t60922_10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
 
FORM 10-Q
 
 x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the quarterly period ended September 30, 2007
 
 
 
or
 
 
 o
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
(State or other jurisdiction of incorporation or organization)
 
 
220 South Ridgewood Avenue, Daytona Beach, FL
(Address of principal executive offices)
®
59-0864469
(I.R.S. Employer Identification Number)
 
 
32114
(Zip Code)
 
Registrant's telephone number, including area code: (386) 252-9601
Registrant's Website:www.bbinsurance.com


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90days.    Yes x   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12-2 of the Exchange Act. (Check one):
 
Large accelerated filer x Accelerated filer o Non-accelerated filero

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o No x
 
The number of shares of the Registrant's common stock, $.10 par value, outstanding as of November 5, 2007 was 140,709,034.
 

 
BROWN & BROWN, INC.
 
INDEX
 

 
PAGE NO.
 
 
 
 
 
 
 
 
 
 
 
3
 
 
4
 
 
5
 
 
6
 
17
 
31
 
32
 
 
 
 
 
 
 
 
 
 
33
 
33
 
34
 
 
 
 
34
 
 

2

 
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,
 
   
2007
   
2006
   
2007
   
2006
 
                         
REVENUES
                       
Commissions and fees
  $
225,421
    $
208,558
    $
701,456
    $
653,900
 
Investment income
   
3,286
     
3,218
     
27,855
     
8,383
 
Other income, net
   
8,577
     
189
     
13,130
     
1,071
 
Total revenues
   
237,284
     
211,965
     
742,441
     
663,354
 
                                 
EXPENSES
                               
Employee compensation and benefits
   
110,491
     
100,821
     
333,937
     
304,731
 
Non-cash stock-based compensation
   
1,491
     
837
     
4,327
     
4,601
 
Other operating expenses
   
32,928
     
29,502
     
96,409
     
90,605
 
Amortization
   
10,331
     
9,089
     
29,798
     
27,067
 
Depreciation
   
3,213
     
2,922
     
9,492
     
8,302
 
Interest
   
3,395
     
3,229
     
10,445
     
10,080
 
Total expenses
   
161,849
     
146,400
     
484,408
     
445,386
 
                                 
Income before income taxes
   
75,435
     
65,565
     
258,033
     
217,968
 
                                 
Income taxes
   
29,219
     
25,295
     
100,078
     
83,241
 
                                 
Net income
  $
46,216
    $
40,270
    $
157,955
    $
134,727
 
                                 
Net income per share:
                               
Basic
  $
0.33
    $
0.29
    $
1.13
    $
0.97
 
Diluted
  $
0.33
    $
0.29
    $
1.12
    $
0.96
 
                                 
Weighted average number of shares outstanding:
                               
Basic
   
140,593
     
139,668
     
140,401
     
139,522
 
Diluted
   
141,288
     
141,027
     
141,209
     
140,949
 
                                 
Dividends declared per share
  $
0.06
    $
0.05
    $
0.18
    $
0.15
 

See accompanying notes to condensed consolidated financial statements.

3

 
BROWN & BROWN, INC.
CONDENSED CONSOLIDATED
BALANCE SHEETS
(UNAUDITED)
 
 
(in thousands, except per share data)
 
September 30,
2007
   
December 31,
2006
 
             
ASSETS
           
Current Assets:
           
  Cash and cash equivalents
  $
74,025
    $
88,490
 
  Restricted cash and investments
   
227,146
     
242,187
 
  Short-term investments
   
3,021
     
2,909
 
  Premiums, commissions and fees receivable
   
271,606
     
282,440
 
  Other current assets
   
35,217
     
32,180
 
Total current assets
   
611,015
     
648,206
 
                 
Fixed assets, net
   
58,322
     
44,170
 
Goodwill
   
803,330
     
684,521
 
Amortizable intangible assets, net
   
421,209
     
396,069
 
Investments
   
652
     
15,826
 
Other assets
   
20,831
     
19,160
 
Total assets
  $
1,915,359
    $
1,807,952
 
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Current Liabilities:
               
  Premiums payable to insurance companies
  $
399,331
    $
435,449
 
  Premium deposits and credits due customers
   
38,900
     
33,273
 
  Accounts payable
   
21,127
     
17,854
 
  Accrued expenses
   
72,883
     
86,009
 
  Current portion of long-term debt
   
11,574
     
18,082
 
Total current liabilities
   
543,815
     
590,667
 
                 
Long-term debt
   
225,403
     
226,252
 
                 
Deferred income taxes, net
   
60,596
     
49,721
 
                 
Other liabilities
   
12,560
     
11,967
 
                 
Shareholders' Equity:
               
  Common stock, par value $0.10 per share;
               
    authorized 280,000 shares; issued and
               
    outstanding 140,709 at 2007 and 140,016 at 2006
   
14,071
     
14,002
 
  Additional paid-in capital
   
230,520
     
210,543
 
  Retained earnings
   
828,336
     
695,656
 
  Accumulated other comprehensive income, net of related income tax
               
   effect of $34 at 2007 and $5,359 at 2006
   
58
     
9,144
 
                 
Total shareholders' equity
   
1,072,985
     
929,345
 
                 
Total liabilities and shareholders' equity
  $
1,915,359
    $
1,807,952
 

See accompanying notes to condensed consolidated financial statements.

4

 
 BROWN & BROWN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS
(UNAUDITED)
 
 
   
For the nine months
ended September 30,
 
(in thousands)
 
2007
   
2006
 
             
Cash flows from operating activities:
           
Net income
  $
157,955
    $
134,727
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Amortization
   
29,798
     
27,067
 
Depreciation
   
9,492
     
8,302
 
Non-cash stock-based compensation
   
4,327
     
4,601
 
Deferred income taxes
   
12,368
     
7,723
 
Net gain on sales of investments, fixed
               
   assets and customer accounts
    (30,198 )     (159 )
Changes in operating assets and liabilities, net of effect
               
    from acquisitions and divestitures:
               
Restricted cash and investments decrease (increase)
   
15,041
      (48,171 )
Premiums, commissions and fees receivable decrease (increase)
   
13,623
      (9,793 )
Other assets decrease (increase)
   
4,107
      (4,628 )
Premiums payable to insurance companies (decrease) increase
    (42,596 )    
42,088
 
Premium deposits and credits due customers increase
   
5,072
     
8,681
 
Accounts payable increase (decrease)
   
2,912
      (1,525 )
Accrued expenses (decrease)
    (14,701 )     (7,104 )
Other liabilities (decrease) increase
    (710 )    
418
 
Net cash provided by operating activities
   
166,490
     
162,227
 
                 
Cash flows from investing activities:
               
Additions to fixed assets
    (24,848 )     (12,322 )
Payments for businesses acquired, net of cash acquired
    (148,365 )     (142,194 )
Proceeds from sales of fixed assets and customer accounts
   
6,059
     
922
 
Purchases of investments
    (2,629 )     (78 )
Proceeds from sales of investments
   
21,594
     
118
 
Net cash used in investing activities
    (148,189 )     (153,554 )
                 
Cash flows from financing activities:
               
Payments on long-term debt
    (23,351 )     (76,726 )
Borrowings on revolving credit facility
   
18,130
     
40,000
 
Payments on revolving credit facility
    (18,130 )    
-
 
Income tax benefit from issuance of common stock
   
4,539
     
-
 
Issuances of common stock for employee stock benefit plans
   
11,321
     
11,071
 
Cash dividends paid
    (25,275 )     (20,943 )
Net cash used in financing activities
    (32,766 )     (46,598 )
Net decrease in cash and cash equivalents
    (14,465 )     (37,925 )
Cash and cash equivalents at beginning of period
   
88,490
     
100,580
 
Cash and cash equivalents at end of period
  $
74,025
    $
62,655
 
 
 
See accompanying notes to condensed consolidated financial statements.
 
