Good morning. Welcome to the Brown & Brown, Inc. 2014 third quarter earnings call. Today's call is being recorded. Please note that certain information discussed during this call, including information contained in the slide presentation posted in connection with this call and including answers given in response to your questions, may relate to future results and events or otherwise be forward-looking in nature. Such statements reflect our current views with respect to future events, including those relating to the company's anticipated financial results for the third quarter of 2014, are intended to fall within the safe harbor provisions of the securities laws. Actual results or events in the future are subject to a number of risks and uncertainties and may differ materially from those currently anticipated or desired or referenced in any forward-looking statements made as a result of a number of factors.
Such factors include the company's determination as it finalizes its financial results for the second quarter of 2014, that its financial results differ from the current preliminary unaudited numbers set forth in the press release issued yesterday. Other factors that the company may not have currently identified or quantified, those risks and uncertainties identified from time to time in the company's reports filed with the Securities and Exchange Commission. Additional discussion of these and other factors affecting the company's business and prospects, as well as additional information regarding forward-looking statements, is contained in the slide presentation posted in connection with this call and in the company's filings with the Securities and Exchange Commission. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
With that said, I will now turn the call over to Powell Brown, President and Chief Executive Officer. You may begin.
Thanks, Deanna. Good morning, everybody. Thanks for joining us for our Q3 earnings call. In the third quarter, we delivered $421 million of revenue for the quarter with growth about 17.3%. Our organic growth in that was 2.9%. We did deliver organic growth in each of our four divisions. We grew our earnings per share at 20.5% versus the prior year to $0.47. Taking out The Wright Insurance Group acquisition, which we acquired in May, our adjusted EPS would be $0.44 versus $0.39 for a 7.7% increase. We are pleased with the performance of Wright and its underlying businesses. We'll talk more about the cat events and their impact on Wright later in the presentation. From an EBITDA perspective, our margins improved to 35.1% from 33.7%, reflecting a 140 basis point improvement.
Excluding Wright, the adjusted EBITDA margin is 34%, reflecting a 30 basis points improvement over 2013. As we've said previously, our goal is to grow our business organically and profitably. We've delivered another quarter of strong cash conversion. We're very pleased with the $500 million of investment-grade rated bonds that we issued in the third quarter. Andy will talk more about the bonds and the evolution of our capital structure later in the presentation. We also initiated a $50 million accelerated share repurchase program that is part of the $200 million plan approved by our board at the end of the second quarter. Andy will talk more about this later in his presentation as well. Lastly, we're continuing to strive for a 4% organic growth this year.
It is going to be challenging because a few of our businesses are being impacted by the lack of weather-related events. We continue to watch as the market softens relative to rates. On slide five, I'd like to dig a little deeper into our results. As you know, retail is just over 50% of our total company today. They delivered 5.1% growth. 2.1% of that was organic. Observations about retail. We are seeing middle market America continues to remain choppy or a little inconsistent, depending on where you are in the country. Property renewal rates, including coastal areas, are down 5%-20% or more, with E&S markets targeting the best catastrophic risks. Employee benefits, especially large groups, continue to see increases of up to 10%. Workers' compensation rates are moving up as a few industry segment payrolls are growing slightly.
We're seeing the frequency of losses decline. The loss severity is rising. Carriers are looking for rate on commercial auto. They're generally flat. Companies with good claims histories are seeing decreases of 5%-15%. In our national programs area, we're experiencing growth in personal property, automobile aftermarket, and earthquake. Our retention rates are steady in most programs. We are continuing to see pressure on property terms and conditions. From a wholesale standpoint, I will tell you that wholesale had another great quarter, posting organic revenue of 7.7%. Our binding authority business is continuing to grow nicely. We're seeing rates for large broker property falling, as I said earlier, 5%-20%, depending on the location. Florida is closer to 20% than 5% in most cases, due to the coastal nature of our state.
Professional liability is flat. Employment practices liability is continuing to see upward pressure. We're seeing some accounts moved from the E&S market back to the standard market. Those are GL accounts. In the services area, the division had a good quarter with organic growth of 2.1%. Considering there were no weather-related events to drive claims processing revenues, we believe that this was a good result. Within our services business, we realized solid growth from new work claims clients. This was partially offset because we're seeing backlogs within our Social Security advocacy business. This has had a direct impact on revenues in that business. I'll turn it over to Andy, who will discuss our financial performance in more detail.
