UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2003
or
For the transition period from to
Commission file number 0-7201
Florida
59-0864469
220 S. Ridgewood Ave., Daytona Beach, FL
32114
Registrant’s telephone number, including area code: (386) 252-9601
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
The number of shares of the Registrant’s common stock, $.10 par value, outstanding as of November 12, 2003, was 68,645,915.
BROWN & BROWN, INC.
INDEX
PART I. FINANCIAL INFORMATION
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PART 1—FINANCIAL INFORMATION
ITEM 1—FINANCIAL STATEMENTS (UNAUDITED)
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in thousands, except per share data)
REVENUES
Commissions and fees
Investment income
Other income (loss), net
Total revenues
EXPENSES
Employee compensation and benefits
Non-cash stock grant compensation
Other operating expenses
Amortization
Depreciation
Interest
Total expenses
Income before income taxes and minority interest
Income taxes
Minority interest, net of income tax
NET INCOME
Net income per share:
Basic
Diluted
Weighted average number of shares outstanding:
Dividends declared per share
See accompanying notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED BALANCE SHEETS
September 30,
2003
December 31,
2002
ASSETS
Current assets:
Cash and cash equivalents
Restricted cash
Short-term investments
Premiums, commissions and fees receivable
Other current assets
Total current assets
Fixed assets, net
Goodwill, net
Other intangible assets, net
Investments
Deferred income taxes, net
Other assets
Total assets
LIABILITIES
Current liabilities:
Premiums payable to insurance companies
Premium deposits and credits due customers
Accounts payable
Accrued expenses
Current portion of long-term debt
Total current liabilities
Long-term debt
Other liabilities
Minority interest
SHAREHOLDERS’ EQUITY
Common stock, par value $.10 per share; authorized 280,000 shares; issued and outstanding, 68,646 shares at 2003 and 68,178 at 2002
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income
Total shareholders’ equity
Total liabilities and shareholders’ equity
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income tax provision (benefit)
Income tax benefit from exercise of stock options
Net (gains) losses on sales of investments, fixed assets and customer accounts
Minority interest in earnings
Changes in operating assets and liabilities, net of effect from insurance agency acquisitions and disposals:
Restricted cash, (increase)
Premiums, commissions and fees receivable, (increase)
Other assets, decrease (increase)
Premiums payable to insurance companies, increase
Premium deposits and credits due customers, increase
Accounts payable, (decrease) increase
Accrued expenses, increase
Other liabilities, increase
NET CASH PROVIDED BY OPERATING ACTIVITIES
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to fixed assets
Payments for businesses acquired, net of cash acquired
Proceeds from sales of fixed assets and customer accounts
Purchases of investments
Proceeds from sales of investments
NET CASH USED IN INVESTING ACTIVITIES
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term debt
Proceeds from issuance of common stock, net of expenses
Issuance of common stock for employee stock benefit plans
Purchase of common stock for employee stock benefit plans
Cash dividends paid
Cash distribution to minority interest shareholders
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES
Net increase in cash and cash equivalents
Cash and cash equivalent at beginning of period
CASH AND CASH EQUIVALENTS AT END OF PERIOD
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 – Basis of Financial Reporting
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. These unaudited, condensed, and consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
Results of operations for the three and nine-month periods ended September 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.
Certain amounts for the prior periods have been reclassified to conform to the current period presentations.
Note 2 – Basic and Diluted Net Income Per Share
The following table sets forth the computation of basic net income per common share and diluted net income per common and common equivalent share (in thousands, except per-share data):
For the three months
ended September 30,
For the nine months
Weighted average number of common shares outstanding
Dilutive effect of stock options using the treasury stock method
Weighted average number of common and common equivalent shares outstanding
Basic net income per share
Diluted net income per common and common equivalent share
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Note 3 – Acquisitions
During the third quarter of 2003, the Company acquired certain assets of three general insurance agencies and two books of business (customer accounts). The aggregate purchase price was approximately $19,718,000, all of which was paid in cash. Additionally, $2,885,000 was paid during the quarter on the “earn-out” purchase price agreements of prior acquisitions. The operating results of each of these acquired businesses have been included in the condensed consolidated financial statements since the date of such transactions. These acquisitions are not material to the consolidated financial statements individually or in aggregate.
