10-Q 1 bro-20170930x10q.htm 10-Q Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
 
FORM 10-Q 
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
Or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 001-13619
 
 
BROWN & BROWN, INC.
(Exact name of Registrant as specified in its charter)
 
 
Florida
 
bba10.jpg
 
59-0864469
(State or other jurisdiction of
incorporation or organization)
 
 
(I.R.S. Employer
Identification Number)
220 South Ridgewood Avenue,
Daytona Beach, FL
 
 
32114
(Address of principal executive offices)
 
 
(Zip Code)
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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
 
ý
  
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
 
 
 
 
 
 
 
Emerging growth company
 
¨
 
 
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
The number of shares of the Registrant’s common stock, $0.10 par value, outstanding as of October 30, 2017 was 139,403,675.
 




BROWN & BROWN, INC.
INDEX
 
 
 
 
 
 
PAGE
NO.
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 6.
 
 

2


Disclosure Regarding Forward-Looking Statements
Brown & Brown, Inc., together with its subsidiaries (collectively, “we,” “Brown & Brown” or the “Company”), makes “forward-looking statements” within the “safe harbor” provision of the Private Securities Litigation Reform Act of 1995, as amended, 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,” “should,” “expect,” “anticipate,” “believe,” “intend,” “estimate,” “plan” and “continue” or similar words. We have based these statements on our current expectations about potential future events. Although we believe the expectations expressed in the forward-looking statements included in this Quarterly Report on Form 10-Q and the reports, statements, information and announcements incorporated by reference into this report are based upon reasonable assumptions within the bounds of our knowledge of our business, a number of factors could cause actual results to differ materially from those expressed in any forward-looking statements, whether oral or written, made by us or on our behalf. Many of these factors have previously been identified in filings or statements made by us or on our behalf. Important factors which could cause our actual results to differ materially from the forward-looking statements in this report include but are not limited to the following items, in addition to those matters described in Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”:
 
Future prospects;
Material adverse changes in economic conditions in the markets we serve and in the general economy;
Premium rates set by insurance companies and insurable exposure units, which have traditionally varied and are difficult to predict;
Future regulatory actions and conditions in the states in which we conduct our business;
The occurrence of adverse economic conditions, an adverse regulatory climate, or a disaster in California, Florida, Georgia, Illinois, Massachusetts, Michigan, New Jersey, New York, Oregon, Pennsylvania, Texas, Virginia and Washington, because a significant portion of business written by us is for customers located in these states;
Our ability to attract, retain and enhance qualified personnel;
Competition from others in or entering into the insurance agency, wholesale brokerage, insurance programs and related service business;
The integration of our operations with those of businesses or assets we have acquired or may acquire in the future and the failure to realize the expected benefits of such integration;
Risks that could negatively affect our acquisition strategy, including continuing consolidation among insurance intermediaries and the increasing presence of private equity investors driving up valuations;
Our ability to forecast liquidity needs through at least the end of 2018;
Our ability to renew or replace expiring leases;
Outcomes of existing or future legal proceedings and governmental investigations;
Policy cancellations and renewal terms, which can be unpredictable;
Potential changes to tax rates that would affect the value of deferred tax assets and liabilities and the impact on income available for investment or distributable to shareholders;
The inherent uncertainty in making estimates, judgments, and assumptions in the preparation of financial statements in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”);
Our ability to effectively utilize technology to provide improved value for our customers or carrier partners as well as applying effective internal controls and efficiencies in operations; and
Other risks and uncertainties as may be detailed from time to time in our public announcements and Securities and Exchange Commission (“SEC”) filings.
Assumptions as to any of the foregoing and all statements are not based upon historical fact, but rather reflect our current expectations concerning future results and events. Forward-looking statements that we make or that are made by others on our behalf are based upon a knowledge of our business and the environment in which we operate, but because of the factors listed above, among others, actual results may differ from those in the forward-looking statements. Consequently, these cautionary statements qualify all of the forward-looking statements we make herein. We cannot assure you that the results or developments anticipated by us will be realized or, even if substantially realized, that those results or developments will result in the expected consequences for us or affect us, our business or our operations in the way we expect. We caution readers not to place undue reliance on these forward-looking statements, which speak only as of their dates. We assume no obligation to update any of the forward-looking statements.

3


PART I — FINANCIAL INFORMATION
ITEM 1 — Financial Statements (Unaudited)
BROWN & BROWN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
 
(in thousands, except per share data)
For the three months 
 ended September 30,
 
For the nine months 
 ended September 30,
 
2017
 
2016
 
2017
 
2016
REVENUES
 
 
 
 
 
 
 
Commissions and fees
$
474,609

 
$
461,652

 
$
1,383,899

 
$
1,329,649

Investment income
491

 
230

 
1,085

 
1,150

Other income, net
546

 
392

 
22,047

 
2,166

Total revenues
475,646

 
462,274

 
1,407,031

 
1,332,965

EXPENSES
 
 
 
 
 
 
 
Employee compensation and benefits
246,062

 
237,653

 
736,445

 
692,814

Other operating expenses
72,058

 
67,433

 
210,289

 
197,329

Loss/(gain) on disposal
(1,902
)
 
(277
)
 
(1,993
)
 
(3,131
)
Amortization
21,435

 
21,805

 
64,402

 
65,025

Depreciation
5,489

 
5,195

 
17,242

 
15,867

Interest
9,393

 
9,883

 
28,949

 
29,617

Change in estimated acquisition earn-out payables
(1,308
)
 
3,610

 
8,309

 
6,846

Total expenses
351,227

 
345,302

 
1,063,643

 
1,004,367

Income before income taxes
124,419

 
116,972

 
343,388

 
328,598

Income taxes
48,506

 
45,427

 
131,263

 
128,733

Net income
$
75,913

 
$
71,545

 
$
212,125

 
$
199,865

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.54

 
$
0.51

 
$
1.52

 
$
1.43

Diluted
$
0.53

 
$
0.50

 
$
1.49

 
$
1.41

Dividends declared per share
$
0.14

 
$
0.12

 
$
0.41

 
$
0.37

See accompanying Notes to Condensed Consolidated Financial Statements.

4


BROWN & BROWN, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
 
(in thousands, except per share data)
September 30,
2017
 
December 31,
2016
ASSETS
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
546,520

 
$
515,646

Restricted cash and investments
276,687

 
265,637

Short-term investments
29,156

 
15,048

Premiums, commissions and fees receivable
525,943

 
502,482

Reinsurance recoverable
2,160,286

 
78,083

Prepaid reinsurance premiums
332,246

 
308,661

Other current assets
45,545

 
50,571

Total current assets
3,916,383

 
1,736,128

Fixed assets, net
71,296

 
75,807

Goodwill
2,701,488

 
2,675,402

Amortizable intangible assets, net
656,054

 
707,454

Investments
14,085

 
23,048

Other assets
54,971

 
44,895

Total assets
$
7,414,277

 
$
5,262,734

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current Liabilities:
 
 
 
Premiums payable to insurance companies
$
653,289

 
$
647,564

Losses and loss adjustment reserve
2,160,286

 
78,083

Unearned premiums
332,246

 
308,661

Premium deposits and credits due customers
97,917

 
83,765

Accounts payable
63,623

 
69,595

Accrued expenses and other liabilities
204,153

 
201,989

Current portion of long-term debt
120,000

 
55,500

Total current liabilities
3,631,514

 
1,445,157

Long-term debt less unamortized discount and debt issuance costs
860,741

 
1,018,372

Deferred income taxes, net
382,228

 
357,686

Other liabilities
56,147

 
81,308

Shareholders’ Equity:
 
 
 
Common stock, par value $0.10 per share; authorized 280,000 shares; issued 148,838 shares and outstanding 139,518 shares at 2017, issued 148,107 shares and outstanding 140,104 shares at 2016
14,884

 
14,811

Additional paid-in capital
493,821

 
468,443

Treasury stock, at cost at 9,320 shares at 2017 and 8,003 shares at 2016, respectively
(315,072
)
 
(257,683
)
Retained earnings
2,290,014

 
2,134,640

Total shareholders’ equity
2,483,647

 
2,360,211

Total liabilities and shareholders’ equity
$
7,414,277

 
$
5,262,734

See accompanying Notes to Condensed Consolidated Financial Statements.


5


BROWN & BROWN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED) 
 
For the nine months 
 ended September 30,
(in thousands)
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
212,125

 
$
199,865

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Amortization
64,402

 
65,025

Depreciation
17,242

 
15,867

Non-cash stock-based compensation
22,362

 
11,593

Change in estimated acquisition earn-out payables
8,309

 
6,846

Deferred income taxes
23,941

 
20,081

Amortization of debt discount
119

 
118

Amortization and disposal of deferred financing costs
1,309

 
1,207

Accretion of discounts and premiums, investment
20

 
36

Income tax benefit from exercise of shares from the stock benefit plans

 
(7,213
)
Net loss/(gain) on sales of investments, fixed assets and customer accounts
(1,739
)
 
(2,860
)
Payments on acquisition earn-outs in excess of original estimated payables
(13,800
)
 
(3,683
)
Changes in operating assets and liabilities, net of effect from acquisitions and divestitures:
 
 
 
Premiums, commissions and fees receivable (increase)
(23,350
)
 
(31,324
)
Reinsurance recoverables (increase)
(2,082,203
)
 
(300,036
)
Prepaid reinsurance premiums (increase)
(23,585
)
 
(24,324
)
Other assets (increase) decrease
(5,314
)
 
1,231

Premiums payable to insurance companies increase
5,585

 
39,787

Premium deposits and credits due customers increase
14,030

 
27,914

Losses and loss adjustment reserve increase
2,082,203

 
300,036

Unearned premiums increase
23,585

 
24,324

Accounts payable increase
22,113

 
13,858

Accrued expenses and other liabilities increase (decrease)
1,018

 
(22,119
)
Other liabilities (decrease)
(34,802
)
 
