14.5 | % | 10,026 | ||||||||||
| Commissions and fees | 1,857,270 | 5.4 | % | 1,762,787 | 6.4 | % | 1,656,951 | ||||||||||
| Investment income | 1,626 | 11.7 | % | 1,456 | 45.0 | % | 1,004 | ||||||||||
| Other income, net | 22,451 | NMF | 2,386 | (6.6 | )% | 2,554 | |||||||||||
| Total revenues | 1,881,347 | 6.5 | % | 1,766,629 | 6.4 | % | 1,660,509 | ||||||||||
| EXPENSES | |||||||||||||||||
| Employee compensation and benefits | 994,652 | 7.5 | % | 925,217 | 8.0 | % | 856,952 | ||||||||||
| Other operating expenses | 283,470 | 7.8 | % | 262,872 | 4.7 | % | 251,055 | ||||||||||
| (Gain)/loss on disposal | (2,157 | ) | 67.1 | % | (1,291 | ) | 108.6 | % | (619 | ) | |||||||
| Amortization | 85,446 | (1.4 | )% | 86,663 | (0.9 | )% | 87,421 | ||||||||||
| Depreciation | 22,698 | 8.1 | % | 21,003 | 0.5 | % | 20,890 | ||||||||||
| Interest | 38,316 | (3.0 | )% | 39,481 | 0.6 | % | 39,248 | ||||||||||
| Change in estimated acquisition earn-out payables | 9,200 | 0.2 | % | 9,185 | NMF | 3,003 | |||||||||||
| Total expenses | 1,431,625 | 6.6 | % | 1,343,130 | 6.8 | % | 1,257,950 | ||||||||||
| Income before income taxes | 449,722 | 6.2 | % | 423,499 | 5.2 | % | 402,559 | ||||||||||
| Income taxes | 50,092 | (69.8 | )% | 166,008 | 4.2 | % | 159,241 | ||||||||||
| NET INCOME | $ | 399,630 | 55.2 | % | $ | 257,491 | 5.7 | % | $ | 243,318 | |||||||
| Organic revenue growth rate(1) | 4.4 | % | 3.0 | % | 2.6 | % | |||||||||||
| Employee compensation and benefits relative to total revenues | 52.9 | % | 52.4 | % | 51.6 | % | |||||||||||
| Other operating expenses relative to total revenues | 15.1 | % | 14.9 | % | 15.1 | % | |||||||||||
| Capital expenditures | $ | 24,192 | $ | 17,765 | $ | 18,375 | |||||||||||
| Total assets at December 31 | $ | 5,747,550 | $ | 5,262,734 | $ | 4,979,844 |
(1) A non-GAAP measure
NMF = Not a meaningful figure
Commissions and Fees
Commissions and fees, including profit-sharing contingent commissions and GSCs for 2017, increased $94.5 million to $1,857.3 million, or 5.4% over 2016. Core commissions and fees for 2017 increased $97.4 million, of which approximately $27.7 million represented core commissions and fees from agencies acquired since 2016 that had no comparable revenues. After accounting for divested business of $4.9 million, the remaining net increase of $74.6 million represented net new business, which reflects an organic revenue growth rate of 4.4% for core commissions and fees. Profit-sharing contingent commissions and GSCs for 2017 decreased by $2.9 million, or 4.5%, compared to the same period in 2016. The net decrease of $2.9 million was mainly driven by a decrease in profit-sharing contingent commissions and GSCs in the Retail and Wholesale Brokerage Segments, as a result of increased loss ratios and lower premium rates, which was partially offset by an increase in profit-sharing contingent commissions and GSCs in the National Programs Segment.
Commissions and fees, including profit-sharing contingent commissions and GSCs for 2016, increased $105.8 million to $1,762.8 million, or 6.4% over 2015. Core commissions and fees in 2016 increased $102.1 million, of which approximately $61.7 million represented core commissions and fees from agencies acquired since 2015 that had no comparable revenues. After accounting for divested business of $6.6 million, the remaining net increase of $47.0 million represented net new business, which reflects an organic revenue growth rate of 3.0% for
core commissions and fees. Profit-sharing contingent commissions and GSCs for 2016 increased by $3.7 million, or 6.1%, compared to the same period in 2015. The net increase of $3.7 million was mainly driven by an increase in profit-sharing contingent commissions and GSCs in the Retail Segment, which was partially offset by a decrease in profit-sharing contingent commissions in the Wholesale Brokerage Segment as a result of increased loss ratios.
Investment Income
Investment income increased to $1.6 million in 2017, compared with $1.5 million in 2016 and increased to $1.5 million in 2016, compared with $1.0 million in 2015. The increases in both years are due to additional interest income driven by higher average invested cash balances accompanied by higher effective earned rates of interest.
Other Income, Net
Other income for 2017 was $22.5 million, compared with $2.4 million in 2016 and $2.6 million in 2015. Other income consists primarily of legal settlements and other miscellaneous income. In 2017, $20.0 million of other income was recognized as a result of a legal settlement in the first quarter of 2017.
Employee Compensation and Benefits
Employee compensation and benefits expense increased 7.5%, or $69.4 million, in 2017 over 2016. This increase included $11.1 million of compensation costs related to stand-alone acquisitions that had no comparable costs in the same period of 2016. Therefore, employee compensation and benefits expense attributable to those offices that existed in the same time periods of 2017 and 2016 increased by $58.3 million or 6.4%. This underlying employee compensation and benefits expense increase was primarily related to (i) higher bonuses due to increased revenue and operating profit as well as the additional cost associated with the Retail Segment’s performance incentive plan introduced in 2017, (ii) an increase in producer commissions driven by new and renewed business, (iii) an increase in non-cash stock-based compensation expense due to forfeiture credits recognized in 2016, and (iv) increased staff salaries attributable to salary inflation and higher volumes in portions of our business. Employee compensation and benefits expense as a percentage of total revenues was 52.9% for 2017 as compared to 52.4% for the year ended December 31, 2016.
Employee compensation and benefits expense increased 8.0%, or $68.3 million, in 2016 over 2015. This increase included $23.3 million of compensation costs related to stand-alone acquisitions that had no comparable costs in the same period of 2015. Therefore, employee compensation and benefits expense attributable to those offices that existed in the same time periods of 2016 and 2015 increased by $45.0 million or 5.2%. This underlying employee compensation and benefits expense increase was primarily related to (i) higher producer commissions driven by new and renewed business, (ii) increased staff salaries that included some severance cost, (iii) increased bonuses due to higher revenue and operating profit, (iv) increased cost of health insurance, and (v) an increase in non-cash stock-based compensation expense due to forfeiture credits recognized in 2015. Employee compensation and benefits expense as a percentage of total revenues was 52.4% for 2016 as compared to 51.6% for the year ended December 31, 2015.