During the second quarter of 2003, the Company acquired certain assets and liabilities of four general insurance agencies and two books of business (customer accounts). The aggregate purchase price was approximately $7,602,000, including $7,176,000 of net cash payments and the issuance of notes payable in the amount of $426,000. Additionally, $1,084,000 was paid, $335,000 of other liabilities were assumed and $12,000 of notes payable were issued during the quarter on the “earn-out” purchase price agreements of prior acquisitions. The operating results of each of these acquired businesses have been included in the condensed consolidated financial statements since the date of such transactions. These acquisitions are not material to the consolidated financial statements individually or in aggregate.
During the first quarter of 2003, the Company acquired certain assets and liabilities of nine general insurance agencies, several books of business (customer accounts) and the remaining 25% minority interest in Florida Intracoastal Underwriters, Limited Company. The aggregate purchase price was approximately $47,965,000, including $47,324,000 of net cash payments and the issuance of notes payable in the amount of $641,000. Additionally, $10,985,000 was paid and $1,540,000 of notes payable were issued during the quarter on the “earn-out” purchase price agreements of prior acquisitions. The operating results of each of these acquired businesses have been included in the condensed consolidated financial statements since the date of such transactions. These acquisitions are not material to the consolidated financial statements individually or in aggregate.
The preliminary allocation of the aggregate purchase price to the fair values of the assets acquired, including earn-out adjustments, through the first nine months of 2003 was as follows: purchased customer accounts—$41,532,000; goodwill—$50,002,000; noncompete agreements—$491,000; and fixed assets and other miscellaneous net assets—$101,000.
Note 4 – Goodwill and Other Intangible Assets
Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”. SFAS No. 142 provides for the non-amortization of goodwill. Goodwill is now subject to at least an annual assessment for impairment by applying a fair value-based test. Other intangible assets will be amortized over their useful lives (other than indefinite life assets) and will be subject to a lower of cost or market impairment testing.
SFAS No. 142 requires the Company to compare the fair value of each reporting unit with its carrying amount to determine if there is potential impairment of goodwill. 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 revenues, earnings before interest, income taxes, depreciation and amortization (EBITDA) and discounted cash flows.
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The changes in goodwill, net of accumulated amortization, for the nine months ended September 30, 2003, are as follows (in thousands):
National
Programs
Balance as of December 31, 2002
Goodwill acquired
Goodwill disposed of relating to saleof businesses (customer accounts)
Balance as of September 30, 2003
Other intangible assets as of September 30, 2003 and December 31, 2002 consisted of the following (in thousands):
Accumulated
NetCarrying
Value
Weighted
Average
Life
Gross
Carrying
Purchased Customer Accounts
Noncompete Agreements
Total
Amortization expense for amortizable assets for the years ended December 31, 2003, 2004, 2005, 2006 and 2007 are estimated to be $17.4 million, $17.6 million, $17.3 million, $15.9 million and $15.4 million, respectively.
Note 5 – Long-Term Debt
In January 2001, the Company entered into a $90 million unsecured seven-year term loan agreement with a national banking institution, bearing an interest rate based upon the 30-, 60- or 90-day London Interbank Offering Rate (LIBOR) plus 0.50% to 1.00%, depending upon the Company’s quarterly ratio of funded debt to earnings before interest, taxes, depreciation and amortization. The 90-day LIBOR was 1.14% as of September 30, 2003. The loan was fully funded on January 3, 2001 and as of September 30, 2003 had an outstanding balance of $54.6 million. This loan is to be repaid in equal quarterly installments of $3.2 million through December 2007.