(17,094
)
Net cash provided by operating activities
313,570

 
319,135

Cash flows from investing activities:
 
 
 
Additions to fixed assets
(12,897
)
 
(13,135
)
Payments for businesses acquired, net of cash acquired
(26,478
)
 
(113,219
)
Proceeds from sales of fixed assets and customer accounts
4,085

 
3,411

Purchases of investments
(10,393
)
 
(24,332
)
Proceeds from sales of investments
5,178

 
16,716

Net cash used in investing activities
(40,505
)
 
(130,559
)
Cash flows from financing activities:
 
 
 
Payments on acquisition earn-outs
(25,488
)
 
(23,872
)
Payments on long-term debt
(91,750
)
 
(34,375
)
Deferred debt issuance costs
(2,809
)
 

Income tax benefit from exercise of shares from the stock benefit plans

 
7,213

Issuances of common stock for employee stock benefit plans
17,387

 
15,959

Repurchase shares to fund tax withholdings for non-cash stock-based compensation

(6,791
)
 
(8,395
)
Purchase of treasury stock
(57,389
)
 
(11,250
)
Settlement (prepayment) of accelerated share repurchase program
(7,500
)
 
11,250

Cash dividends paid
(56,801
)
 
(51,317
)
Net cash used in financing activities
(231,141
)
 
(94,787
)
Net increase in cash and cash equivalents inclusive of restricted cash

41,924

 
93,789

Cash and cash equivalents inclusive of restricted cash at beginning of period

781,283

 
673,173

Cash and cash equivalents inclusive of restricted cash at end of period

$
823,207

 
$
766,962

See accompanying Notes to Condensed Consolidated Financial Statements. Refer to Note 8 for reconciliation of cash and cash equivalents inclusive of restricted cash.

6


BROWN & BROWN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1· Nature of Operations
Brown & Brown, Inc., a Florida corporation, and its subsidiaries (collectively, “Brown & Brown” or the “Company”) is a diversified insurance agency, wholesale brokerage, insurance programs and services organization that markets and sells to its customers, insurance products and services, primarily in the property, casualty and employee benefits areas. Brown & Brown’s business is divided into four reportable segments: the Retail Segment provides a broad range of insurance products and services to commercial, public and quasi-public entities, professional and individual customers; the National Programs Segment, acting as a managing general agent (“MGA”), provides professional liability and related package products for certain professionals, a range of insurance products for individuals, flood coverage, and targeted products and services designated for specific industries, trade groups, governmental entities and market niches, all of which are delivered through nationwide networks of independent agents, including Brown & Brown retail agents; the Wholesale Brokerage Segment markets and sells excess and surplus commercial insurance, primarily through independent agents and brokers, as well as Brown & Brown Retail offices; and 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, as well as Medicare Set-aside services, Social Security disability and Medicare benefits advocacy services, and claims adjusting services.
NOTE 2· Basis of Financial Reporting
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) 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 U.S. GAAP 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 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, 2016.
The preparation of these financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, as well as disclosures of contingent assets and liabilities, at the date of the Consolidated Financial Statements, and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates.
Recently Issued Accounting Pronouncements
In November 2016, the Financial Accountings Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-18, “Statement of Cash Flows (Topic 230)”: Restricted Cash (“ASU 2016-18”), which requires that the Statement of Cash Flows explain the changes during the period of cash and cash equivalents inclusive of amounts categorized as restricted cash. ASU 2016-18 is effective for periods beginning after December 15, 2017. However, the Company elected to early adopt for the reporting period ended March 31, 2017 under the full retrospective approach for all periods presented. With the adoption of ASU 2016-18, the change in restricted cash is no longer reflected as a change in operating assets and liabilities, and the Statement of Cash Flows details the changes in the balance of cash and cash equivalents inclusive of restricted cash. Net cash provided by operating activities for the nine months ended September 30, 2016 were previously reported as $270.6 million. With the retrospective adoption, the net cash provided by operating activities for the nine months ended September 30, 2016 is now reported as $319.1 million. The Company reflects cash collected from customers that is payable to insurance companies as restricted cash if segregation of this cash is required by the state of domicile for the office conducting this transaction or if required by contract with the relevant insurance company providing coverage. Cash collected from customers that is payable to insurance companies is reported in cash and cash equivalents if no such restriction is required.
In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230)”: Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force) (“ASU 2016-15”), which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified and applies to all entities, including both business entities and not-for-profit entities that are required to present a statement of cash flows under Topic 230. ASU 2016-15 will take effect for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017 and early adoption is permitted. The Company has evaluated the impact of ASU 2016-15 and has determined there is no impact on the Company's Statement of Cash Flows. The Company already presents cash paid on contingent consideration in business combination as prescribed by ASU 2016-15 and does not, at this time, engage in the other activities being addressed.

7


In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share Based Payment Accounting” (“ASU 2016-09”), which amends guidance issued in Accounting Standards Codification (“ASC”) Topic 718, Compensation - Stock Compensation. ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years and early adoption is permitted. The Company adopted the guidance on January 1, 2017, as required. Prior periods have not been adjusted, as the guidance was adopted prospectively. The principal impact is that the tax benefit or expense from stock compensation is now presented in the income tax line of the Statement of Income, whereas the prior treatment was to present this amount as a component of equity on the Balance Sheet. Also the tax benefit or expense is now presented as activity in Cash Flow from Operating Activity, rather than the prior presentation as Cash Flow from Financing Activity in the Statement of Cash Flows. The Company also continues to estimate forfeitures of stock grants as allowed by ASU 2016-09.
In March 2016, the FASB issued ASU 2016-08, “Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net)” (“ASU 2016-08”) to clarify certain aspects of the principal-versus-agent guidance included in the new revenue standard ASU 2014-09 “Revenue from Contracts with Customers” (“ASU 2014-09”). The FASB issued the ASU in response to concerns identified by stakeholders, including those related to (1) determining the appropriate unit of account under the revenue standard’s principal-versus-agent guidance and (2) applying the indicators of whether an entity is a principal or an agent in accordance with the revenue standard’s control principle. ASU 2016-08 is effective contemporaneous with ASU 2014-09 beginning January 1, 2018. The impact of ASU 2016-08 is currently being evaluated along with ASU 2014-09. At this point in our evaluation the potential impact would primarily be limited to the claims administering activities within our Services Segment and therefore not material to the Company.
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” (“ASU 2016-02”), which provides guidance for accounting for leases. Under ASU 2016-02, the Company will be required to recognize the assets and liabilities for the rights and obligations created by leased assets. ASU 2016-02 will take effect for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company continues to evaluate the impact of this pronouncement with the principal impact being that the present value of the remaining lease payments be presented as a liability on the Balance Sheet as well as an asset of similar value representing the “Right of Use” for those leased properties. As detailed in Note 13 of the 2016 10-K, the undiscounted contractual cash payments remaining on leased properties was $213.2 million as of December 31, 2016 and is $200.3 million as of September 30, 2017 as detailed in the Liquidity and Capital Resources section of this Quarterly Report on Form 10-Q.
In November 2015, FASB issued ASU No. 2015-17, “Income Taxes (Topic 740) - Balance Sheet Classification of Deferred Taxes” (“ASU 2015-17”), which simplifies the presentation of deferred income taxes by requiring deferred tax assets and liabilities be classified as a single non-current item on the balance sheet. ASU 2015-17 is effective for fiscal years beginning after December 15, 2016 with early adoption permitted as of the beginning of any interim or annual reporting period. The Company adopted the guidance on January 1, 2017, as required. As a result, the Company retrospectively applied the guidance to the 2016 balance sheet by reclassifying $24.6 million from deferred income taxes (asset) to deferred income taxes, net (liability) on the Condensed Consolidated Balance Sheet.
In May 2014, FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“Topic 606”), which provides guidance for revenue recognition. Topic 606 affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets.  It supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition,” and most industry-specific guidance. The standard’s core principle is that a company should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under the current guidance. Specifically, in situations where multiple performance obligations exist within a contract, the use of estimates is required to allocate the transaction price to each separate performance obligation.
Historically, approximately 70% of the Company’s commissions and fees revenue is in the form of commissions paid by insurance carriers. These commissions are earned upon the effective date of bound coverage as no significant performance obligation remains after coverage is bound.
Approximately 20% of the Company's commissions and fees revenue is in the form of fees, which are predominantly in our National Programs and Services Segments, and to a lesser extent in the large accounts business within our Retail Segment. At the conclusion of our evaluation, it may be determined that fee revenue from certain agreements will be recognized in earlier or later periods under the new guidance as compared to our current accounting. Based upon the work completed to date, the Company does not expect the overall impact of these potential changes to be significant on a full-year basis, but they may impact the timing of recognizing revenue among quarters. 
The Company is continuing to evaluate approximately 10% of the Company's commissions and fees revenues and anticipates completion of this evaluation by December 31, 2017. 