Other Operating Expenses
Other operating expenses in 2017 increased 7.8%, or $20.6 million, over 2016, of which $3.3 million was related to acquisitions that had no comparable costs in the same period of 2016. The other operating expenses for those offices that existed in the same periods in both 2017 and 2016 increased by $17.3 million or 6.6%, which was primarily attributable to (i) higher data processing costs related to our multi-year technology investment program, (ii) the receipt of certain premium tax refunds by our National Flood Program business in 2016, and (iii) professional fees at our National Programs Division. Other operating expenses as a percentage of total revenues was 15.1% in 2017, 14.9% in 2016 and 15.1% in 2015.
As a percentage of total revenues, other operating expenses represented 14.9% in 2016 and 15.1% in 2015. Other operating expenses in 2016 increased $11.8 million, or 4.7%, over 2015, of which $9.5 million was related to acquisitions that had no comparable costs in the same period of 2015. The other operating expenses for those offices that existed in the same periods in both 2016 and 2015, increased by $2.3 million or 0.9%, which was primarily attributable to higher data processing costs related to our multi-year technology investment program, partially offset by the receipt of certain premium tax refunds by our National Flood Program business.
Gain or Loss on Disposal
The Company recognized gains on disposal of $2.2 million, $1.3 million and $0.6 million in 2017, 2016 and 2015, respectively. The change in the gain on disposal was due to activity associated with book of business sales. Although we are not in the business of selling customer accounts, we periodically sell an office or a book of business (one or more customer accounts) that we believe does not produce reasonable margins or demonstrate a potential for growth, or because doing so is in the Company’s best interest.
Amortization
Amortization expense decreased $1.2 million, or 1.4%, in 2017, and decreased $0.8 million, or 0.9%, in 2016. These decreases are as a result of certain intangibles becoming fully amortized or otherwise written off as part of disposed businesses, both of which were partially offset with amortization of new intangibles from recently acquired businesses.
Depreciation
Depreciation expense increased $1.7 million, or 8.1%, in 2017 and remained flat in 2016 as compared to 2015. The increase in 2017 is due primarily to the addition of fixed assets resulting from capital projects related to our multi-year technology investment program and other business initiatives in 2017, while the stable level of expense in 2016 versus 2015 reflected capital additions approximately equal to the value of prior capital additions that became fully depreciated.
Interest Expense
Interest expense decreased $1.2 million, or 3.0%, in 2017, and increased $0.2 million, or 0.6% in 2016. The decrease in 2017 was due primarily to having less total debt outstanding. The increase in 2016 was primarily due to an increase in floating interest rates related to the outstanding debt balance on the Credit Facility term loan.
Change in Estimated Acquisition Earn-Out Payables
Accounting Standards Codification (“ASC”) Topic 805-Business Combinations is the authoritative guidance requiring an acquirer to recognize 100% of the fair value of acquired assets, including goodwill, and assumed liabilities (with only limited exceptions) upon initially obtaining control of an acquired entity. Additionally, the fair value of contingent consideration arrangements (such as earn-out purchase price arrangements) at the acquisition date must be included in the purchase price consideration. As a result, the recorded purchase prices for all acquisitions consummated after January 1, 2009 include an estimation of the fair value of liabilities associated with any potential earn-out provisions. Subsequent changes in these earn-out obligations are required to be recorded in the Consolidated Statement of Income when incurred or reasonably estimated. Estimations of potential earn-out obligations are typically based upon future earnings of the acquired operations or entities, usually for periods ranging from one to three years.
The net charge or credit to the Consolidated Statement of Income for the period is the combination of the net change in the estimated acquisition earn-out payables balance, and the interest expense imputed on the outstanding balance of the estimated acquisition earn-out payables.
As of December 31, 2017, the fair values of the estimated acquisition earn-out payables were re-evaluated and measured at fair value on a recurring basis using unobservable inputs (Level 3) as defined in ASC 820-Fair Value Measurement. The resulting net changes, as well as the interest expense accretion on the estimated acquisition earn-out payables, for the years ended December 31, 2017, 2016 and 2015 were as follows:
| (in thousands) | 2017 | 2016 | 2015 | ||||||||
| Change in fair value of estimated acquisition earn-out payables | $ | 6,874 | $ | 6,338 | $ | 13 | |||||
| Interest expense accretion | 2,326 | 2,847 | 2,990 | ||||||||
| Net change in earnings from estimated acquisition earn-out payables | $ | 9,200 | $ | 9,185 | $ | 3,003 |
For the years ended December 31, 2017, 2016 and 2015, the fair value of estimated earn-out payables was re-evaluated and increased by $6.9 million, $6.3 million and $13.0 thousand, respectively, which resulted in charges to the Consolidated Statement of Income.
As of December 31, 2017, the estimated acquisition earn-out payables equaled $36.2 million, of which $25.1 million was recorded as accounts payable and $11.1 million was recorded as other non-current liability. As of December 31, 2016, the estimated acquisition earn-out payables equaled $63.8 million, of which $31.8 million was recorded as accounts payable and $32.0 million was recorded as other non-current liability.
Income Taxes
The effective tax rate on income from operations was 11.1% in 2017, 39.2% in 2016, and 39.6% in 2015. The decrease in the effective tax rate for 2017 was primarily driven by the revaluation of deferred tax liabilities as described in Part II, Note 9 “Income Taxes,” in addition to adoption of FASB Accounting Standards Update 2016-09, “Improvements to Employee Share Based Payment Accounting” (“ASU 2016-09”) in the first quarter of 2017. ASU 2016-09, which requires upon vesting of stock-based compensation, any tax implications be treated as a discrete credit to the income tax expense in the quarter of vesting, amends guidance issued in Accounting Standards Codification (“ASC”) Topic 718, Compensation - Stock Compensation. The decrease in the effective tax rate for 2016 is driven by several permanent tax differences along with the apportionment of taxable income in the states where we operate.
RESULTS OF OPERATIONS — SEGMENT INFORMATION
As discussed in Note 15 of the Notes to Consolidated Financial Statements, we operate four reportable segments: Retail, National Programs, Wholesale Brokerage and Services. On a segmented basis, changes in amortization, depreciation and interest expenses generally result from activity associated with acquisitions. Likewise, other income in each segment reflects net gains primarily from legal settlements and miscellaneous income. As such, in evaluating the operational efficiency and leverage of a segment, management focuses on the organic revenue growth rate of core commissions and fees, the ratio of total employee compensation and benefits to total revenues, and the ratio of other operating expenses to total revenues.
