NOTE 5· Business Combinations

Acquisitions in 2012

During 2012, Brown & Brown has acquired the assets and assumed certain liabilities of 11 insurance intermediaries, all of the stock of one insurance intermediary and a book of business (customer accounts). The aggregate purchase price of these acquisitions was $620,144,000, including $443,475,000 of cash payments, the issuance of notes payable of $59,000, the issuance of $25,776,000 in other payables, the assumption of $135,779,000 of liabilities and $15,055,000 of recorded earn-out payables. The ‘other payables’ amount includes $22,594,000 that the Company is obligated to pay all shareholders of Arrowhead General Insurance Agency Superholding Corporation (“Arrowhead”) on a pro rata basis for certain pre-merger corporate tax refunds and estimated certain potential future income tax credits that were created by net operating loss carryforwards originating from transaction-related tax benefit items. All of these acquisitions were acquired primarily to expand Brown & Brown’s core businesses and to attract and hire high-quality individuals. Acquisition purchase prices are typically based on a multiple of average annual operating profit earned over a one- to three-year period within a minimum and maximum price range. The recorded purchase price for all acquisitions consummated after January 1, 2009 included an estimation of the fair value of liabilities associated with any potential earn-out provisions. Subsequent changes in the fair value of earn-out obligations will be recorded in the consolidated statement of income when incurred.

The fair value of earn-out obligations is based on the present value of the expected future payments to be made to the sellers of the acquired businesses in accordance with the provisions outlined in the respective purchase agreements. In determining fair value, the acquired business’s future performance is estimated using financial projections developed by management for the acquired business and reflects market participant assumptions regarding revenue growth and/or profitability. The expected future payments are estimated on the basis of the earn-out formula and performance targets specified in each purchase agreement compared to the associated financial projections. These payments are then discounted to present value using a risk-adjusted rate that takes into consideration the likelihood that the forecasted earn-out payments will be made.

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 Topic 805 — Business Combinations. However, the Company does not expect any adjustments to such allocations to be material to the Company’s Condensed Consolidated Financial Statements. These acquisitions have been accounted for as business combinations and are as follows:


(in thousands)
Name	Business Segment		2012 Date of Acquisition		Cash Paid		Note Payable		Other Payable		Recorded Earn-out Payable		Net Assets Acquired		Maximum Potential Earn-out Payable
Arrowhead General Insurance Agency Superholding Corporation		National Programs; Services		January 9	$	397,531	$	—	$	22,694	$	3,634	$	423,859	$	5,000
Insurcorp & GGM Investments LLC (d/b/a Maalouf Benefit Resources)		Retail		May 1		15,500		—		900		4,944		21,344		17,000
Texas Security General Insurance Agency, Inc.		Wholesale		September 1		14,506		—		2,182		2,124		18,812		7,200
Other		Various		Various		15,938		59		—		4,353		20,350		10,235

Total					$	443,475	$	59	$	25,776	$	15,055	$	484,365	$	39,435

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


(in thousands)	Arrowhead			Insurcorp			Texas Security			Other			Total
Cash	$	61,786		$	—		$	—		$	—		$	61,786
Other current assets		69,051			180			1,882			524			71,637
Fixed assets		4,629			25			45			67			4,766
Goodwill		322,779			14,745			10,776			12,818			361,118
Purchased customer accounts		99,515			6,490			6,227			8,371			120,603
Non-compete agreements		100			22			14			97			233
Other assets		1			—			—			—			1

Total assets acquired		557,861			21,462			18,944			21,877			620,144
Other current liabilities		(107,579	)		(118	)		(132	)		(1,527	)		(109,356	)
Deferred income taxes, net		(26,423	)		—			—			—			(26,423	)

Total liabilities assumed		(134,002	)		(118	)		(132	)		(1,527	)		(135,779	)

Net assets acquired	$	423,859		$	21,344		$	18,812		$	20,350		$	484,365

The weighted average useful lives for the acquired amortizable intangible assets are as follows: purchased customer accounts, 15.0 years; and non-compete agreements, 5.0 years.

Goodwill of $361,118,000, was allocated to the Retail, National Programs, Wholesale Brokerage and Services Divisions in the amounts of $26,753,000, $253,766,000, $11,586,000 and $69,013,000, respectively. Of the total goodwill of $361,118,000, $28,326,000 is currently deductible for income tax purposes and $317,737,000 is non-deductible. The remaining $15,055,000 relates to the recorded earn-out payables and will not be deductible until it is earned and paid.