Great. Thanks, Powell. Good morning, everyone. Let me talk about our financial highlights and some of the key metrics for the quarter. Our total revenues grew 17.3%, when we remove the revenue related to Wright, we grew the top line by 6.6%. We believe showing our results without an acquired company provides a clearer picture of the comparative financial performance. Our pre-tax income, excluding Wright, grew by 7.1%, even with the increased interest costs related to the bonds. I'll talk more about our run rate on debt later in my presentation. Our employee compensation and benefit costs as a percentage of revenue are running slightly below 50%. As a reminder, in the third quarter of last year, we recognized $1.3 million of one-time cost associated with a large acquisition that did not occur.
This year, we had a true-up of our healthcare reserve that resulted in a benefit of $1.1 million. These two combined resulted in a $2.4 million swing year-over-year. If both items were removed from the applicable year, our margins would be substantially flat year-over-year. We have a very disciplined approach to profitable revenue growth, from an EBITDAC perspective, we delivered good flow-through with an increase of 7.5% versus the 6.6% revenue increase. Our earnings per share increased to $0.47 in the third quarter, which was a $0.04 or 7.7% improvement over the prior year when Wright is excluded. With our share repurchases in the second and third quarters, we've been able to keep our weighted average shares constant, there was no dilution.
In the fourth quarter, we'll get the full effect of the $50 million accelerated share repurchase program we commenced in Q3 and finalized in Q4. As we said previously, not every quarter will show margin expansion, as we'll make investments at certain times to help grow the business. Our goal is to grow our business organically and profitably. Moving over to slide seven, I'd like to highlight the key components of our revenue performance for the quarter. Our total revenue increased by $62 million year-over-year, or 17.3%. A large portion of this growth came from the net acquisitions and dispositions. The largest component was the Wright acquisition. We also realized a $1.2 million increase related to contingents and guaranteed supplemental commissions, which were primarily driven by our wholesale division. Our as-reported EBITDAC margin increased to 35.1% from 33.7% in 2013.
Similar to the organic revenue analysis, we adjusted for Wright in order to arrive at comparative numbers. On an adjusted basis, our EBITDAC margin improved 30 basis points from 33.7% in 2013 to 34% in 2014. Moving to slide eight, let me talk a little bit more detail about each of our divisions. Our retail division delivered 5.1% growth, partially driven by acquisitions completed within the last 12 months, and our underlying organic growth was 2.1%. Our year-over-year EBITDAC margin declined slightly by 30 basis points, which was driven by the investment in new teammates, these we mentioned during the second quarter, and non-recurring facility lease exit costs. Excluding the lease exit costs, our margins would be substantially flat for the quarter. On page nine, our National Programs Division. Revenues grew by 49.7%, mainly due to the acquisition of Wright, and increased 2% organically.
We are continuing to see improvements in the marketplace and more carriers are interested in our niche programs as an alternative approach to addressing market needs. During the quarter, we also had some renewals for certain programs that moved to the fourth quarter. If these were renewed in the third quarter, our organic growth rate would have been slightly over 3%. We realized good margin expansion on an as-reported basis with a 250 basis point improvement, mainly related to Wright. When adjusting for the effect of Wright, the adjusted EBITDAC margin decreased by 20 basis points. The slight decrease is related to the timing of the renewals I previously noted. Please note that the 20.1% decrease in pre-tax margin is related to the intercompany interest charges and the increased amortization and depreciation related to the Wright acquisition. As a reminder, intercompany interest charges are eliminated in our consolidated numbers.
Moving to page 10, our wholesale division had another strong quarter, reporting revenue growth of 12.6% and organic growth of 7.7%. The EBITDAC margin decreased slightly, driven by the investment in new teammates, along with year-over-year unfavorable movement and foreign currency translation related to Decus, our London broker. We've realized FX gains or losses in previous quarters and years when there has been a material movement in the sterling to dollar rate. Excluding the FX impact, margins for this division would be up slightly. For the services division on page 11, it delivered organic growth of 2.1%. We realized growth from our USIS and NuQuest businesses as both businesses have added new customers over the past year. We also experienced a decline in our claims processing businesses of Colonial and ICA, as there were no significant weather-related events to create processing revenues.