The reconciliation of total commissions and fees, included in the Consolidated Statement of Income, to Organic Revenue for the years ended December 31, 2017 and 2016 is as follows:
| For the Year Ended December 31, | |||||||
| (in thousands) | 2017 | 2016 | |||||
| Commissions and fees | $ | 1,857,270 | $ | 1,762,787 | |||
| Less profit-sharing contingent commissions | 52,186 | 54,000 | |||||
| Less guaranteed supplemental commissions | 10,370 | 11,479 | |||||
| Core commissions and fees | 1,794,714 | 1,697,308 | |||||
| Less acquisition revenues | 27,739 | — | |||||
| Less divested businesses | — | 4,912 | |||||
| Organic Revenue | $ | 1,766,975 | $ | 1,692,396 |
The organic revenue growth rates for the year ended December 31, 2017, by Segment, are as follows:
| 2017 | Retail**(1)** | National Programs | Wholesale Brokerage | Services | Total | ||||||||||||||||||||||||||||||||||
| (in thousands, except percentages) | 2017 | 2016 | 2017 | 2016 | 2017 | 2016 | 2017 | 2016 | 2017 | 2016 | |||||||||||||||||||||||||||||
| Commissions and fees | $ | 942,039 | $ | 916,084 | $ | 479,017 | $ | 447,808 | $ | 271,141 | $ | 242,813 | $ | 165,073 | $ | 156,082 | $ | 1,857,270 | $ | 1,762,787 | |||||||||||||||||||
| Total change | $ | 25,955 | $ | 31,209 | $ | 28,328 | $ | 8,991 | $ | 94,483 | |||||||||||||||||||||||||||||
| Total growth % | 2.8 | % | 7.0 | % | 11.7 | % | 5.8 | % | 5.4 | % | |||||||||||||||||||||||||||||
| Contingent commissions | 23,377 | 25,207 | 20,123 | 17,306 | 8,686 | 11,487 | — | — | 52,186 | 54,000 | |||||||||||||||||||||||||||||
| GSCs | 9,108 | 9,787 | 31 | 23 | 1,231 | 1,669 | — | — | 10,370 | 11,479 | |||||||||||||||||||||||||||||
| Core commissions and fees | $ | 909,554 | $ | 881,090 | $ | 458,863 | $ | 430,479 | $ | 261,224 | $ | 229,657 | $ | 165,073 | $ | 156,082 | $ | 1,794,714 | $ | 1,697,308 | |||||||||||||||||||
| Acquisition revenues | 8,151 | — | 2,296 | — | 16,442 | — | 850 | — | 27,739 | — | |||||||||||||||||||||||||||||
| Divested business | — | 4,838 | — | 277 | — | — | — | (203 | ) | — | 4,912 | ||||||||||||||||||||||||||||
| Organic Revenue(2) | $ | 901,403 | $ | 876,252 | $ | 456,567 | $ | 430,202 | $ | 244,782 | $ | 229,657 | $ | 164,223 | $ | 156,285 | $ | 1,766,975 | $ | 1,692,396 | |||||||||||||||||||
| Organic revenue growth(2) | $ | 25,151 | $ | 26,365 | $ | 15,125 | $ | 7,938 | $ | 74,579 | |||||||||||||||||||||||||||||
| Organic revenue growth %(2) | 2.9 | % | 6.1 | % | 6.6 | % | 5.1 | % | 4.4 | % |
| (1) | The Retail Segment includes commissions and fees reported in the “Other” column of the Segment Information in Note 15 of the Notes to the Condensed Consolidated Financial Statements, which includes corporate and consolidation items. |
| (2) | A non-GAAP financial measure. |
The reconciliation of total commissions and fees, included in the Consolidated Statement of Income, to Organic Revenue for the years ended December 31, 2016 and 2015, is as follows:
| For the Year Ended December 31, | |||||||
| (in thousands) | 2016 | 2015 | |||||
| Commissions and fees | $ | 1,762,787 | $ | 1,656,951 | |||
| Less profit-sharing contingent commissions | 54,000 | 51,707 | |||||
| Less guaranteed supplemental commissions | 11,479 | 10,026 | |||||
| Core commissions and fees | 1,697,308 | 1,595,218 | |||||
| Less acquisition revenues | 61,713 | — | |||||
| Less divested businesses | — | 6,669 | |||||
| Organic Revenue | $ | 1,635,595 | $ | 1,588,549 |
The organic revenue growth rates for the year ended December 31, 2016, by Segment, are as follows:
| 2016 | Retail**(1)** | National Programs | Wholesale Brokerage | Services | Total | ||||||||||||||||||||||||||||||||||
| (in thousands, except percentages) | 2016 | 2015 | 2016 | 2015 | 2016 | 2015 | 2016 | 2015 | 2016 | 2015 | |||||||||||||||||||||||||||||
| Commissions and fees | $ | 916,084 | $ | 866,465 | $ | 447,808 | $ | 428,473 | $ | 242,813 | $ | 216,638 | $ | 156,082 | $ | 145,375 | $ | 1,762,787 | $ | 1,656,951 | |||||||||||||||||||
| Total change | $ | 49,619 | $ | 19,335 | $ | 26,175 | $ | 10,707 | $ | 105,836 | |||||||||||||||||||||||||||||
| Total growth % | 5.7 | % | 4.5 | % | 12.1 | % | 7.4 | % | 6.4 | % | |||||||||||||||||||||||||||||
| Contingent commissions | 25,207 | 22,051 | 17,306 | 15,558 | 11,487 | 14,098 | — | — | 54,000 | 51,707 | |||||||||||||||||||||||||||||
| GSCs | 9,787 | 8,291 | 23 | 30 | 1,669 | 1,705 | — | — | 11,479 | 10,026 | |||||||||||||||||||||||||||||
| Core commissions and fees | $ | 881,090 | $ | 836,123 | $ | 430,479 | $ | 412,885 | $ | 229,657 | $ | 200,835 | $ | 156,082 | $ | 145,375 | $ | 1,697,308 | $ | 1,595,218 | |||||||||||||||||||
| Acquisition revenues | 31,151 | — | 1,680 | — | 20,164 | — | 8,718 | — | 61,713 | — | |||||||||||||||||||||||||||||
| Divested business | — | 1,926 | — | 1,296 | — | — | — | 3,447 | — | 6,669 | |||||||||||||||||||||||||||||
| Organic Revenue(2) | $ | 849,939 | $ | 834,197 | $ | 428,799 | $ | 411,589 | $ | 209,493 | $ | 200,835 | $ | 147,364 | $ | 141,928 | $ | 1,635,595 | $ | 1,588,549 | |||||||||||||||||||
| Organic revenue growth(2) | $ | 15,742 | $ | 17,210 | $ | 8,658 | $ | 5,436 | $ | 47,046 | |||||||||||||||||||||||||||||
| Organic revenue growth %(2) | 1.9 | % | 4.2 | % | 4.3 | % | 3.8 | % | 3.0 | % |
| (1) | The Retail Segment includes commissions and fees reported in the “Other” column of the Segment Information in Note 15 of the Notes to the Condensed Consolidated Financial Statements, which includes corporate and consolidation items. |
| (2) | A non-GAAP financial measure. |
The reconciliation of total commissions and fees, included in the Consolidated Statement of Income, to Organic Revenue for the years ended December 31, 2015 and 2014, is as follows:
| For the Year Ended December 31, | |||||||
| (in thousands) | 2015 | 2014 | |||||
| Commissions and fees | $ | 1,656,951 | $ | 1,567,460 | |||
| Less profit-sharing contingent commissions | 51,707 | 57,706 | |||||
| Less guaranteed supplemental commissions | 10,026 | 9,851 | |||||
| Core commissions and fees | 1,595,218 | 1,499,903 | |||||
| Less acquisition revenues | 76,632 | — | |||||
| Less divested businesses | — | 19,336 | |||||
| Organic Revenue | $ | 1,518,586 | $ | 1,480,567 |
Segment results for 2014 have been recast to reflect the current year segmental structure. Certain reclassifications have been made to the prior year amounts reported in this Annual Report on Form 10-K in order to conform to the current year presentation.