5

 
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, and services organization that markets and sells to its customers insurance products and services, primarily in the property and casualty arena. Brown & Brown's business is divided into four reportable segments: the Retail Division, which provides a broad range of insurance products and services to commercial, public and quasi-public entities, professional and individual customers; the National Programs Division, which is comprised of two units - Professional Programs, which provides professional liability and related package products for certain professionals delivered through nationwide networks of independent agents, and Special Programs, which markets targeted products and services designed for specific industries, trade groups, governmental entities and market niches; the Wholesale Brokerage Division, which markets and sells excess and surplus commercial and personal lines insurance and reinsurance, primarily through independent agents and brokers; and the Services Division, which provides insurance-related services, including third-party claims administration and comprehensive medical utilization management services in both the workers' compensation and all-lines liability areas, as well as Medicare set-aside services.
 
NOTE 2 · Basis of Financial Reporting
 
          The accompanying unaudited, condensed, consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“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 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, 2006. 
 
          Results of operations for the three and nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.
 
NOTE 3 · Net Income Per Share
 
Basic net income per share is computed by dividing net income available to shareholders by the weighted average number of shares outstanding for the period. Basic net income per share excludes dilution. Diluted net income per share reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted to common stock.
 
The following table sets forth the computation of basic net income per share and diluted net income per share:

   
For the three months
ended September 30,
   
For the nine months
ended September 30,
 
(in thousands, except per share data)
 
2007
   
2006
   
2007
   
2006
 
                         
                         
Net income
  $
46,216
    $
40,270
    $
157,955
    $
134,727
 
                                 
Weighted average number of common shares
                               
  outstanding
   
140,593
     
139,668
     
140,401
     
139,522
 
                                 
Dilutive effect of stock options using the
                               
  treasury stock method
   
695
     
1,359
     
808
     
1,427
 
                                 
Weighted average number of shares
                               
  outstanding
   
141,288
     
141,027
     
141,209
     
140,949
 
                                 
Net income per share:
                               
Basic
  $
0.33
    $
0.29
    $
1.13
    $
0.97
 
Diluted
  $
0.33
    $
0.29
    $
1.12
    $
0.96
 
 
6

 
NOTE 4 · New Accounting Pronouncements

Accounting for Uncertainty in Income Taxes - In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109” (“FIN 48”). This statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company's financial statements. FIN 48 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. Effective January 1, 2007, the Company adopted the provisions of FIN 48 and there was no significant effect on the financial statements.

As of January 1, 2007, the Company provided a liability in the amount of $591,022 of unrecognized tax benefits related to various federal and state income tax matters.  Of this amount, $591,022 would impact the Company's effective tax rate if recognized. The Company does not expect that the amounts of unrecognized tax benefits will change significantly within the next 12 months.

The Company is currently open to audit under the statute of limitations by the Internal Revenue Service (“IRS”) for the years ended December 31, 2004 through 2006. The Company and its subsidiaries’ state income tax returns are open to audit under the statute of limitations for the years ended December 31, 2002 through 2006. The Company is currently under IRS examination for the tax years ended December 31, 2004 and 2005. In addition, the Company is under an audit by the Department of Revenue for the State of Florida for the tax years ended December 31, 2003 through 2005.

The Company recognizes accrued interest and penalties related to uncertain tax positions in federal and state income tax expense. As of January 1, 2007, the Company accrued $157,787 of interest and penalties related to uncertain tax positions. This amount includes $65,600 in interest and penalties related to the adoption of FIN 48 in the first quarter of 2007. 
 
Fair Value Measurements- In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 establishes a framework for the measurement of assets and liabilities that use fair value and expands disclosures about fair value measurements. SFAS 157 will apply whenever another GAAP standard requires (or permits) assets or liabilities to be measured at fair value but does not expand the use of fair value to any new circumstances. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and for all interim periods within those fiscal years. Accordingly, the Company will be required to adopt SFAS 157 in the first quarter of 2008. The Company is currently evaluating the impact that the adoption of SFAS 157 will have, if any, on its consolidated financial statements and notes thereto.
 
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the potential impact this standard may have on its financial position and results of operations.
 
7

 
NOTE 5 · Business Combinations
 
Acquisitions in 2007
 
For the nine months ended September 30, 2007, Brown & Brown acquired the assets and assumed certain liabilities of 25 insurance intermediaries, the stock of three insurance intermediaries and several book of business (customer accounts). The aggregate purchase price of these acquisitions was $163,485,000, including $144,022,000 of net cash payments, the issuance of $4,961,000 in notes payable and the assumption of $14,502,000 of liabilities. All of these acquisitions were acquired primarily to expand Brown & Brown's core businesses and to attract and obtain high-quality individuals. Acquisition purchase prices are typically based on a multiple of average annual operating profits earned over a one- to three-year period within a minimum and maximum price range. The initial asset allocation of an acquisition is based on the minimum purchase price, and any subsequent earn-out payment is allocated to goodwill. Acquisitions are initially recorded at preliminary fair values. Subsequently, the Company completes the final fair value allocations and any adjustments to assets or liabilities acquired are recorded in the current period.

All of these acquisitions have been accounted for as business combinations and are as follows:


(in thousands)
 
Name
Business
Segment
2007
Date of
Acquisition
 
Net
Cash
Paid
   
Notes
Payable
   
Recorded
Purchase
Price
 
ALCOS, Inc.
Retail
March 1
  $
30,906
    $
3,563
    $
34,469
 
Grinspec, Inc.
Retail
April 1
   
31,939
     
-
     
31,939
 
Sobel Affiliates, Inc.
Retail
April 1
   
33,047
     
-
     
33,047
 
The Combined Group, Inc.
Wholesale Brokerage
August 1
   
24,046
     
-
     
24,046
 
Other
Various
Various
   
24,084
     
1,398
     
25,482
 
Total
      $
144,022
    $
4,961
    $
148,983
 
 
The following table summarizes the estimated fair values of the aggregate assets and liabilities acquired as of the date of each acquisition:


(in thousands)
 