To hedge the risk of increasing interest rates from January 2, 2002 through the remaining six years of its seven-year $90 million term loan, the Company entered into an interest rate swap agreement that effectively converted the floating LIBOR-based interest payments to fixed interest rate payments at 4.53%. This agreement did not affect the required 0.50% to 1.00% credit risk spread portion of the term loan. In accordance with SFAS No. 133, as amended, the Company recorded a liability as of September 30, 2003 for the fair value of the interest rate swap of approximately $1,730,000, net of taxes of approximately $1,060,000, with the related change in fair value reflected as other comprehensive income.
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As of December 31, 2002, the Company recorded a liability for the fair value of the interest rate swap of approximately $2,070,000, net of taxes of approximately $1,269,000. The Company has designated and assessed the derivative as a highly effective cash flow hedge.
In September 2003, the Company established a revolving credit facility with a national banking institution that provided for available borrowings of up to $75 million, with a maturity date of October 2008, bearing an interest rate based upon the 30-, 60- or 90-day LIBOR plus 0.75% to 1.75%, depending upon the Company’s quarterly ratio of funded debt to earnings before interest, taxes, depreciation and amortization. A commitment fee of 0.175% to 0.25% per annum is assessed on the unused balance. There were no borrowings against this facility at September 30, 2003.
Acquisition notes payable as of September 30, 2003 were $16.4 million, which represents debt incurred to former owners of certain agencies or customer accounts acquired by the Company. These notes, including future contingent payments, are payable in monthly, quarterly or annual installments through February 2014, including interest ranging from 1.34% to 15.25%.
Note 6 – Contingencies
The Company is involved in numerous pending or threatened proceedings by or against the Company or one or more of the Company’s subsidiaries that arise in the ordinary course of business. The damages that may be claimed in these various proceedings are substantial, including in many instances claims for punitive or extraordinary damages. Some of these claims and lawsuits have been resolved, others are in the process of being resolved, and others are still in the investigation or discovery phase. The Company will continue to respond appropriately to these claims and lawsuits, and to vigorously protect its interests.
Among the above-referenced claims, and as previously described in the Company’s Report on Form 10-Q for the quarterly period ended March 31, 2003, there are several threatened and pending legal claims against the Company and Brown & Brown Insurance Services of Texas, Inc. (“BBTX”), a subsidiary of the Company, arising out of the procurement and placement of workers’ compensation insurance coverage for entities including several professional employer organizations. On October 27, 2003, the Company and BBTX reached a final settlement in Vega Roofing Co. v. Brown & Brown, Inc., et al., one such case previously described in such Report on Form 10-Q, including settlement of all claims asserted by Aerostaff Services, Inc. against the Company and BBTX. Such settlement is within applicable insurance policy limits, and therefore the settlement does not have a material effect on the Company’s results of operations or cash flows.
Although the ultimate outcome of all matters referred to above cannot be ascertained and liabilities in indeterminate amounts may be imposed on the Company or its subsidiaries, on the basis of present information, availability of insurance coverages and legal advice received, it is the opinion of management that the disposition or ultimate determination of such claims will not have a material adverse effect on the Company’s consolidated financial position.
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Note 7 – Supplemental Disclosures of Cash Flow Information
Cash paid during the period for (in thousands):
The Company’s significant non-cash investing and financing activities are as follows (in thousands):
Unrealized holding gain on available-for-sale securities, net of tax expense of $246 in 2003 and $223 in 2002
Gain (loss) on cash flow-hedging derivative, net of tax expense of $209 for 2003 and net of tax benefit of $1,240 for 2002
Notes payable and other liabilities issued or assumed for purchased customer accounts
Notes receivable on sale of fixed assets and customer accounts
Note 8 – Comprehensive Income
The components of comprehensive income, net of related tax, are as follows (in thousands):
Net change in unrealized holding gain (loss) on available-for-sale securities
Gain (loss) on cash-flow hedging derivative
Comprehensive income
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Note 9 – Stock-Based Compensation and Incentive Plans
The Company applies the intrinsic value-based method of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” to account for its stock plans. Accordingly, the Company adopted the disclosure requirements of SFAS No. 148, “Accounting for Stock-based Compensation—Transition and Disclosure”, effective for the fiscal year ended December 31, 2002, which requires presentation of pro forma net income and earnings per share information under SFAS No. 123 (same title).