The organic revenue growth rates for the year ended December 31, 2015, by Segment, are as follows:
| 2015 | Retail**(1)** | National Programs | Wholesale Brokerage | Services | Total | ||||||||||||||||||||||||||||||||||
| (in thousands, except percentages) | 2015 | 2014 | 2015 | 2014 | 2015 | 2014 | 2015 | 2014 | 2015 | 2014 | |||||||||||||||||||||||||||||
| Commissions and fees | $ | 866,465 | $ | 822,140 | $ | 428,473 | $ | 397,326 | $ | 216,638 | $ | 211,512 | $ | 145,375 | $ | 136,482 | $ | 1,656,951 | $ | 1,567,460 | |||||||||||||||||||
| Total change | $ | 44,325 | $ | 31,147 | $ | 5,126 | $ | 8,893 | $ | 89,491 | |||||||||||||||||||||||||||||
| Total growth % | 5.4 | % | 7.8 | % | 2.4 | % | 6.5 | % | 5.7 | % | |||||||||||||||||||||||||||||
| Contingent commissions | 22,051 | 21,616 | 15,558 | 20,822 | 14,098 | 15,268 | — | — | 51,707 | 57,706 | |||||||||||||||||||||||||||||
| GSCs | 8,291 | 7,730 | 30 | 21 | 1,705 | 2,100 | — | — | 10,026 | 9,851 | |||||||||||||||||||||||||||||
| Core commissions and fees | $ | 836,123 | $ | 792,794 | $ | 412,885 | $ | 376,483 | $ | 200,835 | $ | 194,144 | $ | 145,375 | $ | 136,482 | $ | 1,595,218 | $ | 1,499,903 | |||||||||||||||||||
| Acquisition revenues | 35,644 | — | 38,519 | — | 2,469 | — | — | — | 76,632 | — | |||||||||||||||||||||||||||||
| Divested business | — | 3,291 | — | 8,811 | — | 6,887 | — | 347 | — | 19,336 | |||||||||||||||||||||||||||||
| Organic Revenue(2) | $ | 800,479 | $ | 789,503 | $ | 374,366 | $ | 367,672 | $ | 198,366 | $ | 187,257 | $ | 145,375 | $ | 136,135 | $ | 1,518,586 | $ | 1,480,567 | |||||||||||||||||||
| Organic revenue growth(2) | $ | 10,976 | $ | 6,694 | $ | 11,109 | $ | 9,240 | $ | 38,019 | |||||||||||||||||||||||||||||
| Organic revenue growth %(2) | 1.4 | % | 1.8 | % | 5.9 | % | 6.8 | % | 2.6 | % |
| (1) | The Retail Segment includes commissions and fees reported in the “Other” column of the Segment Information in Note 15 of the Notes to the Condensed Consolidated Financial Statements, which includes corporate and consolidation items. |
| (2) | A non-GAAP financial measure. |
Retail Segment
The Retail Segment provides a broad range of insurance products and services to commercial, public and quasi-public, professional and individual insured customers. Approximately 87.3% of the Retail Segment’s commissions and fees is commission based. Because a significant portion of our operating expenses are not correlated to changes in commissions on insurance premiums, a significant portion of any fluctuation in the commissions we receive, net of related producer compensation, will result in a similar fluctuation in our income before income taxes, unless we make incremental investments or modifications to the costs in the organization.
Financial information relating to our Retail Segment is as follows:
| (in thousands, except percentages) | 2017 | % Change | 2016 | % Change | 2015 | ||||||||||||
| REVENUES | |||||||||||||||||
| Core commissions and fees | $ | 909,762 | 3.2 | % | $ | 881,729 | 5.3 | % | $ | 837,420 | |||||||
| Profit-sharing contingent commissions | 23,377 | (7.3 | )% | 25,207 | 14.3 | % | 22,051 | ||||||||||
| Guaranteed supplemental commissions | 9,108 | (6.9 | )% | 9,787 | 18.0 | % | 8,291 | ||||||||||
| Commissions and fees | 942,247 | 2.8 | % | 916,723 | 5.6 | % | 867,762 | ||||||||||
| Investment income | 8 | (78.4 | )% | 37 | (57.5 | )% | 87 | ||||||||||
| Other income, net | 1,205 | 86.5 | % | 646 | (74.1 | )% | 2,497 | ||||||||||
| Total revenues | 943,460 | 2.8 | % | 917,406 | 5.4 | % | 870,346 | ||||||||||
| EXPENSES | |||||||||||||||||
| Employee compensation and benefits | 515,477 | 6.0 | % | 486,303 | 6.3 | % | 457,351 | ||||||||||
| Other operating expenses | 147,084 | 0.5 | % | 146,286 | 6.4 | % | 137,519 | ||||||||||
| (Gain)/loss on disposal | (2,311 | ) | 79.0 | % | (1,291 | ) | 7.0 | % | (1,207 | ) | |||||||
| Amortization | 42,164 | (3.0 | )% | 43,447 | (3.8 | )% | 45,145 | ||||||||||
| Depreciation | 5,210 | (15.8 | )% | 6,191 | (5.6 | )% | 6,558 | ||||||||||
| Interest | 31,133 | (18.5 | )% | 38,216 | (6.9 | )% | 41,036 | ||||||||||
| Change in estimated acquisition earn-out payables | 8,087 | (21.1 | )% | 10,253 | NMF | 2,006 | |||||||||||
| Total expenses | 746,844 | 2.4 | % | 729,405 | 6.0 | % | 688,408 | ||||||||||
| Income before income taxes | $ | 196,616 | 4.6 | % | $ | 188,001 | 3.3 | % | $ | 181,938 | |||||||
| Organic revenue growth rate(1) | 2.9 | % | 1.9 | % | 1.4 | % | |||||||||||
| Employee compensation and benefits relative to total revenues | 54.6 | % | 53.0 | % | 52.5 | % | |||||||||||
| Other operating expenses relative to total revenues | 15.6 | % | 15.9 | % | 15.8 | % | |||||||||||
| Capital expenditures | $ | 4,494 | $ | 5,951 | $ | 6,797 | |||||||||||
| Total assets at December 31 | $ | 4,255,515 | $ | 3,854,393 | $ | 3,507,476 |
(1) A non-GAAP measure
NMF = Not a meaningful figure
The Retail Segment’s total revenues in 2017 increased 2.8%, or $26.1 million, over the same period in 2016, to $943.5 million. The $28.0 million increase in core commissions and fees was driven by the following: (i) $24.6 million related to net new business, (ii) approximately $8.2 million related to the core commissions and fees from acquisitions that had no comparable revenues in the same period of 2016, and (iii) an offsetting decrease of $4.8 million related to commissions and fees from businesses divested in 2016 and 2017. Profit-sharing contingent commissions and GSCs in 2017 decreased 7.2%, or $2.5 million, over 2016, to $32.5 million. The Retail Segment’s growth rate for total commissions and fees was 2.8% and the organic revenue growth rate was 2.9% for 2017. The organic growth rate was driven by increased new business and higher retention during the preceding twelve months, along with continued increases in commercial auto and employee benefits rates and underlying exposure unit values that drive insurance premiums.