We also continue to face headwinds within our Social Security and disability advocacy business. While we have good incoming volumes, there has been a continued slowdown in processing by the federal government. From an income before income taxes and EBITDAC perspective, it really comes down to the lack of significant weather-related events and their impact on several of our TPAs. Moving over to page 12. Now that we've reviewed our financials, let me shift gears and talk a little bit more about our capital evolution. The issuance of our bonds was the next phase in our debt structure after establishing our credit facility in the second quarter. We're proud to report that the inaugural 10-year public bonds we issued during the quarter received investment grade ratings from S&P and Moody's. We're very pleased with the results and the corresponding coupon of 4.2%.
The proceeds of the bonds were used to pay off the $475 million we had drawn on our revolving credit facility. This results in our revised weighted average cost of debt to be approximately 3%. Our new quarterly run rate for interest expense will be approximately $10 million, barring any future use of the revolver. Moving to slide 13, in transitioning to the equity component of our capital structure, we initiated a $50 million accelerated share repurchase program during the quarter as part of the $200 million plan announced early in the third quarter. A total of approximately 1.3 million shares were purchased at the time of commencing the program. This initial program was completed in October with the final share settlement of approximately 240,000, for a total program purchase of 1.5 million shares. We'll get the full impact of these purchases in the fourth quarter's weighted average share calculation.
Looking at the possibility of future purchases, these will be assessed and evaluated against internal and external investments. With our objective around our capital deployment strategy to be the optimization of shareholder returns, we do expect continued purchasing of shares in order to minimize the impact of share creep related to our stock incentive plans. On slide 14, in the second quarter, we provided ranges of where we expect Wright to perform. We are very pleased to report that the performance of each of the businesses are in line with our expectations for the quarter. As a reminder, in the second quarter, we mentioned that the forecast included $7.5 million of revenues related to catastrophic events. This was based upon the 10-year average, excluding Hurricane Katrina and Superstorm Sandy. As we mentioned, in some years, the actual results will be higher or lower than the average.
Unless there is an unusual storm, it looks like 2014 will be one of those years that will be below the average. We want to let you know that this estimated revenue is budgeted to hit substantially in the fourth quarter due to the historical timing of when the significant events occur, which is normally in the third quarter. Given the fact there have been no significant events during the peak hurricane season, cat revenues will more than likely decrease about $6 million in the fourth quarter, and this will equate to about a 2% impact on earnings per share. Please take this into consideration when updating your Q4 models. With that, Powell, let me turn it back over to you for closing comments.
Thanks, Andy, for a great report. In closing, we have a good pipeline of acquisitions, and we look forward to continuing those discussions with all of them. We are pleased with the strategic positioning across all of our divisions and continue to add new teammates that will drive the business forward. With that, I would like to turn it back over to Deanna, and we will open it up to questions.
Thank you, sir. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, star one for questions. We will go first to Elyse Greenspan with Wells Fargo.
Hi, good morning.
Good morning, Elyse.
I was hoping to first start, I guess, spending a little bit more time on the organic revenue growth target, the 4%, and what really changed, I guess, this quarter to cause you to think that you might not hit that target for the full year. I know just the combination of the rating environment and the slower pickup in the middle market economy. Is that something that you saw that specifically changed in the third quarter or just maybe a build up throughout the whole year? Just some more details on what you're seeing there that caused you to become a little bit, I guess, more pessimistic this quarter.
Yeah, Elyse, I would tell you, I think the thing I would point to is what we see or anticipate is the lack of significant weather event related revenue in the fourth quarter. We watch with interest as the market softens or whatever it's doing. We obviously are a reflection of the middle market economy. If you ask Andy or myself, the first thing that we would point to would be that revenue, which, as Andy said, when we look at some of these claims administration businesses, we have historically looked at them on six or 10 year averages, most of the time 10 year averages, excluding significant events like Superstorm Sandy and Hurricane Katrina. That's the thing that I would point to, as Andy called out in his report.