8


Additionally, the Company is continuing to evaluate the requirement under ASC Topic 340 - Other Assets and Deferred Cost ("ASC 340") to capitalize costs to obtain, and costs to fulfill, customer contracts, and recognize these costs over the associated life of the contract as the performance obligations are fulfilled.  This evaluation includes assessing the costs that would qualify for capitalization as well as the timing to recognize these costs in future periods in accordance with ASC 340.  Presently all costs to obtain, and costs to fulfill, customer contracts are expensed by the Company as incurred.
The primary areas the Company has identified thus far that will be impacted by the adoption of the new revenue recognition standards are summarized below.
Contingent commissions - Under current accounting standards, revenue that is not fixed and determinable because a contingency exists is not recognized until the contingency is resolved.  Under Topic 606 the Company must use judgment to estimate the amount of consideration that will be received such that a significant reversal of revenue is not probable.  Contingent commissions represent a form of variable consideration associated with the same performance obligation, which is in the form of placement of coverage, for which we earn core commissions.  In connection with the new standard, contingent commissions will be estimated with an appropriate constraint applied and accrued relative to the core commissions as they are recognized.  The resulting effect on the timing of recognition of contingent commissions will more closely follow a similar pattern as our core commissions with true-ups recognized when payments are received or as additional information that affects the estimate becomes available.  As disclosed in Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2016, contingent commissions have averaged approximately 3.6% of the previous year’s total commissions and fees revenue over the last three years and have primarily been received in the first and second quarters of the year.
Cost deferrals - ASC 340 requires an entity to defer the incremental costs to obtain a customer contract and recognize these costs over the anticipated life of the customer relationship, inclusive of anticipated renewals.  This requirement will primarily affect the Company as it relates to certain commission-based compensation plans in the Retail Segment whereby the Company pays an incremental amount of compensation on new business in the first year.  As has been disclosed in Note 4 to the Financial Statements contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2016, the weighted average life of purchased customer accounts is 15 years.
ASC 340 also requires a company to defer costs to fulfill a contract and recognize these costs as the associated performance obligations are fulfilled. In order for contract fulfillment costs to be deferred under ASC 340, the costs must (1) relate directly to a specific contract or anticipated contract, (2) generate or enhance resources that the Company will use in satisfying its obligations under the contract, and (3) be expected to be recovered through sufficient net cashflows from the contract.  We are evaluating and believe the impact of ASC 340 related to contract fulfillment costs will primarily affect businesses that recognize revenue based upon on fees. Based upon the work completed to date, the Company does not expect the overall impact of the potential change to be significant on a full-year basis, but may impact the timing of recognizing expense among quarters.
Installment billing - As disclosed in Note 1 to the Financial Statements contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2016, commission revenues related to installment billings are recognized on the latter of the policy effective date (as indicated in the policy) or the date that the premium was billed to the client (as indicated in the premium invoice), with the exception of our Arrowhead businesses, which follows a policy of recognizing these revenues on the latter of the policy effective date or processed date into our systems, regardless of the billing arrangement.  We are still determining the impact of recognizing installment revenue upon delivery of the contract fulfillment obligation.
Topic 606 is effective for the Company beginning January 1, 2018.  Entities are permitted to adopt the guidance under one of the following methods: the "full retrospective" method, which applies the guidance to each period presented (prior years restated), or the "modified retrospective" method, in which the guidance is only applied to the year of adoption, with the cumulative effect of initially applying the guidance recognized as an adjustment to retained earnings. The Company is evaluating the adoption method it will use, but currently expects to use the modified retrospective method.
In connection with the implementation of the above standards, we will augment our current procedures and controls, as necessary to support the new standards.

9


NOTE 3· Net Income Per Share
Basic EPS is computed based on the weighted average number of common shares (including restricted shares) issued and outstanding during the period. Diluted EPS is computed based on the weighted average number of common shares issued and outstanding plus equivalent shares, assuming the exercise of stock options. The dilutive effect of stock options is computed by application of the treasury-stock method. The following is a reconciliation between basic and diluted weighted average shares outstanding:
 
For the three months 
 ended September 30,
 
For the nine months 
 ended September 30,
(in thousands, except per share data)
2017
 
2016
 
2017
 
2016
Net income
$
75,913

 
$
71,545

 
$
212,125

 
$
199,865

Net income attributable to unvested awarded performance stock
(1,852
)
 
(1,873
)
 
(5,181
)
 
(5,210
)
Net income attributable to common shares
$
74,061

 
$
69,672

 
$
206,944

 
$
194,655

Weighted average number of common shares outstanding – basic
139,756

 
140,129

 
140,012

 
139,642

Less unvested awarded performance stock included in weighted average number of common shares outstanding – basic
(3,410
)
 
(3,668
)
 
(3,420
)
 
(3,640
)
Weighted average number of common shares outstanding for basic earnings per common share
136,346

 
136,461

 
136,592

 
136,002

Dilutive effect of stock options
2,547

 
1,721

 
2,419

 
1,582

Weighted average number of shares outstanding – diluted
138,893

 
138,182

 
139,011

 
137,584

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.54

 
$
0.51

 
$
1.52

 
$
1.43

Diluted
$
0.53

 
$
0.50

 
$
1.49

 
$
1.41

NOTE 4· Business Combinations
During the nine months ended September 30, 2017, Brown & Brown acquired the assets and assumed certain liabilities of six insurance intermediaries. Additionally, miscellaneous adjustments were recorded to the purchase price allocation of certain prior acquisitions completed within the last twelve months as permitted by Accounting Standards Codification Topic 805 — Business Combinations (“ASC 805”). Such adjustments are presented in the “Other” category within the following two tables. The recorded purchase price for all acquisitions included an estimation of the fair value of liabilities associated with any potential earn-out provisions. Subsequent changes in the fair value of earn-out obligations will be recorded in the Condensed Consolidated Statement of Income when incurred.
The fair value of earn-out obligations is based on the present value of the expected future payments to be made to the sellers of the acquired businesses in accordance with the provisions outlined in the respective purchase agreements. In determining fair value, the acquired business’s future performance is estimated using financial projections developed by management for the acquired business and reflects market participant assumptions regarding revenue growth and/or profitability. The expected future payments are estimated on the basis of the earn-out formula and performance targets specified in each purchase agreement compared to the associated financial projections. These payments are then discounted to present value using a risk-adjusted rate that takes into consideration the likelihood that the forecasted earn-out payments will be made.
Based on the acquisition date and the complexity of the underlying valuation work, certain amounts included in the Company’s Condensed Consolidated Financial Statements may be provisional and thus subject to further adjustments within the permitted measurement period, as defined in ASC 805. For the nine months ended September 30, 2017, several adjustments were made within the permitted measurement period that resulted in an increase in the aggregate purchase price of the affected acquisitions of $1.5 million relating to the assumption of certain liabilities. These measurement period adjustments have been reflected as current period adjustments in the nine months ended September 30, 2017 in accordance with the guidance in ASU 2015-16 “Business Combinations”. The measurement period adjustments primarily impacted goodwill, with no effect on earnings or cash in the current period.
Cash paid for acquisitions was $26.5 million and $115.3 million in the nine-month periods ended September 30, 2017 and 2016, respectively. We completed six acquisitions (excluding book of business purchases) in the nine-month period ended September 30, 2017. We completed six acquisitions (excluding book of business purchases) in the nine-month period ended September 30, 2016.

10


The following table summarizes the purchase price allocations made as of the date of each acquisition for current year acquisitions and adjustments made during the measurement period for prior year acquisitions. During the measurement periods, the Company will adjust assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date. These adjustments are made in the period in which the amounts are determined and the current period income effect of such adjustments will be calculated as if the adjustments had been completed as of the acquisition date.
(in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
Name
Business
Segment
 
Effective
Date of
Acquisition
 
Cash
Paid
 
Other
Payable
 
Recorded
Earn-Out
Payable
 
Net Assets
Acquired
 
Maximum
Potential Earn-
Out Payable
Other
Various
 
Various
 
26,478

 
11,395

 
1,332

 
39,205

 
11,605

Total
 
 
 
 
$
26,478

 
$
11,395

 
$
1,332

 
$
39,205

 
$
11,605

The following table summarizes the estimated fair values of the aggregate assets and liabilities acquired as of the date of each acquisition and adjustments made during the measurement period of the prior year acquisitions.
(in thousands)
 
Other
 
Total
Other current assets
 
98

 
98

Fixed assets
 
47

 
47

Goodwill
 
27,580

 
27,580

Purchased customer accounts
 
12,858

 
12,858

Non-compete agreements
 
595

 
595

Total assets acquired
 
41,178

 
41,178

Other current liabilities
 
(1,284
)
 
(1,284
)
Deferred income tax, net
 
(689
)
 
(689
)
Total liabilities assumed
 
(1,973
)
 
(1,973
)
Net assets acquired
 
$
39,205

 
$
39,205

The weighted average useful lives for the acquired amortizable intangible assets are as follows: purchased customer accounts, 15 years; and non-compete agreements, 5 years.
Goodwill of $27.6 million, which is net of any opening balance sheet adjustments within the allowable measurement period, was allocated to the Retail, National Programs, Wholesale Brokerage and Service Segments in the amounts of $18.8 million, $7.3 million, $0.8 million and $0.7 million, respectively. Of the total goodwill of $27.6 million, the amount currently deductible for income tax purposes is $26.3 million and the remaining $1.3 million relates to the recorded earn-out payables and will not be deductible until it is earned and paid.