Income before income taxes for 2017 increased 4.6%, or $8.6 million, over the same period in 2016, to $196.6 million. The primary factors affecting this increase were: (i) the net increase in revenue as described above, (ii) offset by a 6.0%, or $29.2 million, increase in employee compensation and benefits, due primarily to the year-on-year impact of salary inflation, additional teammates to support revenue growth and the incremental investment in our performance incentive plan, (iii) operating expenses which increased by $0.8 million, or 0.5%, primarily due to our multi-year technology investment program and increased value-added consulting services to support our customers; offset
by (iv) a reduction in the change in estimated acquisition earn-out payables of $2.2 million, or 21.1%, to $8.1 million, and (v) a combined decrease in amortization, depreciation and intercompany interest expense of $9.3 million.
The Retail Segment’s total revenues in 2016 increased 5.4%, or $47.1 million, over the same period in 2015, to $917.4 million. The $44.3 million increase in core commissions and fees was driven by the following: (i) approximately $31.2 million related to core commissions and fees from acquisitions that had no comparable revenues in the same period of 2015, (ii) $15.7 million related to net new business, and (iii) an offsetting decrease of $2.6 million related to commissions and fees recorded from business divested in 2015 and 2016. Profit-sharing contingent commissions and GSCs in 2016 increased 15.3%, or $4.7 million, over 2015, to $35.0 million. The Retail Segment’s growth rate for total commissions and fees was 5.6%, and the organic revenue growth rate was 1.9% for 2016, which were driven by revenue from net new business written during the preceding twelve months along with modest increases in commercial auto rates and underlying exposure unit values that drive insurance premiums, and partially offset by rate reductions in most lines of coverage, other than commercial auto, with the most pronounced declines realized for insurance premium rates for properties in catastrophe-prone areas.
Income before income taxes for 2016 increased 3.3%, or $6.1 million, over the same period in 2015, to $188.0 million. This growth in income before income taxes was negatively impacted by $10.3 million in expense associated with the change in estimated acquisition earn-out payables, an increase of $8.2 million over the same period in 2015. Other factors affecting this increase were: (i) the net increase in revenue as described above, (ii) a 6.3%, or $29.0 million increase in employee compensation and benefits due primarily to the year-on-year impact of new teammates related to acquisitions completed in the past twelve months and to a lesser extent continued investment in producers and other staff to support current and future expected organic revenue growth, and (iii) operating expenses which increased by $8.8 million, or 6.4%, primarily due to increased value-added consulting services to support our customers and increases in office rent expense, offset by a combined decrease in amortization, depreciation and intercompany interest expense of $4.9 million.
National Programs Segment
The National Programs Segment manages over 51 programs supported by approximately 40 well-capitalized carrier partners. In most cases, the insurance carriers that support the programs have delegated underwriting and, in many instances, claims-handling authority to our programs operations. These programs are generally distributed through a nationwide network of independent agents and Brown & Brown retail agents, and offer targeted products and services designed for specific industries, trade groups, professions, public entities and market niches. The National Programs Segment operations can be grouped into five broad categories: Professional Programs, Personal Lines Programs, Commercial Programs, Public Entity-Related Programs and the National Flood Program. The National Programs Segment’s revenue is primarily commission based.
Financial information relating to our National Programs Segment is as follows:
| (in thousands, except percentages) | 2017 | % Change | 2016 | % Change | 2015 | ||||||||||||
| REVENUES | |||||||||||||||||
| Core commissions and fees | $ | 458,863 | 6.6 | % | $ | 430,479 | 4.3 | % | $ | 412,885 | |||||||
| Profit-sharing contingent commissions | 20,123 | 16.3 | % | 17,306 | 11.2 | % | 15,558 | ||||||||||
| Guaranteed supplemental commissions | 31 | 34.8 | % | 23 | (23.3 | )% | 30 | ||||||||||
| Commissions and fees | 479,017 | 7.0 | % | 447,808 | 4.5 | % | 428,473 | ||||||||||
| Investment income | 384 | (38.9 | )% | 628 | 199.0 | % | 210 | ||||||||||
| Other income, net | 412 | NMF | 80 | 56.9 | % | 51 | |||||||||||
| Total revenues | 479,813 | 7.0 | % | 448,516 | 4.6 | % | 428,734 | ||||||||||
| EXPENSES | |||||||||||||||||
| Employee compensation and benefits | 201,816 | 5.6 | % | 191,199 | 4.6 | % | 182,854 | ||||||||||
| Other operating expenses | 97,988 | 16.9 | % | 83,822 | (2.7 | )% | 86,157 | ||||||||||
| (Gain)/loss on disposal | 99 | — | % | — | (100.0 | )% | 458 | ||||||||||
| Amortization | 27,277 | (2.3 | )% | 27,920 | (2.0 | )% | 28,479 | ||||||||||
| Depreciation | 6,325 | (19.6 | )% | 7,868 | 8.5 | % | 7,250 | ||||||||||
| Interest | 35,561 | (22.3 | )% | 45,738 | (17.9 | )% | 55,705 | ||||||||||
| Change in estimated acquisition earn-out payables | 786 | NMF | 207 | 31.0 | % | 158 | |||||||||||
| Total expenses | 369,852 | 3.7 | % | 356,754 | (1.2 | )% | 361,061 | ||||||||||
| Income before income taxes | $ | 109,961 | 19.8 | % | $ | 91,762 | 35.6 | % | $ | 67,673 | |||||||
| Organic revenue growth rate(1) | 6.1 | % | 4.2 | % | 1.8 | % | |||||||||||
| Employee compensation and benefits relative to total revenues | 42.1 | % | 42.6 | % | 42.6 | % | |||||||||||
| Other operating expenses relative to total revenues | 20.4 | % | 18.7 | % | 20.1 | % | |||||||||||
| Capital expenditures | $ | 5,936 | $ | 6,977 | $ | 6,001 | |||||||||||
| Total assets at December 31 | $ | 3,267,486 | $ | 2,711,378 | $ | 2,503,537 |
(1) A non-GAAP measure
NMF = Not a meaningful figure
The National Programs Segment’s total revenues in 2017 increased 7.0%, or $31.3 million, over 2016, to a total $479.8 million. The $28.4 million increase in core commissions and fees was driven by the following: (i) 26.4 million related to net new business, (ii) an increase of approximately $2.3 million related to core commissions and fees from acquisitions that had no comparable revenues in 2016 offset by (iii) a decrease of $0.3 million related to commissions and fees recorded in 2016 from businesses since divested. Profit-sharing contingent commissions and GSCs were $20.2 million in 2017, which was an increase of $2.8 million over 2016, which was primarily driven by the improved loss experience of our carrier partners.