Pursuant to the above disclosure requirement, the following table provides an expanded reconciliation for all periods presented that: adds back to reported net income the recorded expense under APB No. 25, net of related income tax effects; deducts the total fair value expense under SFAS No. 123, net of related income tax effects; and shows the reported and pro forma earnings per share amounts.
Net income as reported
Total stock-based employee compensation cost included in the determination of net income, net of related tax effects
Total stock-based employee compensation cost determined under fair value method for all awards, net of related tax effects
Pro forma net income
Earnings per share:
Basic, as reported
Basic, pro forma
Diluted, as reported
Diluted, pro forma
Shares – Basic
Shares – Diluted
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Note 10 – Segment Information
The Company’s business is divided into four segments: the Retail Division, which provides a broad range of insurance products and services to commercial, professional and individual clients; the National Programs Division, which is comprised of two units—Professional Programs, which provides professional liability and related packages 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 and market niches; the Services Division, which provides insurance-related services including third-party administration, consulting for the workers’ compensation and employee benefit self-insurance markets and managed healthcare services; and the Brokerage Division, which markets and sells excess surplus commercial insurance and reinsurance, primarily through independent agents and brokers. The Company conducts all of its operations within the United States of America.
Summarized financial information concerning the Company’s reportable segments is shown in the following table. The “Other” column includes corporate-related items and any income and expenses not allocated to reportable segments.
Interest expense
Capital expenditures
Nine Months Ended September 30, 2002:
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THE FOLLOWING DISCUSSION UPDATES THE MD&A CONTAINED IN THE COMPANY’S 2002 ANNUAL REPORT ON FORM 10-K, AND THE TWO DISCUSSIONS SHOULD BE READ TOGETHER.
Critical Accounting Policies
The more critical accounting and reporting policies include our accounting for revenue recognition, business acquisitions and purchase price allocations, intangible assets impairments, reserves for litigation and derivative interests. In particular, the accounting for these areas requires significant judgments 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 in the “Notes to Consolidated Financial Statements” in our 2002 Annual Report on Form 10-K on file with the Securities and Exchange Commission for details regarding all of our critical and significant accounting policies.
Results of Operations
Net Income. Net income for the third quarter of 2003 was $26.1 million, or $0.38 per diluted share, compared with net income in the third quarter of 2002 of $20.2 million, or $0.29 per diluted share, a 31.0% increase on a per-share basis. Net income for the nine months ended September 30, 2003 was $84.5 million, or $1.23 per diluted share, compared with net income for the comparable period in 2002 of $61.7 million, or $0.91 per diluted share, a 35.2% increase on a per-share basis.
Commissions & Fees. Commissions and fees for the third quarter of 2003 increased $22.3 million, or 20.4%, over the same period in 2002. Approximately $20.5 million of this increase represents revenues from agencies acquired since the third quarter of 2002, with the remainder due mainly to new business production and higher renewal commissions. Commissions and fees for the nine months ended September 30, 2003 increased $78.8 million, or 23.5%, over the same period in 2002. Approximately $57.7 million of this increase represents revenues from agencies acquired since the comparable period in 2002, $9.8 million relates to higher contingent commissions (revenue-sharing commissions from insurance companies that are based upon the volume, growth and/or profitability of the business placed with such companies during the prior year), with the remainder due mainly to new business production and higher renewal commissions.
Investment Income. Investment income for the three and nine months ended September 30, 2003 decreased $0.6 million, or 66.6%, and $1.1 million, or 51.2%, respectively, from the same periods in 2002. The reduction in investment income during the three and nine months ended September 30, 2003 was primarily due to lower available investment cash balances along with lower investment yields.