11


For the acquisitions completed during 2017, the results of operations since the acquisition dates have been combined with those of the Company. The total revenues from the acquisitions completed through September 30, 2017, included in the Condensed Consolidated Statement of Income for the three and nine months ended September 30, 2017, were $3.2 million and $3.6 million, respectively. The income before income taxes, including the intercompany cost of capital charge, from the acquisitions completed through September 30, 2017, included in the Condensed Consolidated Statement of Income for the three and nine months ended September 30, 2017, were $0.9 million and $1.0 million, respectively. If the acquisitions had occurred as of the beginning of the respective periods, the Company’s results of operations would be as shown in the following table. These unaudited pro forma results are not necessarily indicative of the actual results of operations that would have occurred had the acquisitions actually been made at the beginning of the respective periods.
(UNAUDITED)
For the three months 
 ended September 30,
 
For the nine months 
 ended September 30,
(in thousands, except per share data)
2017
 
2016
 
2017
 
2016
Total revenues
$
476,124

 
$
465,014

 
$
1,413,278

 
$
1,341,511

Income before income taxes
$
124,582

 
$
117,929

 
$
345,608

 
$
331,574

Net income
$
76,012

 
$
72,130

 
$
213,496

 
$
201,675

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.54

 
$
0.51

 
$
1.52

 
$
1.44

Diluted
$
0.53

 
$
0.51

 
$
1.50

 
$
1.43

Weighted average number of shares outstanding:
 
 
 
 
 
 
 
Basic
136,346

 
136,461

 
136,592

 
136,002

Diluted
138,893

 
138,182

 
139,011

 
137,584

As of September 30, 2017 and 2016, 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 additions, payments, and net changes, as well as the interest expense accretion on the estimated acquisition earn-out payables, for the three and nine months ended September 30, 2017 and 2016, were as follows:
 
For the three months 
 ended September 30,
 
For the nine months 
 ended September 30,
(in thousands)
2017
 
2016
 
2017
 
2016
Balance as of the beginning of the period
$
57,943

 
$
73,447

 
$
63,821

 
$
78,387

Additions to estimated acquisition earn-out payables
1,050

 
1,437

 
1,332

 
3,828

Payments for estimated acquisition earn-out payables
(23,511
)
 
(16,988
)
 
(39,288
)
 
(27,555
)
Subtotal
35,482

 
57,896

 
25,865

 
54,660

Net change in earnings from estimated acquisition earn-out payables:
 
 
 
 
 
 
 
Change in fair value on estimated acquisition earn-out payables
(1,784
)
 
2,883

 
6,402

 
4,704

Interest expense accretion
476

 
727

 
1,907

 
2,142

Net change in earnings from estimated acquisition earn-out payables
(1,308
)
 
3,610

 
8,309

 
6,846

Balance as of September 30,
$
34,174

 
$
61,506

 
$
34,174

 
$
61,506

Of the $34.2 million estimated acquisition earn-out payables as of September 30, 2017, $28.7 million was recorded as accounts payable and $5.5 million was recorded as other non-current liabilities. As of September 30, 2017, the maximum future acquisition contingency payments related to all acquisitions was $81.5 million, inclusive of the $34.2 million estimated acquisition earn-out payables as of September 30, 2017. Included within the additions to estimated acquisition earn-out payables are any adjustments to opening balance sheet items within the allowable measurement period, which may therefore differ from previously reported amounts.

12


NOTE 5· Goodwill
Goodwill is subject to at least an annual assessment for impairment by applying a fair value-based test. The Company completed its most recent annual assessment as of November 30, 2016, and identified no impairment as a result of the evaluation.
The changes in the carrying value of goodwill by reportable segment for the nine months ended September 30, 2017 are as follows:
(in thousands)
Retail
 
National
Programs
 
Wholesale
Brokerage
 
Services
 
Total
Balance as of January 1, 2017
$
1,354,667

 
$
901,294

 
$
284,869

 
$
134,572

 
$
2,675,402

Goodwill of acquired businesses
18,807

 
7,314

 
770

 
689

 
27,580

Goodwill disposed of relating to sales of businesses
(1,494
)
 

 

 

 
(1,494
)
Balance as of September 30, 2017
$
1,371,980

 
$
908,608

 
$
285,639

 
$
135,261

 
$
2,701,488

NOTE 6· Amortizable Intangible Assets
Amortizable intangible assets at September 30, 2017 and December 31, 2016 consisted of the following:
 
September 30, 2017
 
December 31, 2016
(in thousands)
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Weighted
Average
Life
(Years)(1)
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Weighted
Average
Life
(Years)(1)
Purchased customer accounts
$
1,458,405

 
$
(803,764
)
 
$
654,641

 
15.0
 
$
1,447,680

 
$
(741,770
)
 
$
705,910

 
15.0
Non-compete agreements
30,161

 
(28,748
)
 
1,413

 
6.8
 
29,668

 
(28,124
)
 
1,544

 
6.8
Total
$
1,488,566

 
$
(832,512
)
 
$
656,054

 
 
 
$
1,477,348

 
$
(769,894
)
 
$
707,454

 
 
(1)
Weighted average life calculated as of the date of acquisition.
Amortization expense for amortizable intangible assets for the years ending December 31, 2017, 2018, 2019, 2020 and 2021 is estimated to be $85.3 million, $80.6 million, $76.1 million, $68.7 million, and $65.4 million, respectively.

13


NOTE 7· Long-Term Debt
Long-term debt at September 30, 2017 and December 31, 2016 consisted of the following: 
(in thousands)
September 30,
2017
 
December 31, 2016
Current portion of long-term debt:
 
 
 
Current portion of 5-year term loan facility expires June 28, 2022
$
20,000

 
$
55,000

4.500% senior notes, Series E, quarterly interest payments, balloon due 2018
100,000

 

Short-term promissory note

 
500

Total current portion of long-term debt
120,000

 
55,500

Long-term debt:
 
 
 
Note agreements:
 
 
 
4.500% senior notes, Series E, quarterly interest payments, balloon due 2018

 
100,000

4.200% senior notes, semi-annual interest payments, net of the unamortized discount, balloon due 2024
498,904

 
498,785

Total notes
498,904

 
598,785

Credit agreements:
 
 
 
5-year term-loan facility, periodic interest and principal payments, LIBOR plus up to 1.750%, expires June 28, 2022
370,000

 
426,250

5-year revolving-loan facility, periodic interest payments, LIBOR plus up to 1.500%, plus commitment fees up to 0.250%, expires June 28, 2022

 

Total credit agreements
370,000

 
426,250

Debt issuance costs (contra)
(8,163
)
 
(6,663
)
Total long-term debt less unamortized discount and debt issuance costs
860,741

 
1,018,372

Current portion of long-term debt
120,000

 
55,500

Total debt
$
980,741

 
$
1,073,872

On December 22, 2006, the Company entered into a Master Shelf and Note Purchase Agreement (the “Master Agreement”) with a national insurance company (the “Purchaser”). The initial issuance of notes under the Master Agreement occurred on December 22, 2006, through the issuance of $25.0 million in Series C Senior Notes due December 22, 2016, with a fixed interest rate of 5.660% per year. On February 1, 2008, $25.0 million in Series D Senior Notes due January 15, 2015, with a fixed interest rate of 5.370% per year, were issued. On September 15, 2011, and pursuant to a Confirmation of Acceptance (the “Confirmation”), dated January 21, 2011, in connection with the Master Agreement, $100.0 million in Series E Senior Notes were issued and are due September 15, 2018, with a fixed interest rate of 4.500% per year. The Series E Senior Notes were issued for the sole purpose of retiring existing senior notes. On January 15, 2015 the Series D Senior Notes were redeemed at maturity using cash proceeds to pay off the principal of $25.0 million plus any remaining accrued interest. On December 22, 2016, the Series C Senior Notes were redeemed at maturity using cash proceeds to pay off the principal of $25.0 million plus any remaining accrued interest. As of September 30, 2017, there was an outstanding debt balance issued under the provisions of the Master Agreement of $100.0 million.
On April 17, 2014, the Company entered into a credit agreement with JPMorgan Chase Bank, N.A. as administrative agent and certain other banks as co-syndication agents and co-documentation agents (the “Credit Agreement”). The Credit Agreement in the amount of $1,350.0 million provides for an unsecured revolving credit facility (the “Credit Facility”) in the initial amount of $800.0 million and unsecured term loans in the initial amount of $550.0 million, either or both of which may, subject to lenders’ discretion, potentially be increased by up to $500.0 million. The Credit Facility was funded on May 20, 2014 in conjunction with the closing of The Wright Insurance Group, LLC (“Wright”) acquisition, with the $550.0 million term loan being funded as well as a drawdown of $375.0 million on the revolving loan facility. Use of these proceeds was to retire existing term loan debt and to facilitate the closing of the Wright acquisition as well as other acquisitions. The Credit Facility terminates on May 20, 2019, but either or both of the revolving Credit Facility and the term loans may be extended for two additional one-year periods at the Company’s request and at the discretion of the respective lenders. Interest and facility fees in respect to the Credit Facility are based on the better of the Company’s net debt leverage ratio or a non-credit enhanced senior unsecured long-term debt rating. Based on the Company’s net debt leverage ratio, the rates of interest charged on the term loan are 1.000% to 1.750%, and the revolving loan is 0.850% to 1.500% above the adjusted LIBOR rate for outstanding amounts drawn. There are fees included in the facility which include a facility fee based on the revolving credit commitments of the lenders (whether used or unused) at a rate of 0.150% to 0.250% and letter of credit fees based on the amounts of outstanding secured or unsecured letters of credit. The Credit Facility includes various covenants, limitations and events of default customary for similar facilities for similarly rated borrowers.