We continue to see certain areas of the country that are doing really well, and you mirror that with other areas that are not doing as well. An example would be, if you go to Miami right now, there's an unbelievable number of cranes in the air building new condo towers, and you go 80 or 90 miles across the state to Naples, and it's very slow from an economic standpoint. That's what we'd point to, Elyse.
Okay. In terms of, I guess, the slowdown or the lower weather related revenues, that doesn't really have an impact on the retail segment as much. Would you say, I guess, the about 2%, 2.1% growth you saw this quarter, that's about tracking with where you had in mind? Or is that also a little bit slower?
Well, remember, we haven't given organic growth guidance on retail. We've said that we think it's a low to mid single digit organic growth business, and we are always striving to grow our business organically more. I think that, as we've said historically, there will be quarters where there will be ups and/or conversely, there could be slight downs. I don't think that one quarter creates a trend. If you think about it, we've had a little movement in that space over the year, but we are continuing to work on growing it more quickly as we move forward.
Okay. In terms of the acquisition, just on the deal front, we've seen a little bit of a slowdown as of late. Is that more of a function of the size of deals in the market, the potential price associated, multiples associated with deals? Just in terms of how you balance your capital with the $200 million repurchase program, could we potentially see repurchases pick up if, in fact, we continue to see a slowdown on the acquisition front?
You're correct in saying we did not close an acquisition in the third quarter, and we've done about $147 million of annualized revenue year to date. That said, I always think that why and when people sell, there's a whole multitude of reasons for that. We are always in the market talking with people, and whether it happens in Q3, Q4, or ever for that matter, is ultimately dependent on if we can come to some sort of mutually agreeable terms and conditions and a purchase price that will work for both of us. I think that there's lots of activity in the marketplace, Elyse. That does not mean that we're consummating lots of transactions, but there seems to be lots of activity. As we've talked about in the past, I believe that that is driven particularly by a desire for firms to acquire businesses.
Some of those are backed by private equity, which some of those models are driven by very low interest rates, they're able to pay significantly high multiples. As it relates to your question around the share repurchases, we've said, and as Andy said in his presentation, that we will continue to evaluate a share repurchase versus our other options. We have that. It's a little bit like an arrow in our quiver. You've heard Andy and myself say that in our strategy in terms of growing our business, there are really three components. One is internal investment in new teammates and growing the business organically. Two, external investments. Three, returning it to shareholders, which is historically through either, one, dividend increases, which we've been very pleased about, and/or share repurchase, which we've done the $25 million plus the $50 million so far this year.
We will continue to keep our eyes on that. We are not saying categorically that it's going to happen. We will continue to evaluate the options that exist in the other two buckets to see if and/or when we might do something like that.
Okay. Thank you very much.
Sure.
Thank you. We'll take our next question from Dan Farrell of Sterne Agee.
Thank you. Good morning.
Dan, good morning.
Good morning. Just a question on expenses and margins. I think you said that if you adjusted for Wright and then also some comparison issues in both quarters, that would be closer to a flattish margin. I guess my question is, you've talked about step investments that you might be making into various parts of the business. I wonder if there's any particular ones that you might be able to highlight this quarter. Then as we think longer term, I think you've talked about still wanting to be able to show moderate margin growth even as you do these investments. Is that something that you still think is achievable at the current organic growth rates? Thank you.
Okay. Good morning, Dan. Let me take the first one around the expenses. If you recall, in the second quarter, we talked about areas where we were investing in new teammates, and we had called it areas such as our new cybersecurity practice, our M&A, our Zoom product. Within wholesale, Anthony Strianese has been adding new teammates in there to grow the investment. Those are the areas where we're primarily investing right now internally at this stage. With those, though, when we bring on new teammates, they don't pay off in the first quarter. We got to bring them on board. They need a chance to start to build a book. We'll see those in the out quarters on the flow-through from both revenue and down to operating profit.