Other Income (Loss). Other income (loss) primarily includes gains and losses from the sales of customer accounts and other assets. Other income for the three and nine months ended September 30, 2003 increased $1.2 million and $1.9 million, respectively, from the same periods in 2002, primarily due to gains on several sales of books of business (customer accounts) in 2003.
Employee Compensation and Benefits. Employee compensation and benefits for the third quarter of 2003 increased $13.4 million, or 25.0%, over the same period in 2002. For the nine months ended September 30, 2003 employee compensation increased $36.7 million, or 22.3%, over the same period in 2002. These increases are primarily related to the addition of new employees from acquisitions completed since October 1, 2002 and increased producer compensation that resulted from higher commissions and fees revenue. Employee compensation and benefits as a percentage of total revenue increased to 50.1% for the third quarter of 2003 from 48.4% for the third quarter of 2002, primarily due
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to higher profit center bonuses. For the nine months ended September 30, 2003, employee compensation and benefits as a percentage of total revenue decreased to 48.4% from 48.9% from the same period in 2002. The improved ratio for the nine-month period was the result of the continued assimilation of the acquisitions completed in 2002 into our standard compensation program, as well as the positive impact of higher contingent commissions received in 2003.
Non-Cash Stock Grant Compensation. Non-cash stock grant compensation expense represents the expense required to be recorded under Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” relating to our stock performance plan.
The annual cost of this stock performance plan increases only when our average stock price over a 20 trading-day period increases by increments of 20% or more over the price at the time of the original grant, or when more shares are granted and the aforementioned average stock price increases.
Non-cash stock grant compensation expense for the third quarter of 2003 decreased $1.1 million, or 74.4%, from the same period in 2002. For the nine months ended September 30, 2003, non-cash stock grant compensation expense decreased $1.2 million, or 39.7%, from the comparable period in 2002. These decreases are due to forfeited stock grants that resulted in less granted shares being outstanding during the three and nine months ended September 30, 2003 than were outstanding during the three and nine months ended September 30, 2002.
Other Operating Expenses. Other operating expenses for the third quarter of 2003 increased $1.7 million, or 10.5%, over the same period in 2002. For the nine months ended September 30, 2003, other operating expenses increased $8.9 million, or 19.0%, over the same period in 2002. This was the primarily the result of acquisitions completed since the third quarter of 2002. Other operating expenses as a percentage of revenue for the third quarter of 2003 decreased to 13.1% from 14.3% in the third quarter of 2002. For the nine months ended September 30, 2003, other operating expenses as a percentage of revenue decreased to 13.5%, compared with 14.0% for the same period in 2002. The improved ratios are the result of operating efficiencies as well as the positive impact of higher contingent commissions received in the first and second quarter of 2003.
Amortization. Amortization expense for the third quarter of 2003 increased $0.8 million, or 22.5%, from the third quarter of 2002. For the nine months ended September 30, 2003, amortization expense increased $2.8 million, or 27.2%, from the same period in 2002. These increases are primarily due to acquisitions completed since October 1, 2002.
Depreciation. Depreciation expense for the third quarter of 2003 increased $0.3 million, or 13.8%, over the third quarter of 2002. For the nine months ended September 30, 2003, depreciation expense increased $0.7 million, or 14.0%, over the same period in 2002. These increases are due to capital expenditures and fixed assets acquired from acquisitions completed since October 1, 2002.
Interest Expense. Interest expense for the third quarter of 2003 decreased $0.3 million, or 26.2%, from the same period in 2002. For the nine months ended September 30, 2003 interest expense decreased $0.7 million, or 21.0%, from the same period in 2002. These decreases are a result of lower outstanding debt balances.
Segment Information
As discussed in Note 10 of the notes to our condensed consolidated financial statements, we operate in four business segments: the Retail, National Programs, Services and Brokerage Divisions.