14


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 unsecured term loans at $400.0 million while also extending the applicable maturity date to June 28, 2022. The term loan principal amortization schedule was reset with payments due quarterly. 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 the modified agreement, while also carrying forward $1.6 million on the Consolidated Balance Sheet the unamortized portion of the Original Credit Agreement debt issuance costs which will amortize over the term of the Amended and Restated Credit Agreement. On September 30, 2017, a scheduled principal payment of $5.0 million was satisfied per the terms of the Amended and Restated Credit Agreement. As of September 30, 2017, there was an outstanding debt balance issued under the terms of the Amended and Restated Credit Agreement of $390.0 million with no borrowings outstanding against the revolving loan. Per the terms of the Amended and Restated Credit Agreement, a scheduled principal payment of $5.0 million is due December 31, 2017.
On September 18, 2014, the Company issued $500.0 million of 4.200% unsecured senior notes due in 2024. The senior notes were given investment grade ratings of BBB-/Baa3 with a stable outlook. The notes are subject to certain covenant restrictions and regulations which are customary for credit rated obligations. At the time of funding, the proceeds were offered at a discount of the original note amount which also excluded an underwriting fee discount. The net proceeds received from the issuance were used to repay the outstanding balance of $475.0 million on the revolving Credit Facility and for other general corporate purposes. As of September 30, 2017 and December 31, 2016, there was an outstanding debt balance of $500.0 million exclusive of the associated discount balance.
In conjunction with the acquisition of Social Security Advocates for the Disabled (SSAD) effective February 1, 2016, the company added a $0.5 million promissory note incurred as a payment to the sellers and payable after the one-year anniversary of the acquisition. The note had a nominal rate of interest 0.810%. On March 10, 2017, the promissory note was settled, plus any outstanding accrued interest, using cash.
The Master Agreement and the Amended and Restated Credit Agreement require the Company to maintain certain financial ratios and comply with certain other covenants. The Company was in compliance with all such covenants as of September 30, 2017 and December 31, 2016.
The 30-day Adjusted LIBOR Rate as of September 30, 2017 was 1.250%.
NOTE 8· Supplemental Disclosures of Cash Flow Information and Non-Cash Financing and Investing Activities
 
For the nine months 
 ended September 30,
(in thousands)
2017
 
2016
Cash paid during the period for:
 
 
 
Interest
$
32,504

 
$
33,122

Income taxes
$
110,853

 
$
104,739

Brown & Brown’s significant non-cash investing and financing activities are summarized as follows:
 
For the nine months 
 ended September 30,
(in thousands)
2017
 
2016
Other payable issued for purchased customer accounts
$
11,395

 
$
10,505

Estimated acquisition earn-out payables and related charges
$
1,332

 
$
3,828

Notes payable issued or assumed for purchased customer accounts
$

 
$
492


15


The following is a reconciliation of cash and cash equivalents inclusive of restricted cash as of September 30, 2017 and 2016.
 
Balance as of September 30,
(in thousands)
2017
 
2016
Table to reconcile cash and cash equivalents inclusive of restricted cash
 
 
 
Cash and cash equivalents
$
546,520

 
$
488,683

Restricted cash
276,687

 
278,279

Total cash and cash equivalents inclusive of restricted cash at the end of the period
$
823,207

 
$
766,962

The following is a reconciliation of cash and cash equivalents inclusive of restricted cash as of December 31, 2016 and 2015.
 
Balance as of December 31,
(in thousands)
2016
 
2015
Table to reconcile cash and cash equivalents inclusive of restricted cash
 
 
 
Cash and cash equivalents
$
515,646

 
$
443,420

Restricted cash
265,637

 
229,753

Total cash and cash equivalents inclusive of restricted cash at the end of the period
$
781,283

 
$
673,173

NOTE 9· Legal and Regulatory Proceedings
The Company is involved in numerous pending or threatened proceedings by or against Brown & Brown, Inc. or one or more of its subsidiaries that arise in the ordinary course of business. The damages that may be claimed against the Company in these various proceedings are in some cases substantial, including in certain 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.
During the first quarter of 2017, the Company was successful in settling a lawsuit it had brought against certain former employees of Brown & Brown, their employer, AssuredPartners, Inc. and certain key executives of AssuredPartners.  The settlement included a payment of $20,000,000 by AssuredPartners to Brown & Brown in exchange for releasing certain individuals from restrictive covenants in the employment contracts they had signed with the Company and provides protection for current Brown & Brown teammates from continued solicitation for employment by AssuredPartners.
The proceeds of the settlement were received in March 2017 and were recorded in the Other income line in the Statement of Income.
We continue to assess certain litigation and claims to determine the amounts, if any, that management believes will be paid as a result of such claims and litigation and, therefore, additional losses may be accrued and paid in the future, which could adversely impact the Company’s operating results, cash flows and overall liquidity. The Company maintains third-party insurance policies to provide coverage for certain legal claims, in an effort to mitigate its overall exposure to unanticipated claims or adverse decisions. However, as (i) one or more of the Company’s insurance carriers could take the position that portions of these claims are not covered by the Company’s insurance, (ii) to the extent that payments are made to resolve claims and lawsuits, applicable insurance policy limits are eroded and (iii) the claims and lawsuits relating to these matters are continuing to develop, it is possible that future results of operations or cash flows for any particular quarterly or annual period could be materially affected by unfavorable resolutions of these matters. Based on the AM Best Company ratings of these third-party insurers, management does not believe there is a substantial risk of an insurer’s material non-performance related to any current insured claims.
On the basis of current information, the availability of insurance and legal advice, in management’s opinion, the Company is not currently involved in any legal proceedings which, individually or in the aggregate, would have a material adverse effect on its financial condition, operations and/or cash flows.
NOTE 10· Segment Information
Brown & Brown’s business is divided into four reportable segments:(1) the Retail Segment, which provides a broad range of insurance products and services to commercial, public and quasi-public entities, and to professional and individual customers; (2) the National Programs Segment, which acts as a MGA, provides professional liability and related package products for certain professionals, a range of insurance products for individuals, flood coverage, and targeted products and services designated for specific industries, trade groups, governmental entities and market niches, all of which are delivered through nationwide networks of independent agents, and Brown & Brown retail agents; (3) the Wholesale Brokerage Segment, which markets and sells excess and surplus commercial and personal lines insurance, primarily through independent agents and brokers, as well as Brown & Brown retail agents; and (4) the 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.

16


Brown & Brown conducts all of its operations within the United States of America, except for a wholesale brokerage operation based in London, England, and retail operations in Bermuda and the Cayman Islands. These operations earned $3.9 million and $3.8 million of total revenues for the three months ended September 30, 2017 and 2016, respectively. These operations earned $11.1 million and $10.3 million of total revenues for the nine months ended September 30, 2017 and 2016, respectively. Long-lived assets held outside of the United States as of September 30, 2017 and 2016 were not material.
The accounting policies of the reportable segments are the same as those described in Note 1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. The Company evaluates the performance of its segments based upon revenues and income before income taxes. Inter-segment revenues are eliminated.
Summarized financial information concerning the Company’s reportable segments is shown in the following table. The “Other” column includes any income and expenses not allocated to reportable segments, corporate-related items, including the inter-company interest expense charge to the reporting segment, and the elimination of inter-segment activities.
 
For the three months ended September 30, 2017
(in thousands)
Retail
 
National
Programs
 
Wholesale
Brokerage
 
Services
 
Other
 
Total
Total revenues
$
234,483

 
$
127,718

 
$
71,574

 
$
41,491

 
$
380

 
$
475,646

Investment income
$
3

 
$
124

 
$

 
$
72

 
$
292

 
$
491

Amortization
$
10,540

 
$
6,913

 
$
2,845

 
$
1,137

 
$

 
$
21,435

Depreciation
$
1,262

 
$
1,412

 
$
471

 
$
402

 
$
1,942

 
$
5,489

Interest expense
$
7,216

 
$
8,304

 
$
1,515

 
$
876

 
$
(8,518
)
 
$
9,393

Income before income taxes
$
54,950

 
$
32,203

 
$
21,219

 
$
7,910

 
$
8,137

 
$
124,419

Total assets
$
4,246,422

 
$
5,026,918

 
$
1,258,783

 
$
432,331

 
$
(3,550,177
)
 
$
7,414,277

Capital expenditures
$
844

 
$
1,357

 
$
214

 
$
364

 
$
1,270

 
$
4,049

 
For the three months ended September 30, 2016
(in thousands)
Retail
 
National
Programs
 
Wholesale
Brokerage
 
Services
 
Other
 
Total
Total revenues
$
228,645

 
$
123,632

 
$
70,192

 
$
39,586

 
$
219

 
$
462,274

Investment income
$
5

 
$
96

 
$

 
$
57

 
$
72

 
$
230

Amortization
$
10,861

 
$
6,921

 
$
2,882

 
$
1,140

 
$
1

 
$
21,805

Depreciation
$
1,508

 
$
1,945

 
$
503

 
$
473

 
$
766

 
$
5,195

Interest expense
$
9,026

 
$
10,844

 
$
1,540

 
$
1,257

 
$
(12,784
)
 
$
9,883

Income before income taxes
$
44,894

 
$
32,319

 
$
20,862

 
$
5,971

 
$
12,926

 
$
116,972

Total assets
$
3,652,977

 
$
2,933,568

 
$
1,053,516

 
$
342,360

 
$
(2,460,394
)
 
$
5,522,027

Capital expenditures
$
1,443

 
$
2,153

 
$
11

 
$
80

 
$
504

 
$
4,191

 
For the nine months ended September 30, 2017
(in thousands)
Retail
 
National
Programs
 
Wholesale
Brokerage
 
Services
 
Other
 
Total
Total revenues
$
712,739

 
$
342,576

 
$
208,812

 
$
122,397

 
$
20,507

 
$
1,407,031

Investment income
$
6

 
$
279

 
$

 
$
224

 
$
576

 
$
1,085

Amortization
$
31,704

 
$
20,664

 
$
8,621

 
$
3,412

 
$
1

 
$
64,402

Depreciation
$
3,975

 
$
4,975

 
$
1,438

 
$
1,191

 
$
5,663

 
$
17,242

Interest expense
$
23,918

 
$
27,257

 
$
4,803

 
$
2,783

 
$
(29,812
)
 
$
28,949

Income before income taxes
$
151,783

 
$
68,127

 
$
56,569

 
$
22,480

 
$
44,429

 
$
343,388

Total assets
$
4,246,422

 
$
5,026,918

 
$
1,258,783

 
$
432,331

 
$
(3,550,177
)
 