Dan, to the second question about growth in margins or organic growth, and I know that you and others have wanted us to say at what point do you have margin expansion when you have organic growth? What we've said is when we have organic growth, we can have margin expansion that is dependent upon the investments that we're making in the business. I want everybody to understand that I'm very comfortable of where we are relative to the profitability of our company. What I mean by that is we are trying to have a healthy balance between organic growth and profitability. As you know, we have the industry-leading margins and free cash generation on those dollars generated, something that we're really proud of.
I'm not trying to be vague so much as to say that we have 7,700 teammates at Brown & Brown, and in order to get to our $2 billion goal, we believe we're going to have to hire or acquire roughly 3,000 additional teammates. We are doing this, as you know, for the long term. We are thinking around when we find somebody that we think is that talented, we've got to get them on our team, and there might be a short-term impact for a long-term gain. That's the way we're looking at it.
Dan, for clarification on that, the $2 billion that Powell talks about, that's our intermediate goal. That doesn't mean that's our endpoint.
Yeah.
Okay. Thank you very much, guys.
Yeah. Thanks, Dan.
Thank you.
Thank you. We'll take our next question from John Campbell of Stephens Inc.
Hey, good morning, Powell and Andy.
Good morning, John.
Hey, John.
Hey, if you guys could just run back through your foreign exchange risk or just the exposure in wholesale. Just want to make sure we got a good grip on that going forward.
Yeah, perfect. John, our Decus operations over there are U.S. dollar denominated. Whenever there's any change in FX, all of that flows through our P&L. A lot of it depends upon the materiality in rate changes on a quarterly basis. In this case, we had a fair movement in the dollar to sterling. Last year, we had it in Q1. It does kind of ebb and flow back and forth.
That was a positive, though, last year.
No, Q1 of last year was a negative.
Oh, yeah.
It was $800,000 of a negative in Q1 of last year. It does move back and forth. In the last couple of quarters, it hasn't been that material to us. This one, we had a little bit more of a spike in the rate.
Got it. Maybe could you just walk through what the rate environment looks like for wholesale in the U.K.?
Well, you're talking about Our international business in London is actually riding North American business primarily.
Got it.
When we talk about the wholesale rates, and we talk about cat property, we talk about liability, and professional lines, that would include that.
Got it. That makes sense.
Yeah.
On contingent commissions, just the lack of losses this year, could you guys just kind of point us in the direction where you kind of expect that to go throughout the next two or three quarters?
Remember, we recognized in Q1 of this year the FIU contingency, we don't believe that there will be any contingencies. We're checking on that, so let's be careful of that. There might be some, but we don't think that's the case. Do you have an estimate on Q4 contingencies from a historic perspective?
Well, we had FIU in Q3.
That was it.
Of last year. On this one, John, and I think we've talked about this on previous quarters, is around the contingents and GSC. It's not something that we have or that we give any guidance for into the future, just because not all of those we can control because they're based on loss activity.
Sure. That makes sense. Thanks for taking our questions, guys.
Yeah, no problem. Thanks.
Thank you. We'll go next to Kai Pan of Morgan Stanley.
Good morning, guys.
Good morning.
Hi.
Drill down a little bit on the organic growth on the two segments. First, on National Programs, it looks like 2% or 3%, depending on the timing. Just wonder underneath that, do you have a breakdown what Arrowhead is growing at? How do you think, what's the business going forward, essentially, in terms of organic growth? I believe before the part of business Arrowhead was growing like 5%-6%. Does it mean that the business is slowing down to low single digits as well?
Okay. We don't break out now the growth specifically related to Arrowhead. As we said last quarter, effective 7/1, all of the programs across the country now report to Chris Walker. There are a team of leaders that are there, not only in San Diego, but around the country that run those businesses in the program space. We've not specifically said, relative to the growth of Arrowhead or to the program space. We haven't given that growth guidance, but we've said that there is, as an organization, we believe our business grows at low to mid-single digits. Some programs, as you know, will be performing well and at some times, and other times there will be programs that will be slow or being impacted by something with another competitor in that particular space, over that period of time.
We're very pleased with how our Programs division is performing, and specifically the leaders that run those businesses, which enable us to either expand the existing programs or create new programs going forward.