ALCOS
   
Grinspec
   
Sobel
   
Combined
   
Other
   
Total
 
Fiduciary cash
  $
627
    $
-
    $
-
    $
2,686
    $
716
    $
4,029
 
Other current assets
   
1,224
     
669
     
286
     
-
     
800
     
2,979
 
Fixed assets
   
720
     
-
     
50
     
212
     
214
     
1,196
 
Purchased customer accounts
   
10,046
     
12,498
     
13,129
     
7,448
     
11,710
     
54,831
 
Noncompete agreements
   
130
     
-
     
31
     
66
     
210
     
437
 
Goodwill
   
26,863
     
19,235
     
19,653
     
16,320
     
17,817
     
99,888
 
Other Assets
   
115
     
-
     
-
     
-
     
10
     
125
 
Total assets acquired
   
39,725
     
32,402
     
33,149
     
26,732
     
31,477
     
163,485
 
Other current liabilities
    (2,173 )     (463 )     (102 )     (1,383 )     (5,246 )     (9,367 )
Deferred income taxes
    (3,083 )    
-
     
-
     
-
      (749 )     (3,832 )
Other liabilities
   
-
     
-
     
-
      (1,303 )    
-
      (1,303 )
Total liabilities assumed
    (5,256 )     (463 )     (102 )     (2,686 )     (5,995 )     (14,502 )
Net assets acquired
  $
34,469
    $
31,939
    $
33,047
    $
24,046
    $
25,482
    $
148,983
 

 
 The weighted average useful lives for the above acquired amortizable intangible assets are as follows: purchased customer accounts, 15.0 years; and noncompete agreements, 4.8 years.
 
Goodwill of $99,888,000, of which $70,054,000 is expected to be deductible for income tax purposes, was assigned to the Retail, National Programs, Wholesale Brokerage and Services Divisions in the amounts of $81,283,000, $391,000, $17,767,000 and $447,000, respectively.

8

 
The results of operations for the acquisitions completed during 2007 have been combined with those of the Company since their respective acquisition dates. If the acquisitions had occurred as of the beginning of each period, 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.
 
   
For the three months
   
For the nine months
 
(UNAUDITED)
 
ended September 30,
   
ended September 30,
 
(in thousands, except per share data)
 
2007
   
2006
   
2007
   
2006
 
                         
Total revenues
  $
239,671
    $
230,359
    $
766,810
    $
719,967
 
                                 
Income before income taxes
   
76,151
     
71,103
     
265,573
     
234,853
 
                                 
Net income
   
46,654
     
43,672
     
162,571
     
145,164
 
                                 
Net income per share:
                               
Basic
  $
0.33
    $
0.31
    $
1.16
    $
1.04
 
Diluted
  $
0.33
    $
0.31
    $
1.15
    $
1.03
 
                                 
Weighted average number of shares outstanding:
                               
Basic
   
140,593
     
139,668
     
140,401
     
139,522
 
Diluted
   
141,288
     
141,027
     
141,209
     
140,949
 
 
Additional consideration paid to sellers as a result of purchase price “earn-out” provisions are recorded as adjustments to intangible assets when the contingencies are settled. The net additional consideration paid by the Company in 2007 as a result of these adjustments totaled $18,969,000, of which $18,921,000 was allocated to goodwill and $48,000 to noncompete agreements. Of the $18,969,000 net additional consideration paid, $8,372,000 was paid in cash, $10,896,000 was issued in notes payable and $299,000 of net liabilities were forgiven. As of September 30, 2007, the maximum future contingency payments related to acquisitions totaled $204,777,000.

Acquisitions in 2006
 
For the nine months ended September 30, 2006, Brown & Brown acquired the assets and assumed certain liabilities of 30 entities. The aggregate purchase price of these acquisitions was $153,584,000, including $139,100,000 of net cash payments, the issuance of $3,582,000 in notes payable and the assumption of $10,902,000 of liabilities. Substantially all of these acquisitions were acquired primarily to expand Brown & Brown's core businesses and to attract and obtain high-quality individuals. Acquisition purchase prices are based primarily on a multiple of average annual operating profits earned over a one- to three-year period within a minimum and maximum price range. The initial asset allocation of an acquisition is based on the minimum purchase price, and any subsequent earn-out payment is allocated to goodwill.

All of these acquisitions have been accounted for as business combinations and are as follows:
 
(in thousands)
 
2006
 
Net
         
Recorded
 
 
Business
Date of
 
Cash
   
Notes
   
Purchase
 
Name
Segment
Acquisition
 
Paid
   
Payable
   
Price
 
Axiom Intermediaries, LLC
Wholesale Brokerage
January 1
  $
60,333
    $
-
    $
60,333
 
Delaware Valley Underwriting  Agency, Inc.
Wholesale Brokerage/National Programs
September 30
   
48,000
     
c
     
48,000
 
Other
Various
Various
   
30,767
     
3,582
     
34,349
 
     Total
      $
139,100
    $
3,582
    $
142,682
 
 
9


The following table summarizes the estimated fair values of the aggregate assets and liabilities acquired as of the date of each acquisition:

(in thousands)
 
Axiom
   
DVUA
   
Other
   
Total
 
Fiduciary cash 
  $
9,598
    $
-
    $
-
    $
9,598
 
Other current assets 
   
445
     
-
     
100
     
545
 
Fixed assets 
   
435
     
648
     
406
     
1,489
 
Purchased customer accounts 
   
14,022
     
25,549
     
18,047
     
57,618
 
Noncompete agreements 
   
31
     
52
     
443
     
526
 
Goodwill 
   
45,860
     
21,751
     
16,197
     
83,808
 
Total assets acquired 
   
70,391
     
48,000
     
35,193
     
153,584
 
Other current liabilities 
    (10,058 )    
-
      (652 )     (10,710 )
Other liabilities 
   
-
     
-
      (192 )     (192 )
Total liabilities assumed 
    (10,058 )    
-
      (844 )     (10,902 )
Net assets acquired 
  $
60,333
    $
48,000
    $
34,349
    $
142,682
 
 
The results of operations for the acquisitions completed during 2006 have been combined with those of the Company since their respective acquisition dates. If the acquisitions had occurred as of the beginning of each period, 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.


   
For the three months
   
For the nine months
 
 (UNAUDITED)
 
ended September 30,
   
ended September 30,
 
(in thousands, except per share data)
 
2006
   
2005
   
2006
   
2005
 
                         
Total revenues
  $
217,612
    $
203,758
    $
686,865
    $
630,900
 
                                 
Income before income taxes
   
67,619
     
60,134
     
226,317
     
200,875
 
                                 
Net income
   
41,532
     
37,559
     
139,887
     
123,573
 
                                 
Net income per share:
                               
Basic
  $
0.30
    $
0.27
    $
1.00
    $
0.89
 
Diluted
  $
0.29
    $
0.27
    $
0.99
    $
0.89
 
                                 
Weighted average number of shares outstanding:
                               
Basic
   
139,668
     
138,484
     
139,522
     
138,374
 
Diluted
   
141,027
     
139,638
     
140,949
     
139,504
 
 
Additional consideration paid to sellers as a result of purchase price “earn-out” provisions are recorded as adjustments to intangible assets when the contingencies are settled. The net additional consideration paid by the Company in 2006 as a result of these adjustments totaled $46,305,000, of which $46,340,000 was allocated to goodwill. Of the $46,305,000 net additional consideration paid, $12,692,000 was paid in cash, $32,656,000 was issued in notes payable and $957,000 was assumed as net liabilities. As of September 30, 2006, the maximum future contingency payments related to acquisitions totaled $170,377,000.