$
7,414,277

Capital expenditures
$
3,384

 
$
3,885

 
$
1,606

 
$
856

 
$
3,166

 
$
12,897


17


 
For the nine months ended September 30, 2016
(in thousands)
Retail
 
National
Programs
 
Wholesale
Brokerage
 
Services
 
Other
 
Total
Total revenues
$
695,393

 
$
333,522

 
$
184,893

 
$
117,906

 
$
1,251

 
$
1,332,965

Investment income
$
33

 
$
583

 
$
4

 
$
204

 
$
326

 
$
1,150

Amortization
$
32,743

 
$
21,011

 
$
7,915

 
$
3,345

 
$
11

 
$
65,025

Depreciation
$
4,761

 
$
5,881

 
$
1,487

 
$
1,432

 
$
2,306

 
$
15,867

Interest expense
$
29,415

 
$
34,895

 
$
2,472

 
$
3,820

 
$
(40,985
)
 
$
29,617

Income before income taxes
$
144,496

 
$
68,367

 
$
51,711

 
$
17,929

 
$
46,095

 
$
328,598

Total assets
$
3,652,977

 
$
2,933,568

 
$
1,053,516

 
$
342,360

 
$
(2,460,394
)
 
$
5,522,027

Capital expenditures
$
4,664

 
$
5,399

 
$
925

 
$
561

 
$
1,586

 
$
13,135

NOTE 11· Investments
At September 30, 2017, the Company’s amortized cost and fair values of fixed maturity securities are summarized as follows: 
(in thousands)
Cost
 
Gross Unrealized
Gains
 
Gross Unrealized
Losses
 
Fair Value
U.S. Treasury securities, obligations of U.S. Government agencies and Municipalities
$
32,724

 
$
1

 
$
(94
)
 
$
32,631

Corporate debt
1,407

 
16

 

 
1,423

Total
$
34,131

 
$
17

 
$
(94
)
 
$
34,054

At September 30, 2017, the Company held $32.6 million in fixed income securities composed of U.S. Treasury securities, securities issued by U.S. Government agencies and municipalities, and $1.4 million issued by corporations with investment grade ratings. Of that total, $20.0 million is classified as short-term investments on the Consolidated Balance Sheet as maturities are less than one-year. Additionally, the Company holds $9.2 million in short-term investments which are related to time deposits held with various financial institutions.
For securities in a loss position, the following table shows the investments’ gross unrealized loss and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2017:
 
Less than 12 Months
 
12 Months or More
 
Total
(in thousands)
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
U.S. Treasury securities, obligations of U.S. Government agencies and Municipalities
$
24,444

 
$
(60
)
 
$
7,364

 
$
(34
)
 
$
31,808

 
$
(94
)
Corporate debt
200

 

 

 

 
200

 

Total
$
24,644

 
$
(60
)
 
$
7,364

 
$
(34
)
 
$
32,008

 
$
(94
)
The unrealized losses were caused by interest rate increases. At September 30, 2017, the Company had 27 securities in an unrealized loss position. The corporate securities are highly rated securities with no indicators of potential impairment. Based on the ability and intent of the Company to hold these investments until recovery of fair value, which may be maturity, the bonds were not considered to be other-than-temporarily impaired at September 30, 2017.
At December 31, 2016, the Company’s amortized cost and fair values of fixed maturity securities are summarized as follows:
(in thousands)
Cost
 
Gross Unrealized
Gains
 
Gross Unrealized
Losses
 
Fair Value
U.S. Treasury securities, obligations of U.S. Government agencies and Municipalities
$
26,280

 
$
11

 
$
(59
)
 
$
26,232

Corporate debt
2,358

 
13

 
(1
)
 
2,370

Total
$
28,638

 
$
24

 
$
(60
)
 
$
28,602


18


At December 31, 2016, the Company held $26.2 million in fixed income securities composed of U.S. Treasury securities, securities issued by U.S. Government agencies and municipalities, and $2.4 million issued by corporations with investment grade ratings. Of that total, $5.6 million is classified as short-term investments on the Consolidated Balance Sheet as maturities are less than one-year. Additionally, the Company holds $9.5 million in short-term investments which are related to time deposits held with various financial institutions.
For securities in a loss position, the following table shows the investments’ gross unrealized loss and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2016:
 
Less than 12 Months
 
12 Months or More
 
Total
(in thousands)
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
U.S. Treasury securities, obligations of U.S. Government agencies and Municipalities
$
14,663

 
$
(59
)
 
$

 
$

 
$
14,663

 
$
(59
)
Corporate debt
1,001

 
(1
)
 

 

 
1,001

 
(1
)
Total
$
15,664

 
$
(60
)
 
$

 
$

 
$
15,664

 
$
(60
)
The unrealized losses from corporate issuers were caused by interest rate increases. At December 31, 2016, the Company had 20 securities in an unrealized loss position. The corporate securities are highly rated securities with no indicators of potential impairment. Based on the ability and intent of the Company to hold these investments until recovery of fair value, which may be maturity, the bonds were not considered to be other-than-temporarily impaired at December 31, 2016.
The amortized cost and estimated fair value of the fixed maturity securities at September 30, 2017 by contractual maturity are set forth below:
(in thousands)
Amortized Cost
 
Fair Value
Years to maturity:
 
 
 
Due in one year or less
$
20,005

 
$
19,969

Due after one year through five years
13,893

 
13,843

Due after five years
233

 
242

Total
$
34,131

 
$
34,054

The amortized cost and estimated fair value of the fixed maturity securities at December 31, 2016 by contractual maturity are set forth below:
(in thousands)
Amortized Cost
 
Fair Value
Years to maturity:
 
 
 
Due in one year or less
$
5,551

 
$
5,554

Due after one year through five years
22,757

 
22,708

Due after five years
330

 
340

Total
$
28,638

 
$
28,602

The expected maturities in the foregoing table may differ from the contractual maturities because certain borrowers have the right to call or prepay obligations with or without penalty.
Proceeds from the sales and maturity of the Company’s investment in fixed maturity securities were $2.7 million. This along with maturing time deposits yielded total cash proceeds from the sale of investments of $5.2 million in the period of January 1, 2017 to September 30, 2017. These proceeds were used to purchase additional fixed maturity securities and time deposits. The gains and losses realized on those sales for the period from January 1, 2017 to September 30, 2017 were insignificant.
Realized gains and losses are reported on the Condensed Consolidated Statements of Income, with the cost of securities sold determined on a specific identification basis.
At September 30, 2017, investments with a fair value of approximately $4.0 million were on deposit with state insurance departments to satisfy regulatory requirements.

19


NOTE 12· Reinsurance
Although the reinsurers are liable to the Company for amounts reinsured, our subsidiary, Wright National Flood Insurance Company (“Wright Flood”) remains primarily liable to its policyholders for the full amount of the policies written whether or not the reinsurers meet their obligations to the Company when they become due. The effects of reinsurance on premiums written and earned are as follows:
 
 
Period from January 1, 2017 to
September 30, 2017
(in thousands)
Written
 
Earned
Direct premiums
$
462,718

 
$
439,134

Ceded premiums
(462,710
)
 
(439,126
)
Net premiums
$
8

 
$
8

All premiums written by Wright Flood under the National Flood Insurance Program are 100% ceded to the Federal Emergency Management Agency, or FEMA, for which Wright Flood received a 30.9% expense allowance from January 1, 2017 through September 30, 2017. For the period from January 1, 2017 through September 30, 2017, the Company ceded $461.5 million of written premiums.
Effective April 1, 2014, Wright Flood is also a party to a quota share agreement whereby it cedes 100% of its gross excess flood premiums, excluding fees, to Arch Reinsurance Company and receives a 30.5% commission. Wright Flood ceded $1.2 million for the period from January 1, 2017 through September 30, 2017. No loss data exists on this agreement.
Wright Flood also ceded 100% of the Homeowners, Private Passenger Auto Liability, and Other Liability Occurrence to Stillwater Insurance Company, formerly known as Fidelity National Insurance Company. This business is in runoff. Therefore, only loss data exists on this business. As of September 30, 2017, no ceded unpaid losses and loss adjustment expenses or incurred but not reported expenses for Homeowners, Private Passenger Auto Liability and Other Liability Occurrence existed.
As of September 30, 2017 the Condensed Consolidated Balance Sheet contained reinsurance recoverable of $2,160.3 million and prepaid reinsurance premiums of $332.2 million. There was no net activity in the reserve for losses and loss adjustment expense during the period January 1, 2017 through September 30, 2017, as Wright Flood's direct premiums written were 100% ceded to two reinsurers. The balance of the reserve for losses and loss adjustment expense, excluding related reinsurance recoverable, as of September 30, 2017 was $2,160.3 million.
NOTE 13· Statutory Financial Data
Wright Flood maintains capital in excess of the minimum statutory amount of $7.5 million as required by regulatory authorities. The unaudited statutory capital and surplus of Wright Flood was $26.7 million at September 30, 2017 and $23.5 million as of December 31, 2016. For the period from January 1, 2017 through September 30, 2017, Wright Flood generated statutory net income of $2.9 million. For the period from January 1, 2016 through December 31, 2016, Wright Flood generated statutory net income of $8.2 million.
NOTE 14· Subsidiary Dividend Restrictions
Under the insurance regulations of Texas, where Wright Flood is incorporated, the maximum amount of ordinary dividends that Wright Flood can pay to shareholders in a rolling twelve-month period is limited to the greater of 10% of statutory adjusted capital and surplus as shown on Wright Flood’s last annual statement on file with the superintendent of the Texas Department of Insurance or 100% of adjusted net income. There was no dividend payout in 2016 and the maximum dividend payout that may be made in 2017 without prior approval is $8.2 million.
NOTE 15· Shareholders’ Equity
Between May 18, 2017 and June 30, 2017, the Company made share repurchases in the open market in total of 216,615 shares at a total cost of $11.2 million. Between July 1, 2017 and July 14, 2017, the Company made share repurchases in the open market in total of 131,845 shares at a total cost of $3.7 million.
On August 14, 2017, the Company entered into an accelerated share repurchase agreement ("ASR") with an investment bank to purchase an aggregate $50.0 million of the Company's common stock. As part of the ASR, the company received an initial delivery of 967,888 shares of the Company's common stock with a fair market value of approximately $42.5 million. On October 16, 2017, the Company was notified by its investment bank that the accelerated share repurchase was completed. To complete the transaction, the investment bank delivered an additional 108,288 shares of the Company's common stock for a total of 1,076,176 shares repurchased under the ASR.
Under the authorization from the Company’s Board of Directors, shares may be purchased from time to time, at the Company’s discretion and subject to the availability of stock, market conditions, the trading price of the stock, alternative uses for capital, the Company’s financial performance and other potential factors. These purchases may be carried out through open market purchases, block trades, accelerated share repurchase plans of up to $100.0 million each (unless otherwise approved by the Board of Directors), negotiated private transactions or