That's great. On the wholesale side, it looks like your market commentary looks like pricing is flat to down, yet the organic growth is pretty strong and close to 8%. Could you talk a little bit more about that? Is that you are gaining accounts or gaining shares?
Sure. Remember, we have two sides of our brokerage or our wholesale business, as you know. The binding authority business, and those are premiums that might average $3,000 to $4,000 in premium. The individual production underwriters in that part of the space are writing lots and lots, and lots, and lots of accounts. Then in the brokerage space, whether it be property liability or professional liability, let's just use property since we're here in Florida. When you see that, you have, as we've talked about, there's a lot of interest in large catastrophic property accounts, and the bigger the account, the more attention it gains. So carriers are very focused on trying to write some of those bigger accounts, so there's more pricing pressure on those.
So what we're trying to do, as either in the binding authority space or the brokerage space, is to be the solution provider of choice to our clients. So what that means is we've got all kinds of inventory that we're trying to manage for our retail clients all over the place. In that, we are writing a lot of that business. So as you've seen, the organic growth rate is down slightly from the prior quarter in that space. I do think that that's as a result of continued downward pressure on rates. It's something that we watch carefully. That space has grown very nicely over the last several quarters. I will point out, the wholesale arena is an arena where you have more, I would say, vicious swings typically in rates.
So they could be high or low, and that impacts higher or much higher or much lower than maybe the overall retail market, which in turn exacerbates organic growth, either growth or shrinkage, when it gets really competitive. That's how we see it.
Okay. That's a great counter. Lastly, on the sort of like if you just step back a little bit and think about the pricing cycle we're in right now, if this environment is basically for the broker competition, do you think there'll be more competition or actually good for you because the market sort of carriers need to access the market or get business?
Okay. What I would say is this. Number one, there's about $680 billion of surplus now in a marketplace that writes less than $500 billion of premium. That in and of itself, in my mind, means there's basically, simply stated, there's more surplus than premium. Therefore, there's going to continue to be downward pressure on rates. We're seeing rate increases either moderate or flatten. I think that if you want to speculate a little bit, I think that rates into next year, across the board, if I were to give an indication of kind of what I've heard in talking with our carrier partners and just the gut instinct, I think we're going to see rates slightly negative in 2015.
Particularly depending on the second half of the year with catastrophic events, meaning if there's not a hurricane that occurs somewhere in the coastal areas of the U.S., that'll probably also make that speed up a little bit. I'm saying maybe 0%-5%. Also, as you know, at the end of every year, there are some companies that become overly aggressive in the fourth quarter. I do not anticipate this year to be any different. As people are looking at their goals and their premium commitments. Depending on how they're looking at their business, some may get more aggressive than others in the fourth quarter. All of that, in my mind, is a positive for our clients, because as you know, we're trying to provide the best coverage for the most competitive price for our clients.
Having said that, I watch, and we watch carefully, the economy and the rates. I tell people that we have seen scenarios where rates are down 3%, 5%, 7%, 9% before, and we can grow the business organically. Slightly, but organically. We're not to that level yet, and we'll watch with great interest, and we'll see.
Thank you so much.
Thank you.
Thank you. We'll go next to Meyer Shields of KBW.
Thanks. Good morning.
Hey, Meyer.
How are you?
Morning, Meyer. Good.
Just a couple of smallish detail questions, I guess.
Powell, you mentioned that you need to add about 3,000 new teammates. Do you have a timeframe for that? Can you give us an update in terms of how many of those have already been added to the roster?
Okay. No, we haven't set a specific timeframe. If our only goal was to get to $2 billion in revenue, which it's not, but if that were the goal, we could've done that last week, last month, or last year. That would not have been the appropriate thing to do on behalf of our shareholders, and we wouldn't do that. Having said that, the number that I gave you, right now, our total number of teammates is about 77 and change. I think it's like 7,762 was the last number I saw. When I said 3,000 teammates, I usually have said that around 7,600 teammates. I think we're going to probably have somewhere between 10,500 and 10,700. It's not something where we're keeping track necessarily of so-called the teammate specific.