10

 
NOTE 6 · Goodwill
 
Goodwill is subject to at least an annual assessment for impairment by applying a fair value-based test. Brown & Brown completed its most recent annual assessment as of November 30, 2006 and identified no impairment as a result of the evaluation.
 
The changes in goodwill for the nine months ended September 30, 2007 are as follows:
 
   
 
   
National
   
Wholesale
   
 
   
 
 
(in thousands)
 
Retail
   
Programs
   
Brokerage
   
Services
   
Total
 
Balance as of January 1, 2007
  $
329,504
    $
142,329
    $
209,865
    $
2,823
    $
684,521
 
Goodwill of acquired businesses
   
89,033
     
4,527
     
24,802
     
447
     
118,809
 
Goodwill disposed of relating to sales of businesses
   
-
     
-
     
-
     
-
     
-
 
Balance as of September 30, 2007
  $
418,537
    $
146,856
    $
234,667
    $
3,270
    $
803,330
 
 
NOTE 7 · Amortizable Intangible Assets
 
Amortizable intangible assets at September 30, 2007 and December 31, 2006 consisted of the following:
 
   
September 30, 2007
   
December 31, 2006
 
                     
Weighted
                     
Weighted
 
   
Gross
         
Net
   
Average
   
Gross
         
Net
   
Average
 
   
Carrying
   
Accumulated
   
Carrying
   
Life
   
Carrying
   
Accumulated
   
Carrying
   
Life
 
(in thousands)
 
Value
   
Amortization
   
Value
   
(years)
   
Value
   
Amortization
   
Value
   
(years)
 
Purchased customer accounts
  $
596,069
    $ (177,679 )   $
418,390
     
14.9
    $
541,967
    $ (149,764 )   $
392,203
     
14.9
 
Noncompete agreements
   
26,074
      (23,255 )    
2,819
     
7.7
     
25,589
      (21,723 )    
3,866
     
7.7
 
Total
  $
622,143
    $ (200,934 )   $
421,209
            $
567,556
    $ (171,487 )   $
396,069
         
   
Amortization expense for other amortizable intangible assets for the years ending December 31, 2007, 2008, 2009, 2010 and 2011 is estimated to be $40,036,000, $40,317,000, $39,847,000, $39,168,000, and $37,746,000 respectively.
 
11

 
NOTE 8 · Investments
 
Investments consisted of the following:

   
September 30, 2007
   
December 31, 2006
 
   
Carrying Value
   
Carrying Value
 
(in thousands)
 
Current
   
Non-
Current
   
Current
   
Non-
Current
 
Available-for-sale marketable equity securities 
  $
76
    $
-
    $
240
    $
15,181
 
Non-marketable equity securities and certificates of deposit 
   
2,945
     
652
     
2,669
     
645
 
Total investments 
  $
3,021
    $
652
    $
2,909
    $
15,826
 
 
The following table summarizes available-for-sale securities:

(in thousands)
 
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Estimated
Fair
Value
 
Marketable equity securities:
                       
September 30, 2007 
  $
52
    $
24
    $
-
    $
76
 
December 31, 2006 
  $
550
    $
14,871
    $
-
    $
15,421
 
 
The following table summarizes the proceeds and realized gains/(losses) on non-marketable equity securities and certificates of deposit for the three and nine months ended September 30, 2007 and 2006:

(in thousands)
 
Proceeds
   
Gross
Realized
Gains
   
Gross
Realized
Losses
 
For the three months ended:
                 
September 30, 2007 
  $
2,112
    $
1
    $
-
 
September 30, 2006 
  $
106
    $
13
    $
-
 
For the nine months ended:
                       
September 30, 2007 
  $
21,594
    $
18,760
    $ (500 )
September 30, 2006 
  $
118
    $
25
    $
-
 

As of December 31, 2006, our largest security investment was 559,970 common stock shares of Rock-Tenn Company, a New York Stock Exchange listed company, which we have owned for more than 25 years. Our investment in Rock-Tenn Company accounted for 81% of the total value of available-for-sale marketable equity securities, non-marketable equity securities and certificates of deposit as of December 31, 2006. Rock-Tenn Company's closing stock price at December 31, 2006 was $27.11. In late January 2007, the Board of Directors authorized the sale of half of our investment in Rock-Tenn Company, and subsequently authorized the sale of the balance of the shares. We realized a gain in excess of our original cost basis of $8,840,000 in the first quarter of 2007 and $9,824,000 in the second quarter of 2007. As of September 30, 2007, we have no remaining shares of Rock-Tenn Company.
 
12


NOTE 9 · Long-Term Debt
 
Long-term debt at September 30, 2007 and December 31, 2006 consisted of the following:
 
(in thousands)
 
2007
   
2006
 
Unsecured senior notes
  $
225,000
    $
225,000
 
Acquisition notes payable
   
8,536
     
6,310
 
Term loan agreements
   
3,214
     
12,857
 
Revolving credit facility
   
-
     
-
 
Other notes payable
   
227
     
167
 
Total debt
   
236,977
     
244,334
 
Less current portion
    (11,574 )     (18,082 )
Long-term debt
  $
225,403
    $
226,252
 
 
        In July 2004, the Company completed a private placement of $200.0 million of unsecured senior notes (the “Notes”). The $200.0 million is divided into two series: Series A, for $100.0 million due in 2011 and bearing interest at 5.57% per year; and Series B, for $100.0 million due in 2014 and bearing interest at 6.08% per year. The closing on the Series B Notes occurred on July 15, 2004. The closing on the Series A Notes occurred on September 15, 2004. Brown & Brown has used the proceeds from the Notes for general corporate purposes, including acquisitions and repayment of existing debt. As of September 30, 2007 and December 31, 2006 there was an outstanding balance of $200.0 million on the Notes.
 
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 Purchaser also purchased Notes issued by the Company in 2004. The Master Agreement provides for a $200.0 million private uncommitted “shelf” facility for the issuance of senior unsecured notes over a three-year period, with interest rates that may be fixed or floating and with such maturity dates, not to exceed ten years, as the parties may determine. The Master Agreement includes various covenants, limitations and events of default similar to the Notes issued in 2004. The initial issuance of notes under the Master Facility Agreement occurred on December 22, 2006, through the issuance of $25.0 million in Series C Senior Notes due December 22, 2016, with a fixed interest rate of 5.66% per annum.
 