The results of operations for the acquisitions completed during 2012 have been combined with those of the Company since their respective acquisition dates. The total revenues and income before income taxes from the acquisitions completed through September 30, 2012, included in the Condensed Consolidated Statement of Income for the three months ended September 30, 2012, were $37,754,000 and $4,731,000, respectively. The total revenues and income before income taxes from the acquisitions completed through September 30, 2012, included in the Condensed Consolidated Statement of Income for the nine months ended September 30, 2012, were $96,020,000 and $4,279,000, respectively. If the acquisitions had occurred as of the beginning of the 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.


(UNAUDITED)	For the three months ended September 30,				For the nine months ended September 30,
(in thousands, except per share data)	2012		2011		2012		2011
Total revenues	$	304,776	$	292,599	$	907,796	$	866,115
Income before income taxes		81,998		81,785		239,286		238,144
Net income		49,715		49,699		143,630		144,021

Net income per share:
Basic	$	0.35	$	0.35	$	1.00	$	1.01
Diluted	$	0.34	$	0.34	$	0.98	$	1.00

Weighted average number of shares outstanding:
Basic		139,465		138,690		139,185		138,475
Diluted		142,097		140,443		141,769		140,120

Acquisitions in 2011

For the nine months ended September 30, 2011, Brown & Brown acquired the assets and assumed certain liabilities of 29 insurance intermediaries, all of the stock of one insurance intermediary and several books of business (customer accounts). The aggregate purchase price of these acquisitions was $126,462,000, including $100,449,000 of cash payments, the issuance of notes payable of $1,194,000, the assumption of $9,356,000 of liabilities, and $15,463,000 of recorded earn-out payables. All of these acquisitions were acquired primarily to expand Brown & Brown’s core businesses and to attract and hire high-quality individuals. Acquisition purchase prices are typically based on a multiple of average annual operating profit earned over a one- to-three-year period, within a minimum and maximum price range. The recorded purchase prices for all acquisitions consummated after January 1, 2009 include an estimation of the fair value of liabilities associated with any potential earn-out provisions. Subsequent changes in the fair value of earn-out obligations are recorded in the consolidated statement of income when 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 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 with 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.

These acquisitions have been accounted for as business combinations and are as follows:


(in thousands)
Name	Business Segment		2011 Date of Acquisition		Cash Paid		Note Payable		Recorded Earn-out Payable		Net Assets Acquired		Maximum Potential Earn-out Payable
Balcos Insurance, Inc.		Retail		January 1	$	8,611	$	—	$	1,595	$	10,206	$	5,766
Associated Insurance Service, Inc. et al.		Retail		January 1		12,000		—		1,575		13,575		6,000
United Benefit Services Insurance Agency LLC et al.		Retail		February 1		14,559		—		3,199		17,758		9,133
First Horizon Insurance Group, Inc. et al.		Retail		April 30		24,835		—		—		24,835		—
Fitzharris Agency, Inc. et al.		Retail		May 1		6,159		—		888		7,047		3,832
Corporate Benefit Consultants, LLC		Retail		June 1		9,000		—		2,038		11,038		4,520
Other		Various		Various		25,285		1,194		6,168		32,647		12,865

Total					$	100,449	$	1,194	$	15,463	$	117,106	$	42,116

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


(in thousands)	Balcos			AIS			United			FHI			FA			CBC		Other			Total
Cash	$	—		$	—		$	—		$	5,170		$	—		$	—	$	—		$	5,170
Other current assets		187			252			438			1,415			77			—		879			3,248
Fixed assets		20			100			20			134			60			6		65			405
Goodwill		6,486			9,055			10,501			14,701			7,244			6,965		18,624			73,576
Purchased customer accounts		3,530			4,086			6,787			8,094			3,351			4,046		13,746			43,640
Non-compete agreements		42			92			45			10			21			21		177			408
Other assets		—			—			4			9			—			—		2			15

Total assets acquired		10,265			13,585			17,795			29,533			10,753			11,038		33,493			126,462

Other current liabilities		(59	)		(10	)		(37	)		(3,790	)		(3,706	)		—		(846	)		(8,448	)
Deferred income taxes, net		—			—			—			(908	)		—			—		—			(908	)


Total liabilities assumed		(59	)		(10	)		(37	)		(4,698	)		(3,706	)		—		(846	)		(9,356	)

Net assets acquired	$	10,206		$	13,575		$	17,758		$	24,835		$	7,047		$	11,038	$	32,647		$	117,106

The weighted average useful lives for the above acquired amortizable intangible assets, as of the acquisition date, are as follows: purchased customer accounts, 15.0 years; and non-compete agreements, 5.0 years.