20


pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934. After completion of this ASR transaction, the Company has approval to repurchase up to $302.4 million, in the aggregate, of the Company's outstanding common stock.
ITEM 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion updates the MD&A contained in the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2016, and the two discussions should be read together.
GENERAL
Company Overview — Third Quarter of 2017
The following discussion should be read in conjunction with our Condensed Consolidated Financial Statements and the related Notes to those Financial Statements included elsewhere in this Quarterly Report on Form 10-Q. In addition, please see “Information Regarding Non-GAAP Financial 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.
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 and the occurrence of catastrophic weather events 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.
“Commissions and fees” is included in our Condensed Consolidated Statements of Income. The term “Organic Revenue”, a non-GAAP financial measure, is our “core commissions and fees” (which are our commissions and fees less profit-sharing contingent commissions and less guaranteed supplemental commissions, and therefore represents the revenues earned directly from specific insurance policies sold, and specific fee-based services rendered) 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). “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. We believe that Organic Revenue provides a meaningful representation of the Company’s operating performance. The Company has historically viewed Organic Revenue growth as an important indicator when assessing and evaluating the performance of its four segments. Organic revenue is reported in the Results of Operations and in the Results of Operations - Segment sections of this Quarterly Report on Form 10-Q.
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 3.6% of the previous year’s commissions and fees revenue. Profit-sharing contingent commissions are included in our commissions and fees in the Consolidated Statement of Income in the year received. For the three-month period ended September 30, 2017, profit-sharing contingent commissions were down $4.7 million as compared to the same period of the prior year, primarily realized in our Wholesale Brokerage Segment.
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 on actual premiums written. For the twelve-month period ending December 31, 2016, we had earned $11.5 million of GSCs, of which $9.2 million remained accrued at December 31, 2016, the balance of which is typically collected over the first and second quarter. For the three-month periods ended September 30, 2017 and 2016, we earned and accrued $2.5 million and $2.9 million, respectively, from GSCs.

21


Combined, our profit-sharing contingent commissions and GSCs for the three months ended September 30, 2017 decreased by $5.2 million compared to the third quarter of 2016 reflecting the actual loss experience from our carrier partners.
Fee revenues primarily relate to services other than securing coverage for our customers and are recognized as services are rendered, as well as fees negotiated in lieu of commissions. 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. Fee revenues, on a consolidated basis, as a percentage of our total commissions and fees, represented 31.3% in 2016, 30.6% in 2015 and 30.6% in 2014.
For the three-month period ended September 30, 2017, our total commissions and fees growth rate was 2.8% and our consolidated organic revenue growth rate was 3.4%. In the event that the gradual increases in insurable exposure units that occurred in the past few years continues through 2017 and premium rate changes are similar with 2016, we believe we will continue to see positive quarterly organic revenue growth for the remainder of 2017.
Historically, investment income has consisted primarily of interest earnings on operating cash and where permitted, 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 three-month period ended September 30, 2017 increased from the third quarter of 2016 by $7.4 million, primarily as a result of a change in estimated acquisition earn-out payables, acquisitions completed in the past twelve months and profits from existing customers and net new business.
Information Regarding Non-GAAP Measures
In the discussion and analysis of our results of operations, in addition to reporting financial results in accordance with generally accepted accounting principles ("GAAP"), we provide references to the following non-GAAP financial measures as defined in Regulation G of SEC rules: organic revenue and organic revenue growth. We view these non-GAAP financial 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. We believe that organic revenue provides a meaningful representation of our operating performance and view organic revenue growth as an important indicator when assessing and evaluating the performance of our four segments. We also use organic revenue growth for incentive compensation determinations for executive officers and other key employees.
These measures are not in accordance with, or an alternative to the GAAP information provided in this Quarterly Report on Form 10-Q. We present such non-GAAP supplemental financial information because we believe such information is of interest to the investment community and because we believe they provide additional meaningful methods of evaluating certain aspects of the Company’s operating performance from period to period on a basis that may not be otherwise apparent on a GAAP basis. We believe these non-GAAP financial measures improve the comparability of results between periods by eliminating the impact of certain items that have a high degree of variability. 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 Condensed Consolidated Financial Statements.
Tabular reconciliations of this supplemental non-GAAP financial information to our most comparable GAAP information are contained in this Quarterly Report on Form 10-Q under “Results of Operation - Segment Information.”
Acquisitions
Part of our continuing business strategy is to attract high-quality insurance intermediaries to join our operations. From 1993 through the third quarter of 2017, we acquired 485 insurance intermediary operations, excluding acquired books of business (customer accounts).
Critical Accounting Policies
We have had no changes to our Critical Accounting Policies. 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 in the “Notes to Consolidated Financial Statements” in our Annual Report on Form 10-K for the year ended December 31, 2016 on file with the Securities and Exchange Commission for details regarding our critical and significant accounting policies.

22


RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2017 AND 2016
The following discussion and analysis regarding results of operations and liquidity and capital resources should be considered in conjunction with the accompanying Condensed Consolidated Financial Statements and related Notes.
Financial information relating to our Condensed Consolidated Financial results for the three and nine months ended September 30, 2017 and 2016 is as follows: 
 
For the three months 
 ended September 30,
 
For the nine months 
 ended September 30,
(in thousands, except percentages)
2017
 
2016
 
%
Change
 
2017
 
2016
 
%
Change
REVENUES
 
 
 
 
 
 
 
 
 
 
 
Core commissions and fees
$
468,574

 
$
450,464

 
4.0
 %
 
$
1,330,341

 
$
1,274,170

 
4.4
 %
Profit-sharing contingent commissions
3,542

 
8,247

 
(57.1
)%
 
45,409

 
46,586

 
(2.5
)%
Guaranteed supplemental commissions
2,493

 
2,941

 
(15.2
)%
 
8,149

 
8,893

 
(8.4
)%
Investment income
491

 
230

 
113.5
 %
 
1,085

 
1,150

 
(5.7
)%
Other income, net
546

 
392

 
39.3
 %
 
22,047

 
2,166

 
NMF

Total revenues
475,646

 
462,274

 
2.9
 %
 
1,407,031

 
1,332,965

 
5.6
 %
EXPENSES
 
 
 
 
 
 
 
 
 
 
 
Employee compensation and benefits
246,062

 
237,653

 
3.5
 %
 
736,445

 
692,814

 
6.3
 %
Other operating expenses
72,058

 
67,433

 
6.9
 %
 
210,289

 
197,329

 
6.6
 %
Loss/(gain) on disposal
(1,902
)
 
(277
)
 
NMF

 
(1,993
)
 
(3,131
)
 
(36.3
)%
Amortization
21,435

 
21,805

 
(1.7
)%
 
64,402

 
65,025

 
(1.0
)%
Depreciation
5,489

 
5,195

 
5.7
 %
 
17,242

 
15,867

 
8.7
 %
Interest
9,393

 
9,883

 
(5.0
)%
 
28,949

 
29,617

 
(2.3
)%
Change in estimated acquisition earn-out payables
(1,308
)
 
3,610

 
(136.2
)%
 
8,309

 
6,846

 
21.4
 %
Total expenses
351,227

 
345,302

 
1.7
 %
 
1,063,643

 
1,004,367

 
5.9
 %
Income before income taxes
124,419

 
116,972

 
6.4
 %
 
343,388

 
328,598

 
4.5
 %
Income taxes
48,506

 
45,427

 
6.8
 %
 
131,263

 
128,733

 
2.0
 %
NET INCOME
$
75,913

 
$
71,545

 
6.3
 %
 
$
212,125

 
$
199,865

 
6.2
 %
Organic revenue growth rate (1)
3.4
%
 
4.3
%
 
 
 
2.8
%
 
2.8
%
 
 
Employee compensation and benefits relative to total revenues
51.7
%
 
51.4
%
 
 
 
52.3
%
 
52.0
%
 
 
Other operating expenses relative to total revenues
15.1
%
 
14.6
%
 
 
 
14.9
%
 
14.8
%
 
 
Capital expenditures
$
4,049

 
$
4,191

 
 
 
$
12,897

 
$
13,135

 
 
Total assets at September 30
 
 
 
 
 
 
$
7,414,277

 
$
5,522,027

 
 
 
(1) A non-GAAP financial measure
NMF = Not a meaningful figure
Commissions and Fees
Commissions and fees, including profit-sharing contingent commissions and GSCs, for the three months ended September 30, 2017 increased $13.0 million to $474.6 million, or 2.8% over the same period in 2016. Core commissions and fees revenue for the third quarter of 2017 increased $18.1 million, of which approximately $4.3 million represented core commissions and fees from agencies acquired since 2016 that had no comparable revenues in the same period of 2016. After accounting for divested business of $1.3 million, the remaining net increase of $15.1 million represented net new and renewal business, which reflects an organic revenue growth rate of 3.4%. Profit-sharing contingent commissions and GSCs for the third quarter of 2017 decreased by $5.2 million, or 46.1%, compared to the same period in 2016. The net decrease of $5.2 million in the third quarter was mainly driven by a decrease in profit-sharing contingent commissions in the Wholesale Brokerage Segment as a result of loss experience for insurance carriers.