Also on December 22, 2006, the Company entered into a Second Amendment to Amended and Restated Revolving and Term Loan Agreement (the “Second Term Amendment”) and a Third Amendment to Revolving Loan Agreement (the “Third Revolving Amendment”) with a national banking institution, amending the existing Amended and Restated Revolving and Term Loan Agreement dated January 3, 2001 (the “Term Agreement”) and the existing Revolving Loan Agreement dated September 29, 2003, as amended (the “Revolving Agreement”), respectively. The amendments provided covenant exceptions for the notes issued or to be issued under the Master Agreement, and relaxed or deleted certain other covenants. In the case of the Third Revolving Amendment, the lending commitment was reduced from $75.0 million to $20.0 million, the maturity date was extended from September 30, 2008 to December 20, 2011, and the applicable margins for advances and the availability fee were reduced. Based on the Company's funded debt-to-EBITDA ratio, the applicable margin for Eurodollar advances changed from a range of 0.625% to 1.625% to a range of 0.450% to 0.875%. The applicable margin for base rate advances changed from a range of 0.000% to 0.125% to the Prime Rate less 1.000%. The availability fee changed from a range of 0.175% to 0.250% to a range of 0.100% to 0.200%. The 90-day London Interbank Offering Rate (“LIBOR”) was 5.20% and 5.36% as of September 30, 2007 and December 31, 2006, respectively. There were no borrowings against this facility at September 30, 2007 or December 31, 2006.
 
In January 2001, Brown & Brown entered into a $90.0 million unsecured seven-year term loan agreement with a national banking institution, bearing an interest rate based upon the 30-, 60- or 90-day LIBOR plus 0.50% to 1.00%, depending upon Brown & Brown's quarterly ratio of funded debt to earnings before interest, taxes, depreciation, amortization and non-cash stock grant compensation. The 90-day LIBOR was 5.20% and 5.36% as of September 30, 2007 and December 31, 2006, respectively. The loan was fully funded on January 3, 2001 and as of September 30, 2007 had an outstanding balance of $3,214,000. This loan is to be repaid in equal quarterly installments of $3,214,000 through December 31, 2007.
 
All four of these credit agreements require Brown & Brown to maintain certain financial ratios and comply with certain other covenants. Brown & Brown was in compliance with all such covenants as of September 30, 2007 and December 31, 2006.
 
To hedge the risk of increasing interest rates from January 2, 2002 through the remaining six years of its seven-year $90.0 million term loan, Brown & Brown entered into an interest rate swap agreement that effectively converted the floating rate LIBOR-based interest payments to fixed interest rate payments at 4.53%. This agreement did not affect the required 0.50% to 1.00% credit risk spread portion of the term loan. In accordance with SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities”, as amended, the fair value of the interest rate swap of approximately $5,000, net of related income taxes of approximately $2,000, was recorded in other assets as of September 30, 2007, and $37,000, net of related income taxes of approximately $22,000, was recorded in other assets as of December 31, 2006; with the related change in fair value reflected as other comprehensive income. Brown & Brown has designated and assessed the derivative as a highly effective cash flow hedge.
 
Acquisition notes payable represent debt incurred to former owners of certain insurance operations acquired by Brown & Brown. These notes and future contingent payments are payable in monthly, quarterly and annual installments through April 2011, including interest in the range from 0.00% to 8.00%.
 
13

 
NOTE 10 · Supplemental Disclosures of Cash Flow Information

 (in thousands)
 
For the nine months
ended September 30,
 
   
2007
   
2006
 
Cash paid during the period for:
           
Interest
  $
13,054
    $
13,821
 
Income taxes
  $
74,132
    $
78,469
 

Brown & Brown's significant non-cash investing and financing activities are summarized as follows:
 
   
For the nine months
ended September 30,
 
(in thousands)
 
2007
   
2006
 
             
Unrealized holding (loss) gain on available-for-sale securities, net of tax benefit of $5,305 for 2007; net of tax effect of $1,245 for 2006
  $ (9,051 )   $
2,106
 
Net (loss) gain on cash-flow hedging derivative, net of tax benefit of $20 for 2007, net of tax effect of $9 for 2006
  $ (35 )   $
16
 
Notes payable issued or assumed for purchased customer accounts
  $
15,857
    $
36,238
 
Notes received on the sale of fixed assets and customer accounts
  $
8,580
    $
2,135
 
 
NOTE 11 · Comprehensive Income

The components of comprehensive income, net of related income tax effects, are as follows:
 
   
For the three months
   
For the nine months
 
   
ended September 30,
   
ended September 30,
 
(in thousands)
 
2007
   
2006
   
2007
   
2006
 
                         
Net income
  $
46,216
    $
40,270
    $
157,955
    $
134,727
 
Net unrealized holding (loss) gain on
available-for-sale securities
    (7 )    
1,330
      (9,051 )    
2,106
 
Net (loss) gain on cash-flow hedging derivative
    (9 )     (58 )     (35 )    
16
 
Comprehensive income
  $
46,200
    $
41,542
    $
148,869
    $
136,849
 
 
14

 
NOTE 12 · Legal and Regulatory Proceedings
 
Governmental Investigations
 
As previously disclosed in our public filings, offices of the Company are party to profit-sharing contingent compensation agreements with certain insurance companies, including agreements providing for potential payment of revenue-sharing commissions by insurance companies based primarily on the overall profitability of the aggregate business written with that insurance company, and/or additional factors such as retention ratios and overall volume of business that an office or offices place with the insurance company. Additionally, to a lesser extent, some offices of the Company are party to override commission agreements with certain insurance companies, and these agreements provide for commission rates in excess of standard commission rates to be applied to specific lines of business, such as group health business, based primarily on the overall volume of such business that the office or offices in question place with the insurance company. The Company has not chosen to discontinue receiving profit-sharing contingent compensation or override commissions.

As previously reported, governmental agencies in a number of states have looked or are looking into issues related to compensation practices in the insurance industry, and the Company continues to respond to written and oral requests for information and/or subpoenas seeking information related to this topic. To date, requests for information and/or subpoenas have been received from governmental agencies such as attorneys general and departments of insurance. Agencies in Arizona, Virginia and Washington have concluded their respective investigations of subsidiaries of Brown & Brown, Inc. based in those states with no further action as to these entities.

The Company cannot currently predict the impact or resolution of the various governmental inquiries and thus cannot reasonably estimate a range of possible loss, which could be material, or whether the resolution of these matters may harm the Company's business and/or lead to a decrease in or elimination of profit-sharing contingent compensation and override commissions, which could have a material adverse impact on the Company's consolidated financial condition.
 
Other
 
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 substantial, including in many instances claims for punitive or extraordinary damages. Some of these claims and lawsuits have been resolved, others are in the process of being resolved, and others are still in the investigation or discovery phase. The Company will continue to respond appropriately to these claims and lawsuits, and to vigorously protect its interests.
 