The National Programs Segment’s growth rate for total commissions and fees was 7.0% and the organic revenue growth rate was 6.1% for 2017. This organic revenue growth rate was mainly due to increased flood claims revenues and our new core commercial program with QBE. Growth in these businesses was partially offset by certain programs that have been affected by certain carriers changing their risk appetite for new or existing programs or lower premium rates for certain lines of business.
Income before income taxes for 2017 increased 19.8%, or $18.2 million, from the same period in 2016, to $110.0 million. The increase is the result of a lower intercompany interest charge of $10.2 million, along with leveraging revenue growth of $31.3 million.
The National Programs Segment’s total revenues in 2016 increased 4.6%, or $19.8 million, over 2015, to a total of $448.5 million. The $17.6 million increase in core commissions and fees was driven by the following: (i) $17.2 million related to net new business, (ii) an increase of approximately $1.7 million related to core commissions and fees from acquisitions that had no comparable revenues in 2015; offset by (iii) a decrease of $1.3 million related to commissions and fees recorded in 2015 from businesses since divested. Profit-sharing contingent commissions and GSCs were $17.3 million in 2016, which was an increase of $1.7 million over 2015, which was primarily driven by the improved loss experience of our carrier partners.
The National Programs Segment’s growth rate for total commissions and fees was 4.5% and the organic revenue growth rate was 4.2% for 2016. This organic revenue growth rate was mainly due to increased flood claims revenues and the on-boarding of net new customers by our lender-placed coverage program. Growth in these businesses was partially offset by certain programs that have been affected by lower rates and certain carriers changing their risk appetite for new or existing programs.
Income before income taxes for 2016 increased 35.6%, or $24.1 million, from the same period in 2015, to $91.8 million. The increase is the result of a lower intercompany interest charge of $10.0 million, the receipt of certain premium tax refunds by our National Flood Program business, along with revenue growth of $19.8 million.
Wholesale Brokerage Segment
The Wholesale Brokerage Segment markets and sells excess and surplus commercial and personal lines insurance, primarily through independent agents and brokers, including Brown & Brown retail agents. Like the Retail and National Programs Segments, the Wholesale Brokerage Segment’s revenues are primarily commission based.
Financial information relating to our Wholesale Brokerage Segment is as follows:
| (in thousands, except percentages) | 2017 | % Change | 2016 | % Change | 2015 | ||||||||||||
| REVENUES | |||||||||||||||||
| Core commissions and fees | $ | 261,224 | 13.7 | % | $ | 229,657 | 14.4 | % | $ | 200,835 | |||||||
| Profit-sharing contingent commissions | 8,686 | (24.4 | )% | 11,487 | (18.5 | )% | 14,098 | ||||||||||
| Guaranteed supplemental commissions | 1,231 | (26.2 | )% | 1,669 | (2.1 | )% | 1,705 | ||||||||||
| Commissions and fees | 271,141 | 11.7 | % | 242,813 | 12.1 | % | 216,638 | ||||||||||
| Investment income | — | (100.0 | )% | 4 | (97.3 | )% | 150 | ||||||||||
| Other income, net | 596 | 108.4 | % | 286 | 37.5 | % | 208 | ||||||||||
| Total revenues | 271,737 | 11.8 | % | 243,103 | 12.0 | % | 216,996 | ||||||||||
| EXPENSES | |||||||||||||||||
| Employee compensation and benefits | 138,297 | 13.5 | % | 121,863 | 16.4 | % | 104,692 | ||||||||||
| Other operating expenses | 44,665 | 6.0 | % | 42,139 | 22.6 | % | 34,379 | ||||||||||
| (Gain)/loss on disposal | — | — | % | — | (100.0 | )% | (385 | ) | |||||||||
| Amortization | 11,456 | 6.1 | % | 10,801 | 10.9 | % | 9,739 | ||||||||||
| Depreciation | 1,885 | (4.6 | )% | 1,975 | (7.8 | )% | 2,142 | ||||||||||
| Interest | 6,263 | 57.5 | % | 3,976 | NMF | 891 | |||||||||||
| Change in estimated acquisition earn-out payables | 327 | NMF | (274 | ) | (133.0 | )% | 830 | ||||||||||
| Total expenses | 202,893 | 12.4 | % | 180,480 | 18.5 | % | 152,288 | ||||||||||
| Income before income taxes | $ | 68,844 | 9.9 | % | $ | 62,623 | (3.2 | )% | $ | 64,708 | |||||||
| Organic revenue growth rate(1) | 6.6 | % | 4.3 | % | 5.9 | % | |||||||||||
| Employee compensation and benefits relative to total revenues | 50.9 | % | 50.1 | % | 48.2 | % | |||||||||||
| Other operating expenses relative to total revenues | 16.4 | % | 17.3 | % | 15.8 | % | |||||||||||
| Capital expenditures | $ | 1,836 | $ | 1,301 | $ | 3,084 | |||||||||||
| Total assets at December 31 | $ | 1,260,239 | $ | 1,108,829 | $ | 895,782 |
(1) A non-GAAP measure
NMF = Not a meaningful figure
The Wholesale Brokerage Segment’s total revenues for 2017 increased 11.8%, or $28.6 million, over 2016, to $271.7 million. The $31.6 million net increase in core commissions and fees was driven by the following: (i) $16.5 million related to the core commissions and fees from acquisitions that had no comparable revenues in 2016, and (ii) $15.1 million related to net new business. Profit-sharing contingent commissions and GSCs for 2017 decreased $3.2 million over 2016, to $9.9 million. This decrease was driven by higher loss ratios experienced for several carriers, and partially offset by profit-sharing contingent commissions received from acquisitions that had no comparable profit-sharing contingent commissions in 2016. The Wholesale Brokerage Segment’s growth rate for total commissions and fees was 11.7%, and the organic revenue growth rate was 6.6% for 2017, which were driven by net new business and modest increases in exposure units that were partially offset by significant contraction in insurance premium rates for catastrophe-prone properties during the first half of the year, which moderated in the latter part of the year.
Income before income taxes for 2017 increased 9.9%, or $6.2 million, over 2016, to $68.8 million, primarily due to the following: (i) the net increase in revenue as described above, offset by (ii) an increase in employee compensation and benefits of $16.4 million, of which $10.4 million was related to acquisitions that had no comparable compensation and benefits in the same period of 2016, with the remainder related to additional teammates to support increased transaction volumes and compensation increases for existing teammates, (iii) a decrease in profit from lower profit-sharing contingent commissions and GSCs, (iv) a net $2.5 million increase in operating expenses, of which $3.1 million was related to acquisitions that had no comparable expenses in the same period of 2016 and (v) higher intercompany interest charges related to acquisitions completed in the previous year.
The Wholesale Brokerage Segment’s total revenues for 2016 increased 12.0%, or $26.1 million, over 2015, to $243.1 million. The $28.8 million net increase in core commissions and fees was driven by the following: (i) $20.2 million related to the core commissions and fees from acquisitions that had no comparable revenues in 2016, (ii) $8.7 million related to net new business; and (iii) an offsetting decrease of $0.1 million related to commissions and fees recorded in 2015 from businesses divested in the past year. Profit-sharing contingent commissions and GSCs for 2016 decreased $2.6 million over 2015, to $13.2 million. This decrease was driven by an increase in loss ratios for one carrier. The Wholesale Brokerage Segment’s growth rate for total commissions and fees was 12.1%, and the organic revenue growth rate was 4.3% for 2016, which were driven by net new business and modest increases in exposure units, partially offset by significant contraction in insurance premium rates for catastrophe-prone properties and to a lesser extent all other lines of coverage.