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The Retail Division is our insurance agency business, which provides a broad range of insurance products and services directly to commercial, governmental, professional and individual clients. The Retail Division’s total revenues during the three and nine months ended September 30, 2003 increased 13.5%, or $11.7 million, to $97.7 million, and 16.7%, or $44.0 million, to $308.1 million over the same period in 2002, respectively. Of this increase, approximately $10.8 million and $34.4 million for the three and nine months ended September 30, 2003, respectively, related to the core commissions and fees from acquisitions that had no comparable revenues in the same periods of 2002. The remaining increases are primarily due to net new business growth, which benefited from continued rising premium rates from the corresponding periods in 2002. Income before income taxes and minority interest for the three and nine months ended September 30, 2003 increased 16.3%, or $3.1 million, to $22.4 million, and 23.3%, or $15.2 million, to $80.1 million over the same periods in 2002. These increases are due to higher revenues, increases in premium rates and improved cost structure.
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 and market niches. Total revenues for National Programs for the three and nine months ended September 30, 2003 increased 74.8%, or $8.8 million, to $20.6 million, and 61.6%, or $22.5 million, to $59.1 million over the same periods in 2002, respectively. Of these increases, approximately $9.7 million and $21.6 million for the three and nine-month periods, respectively, related to core commissions and fees from acquisitions that had no comparable revenues in the same periods of 2002. The remaining increase is primarily due to net new business growth, which benefited from continued rising premium rates from the corresponding periods in 2002. Income before income taxes and minority interest for the three and nine months ended September 30, 2003 increased 36.6%, or $1.9 million, to $7.0 million, and 28.0%, or $4.5 million, to $20.4 million, respectively, over the same periods in 2002, due primarily to net increases in revenues.
The Services Division provides insurance-related services, including third-party administration, consulting for the workers’ compensation and employee benefit self-insurance markets and managed healthcare services. Unlike our other segments, the majority of the Services Division’s revenues are fees, which are not significantly affected by fluctuations in general insurance premiums. The Service Division’s total revenues in the three and nine months ended September 30, 2003 increased 11.8%, or $0.9 million, to $8.3 million, and 7.5%, or $1.6 million, to $22.8 million over the same periods of 2002, respectively, the majority of which related to net new business growth. Income before income taxes and minority interest for the three and nine months ended September 30, 2003 increased 70.5%, or $0.8 million, to $2.0 million, and 36.5%, or $1.2 million, to $4.4 million from the same periods in 2002, respectively. This increase was driven primarily by net new business revenues.
The Brokerage Division markets and sells excess and surplus commercial insurance and reinsurance, primarily through independent agents and brokers. The Brokerage Division’s total revenues in the three and nine months ended September 30, 2003 increased 7.0%, or $0.4 million, to $6.7 million, and 42.0%, or $7.5 million, to $25.2 million over the same periods of 2002. Of these increases, approximately $0.1 million and $1.8 million for the three and nine-month periods, respectively, related to core commissions and fees from acquisitions that had no comparable revenues in the same periods of 2002. The remaining increase is primarily due to net new business growth which also benefited from continued rising premium rates from the corresponding periods in 2002. Income before income taxes and minority interest for the three months ended September 30, 2003 decreased 20.0%, or $0.3 million, to $1.2 million due primarily to higher costs and payrolls associated with the opening of several new brokerage offices. Income before income taxes and minority interest for the nine months ended September 30, 2003 increased 60.8%, or $3.3 million, to $8.8 million from the same period in 2002, due primarily to net new business revenues offset by slightly higher costs.
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Liquidity and Capital Resources
Our cash and cash equivalents of $68.7 million at September 30, 2003 increased by $0.7 million from the $68.0 million balance at December 31, 2002. For the nine-month period ended September 30, 2003, $119.0 million of cash was provided from operating activities. Also during this period, $89.2 million was used to acquire other agencies and books of business (customer accounts), $6.6 million was used for additions to fixed assets, $16.5 million was used for payments on long-term debt, and $11.8 million was used for payment of dividends.