Among the above-referenced claims, and as previously described in the Company's public filings, there are several threatened and pending legal claims and lawsuits against Brown & Brown, Inc. and Brown & Brown Insurance Services of Texas, Inc. (BBTX), a subsidiary of Brown & Brown, Inc., arising out of BBTX's involvement with the procurement and placement of workers' compensation insurance coverage for entities including several professional employer organizations. One such action, styled Great American Insurance Company, et al. v. The Contractor's Advantage, Inc., et al., Cause No.2002-33960, pending in the 189th Judicial District Court in Harris County, Texas, asserts numerous causes of action, including fraud, civil conspiracy, federal Lanham Act and RICO violations, breach of fiduciary duty, breach of contract, negligence and violations of the Texas Insurance Code against BBTX, Brown & Brown, Inc. and other defendants, and seeks recovery of punitive or extraordinary damages (such as treble damages) and attorneys' fees. Although the ultimate outcome of the matters referenced in this section titled “Other” cannot be ascertained and liabilities in indeterminate amounts may be imposed on Brown & Brown, Inc. or its subsidiaries, on the basis of present information, availability of insurance and legal advice received, it is the opinion of management that the disposition or ultimate determination of such claims will not have a material adverse effect on the Company's consolidated financial position. However, as (i) one or more of the Company' 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.
 
For a more complete discussion of the foregoing matters, please see Item 3 of Part I of our Annual Report on Form 10-K filed with the Securities and Exchange Commission for our fiscal year ended December 31, 2006 and Note 13 to the Consolidated Financial Statements contained in Item 8 of Part II thereof.
 
15


NOTE 13 · Segment Information
 
Brown & Brown's business is divided into four reportable segments: the Retail Division, which provides a broad range of insurance products and services to commercial, governmental, professional and individual customers; the National Programs Division, which is comprised of two units - Professional Programs, which provides professional liability and related package products for certain professionals delivered through nationwide networks of independent agents, and Special Programs, which markets targeted products and services designed for specific industries, trade groups, public and quasi-public entities, and market niches; the Wholesale Brokerage Division, which markets and sells excess and surplus commercial and personal lines insurance, and reinsurance, primarily through independent agents and brokers; and the Services Division, which provides insurance-related services, including third-party administration, consulting for the workers' compensation and employee benefit self-insurance markets, managed healthcare services and Medicare set-aside services. Brown & Brown conducts all of its operations within the United States of America.

Summarized financial information concerning Brown & Brown's reportable segments for the nine months ended September 30, 2007 and 2006 is shown in the following table. The “Other” column includes any income and expenses not allocated to reportable segments and corporate-related items, including the inter-company interest expense charge to the reporting segment.
 
   
For the nine months ended September 30, 2007
 
         
National
   
Wholesale
                   
(in thousands)
 
Retail
   
Programs
   
Brokerage
   
Services
   
Other
   
Total
 
Total revenues
  $
434,234
    $
113,253
    $
142,544
    $
27,409
    $
25,001
    $
742,441
 
Investment income
   
164
     
377
     
2,262
     
25
     
25,027
     
27,855
 
Amortization
   
15,885
     
6,779
     
6,759
     
346
     
29
     
29,798
 
Depreciation
   
4,255
     
2,088
     
1,974
     
420
     
755
     
9,492
 
Interest
   
15,217
     
7,694
     
14,197
     
526
      (27,189 )    
10,445
 
Income before income taxes
   
133,320
     
31,548
     
29,147
     
7,094
     
56,924
     
258,033
 
Total assets
   
1,285,096
     
553,453
     
649,610
     
38,926
      (611,726 )    
1,915,359
 
Capital expenditures
   
4,591
     
1,516
     
2,425
     
283
     
16,033
     
24,848
 


   
For the nine months ended September 30, 2006
 
         
National
   
Wholesale
                   
(in thousands)
 
Retail
   
Programs
   
Brokerage
   
Services
   
Other
   
Total
 
Total revenues
  $
395,812
    $
113,149
    $
125,110
    $
23,893
    $
5,390
    $
663,354
 
Investment income
   
71
     
320
     
3,310
     
35
     
4,647
     
8,383
 
Amortization
   
14,507
     
6,458
     
5,848
     
220
     
34
     
27,067
 
Depreciation
   
4,251
     
1,697
     
1,464
     
383
     
507
     
8,302
 
Interest
   
14,372
     
7,768
     
13,568
     
275
      (25,903 )    
10,080
 
Income before income taxes
   
114,845
     
35,383
     
24,351
     
6,030
     
37,359
     
217,968
 
Total assets
   
1,082,425
     
564,337
     
617,665
     
31,578
      (492,837 )    
1,803,168
 
Capital expenditures
   
4,832
     
2,976
     
1,506
     
472
     
2,536
     
12,322
 


NOTE 14 · Subsequent Events
 
From October 1, 2007 through November 6, 2007, Brown & Brown acquired the assets and assumed certain liabilities of seven insurance intermediaries and several book of business (customer accounts). The aggregate purchase price of these acquisitions was $41,758,000, including $33,277,000 of net cash payments, the issuance of $3,600,000 in notes payable and the assumption of $4,881,000 of liabilities. All of these acquisitions were acquired primarily to expand Brown & Brown’s core businesses and to attract and obtain high-quality individuals. Acquisition purchase prices are based primarily on a multiple of average annual operating profits earned over a one- to three-year period within a minimum and maximum price range. The initial asset allocation of an acquisition is based on the minimum purchase price, and any subsequent earn-out payment is allocated to goodwill.
 
16


  
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS.
 
THE FOLLOWING DISCUSSION UPDATES THE MD&A CONTAINED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED IN 2006, AND THE TWO DISCUSSIONS SHOULD BE READ TOGETHER.
 
GENERAL
 
We are a diversified insurance agency, wholesale brokerage and services organization with origins dating from 1939, headquartered in Daytona Beach and Tampa, Florida. We market and sell to our customers insurance products and services, primarily in the property, casualty and the employee benefits areas. As an agent and broker, we do not assume underwriting risks. Instead, we provide our customers with quality insurance contracts, as well as other targeted, customized risk management products and services.
 
Our commissions and fees revenue is comprised of commissions paid by insurance companies and fees paid directly by customers. Commission revenues generally represent a percentage of the premium paid by the insured and are materially affected by fluctuations in both premium rate levels charged by insurance companies and the insureds' underlying “insurable exposure units,” which are units that insurance companies use to measure or express insurance exposed to risk (such as property values, sales and payroll levels) in order to determine what premium to charge the insured. These premium rates are established by insurance companies based upon many factors, including reinsurance rates paid by insurance carriers, none of which we control. Beginning in 1986 and continuing through 1999, commission revenues were adversely influenced by a consistent decline in premium rates resulting from intense competition among property and casualty insurance companies for market share. This condition of a prevailing decline in premium rates, commonly referred to as a “soft market,” generally resulted in flat to reduced commissions on renewal business. The effect of this softness in rates on our commission revenues was somewhat offset by our acquisitions and net new business production. As a result of increasing “loss ratios” (the comparison of incurred losses plus adjustment expenses against earned premiums) of insurance companies through 1999, there was a general increase in premium rates beginning in the first quarter of 2000 and continuing into 2003.  During 2003, the increases in premium rates began to moderate, and in certain lines of insurance, premium rates decreased. In 2004, as general premium rates continued to moderate, the insurance industry experienced the worst hurricane season since 1992 (when Hurricane Andrew hit south Florida). The insured losses from the 2004 hurricane season were absorbed relatively easily by the insurance industry and the general insurance premium rates continued to soften during 2005. During the third quarter of 2005, the insurance industry experienced the worst hurricane season ever recorded. As a result of the significant losses incurred by the insurance carriers due to these hurricanes, the insurance premium rates in 2006 increased on coastal property, primarily in the southeastern region of the United States. In the other regions of the United States, insurance premium rates generally declined during 2006. During 2007, a “soft market” generally prevailed in most regions of the United States, and this condition is expected to continue throughout the year.