23


For the nine months ended September 30, 2017 commissions and fees, including profit-sharing contingent commissions and GSCs, increased $54.3 million to $1,383.9 million, or 4.1% over the same period in 2016. Core commissions and fees revenue for the nine months ended September 30, 2017 increased $56.2 million, of which approximately $22.9 million represented core commissions and fees from acquisitions that had no comparable revenues in the same period of 2016. After accounting for divested business of $2.2 million, the remaining net increase of $35.5 million represented net new and renewal business, which reflects an organic revenue growth rate of 2.8%. Profit-sharing contingent commissions and GSCs for the nine months ended September 30, 2017 decreased by $1.9 million, or 3.5%, compared to the same period in 2016. The net decrease of $1.9 million in the first nine months of 2017 was mainly driven by a decrease in profit-sharing contingent commissions in the Retail and Wholesale Brokerage Segments as a result of loss experience for insurance carriers partially offset by an increase in the National Programs Segment.
Investment Income
Investment income for the three months ended September 30, 2017 increased $0.3 million, or 113.5% over the same period in 2016. The increase was primarily driven by cash management activities to earn a higher yield on excess cash balances.
Investment income for the nine months ended September 30, 2017 decreased $0.1 million, or 5.7%, over the same period in 2016. This decrease was related to a one-time receipt of interest on premium tax refunds received in 2016.
Other Income, net
Other income for the three months ended September 30, 2017 was $0.5 million, compared with $0.4 million in the same period in 2016. Other income consists primarily of legal settlements and other miscellaneous income.
Other income for the nine months ended September 30, 2017 was $22.0 million, compared with $2.2 million in the same period in 2016. The $19.8 million increase for the nine months ended September 30, 2017 from the comparable period in 2016 was a result of a legal settlement recognized in the first quarter of 2017.
Employee Compensation and Benefits
Employee compensation and benefits expense as a percentage of total revenues increased to 51.7% for the three months ended September 30, 2017, from 51.4% for the three months ended September 30, 2016. Employee compensation and benefits for the third quarter of 2017 increased approximately 3.5%, or $8.4 million, over the same period in 2016. This net increase included (i) $0.4 million of compensation costs related to stand-alone acquisitions that had no comparable costs in the same period of 2016; (ii) an increase in staff salaries attributable to salary inflation and higher volumes in portions of our business; (iii) increased producer commissions due to higher revenue; and (iv) the additional cost associated with the Retail Segment's performance incentive plan introduced in 2017.
Employee compensation and benefits expense as a percentage of total revenues increased to 52.3% for the nine months ended September 30, 2017, from 52.0% for the nine months ended September 30, 2016. Employee compensation and benefits for the first nine months of 2017 increased, by approximately 6.3%, or $43.6 million, over the same period in 2016. This increase included (i) $10.1 million of compensation costs related to acquisitions that had no comparable costs in the same period of 2016; (ii) an increase in staff salaries attributable to salary inflation and higher volumes in portions of our business; (iii) increased producer commissions due to higher revenue; (iv) increased non-cash stock based compensation due to larger forfeiture credits recorded in 2016; and (v) the additional cost associated with the Retail Segment's performance incentive plan introduced in 2017.
Other Operating Expenses
As a percentage of total revenues, other operating expenses represented 15.1% in the third quarter of 2017, versus 14.6% reported in the third quarter of 2016. Other operating expenses for the third quarter of 2017 increased $4.6 million, or 6.9%, over the same period of 2016, of which $0.1 million was related to acquisitions that had no comparable costs in the same period of 2016. The remaining other operating expenses for both three-month periods ended September 30, 2017 and 2016, respectively, increased by $4.5 million, which was primarily attributable to (i) increased expenses associated with our investment in information technology and consulting; partially offset by (ii) a foreign exchange gains and (iii) the benefits from our strategic purchasing program.
Other operating expenses represented 14.9% of total revenues for the nine months ended September 30, 2017, versus 14.8% for the nine months ended September 30, 2016. Other operating expenses for the first nine months of 2017 increased $13.0 million, or 6.6%, over the same period of 2016, of which $3.1 million was related to acquisitions that had no comparable costs in the same period of 2016. The remaining other operating expenses for both of the nine months ended September 30, 2017 and 2016, respectively, increased by $9.8 million, which was primarily attributable to (i) increased expenses associated with our investment in information technology; (ii) a credit of approximately $5.3 million associated with premium tax refunds recognized in the first nine months of 2016; and (iii) partially offset by foreign exchange gains and (iv) the benefits from our strategic purchasing program.

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Gain on Disposal
Gain on disposal for the third quarter of 2017 increased $1.6 million from the third quarter of 2016. Gain on disposal for the nine months ended September 30, 2017 decreased $1.1 million from the nine months ended September 30, 2016. The change in the gain on disposal for the three and nine months ended September 30, 2017 was due to activity associated with book of business sales. Although we are not in the business of selling customer accounts or businesses, we periodically sell an office or a book of business (one or more customer accounts) because we believe doing so is in the Company’s best interest.
Amortization
Amortization expense for the third quarter of 2017 decreased $0.4 million, or 1.7%, over the third quarter of 2016. Amortization expense for the nine months ended September 30, 2017 decreased $0.6 million, or 1.0%, over the nine months ended September 30, 2016. These decreases reflect certain intangibles becoming fully amortized, partially offset with amortization of new intangibles from recently acquired businesses.
Depreciation
Depreciation expense for the third quarter of 2017 increased $0.3 million, or 5.7%, compared to the third quarter of 2016. Depreciation expense for the nine months ended September 30, 2017 increased $1.4 million, or 8.7%, over the nine months ended September 30, 2016. These changes were due primarily to the addition of fixed assets resulting from acquisitions completed since the first nine months of 2016, net of assets which became fully depreciated.
Interest Expense
Interest expense for the third quarter of 2017 decreased $0.5 million, or 5.0%, compared to the third quarter of 2016. Interest expense for the nine months ended September 30, 2017 decreased $0.7 million, or 2.3%, over the nine months ended September 30, 2016. This decrease was due to a lower effective interest rate for our Credit Facility term loan and the scheduled amortized principal payments on the Credit Facility term loan, which has reduced the Company's average debt balance.
Change in Estimated Acquisition Earn-Out Payables
Accounting Standards Codification (“ASC”) Topic 805-Business Combinations is the authoritative guidance requiring an acquiring entity 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 Condensed 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 September 30, 2017 and 2016, the fair values of the estimated acquisition earn-out payables were re-evaluated based upon projected operating results 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 three and nine month periods ended September 30, 2017 and 2016 were as follows:
 
For the three months 
 ended September 30,
 
For the nine months 
 ended September 30,
(in thousands)
2017
 
2016
 
2017
 
2016
Change in fair value of estimated acquisition earn-out payables
$
(1,784
)
 
$
2,883

 
$
6,402

 
$
4,704

Interest expense accretion
476

 
727

 
1,907

 
2,142

Net change in earnings from estimated acquisition earn-out payables
$
(1,308
)
 
$
3,610

 
$
8,309

 
$
6,846


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For the three months ended September 30, 2017 and 2016, the fair value of estimated earn-out payables was re-evaluated and decreased by $1.8 million and increased by $2.9 million, respectively, which resulted in credits and charges to the Condensed Consolidated Statement of Income, respectively. For the nine months ended September 30, 2017 and 2016, the fair value of estimated earn-out payables was re-evaluated and increased by $6.4 million and $4.7 million, respectively, which resulted in charges to the Condensed Consolidated Statement of Income.
As of September 30, 2017, the estimated acquisition earn-out payables equaled $34.2 million, of which $28.7 million was recorded as accounts payable and $5.5 million was recorded as other non-current liabilities.
Income Taxes
The effective tax rate on income from operations for the three months ended September 30, 2017 and 2016 was 39.0% and 38.8%, respectively. The effective tax rate on income from operations for the nine months ended September 30, 2017 and 2016 was 38.2% and 39.2% respectively. The decrease for the nine months ended September 30, 2017 is related to the adoption in the first quarter of 2017, of FASB Accounting Standards Update 2016-09, “Improvements to Employee Share Based Payment Accounting” (“ASU 2016-09”), which amends guidance issued in Accounting Standards Codification (“ASC”) Topic 718, Compensation - Stock Compensation, that 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.
RESULTS OF OPERATIONS — SEGMENT INFORMATION
As discussed in Note 10 to the Condensed 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 of a segment, management focuses upon the organic revenue growth rate of core commissions and fees revenue, the ratio of total employee compensation and benefits to total revenues, and the ratio of other operating expenses to total revenues.
The reconciliation of commissions and fees, included in the Condensed Consolidated Statement of Income, to organic revenue for the three months ended September 30, 2017, and 2016, is as follows:
 
For the three months 
 ended September 30,
(in thousands)
2017
 
2016
Commissions and fees
$
474,609

 
$
461,652

Less profit-sharing contingent commissions
3,542

 
8,247

Less guaranteed supplemental commissions
2,493

 
2,941

Core commissions and fees
468,574

 
450,464

Less acquisition revenues
4,337