As of September 30, 2003, our contractual cash obligations were as follows (in thousands):
Payments Due by Period
Long-Term Debt
Capital Lease Obligations
Other Long Term Liabilities
Operating Leases
Maximum Future Acquisition Contingency Payments
Total Contractual Cash Obligations
In January 2001, we entered into a $90 million unsecured seven-year term loan agreement with a national banking institution, bearing an interest rate based upon the 30-, 60- or 90-day London Interbank Offering Rate (LIBOR) plus 0.50% to 1.00%, depending upon our quarterly ratio of funded debt to earnings before interest, taxes, depreciation and amortization. The 90-day LIBOR was 1.14% as of September 30, 2003. The loan was fully funded on January 3, 2001 and as of September 30, 2003 had an outstanding balance of $54.6 million. This loan is to be repaid in equal quarterly installments of $3.2 million through December 2007.
To hedge the risk of increasing interest rates from January 2, 2002 through the remaining six years of its seven-year $90 million term loan, we entered into an interest rate swap agreement that effectively converted the floating LIBOR-based interest payments to fixed interest payments at an annual rate of 4.53%. This agreement did not impact or change the required 0.50% to 1.00% credit risk spread portion of the term loan. In accordance with SFAS No. 133, as amended, we recorded a liability as of September 30, 2003 for the fair value of the interest rate swap at September 30, 2003 of approximately $1,730,000, net of taxes of approximately $1,060,000. We have designated and assessed the derivative as a highly effective cash flow hedge, and accordingly, the effect is reflected in other comprehensive income.
In September 2003, we established a revolving credit facility with a national banking institution that provided for available borrowings of up to $75 million, with a maturity date of October 2008, bearing an interest rate based upon the 30-, 60- or 90-day LIBOR plus 0.75% to 1.75%, depending upon our quarterly ratio of funded debt to earnings before interest, taxes, depreciation and amortization. A commitment fee of 0.175% to 0.25% per annum is assessed on the unused balance. There were no borrowings against this facility at September 30, 2003.
The Company (including its subsidiaries) has never 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 investments portfolio, funds generated from operations, and available credit facility borrowings are sufficient to satisfy our normal financial needs.
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New Accounting Pronouncements
In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, for certain decisions made by the FASB as part of the Derivatives Implementation Group process and to incorporate clarifications of the definitions of a derivative. SFAS No. 149 is effective for contracts modified or entered into after June 30, 2003 and hedging relationships designated after June 30, 2003. We adopted the standard on July 1, 2003. There has been no impact on our financial condition, results of operations or cash flows upon adoption.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement established standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity. The statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We have not entered into or modified any financial instruments with characteristics outlined in the statement and adopted the standard on July 1, 2003. There has been no material impact on our financial condition, results of operations or cash flows upon adoption.
Disclosure Regarding Forward-Looking Statements
We make “forward-looking statements” within the “safe harbor” provision of the Private Securities Litigation Reform Act of 1995 throughout this report and in the documents we incorporate by reference into this report. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “anticipate,” “believe,” “estimate,” “plan” and “continue” or similar words. We have based these statements on our current expectations about future events. Although we believe that our expectations reflected in or suggested by our forward-looking statements are reasonable, our actual results may differ materially from what we currently expect. Important factors which could cause our actual results to differ materially from the forward-looking statements in this report include:
You should carefully read this report completely and with the understanding that our actual future results may be materially different from what we expect. All forward-looking statements attributable to us are expressly qualified by these cautionary statements.
We do not undertake any obligation to publicly update or revise any forward-looking statements.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the potential loss arising from adverse changes in market rates and prices, such as interest rates and equity prices. We are exposed to market risk through our investments, revolving credit line and term loan agreements.
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Our invested assets are held as cash and cash equivalents, restricted cash, available-for-sale marketable equity securities, non-marketable equity securities and certificates of deposit. These investments are subject to interest rate risk and equity price risk. The fair values of our cash and cash equivalents, restricted cash, and certificates of deposit at September, 2003 and December 31, 2002 approximated their respective carrying values due to their short-term duration and therefore such market risk is not considered to be material.