The volume of business from new and existing insured customers, fluctuations in insurable exposure units and changes in general economic and competitive conditions further impact our revenues. For example, the increasing costs of litigation settlements and awards have caused some customers to seek higher levels of insurance coverage. Conversely, level rates of inflation or general declines in economic activity could limit increases in the values of insurable exposure units. Our revenues have continued to grow as a result of an intense focus on net new business growth and acquisitions. We anticipate that results of operations will continue to be influenced by these competitive and economic conditions throughout 2007.
 
We also earn “profit-sharing contingent commissions,” which are profit-sharing commissions based primarily on underwriting results, but may also reflect considerations for volume, growth and/or retention. These commissions are primarily received in the first and second quarters of each year, based on underwriting results and other aforementioned considerations for the prior year(s). Over the last three calendar years profit-sharing contingent commissions have averaged approximately 5.4% of the previous year's total commissions and fees revenue. Profit-sharing contingent commissions are included in our total commissions and fees in the Consolidated Statements of Income in the year received. The term “core commissions and fees” excludes profit-sharing contingent commissions and therefore represents the revenues earned directly from specific insurance policies sold, and specific fee-based services rendered. Recently, three national insurance carriers announced the replacement of the current loss-ratio based profit-sharing contingent commission calculation with a guaranteed fixed-based methodology. As of September 30, 2007, $5.0 million was accrued for these new “Guaranteed Supplemental Commissions” and additional accruals will be made on a quarterly basis going forward, as appropriate.
 
Fee revenues are generated primarily by our Services Division, which provides insurance-related services, including third-party claims administration and comprehensive medical utilization management services in both the workers' compensation and all-lines liability arenas, as well as Medicare set-aside services. In each of the past three calendar years, fee revenues generated by the Services Division have declined as a percentage of our total commissions and fees, from 4.0% in 2004 to 3.8% in 2006. This declining trend is expected to continue as the revenues from our other reportable segments grow at a faster pace. 
 
Investment income consists primarily of interest earnings on premiums and advance premiums collected and held in a fiduciary capacity before being remitted to insurance companies. Our policy is to invest available funds in high-quality, short-term fixed income investment securities, subject to the requirements of applicable laws. Investment income also includes gains and losses realized from the sale of investments.
 
Other income consists primarily of gains and losses from the sale and disposition of assets. Although we are not in the business of selling customer accounts, we periodically will sell an office or a book of business (one or more customer accounts) that does not produce reasonable margins or demonstrate a potential for growth.
 
Critical Accounting Policies
 
Our Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We continually evaluate our estimates, which are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. These estimates form the basis for our judgments about the carrying values of our assets and liabilities, which values are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The more critical accounting and reporting policies include our accounting for revenue recognition, business acquisitions and purchase price allocations, intangible asset impairments, reserves for litigation and derivative interests. In particular, the accounting for these areas requires significant judgments to be made by management. Different assumptions in the application of these policies could result in material changes in our consolidated financial position or consolidated results of operations. Refer to Note 1 in the “Notes to Consolidated Financial Statements” in our Annual Report on Form 10-K for the year ended December 31, 2006 on file with the Securities and Exchange Commission for details regarding our critical and significant accounting policies.
 
17


RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
 
The following discussion and analysis regarding results of operations and liquidity and capital resources should be considered in conjunction with the accompanying Consolidated Financial Statements and related Notes.

Financial information relating to our Condensed Consolidated Financial Results for the three- and nine-month periods ended September 30, 2007 and 2006 is as follows (in thousands, except percentages):
 
   
For the three months
   
For the nine months
 
   
ended September 30,
   
ended September 30,
 
               
%
               
%
 
   
2007
   
2006
   
Change
   
2007
   
2006
   
Change
 
REVENUES
                                   
Commissions and fees
  $
216,546
    $
206,466
      4.9 %   $
645,778
    $
613,737
      5.2 %
Profit-sharing contingent commissions
   
8,875
     
2,092
      324.2 %    
55,678
     
40,163
      38.6 %
Investment income
   
3,286
     
3,218
      2.1 %    
27,855
     
8,383
      232.3 %
Other income, net
   
8,577
     
189
   
NMF
     
13,130
     
1,071
   
NMF
 
Total revenues
   
237,284
     
211,965
      11.9 %    
742,441
     
663,354
      11.9 %
                                                 
EXPENSES
                                               
Employee compensation and benefits
   
110,491
     
100,821
      9.6 %    
333,937
     
304,731
      9.6 %
Non-cash stock-based compensation
   
1,491
     
837
      78.1 %    
4,327
     
4,601
      (6.0 )%
Other operating expenses
   
32,928
     
29,502
      11.6 %    
96,409
     
90,605
      6.4 %
Amortization
   
10,331
     
9,089
      13.7 %    
29,798
     
27,067
      10.1 %
Depreciation
   
3,213
     
2,922
      10.0 %    
9,492
     
8,302
      14.3 %
Interest
   
3,395
     
3,229
      5.1 %    
10,445
     
10,080
      3.6 %
Total expenses
   
161,849
     
146,400
      10.6 %    
484,408
     
445,386
      8.8 %
                                                 
Income before income taxes
   
75,435
     
65,565
      15.1 %    
258,033
     
217,968
      18.4 %
                                                 
Income taxes
   
29,219
     
25,295
      15.5 %    
100,078
     
83,241
      20.2 %
                                                 
NET INCOME
  $
46,216
    $
40,270
      14.8 %   $
157,955
    $
134,727
      17.2 %
                                                 
Net internal growth rate – core commissions and fees
    (3.0 )%     5.2 %             (1.9 )%     4.5 %        
Employee compensation and benefits ratio
    46.6 %     47.6 %             45.0 %     45.9 %        
Other operating expenses ratio
    13.9 %     13.9 %             13.0 %     13.7 %        
                                                 
Capital expenditures
  $
4,848
    $
3,226
            $
24,848
    $
12,322
         
Total assets at September 30, 2007 and 2006
                          $
1,915,359
    $
1,803,168
         
 
 
Net Income
 
Net income for the third quarter of 2007 was $46.2 million, or $0.33 per diluted share, compared with net income in the third quarter of 2006 of $40.3 million, or $0.29 per diluted share, a 13.8% increase on a per-share basis.  Net income for the nine months ended September 30, 2007 was $158.0 million or $1.12 per diluted share, compared with net income for the comparable period in 2006 of $134.7 million, or $0.96 per diluted share, a 16.7 % increase on a per-share basis.
 