Goodwill of $73,576,000 was assigned to the Retail and National Programs Divisions in the amounts of $71,287,000 and $2,289,000, respectively. Of the total goodwill of $73,576,000, $43,412,000 is currently deductible for income tax purposes and $14,701,000 is non-deductible. The remaining $15,463,000 relates to the recorded earn-out payables and will not be deductible until it is earned and paid.

The results of operations for the acquisitions completed during 2011 have been combined with those of the Company since their respective acquisition dates. The total revenues and income before income taxes from the acquisitions completed through September 30, 2011, included in the Condensed Consolidated Statement of Income for the three months ended September 30, 2011, were $1,471,000 and $894,000, respectively. The total revenues and income before income taxes from the acquisitions completed through September 30, 2011, included in the Condensed Consolidated Statement of Income for the nine months ended September 30, 2011, were $3,026,000 and $1,832,000, respectively. If the acquisitions had occurred as of the beginning of the period, the Company’s estimated 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)	2011		2010		2011		2010
Total revenues	$	261,015	$	260,735	$	782,561	$	783,433
Income before income taxes		72,933		77,284		215,159		227,040
Net income		44,319		47,501		130,119		137,420

Net income per share:
Basic	$	0.31	$	0.33	$	0.91	$	0.97
Diluted	$	0.31	$	0.33	$	0.90	$	0.96

Weighted average number of shares outstanding:
Basic		138,690		138,093		138,475		137,802
Diluted		140,443		139,507		140,120		139,128

For acquisitions consummated prior to January 1, 2009, 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 2012 as a result of these adjustments totaled $2,907,000, all of which was allocated to goodwill. Of the $2,907,000 net additional consideration paid, $2,907,000 was paid in cash. The net additional consideration paid by the Company in 2011 as a result of these adjustments totaled $4,446,000, all of which was allocated to goodwill. Of the $4,446,000 net additional consideration paid, $3,781,000 was paid in cash and $665,000 was issued as a note payable.

As of September 30, 2012, the maximum future contingency payments related to all acquisitions totaled $148,950,000, of which all of the $148,950,000 relates to acquisitions consummated subsequent to January 1, 2009.

ASC Topic 805 — Business Combinations is the authoritative guidance requiring an acquirer to recognize 100% of the fair values 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 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 will be recorded in the consolidated statement of income when incurred. Potential earn-out obligations are typically based upon future earnings of the acquired entities, usually between one and three years.

As of September 30, 2012, 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). 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, 2012 and 2011, were as follows:


	For the three months ended September 30,						For the nine months ended September 30,
(in thousands)	2012			2011			2012			2011
Balance as of the beginning of the period	$	57,997		$	41,913		$	47,715		$	29,609
Additions to estimated acquisition earn-out payables		2,136			1,648			15,055			15,463
Payments for estimated acquisition earn-out payables		(2,743	)		(2,290	)		(4,388	)		(5,267	)

Subtotal		57,390			41,271			58,382			39,805

Net change in earnings from estimated acquisition earn-out payables:
Change in fair value on estimated acquisition earn-out payables		240			(1,286	)		(1,966	)		(697	)
Interest expense accretion		618			476			1,832			1,353

Net change in earnings from estimated acquisition earn-out payables		858			(810	)		(134	)		656

Balance as of September 30	$	58,248		$	40,461		$	58,248		$	40,461

Of the $58,248,000 estimated acquisition earn-out payables as of September 30, 2012, $17,552,000 was recorded as accounts payable and $40,696,000 was recorded as other non-current liabilities. Of the $40,461,000 in estimated acquisition earn-out payables as of September 30, 2011, $7,365,000 was recorded as accounts payable and $33,096,000 was recorded as other non-current liabilities.