We do not actively invest or trade in equity securities. In addition, we generally dispose of any significant equity securities received in conjunction with an acquisition shortly after the acquisition date. However, we have no current intentions to add to or dispose of any of the 559,970 common stock shares of Rock-Tenn Company, a publicly-held New York Stock Exchange-listed company, which we have owned for over ten years. The investment in Rock-Tenn Company accounted for 83.9% and 83.6% of the total value of available-for-sale marketable equity securities, non-marketable equity securities and certificates of deposit as of September 30, 2003 and December 31, 2002, respectively. Rock-Tenn Company’s closing stock price at September 30, 2003 and December 31, 2002 was $14.58 and $13.48, respectively. Our exposure to equity price risk is primarily related to the Rock-Tenn Company investment. As of September 30, 2003, the value of the Rock-Tenn Company investment was $8,164,000.
To hedge the risk of increasing interest rates from January 2, 2002 through the remaining six years of our seven-year $90 million term loan, on December 5, 2001 we entered into an interest rate swap agreement that effectively converted the floating rate LIBOR-based interest payments to fixed interest rate payments at 4.53%. We do not otherwise enter into derivatives, swaps or other similar financial instruments for trading or speculative purposes.
At September 30, 2003, the interest rate swap agreement was as follows:
(in thousands, except
percentages)
Contractual/
Notional Amount
Interest rate swap agreement
ITEM 4: CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Within 90 days prior to the date of this report, we completed an evaluation (the “Evaluation”), under the supervision and with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures (“Disclosure Controls”). Based on the Evaluation, our CEO and CFO concluded that, subject to the limitations noted below, our Disclosure Controls are effective in timely alerting them to material information required to be included in our periodic Securities and Exchange Commission reports.
Changes in Internal Controls
We have also evaluated our internal controls for financial reporting, and there have been no significant changes in our internal controls or in other factors that could significantly affect those controls subsequent to the date of their last evaluation.
Limitations on the Effectiveness of Controls
Our management, including our CEO and CFO, does not expect that our Disclosure Controls and internal controls will prevent all error and all fraud. A control system, no matter how well conceived and
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operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.
The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
CEO and CFO Certifications
Appearing immediately following the Signatures section of this report there are Certifications of the CEO and the CFO. The Certifications are required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (the “Section 302 Certifications”). This Item 4, which you are currently reading, is the information concerning the Evaluation referred to in the Section 302 Certifications and this information should be read in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented.
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PART II—OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Among the above-referenced claims, and as previously described in the Company’s Report on Form 10-Q for the quarterly period ending March 31, 2003, there are several threatened and pending legal claims against the Company and Brown & Brown Insurance Services of Texas, Inc. (“BBTX”), a subsidiary of the Company, arising out of the procurement and placement of workers’ compensation insurance coverage for entities including several professional employer organizations. On October 27, 2003, the Company and BBTX reached a final settlement in Vega Roofing Co. v. Brown & Brown, Inc., et al., one such case previously described in such Report on Form 10-Q, including settlement of all claims asserted by Aerostaff Services, Inc. against the Company and BBTX. Such settlement is within applicable insurance policy limits, and therefore the settlement does not have a material effect on the Company’s results of operations or cash flows.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
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(b) REPORTS ON FORM 8-K
The Company filed a current report on Form 8-K on July 24, 2003. This current report reported (a) Item 9, which announced that the Company issued a press release on July 9, 2003, relating to the Company’s earnings for the second quarter of fiscal year 2003 (the “Press Release”), and (b) Item 7, which attached the Press Release as Exhibit 99.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/S/ CORY T. WALKER
Date: November 13, 2003
Cory T. Walker
Vice President, Chief Financial Officer
and Treasurer
(duly authorized officer, principal financial
officer and principal accounting officer)
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