Income before income taxes for 2016, decreased 3.2%, or $2.1 million, over 2015, to $62.6 million, primarily due to the following: (i) the net increase in revenue as described above, offset by, (ii) an increase in employee compensation and benefits of $17.2 million, of which $10.8 million was related to acquisitions that had no comparable compensation and benefits in the same period of 2015, with the remainder related to additional teammates to support increased transaction volumes, (iii) a decrease in profit from lower profit-sharing contingent commissions and GSCs, (iv) a $7.8 million increase in operating expenses, of which $3.2 million was related to acquisitions that had no comparable expenses in the same period of 2015 and (v) higher intercompany interest charge related to acquisitions completed in the previous year.
Services Segment
The Services Segment provides insurance-related services, including third-party claims administration and comprehensive medical utilization management services in both the workers’ compensation and all-lines liability arenas. The Services Segment also provides Medicare Set-aside account services, Social Security disability and Medicare benefits advocacy services, and claims adjusting services.
Unlike the other segments, nearly all of the Services Segment’s revenue is generated from fees, which are not significantly affected by fluctuations in general insurance premiums.
Financial information relating to our Services Segment is as follows:
| (in thousands, except percentages) | 2017 | % Change | 2016 | % Change | 2015 | ||||||||||||
| REVENUES | |||||||||||||||||
| Core commissions and fees | $ | 165,073 | 5.8 | % | $ | 156,082 | 7.4 | % | $ | 145,375 | |||||||
| Profit-sharing contingent commissions | — | — | % | — | — | % | — | ||||||||||
| Guaranteed supplemental commissions | — | — | % | — | — | % | — | ||||||||||
| Commissions and fees | 165,073 | 5.8 | % | 156,082 | 7.4 | % | 145,375 | ||||||||||
| Investment income | 299 | 5.7 | % | 283 | NMF | 42 | |||||||||||
| Other income, net | — | — | % | — | (100.0 | )% | (52 | ) | |||||||||
| Total revenues | 165,372 | 5.8 | % | 156,365 | 7.6 | % | 145,365 | ||||||||||
| EXPENSES | |||||||||||||||||
| Employee compensation and benefits | 80,944 | 2.7 | % | 78,804 | 2.2 | % | 77,094 | ||||||||||
| Other operating expenses | 44,205 | 3.0 | % | 42,908 | 19.0 | % | 36,057 | ||||||||||
| (Gain)/loss on disposal | 55 | — | % | — | (100.0 | )% | 515 | ||||||||||
| Amortization | 4,548 | 1.4 | % | 4,485 | 11.6 | % | 4,019 | ||||||||||
| Depreciation | 1,600 | (14.9 | )% | 1,881 | (5.4 | )% | 1,988 | ||||||||||
| Interest | 3,522 | (28.8 | )% | 4,950 | (17.1 | )% | 5,970 | ||||||||||
| Change in estimated acquisition earn-out payables | — | (100.0 | )% | (1,001 | ) | NMF | 9 | ||||||||||
| Total expenses | 134,874 | 2.2 | % | 132,027 | 5.1 | % | 125,652 | ||||||||||
| Income before income taxes | $ | 30,498 | 25.3 | % | $ | 24,338 | 23.5 | % | $ | 19,713 | |||||||
| Organic revenue growth rate(1) | 5.1 | % | 3.8 | % | 6.8 | % | |||||||||||
| Employee compensation and benefits relative to total revenues | 48.9 | % | 50.4 | % | 53.0 | % | |||||||||||
| Other operating expenses relative to total revenues | 26.7 | % | 27.4 | % | 24.8 | % | |||||||||||
| Capital expenditures | $ | 1,033 | $ | 656 | $ | 1,088 | |||||||||||
| Total assets at December 31 | $ | 399,240 | $ | 371,645 | $ | 285,459 |
(1) A non-GAAP measure
NMF = Not a meaningful figure
The Services Segment’s total revenues for 2017 increased 5.8%, or $9.0 million, over 2016, to $165.4 million. The $9.0 million increase in core commissions and fees was driven primarily by the following: (i) $7.9 million related to net new business, (ii) $0.9 million related to the core commissions and fees from acquisitions that had no comparable revenues in the same period of 2016, and (iii) an increase of $0.2 million related to commissions and fees recorded in 2016 from business since divested. The Services Segment’s growth rate for total commissions and fees was 5.8%, and the organic revenue growth rate was 5.1% for 2017, primarily driven by our claims offices that handle catastrophe claims.
Income before income taxes for 2017 increased 25.3%, or $6.2 million, over 2016, to $30.5 million due to a combination of: (i) new business realized across most of our businesses, (ii) our claims offices that handled catastrophe claims, (iii) the continued efficient operation of our businesses, and (iv) lower intercompany interest charges.
The Services Segment’s total revenues for 2016 increased 7.6%, or $11.0 million, over 2015, to $156.4 million. The $10.7 million increase in core commissions and fees was driven primarily by the following: (i) $8.7 million related to the core commissions and fees from acquisitions that had no comparable revenues in the same period of 2015, (ii) $5.4 million related to net new business, and (iii) partially offset by a decrease of $3.4 million related to commissions and fees recorded in 2015 from business since divested. The Services Segment’s growth rate for total commissions and fees was 7.4% and the organic revenue growth rate was 3.8% for 2016, primarily driven by our claims.
Income before income taxes for 2016 increased 23.5%, or $4.6 million, over 2015, to $24.3 million due to a combination of: (i) the acquisition of SSAD, (ii) our claims office that handled catastrophe claims, (iii) the continued efficient operation of our businesses, and (iv) lower intercompany interest charges.
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 intercompany interest expense charges to reporting segments.
LIQUIDITY AND CAPITAL RESOURCES
The Company seeks to maintain a conservative balance sheet and liquidity profile. Our capital requirements to operate as an insurance intermediary are low and we have been able to grow and invest in our business principally through cash that has been generated from operations. We have the ability to utilize our revolving credit facility, which provides up to $800.0 million in available cash, and we believe that we have access to additional funds, if needed, through the capital markets to obtain further debt financing under the current market conditions. The Company believes that its existing cash, cash equivalents, short-term investment portfolio and funds generated from operations, together with the funds available under the credit facility, will be sufficient to satisfy our normal liquidity needs, including principal payments on our long-term debt, for at least the next twelve months.
Our cash and cash equivalents of $573.4 million at December 31, 2017 reflected an increase of $57.8 million from the $515.6 million balance at December 31, 2016. During 2017, $442.0 million of cash was generated from operating activities, representing an increase of 7.5%. During this period, $41.5 million of cash was used for acquisitions, $43.8 million was used for acquisition earn-out payments, $24.2 million was used to purchase additional fixed assets, $77.7 million was used for payment of dividends, $139.9 million was used for share repurchases, and $96.8 million was used to pay outstanding principal balances owed on long-term debt.