18


Commissions and Fees 

Commissions and fees, including profit-sharing contingent commissions, for the third quarter of 2007 increased $16.9 million, or 8.1%, over the same period in 2006. Profit-sharing contingent commissions for the third quarter of 2007 increased $6.8 million over the third quarter of 2006, to $8.9 million. Core commissions and fees are our commissions and fees, less (i) profit-sharing contingent commissions and (ii) divested business (commissions and fees generated from offices, books of business or niches sold or terminated). Core commissions and fees revenue for the third quarter of 2007 increased $12.0 million, of which approximately $18.1 million represents core commissions and fees from agencies acquired since the fourth quarter of 2006. After divested business of $1.9 million, the remaining net decrease of $6.1 million represents net lost business, which reflects a (3.0%) internal growth rate for core commissions and fees.

Commissions and fees, including profit-sharing contingent commisions, for the nine months ended September 30, 2007 increased $47.6 million, or 7.3%, over the same period in 2006. For the nine months ended September 30, 2007, profit-sharing contingent commissions increased $15.5 million over the comparable period in 2006. Core commissions and fees revenue for the first nine months of 2007 increased $35.9 million, of which approximately $47.7 million of the total increase represents core commissions and fees from agencies acquired since the comparable period in 2006. After divested business of $3.9 million, the remaining $11.7 million represents net lost business, which reflects a (1.9%) internal growth rate for core commissions and fees.
 
 Investment Income

Investment income for the three months ended September 30, 2007 increased $0.1 million, or 2.1%, over the same period in 2006. Investment income for the nine months ended September 30, 2007 increased $19.5 million, or 232.3%, over the same period in 2006. These increases are primarily due to the sale of our investment in Rock-Tenn Company which we have owned for over 25 years, for net gains of approximately $8.8 million in the first quarter of 2007 and $9.8 million in the second quarter of 2007.
 
Other Income, net
 
Other income for the three months ended September 30, 2007 was $8.6 million compared with $0.1 million in the same period in 2006. Other income for the nine months ended September 30, 2007 was $13.1 million compared with $1.1 million in the same period in 2006. Other income consists primarily of gains and losses from the sale and disposition of assets. Although we are not in the business of selling customer accounts, we periodically will sell an office or a book of business (one or more customer accounts) that does not produce reasonable margins or demonstrate a potential for growth.
 
Employee Compensation and Benefits
 
Employee compensation and benefits for the third quarter of 2007 increased $9.7 million, or 9.6%, over the same period in 2006.  This increase is primarily related to the addition of new employees from acquisitions completed since October 1, 2006. Employee compensation and benefits as a percentage of total revenue decreased to 46.6% for the third quarter of 2007, from 47.6% for the third quarter of 2006. Excluding the impact of the gains on the sale of several books of business, employee compensation and benefits as a percentage of total revenues increased to 48.0% from 47.6% in the third quarter of 2006. This increase in the expense percentage represents approximately $1.0 million in net additional salary costs and is primarily due to acquisitions.
 
Employee compensation and benefits for the nine months ended September 30, 2007 increased $29.2 million, or 9.6%, over the same period in 2006. For the nine months ended September 30, 2007, employee compensation and benefits as a percentage of total revenue decreased to 45.0%, from 45.9% for the same period in 2006. The improved percentage for the nine months ended September 30, 2007 was primarily the result of the impact of increased revenues due to more profit-sharing contingent commissions received in the first nine months of 2007 versus 2006, and the gains on the sales of the Rock-Tenn Company stock and several books of businesses. Excluding the impact of the gains on the sales of the Rock-Tenn Company stock and several books of businesses, employee compensation and benefits as a percentage of the total revenues increased to 46.9% from 46.0% in the first nine months of 2006. This increase in the expense percentage represents approximately $6.3 million in net additional salary costs and is primarily due to acquisitions.
 
Non-Cash Stock-Based Compensation

Non-cash stock-based compensation for the three and nine months ended September 30, 2007 increased approximately $0.7 million, or 78.1%, and decreased $0.3 million, or 6.0%, respectively. For the entire year of 2007, we expect the total non-cash stock-based compensation expense to be approximately $6.0 million to $6.5 million, as compared to the total cost for the year 2006 of $5.4 million. The increased annual estimated cost primarily relates to the expensing of the 15% discount granted to employees under the Company's Employee Stock Purchase Plan.
 
19


Other Operating Expenses
 
Other operating expenses for the third quarter of 2007 increased $3.4 million, or 11.6%, over the same period in 2006. These increases are primarily the result of acquisitions completed since the fourth quarter of 2006 that had no comparable results in the same period of 2006. Other operating expenses as a percentage of revenues for the third quarter of 2007 and the same period in 2006 were 13.9%. Excluding the impact of the gains on the sale of the several books of businesses, other operating expenses as a percentage of the total revenues increased to 14.3% of total revenues from 13.9% in the third quarter of 2006. The change in this expense percentage represents approximately $1.0 million in net additional costs which were generated primarily from acquisitions.
 
For the nine months ended September 30, 2007, other operating expenses increased $5.8 million, or 6.4%, over the same period in 2006. For the nine months ended September 30, 2007, other operating expenses as a percentage of revenues decreased to 13.0%, compared with 13.7% for the same period in 2006. Excluding the impact of the gains on the sales of the Rock-Tenn Company stock and several books of businesses, other operating expenses as a percentage of the total revenues decreased to 13.5% of total revenues from 13.7% in the first nine months of 2006. The improvement in this expense percentage represents approximately $1.2 million in net cost savings which were generated primarily from lower errors and omissions expense and bad debt expense in the first nine months of 2007 than in the comparable period of 2006.
 
Amortization
 
Amortization expense for the third quarter of 2007 increased $1.2 million, or 13.7%, over the third quarter of 2006. For the nine months ended September 30, 2007, amortization expense increased $2.7 million, or 10.1%, over the same period in 2006. These increases are primarily due to the amortization of additional intangible assets as a result of acquisitions completed since October 1, 2006.
  
Depreciation
 
 Depreciation expense for the third quarter of 2007 increased $0.3 million, or 10.0%, over the third quarter of 2006. For the nine months ended September 30, 2007, depreciation expense increased $1.2 million, or 14.3%, over the same period in 2006. These increases are due primarily to the purchase of new computers, related equipment and software, and the depreciation associated with acquisitions completed since October 1, 2006.
 
Interest Expense
  
Interest expense for the third quarter of 2007 increased $0.2 million, or 5.1%, over the same period in 2006. For the nine months ended September 30, 2007, interest expense increased $0.4 million, or 3.6%, over the same period in 2006. These increases are primarily due to the additional $25.0 million of unsecured Series C Senior Notes issued in the fourth quarter of 2006.
 
20


 RESULTS OF OPERATIONS - SEGMENT INFORMATION
 
As discussed in Note 13 of the Notes to Condensed Consolidated Financial Statements, we operate in four reportable segments: the Retail, National Programs, Wholesale Brokerage and Services Divisions. On a divisional basis, increases in amortization, depreciation and interest expenses are the result of acquisitions within a given division in a particular year. Likewise, other income in each division primarily reflects net gains on sales of customer accounts and fixed assets. As such, in evaluating the operational efficiency of a division, management places greater emphasis on the net internal growth rate of core commissions and fees revenue, the gradual improvement of the ratio of employee compensation and benefits to to