It's more as a result of the revenue, whether as we grow it organically or we acquire it along the way. I wouldn't want you to focus so much on the teammate piece, which is the most important piece, but the number of teammates, I'd rather you be focused on, and you're going to know about it when we get there, but when we get to our intermediate goal of $2 billion in revenue, we're going to set another goal, and we'll go forward from there.
Yeah. Meyer, I'd probably add to that. The backdrop, and you've probably heard it in comments from both Powell and myself, is our goal is we want to make sure we grow the business profitably and organically. We're going to feather in the new teammates as most appropriate for each of the businesses. We're going to monitor those very closely. We look at every one of our investments. We look at the markets that we play in, the rates, and the opportunities. I think keep that as your backdrop as to how you think about our investment in the people.
Okay. That's helpful.
Okay, perfect.
I think, Andy, you mentioned that there's a $1.1 million medical reserve adjustment. Which segment or segments was that in?
Yeah. That's across the board. That's for all of our teammates, Meyer. What we did in the third quarter was we had some true-up with our outside actuaries, and we do this generally on a regular basis, normally once a year, just making sure where we are on loss runs and everything. That's spread across all groups. In this case, we recorded at the corporate level for the quarter.
Okay. Got it.
Yeah.
Lastly, the timing issues with regard to the program revenues.
Are the expenses also, I don't know if deferred is the right word, but are those going to show up in the fourth quarter, or are those there in the third quarter?
No, they were there in the third quarter. These were, again, just a group of accounts that were scheduled to renew in the third quarter, and for budgeting reasons, they wanted to move them to the fourth quarter. It's just a shifting of revenue. The cost is still the same where it was. That's why, as I mentioned, the impact on the margins.
Right. Okay, perfect.
Yeah.
Thanks, Powell.
Thank you.
You bet. Thank you.
Thank you. We'll take our next question from Mark Hughes of SunTrust.
Yeah, thank you very much.
Hey, Mark.
Morning.
Good morning. The $6 million, $0.02 in EPS. Andy, how did you frame that? Was that relative to the long-term trend in terms of claims, or was that relative to last year? How do we think about that?
Yeah, Mark. A good way to think about it is we said we had $7.5 million in our forecast originally for revenues related to weather events. That was our 10-year average when we excluded Hurricane Katrina as well as Superstorm Sandy. When we look at the fact there's been no storms during the third quarter, that takes out a significant portion of that in the back end of the year. That $7.5 million will drop by just about $6 million, somewhere right in that range, and the flow-through effect on it will be about $0.02 on EPS.
Is that to say most of that, all of that would've been expected in the fourth quarter?
Yeah, almost all of it in the fourth quarter. Just historically, the way it works, Mark, is hurricane season is June through November, but the prime season is the third quarter. There's normally a 60 to 90-day lag from when the storm occurs and when revenues flow. You'll normally see a spike if we're ever going to have it in the fourth quarter.
Right.
Yeah.
Okay. Then one other question. Any way to quantify how much growth you've seen in the backlog in the Social Security disability applications? Is the merit of those applications, the quality of the applications, do you think, as good as what you've seen historically? Then any outlook for the pace of the government handle those. Is that going to pick up anytime soon? What do you think?
Okay. Mark, what I would say is, we believe that the quality of the opportunities are as good as we've had in the past. The analogy that I will give you is kind of an unusual one. If you have a visual of a large snake eating a wild boar, you know that it is barely getting it through the mouth, and there's a place as it's trying to digest this animal to get it into the flow. There's this place which is holding up that animal from passing through for a period of time. That's how we describe it internally relative to the government. There is this hold up. Apparently, as history would have it, this goes in kind of waves.
Some people would say, "Well, sequestration impacted the business, meaning the government, they had people retiring, they didn't hire a number of people back, i.e., 2,000 to 3,000 people. Until they hire those people back, they won't be able to process the same number of claims at the same pace." I would say that that sounds nice, but I don't believe it till I see it. I think it's more of a trend. We have not seen anything at the present time that would lead us to believe that they're going to be processing more claims in the near term.