We hold approximately $19.4 million in cash outside of the U.S. for which we currently have no plans to repatriate in the near future. With the passage of the Tax Cuts and Jobs Act of 2017, we will reevaluate the most advantageous opportunities to deploy this capital on an after-tax basis.
Our cash and cash equivalents of $515.6 million at December 31, 2016 reflected an increase of $72.2 million from the $443.4 million balance at December 31, 2015. During 2016, $411.0 million of cash was generated from operating activities. During this period, $122.6 million of cash was used for acquisitions, $28.2 million was used for acquisition earn-out payments, $17.8 million was used for additions to fixed assets, $70.3 million was used for payment of dividends, $7.7 million was used for share repurchases, and $73.1 million was used to pay outstanding principal balances owed on long-term debt.
Our cash and cash equivalents of $443.4 million at December 31, 2015 reflected a decrease of $26.6 million from the $470.0 million balance at December 31, 2014. During 2015, $381.8 million of cash was generated from operating activities. During this period, $136.0 million of cash was used for acquisitions, $36.8 million was used for acquisition earn-out payments, $18.4 million was used for additions to fixed assets, $64.1 million was used for payment of dividends, $175.0 million was used as part of accelerated share repurchase programs, and $45.6 million was used to pay outstanding principal balances owed on long-term debt.
Our ratio of current assets to current liabilities (the “current ratio”) was 1.13 and 1.20 at December 31, 2017 and 2016, respectively.
Contractual Cash Obligations
As of December 31, 2017, our contractual cash obligations were as follows:
| Payments Due by Period | |||||||||||||||||||
| (in thousands) | Total | Less Than 1 Year | 1-3 Years | 4-5 Years | After 5 Years | ||||||||||||||
| Long-term debt | $ | 985,000 | $ | 120,000 | $ | 70,000 | $ | 295,000 | $ | 500,000 | |||||||||
| Other liabilities(1) | 51,266 | 3,973 | 8,305 | 2,430 | 36,558 | ||||||||||||||
| Operating leases | 210,559 | 43,080 | 73,272 | 49,711 | 44,496 | ||||||||||||||
| Interest obligations | 188,285 | 35,450 | 62,455 | 54,505 | 35,875 | ||||||||||||||
| Unrecognized tax benefits | 1,694 | — | 1,694 | — | — | ||||||||||||||
| Maximum future acquisition contingency payments(2) | 88,382 | 42,233 | 46,149 | — | — | ||||||||||||||
| Total contractual cash obligations | $ | 1,525,186 | $ | 244,736 | $ | 261,875 | $ | 401,646 | $ | 616,929 |
| (1) | Includes the current portion of other long-term liabilities. |
| (2) | Includes $36.2 million of current and non-current estimated earn-out payables resulting from acquisitions consummated after January 1, 2009. |
Debt
Total debt at December 31, 2017 was $976.1 million net of unamortized discount and debt issuance costs, which was a decrease of $97.7 million compared to December 31, 2016. The decrease reflects the repayment of $96.8 million in principal, related to our credit agreements, repayment of the $0.5 million in a short-term note payable related to the 2016 acquisition of Social Security Advocates for the Disabled, LLC (“SSAD”), net of the amortization of discounted debt related to our Senior Notes due 2024, with a fixed interest rate of 4.200% per year and debt issuance cost amortization of $1.9 million. The Company also added $2.8 million in debt issuance costs related to the Amended and Restated Credit Agreement (as defined below) that was executed in June 2017.
During 2017, the $100.0 million of Series E Senior Notes were issued and are due September 15, 2018, with a fixed interest rate of 4.500% per year were reclassified as current portion of long-term debt in the Consolidated Balance Sheet, as the date of maturity is less than one year.
On June 28, 2017, the Company entered into an amended and restated credit agreement (the “Amended and Restated Credit Agreement”) with the lenders named therein, JPMorgan Chase Bank, N.A. as administrative agent and certain other banks as co-syndication agents and co-documentation agents. The Amended and Restated Credit Agreement amended and restated the credit agreement dated April 17, 2014, among such parties (the “Original Credit Agreement”). The Amended and Restated Credit Agreement extends the applicable maturity date of the existing revolving credit facility (the “Facility”) of $800.0 million to June 28, 2022 and re-evidences the unsecured term loans in the amount of $400.0 million while also extending the applicable maturity date to June 28, 2022. In connection with the Amended and Restated Credit Agreement, the quarterly term loan principal amortization schedule was reset. At the time of the execution of the Amended and Restated Credit Agreement, $67.5 million of principal from the original unsecured term loans was repaid using operating cash balances, and the Company added an additional $2.8 million in debt issuance costs related to the Facility to the Consolidated Balance Sheet. The Company also expensed to the Consolidated Statements of Income $0.2 million of debt issuance costs related to the Original Credit Agreement due to certain lenders exiting prior to execution of the Amended and Restated Credit Agreement. The Company also carried forward $1.6 million on the Consolidated Balance Sheet, the remaining unamortized portion of the Original Credit Agreement debt issuance costs, which will be amortized over the term of the Amended and Restated Credit Agreement. On December 31, 2017, the Company made a scheduled principal payment of $5.0 million per the terms of the Amended and Restated Credit Agreement. As of December 31, 2017, there was an outstanding debt balance issued under the term loan of the Amended and Restated Credit Agreement of $385.0 million with no borrowings outstanding against the Facility. Per the terms of the Amended and Restated Credit Agreement, a scheduled principal payment of $5.0 million is due March 31, 2018.
Total debt at December 31, 2016 was $1,073.9 million, which was a decrease of $70.9 million compared to December 31, 2015. The decrease includes the repayment of $73.1 million in principal, net of the amortization of discounted debt related to our 4.200% Notes due 2024 and debt issuance cost amortization of $1.7 million plus the addition of $0.5 million in a short-term note payable related to the recent acquisition of SSAD.
As of December 31, 2016, the Company satisfied the sixth installment of scheduled quarterly principal payments on the Credit Facility term loan. The Company has satisfied $68.8 million in total principal payments through December 31, 2016 since the inception of the note. Scheduled quarterly principal payments are expected to be made until maturity. The balance of the Credit Facility term loan was $481.3 million as of December 31, 2016. Of the total amount, $55.0 million is classified as current portion of long-term debt in the Condensed Consolidated Balance Sheet as the date of maturity is less than one year.
On March 14, 2016, the Company terminated the Wells Fargo Revolver $25.0 million facility without incurring any fees. The facility was to mature on December 31, 2016. The Company terminated the Wells Fargo Revolver as it has flexibility with the Credit Facility revolver capacity and current capital and credit resources available.
Off-Balance Sheet Arrangements
Neither we nor our subsidiaries have 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.
For further discussion of our cash management and risk management policies, see “Quantitative and Qualitative Disclosures About Market Risk.”
Previous: Item 6. Selected Financial Data. · Next: Item 7A. Quantitative and Qualitative Disclosures About Market Risk.