Once again, the way I look at it is, if you remember the analogy, if you think of the wild boar in the mouth of the snake, at some point that starts to break down, starts to pass along in the snake. We feel good about the opportunities that it presents, but it also, we continue to have to service it and incur costs on the front end without receiving revenue, the corresponding revenue, on the front end. There is a backlog of that, and I wish we had better transparency for it, and I could say categorically, but unfortunately, it's our government model of efficiency relative to that particular thing.
Mark, to your question about quality incoming is, no, we're not seeing any changes in the quality of that. Maybe your question is going to is that the reason why the revenue's down, they're not being approved? No, that's not the case. This is only how much can we get through the funnel right now.
The snake.
Yep. Or also known as the snake.
The snake, yeah.
Thank you. I appreciate the snake analogy.
I thought you'd like that, Mark. Did you have another question, Mark?
I did not. Thank you.
All right. Thank you.
Thank you.
Thank you. We'll go next to Adam Klauber of William Blair.
Thanks. Good morning, everyone.
Good morning.
Just a couple different questions. In the retail, how's Beecher doing?
Well, our retail business, it's all Brown & Brown, and everybody's doing fine. As I said, sometimes we grow it as quickly as we want, and sometimes we don't. Like I said, we are pleased with the overall performance of all of our retail operations.
Okay. On the program side, excluding obviously the Zurich and some of the other transactions last year, is the drop in organic, is that mainly property related, would you say?
Actually, there is a component of it that is property related, but I would say it is not exclusive to that.
Okay. Could you give us just some idea, I guess, Just generally, not look for exact numbers, but generally, what are some of the other factors that are, I guess, impacting that?
Okay. Just think about the same concept, Adam, that we talked about earlier, relative to some of the questions on the market. If you have standard markets, admitted markets on one-off basis, periodically as rates may mitigate or even go negative periodically, you might get a market in a particular area in a class of business that would become as competitive or even potentially more competitive than an existing program for a short period of time. What I mean by that is it's conceivable whether you have a social services account or you have a professional liability account or you have an earthquake account or you have a wind account, a property account with wind. Any one of those programs could actually have an individual one-off account that would become more competitive than the program.
That retail agent could be placing it directly with one of their markets. Their commission, retained commission, would be higher. Usually, it would be 15% rather than maybe 10% retained. Usually, when the market goes below the programs for an extended period of time, there will be a correction. This is not something that's new. It's just maybe a little bit exacerbated by the fact that we talked about the surplus to premium ratio, we're getting into the second half of the year, and some carriers sometimes get a little more aggressive in the second half, most notably in the fourth quarter.
Okay. That's very helpful.
The service, the claims area, will the lack of CATs in the third quarter, will that impact the fourth quarter also for that division?
That actually is what Andy's talking about, that $6 million-
Oh, that's for that, okay.
Yeah, that's the fourth quarter. Yes. The answer is yes.
Okay.
Adam, on that, the $6 million is on the CAT component. We'll see also effects within our Colonial Claims business and probably a bit inside of-
ICA
our other ICA and ACM. There is a ripple effect through the business. Primary would be over in Wright.
Okay, thanks for the clarification.
Yeah, no problem.
Then how is the benefit business doing? Could you just give some idea compared to overall Retail? Is that doing better or worse?
Right. We don't break out the organic growth of employee benefits. As you know, Adam, it's a $250 million business roughly for us now. We write from small group all the way to very large group. We continue to see, as some of the mandates come down, interesting opportunities that are created there. We are writing lots of new business in our benefits operations. Part of that is our ability to navigate and clearly articulate the nuances of ACA. We don't break it out rather than our Retail. It's just part of the Retail Division.
Okay. Well, that color is helpful. Thank you very much.
Thank you, Adam.
Thank you. We'll take our next question from Ken Billingsley of Compass Point.
Good morning. Just had a few follow-up questions to some earlier answers. Regarding M&A deals and what you're looking at, has your appetite for deal size changed at all, again, large maybe versus smaller deals, given where you think premium rates are moving towards? Also how you look at funding them, has that changed given the low interest rate environment?
Okay. Ken, relative to what we're looking at, no, our view hasn't changed relative to those businesses that fit culturally that we can come to a financial transaction that we can agree to. We're looking to do fold-ins into existing offices. We're looking to do standalone operations. Periodically, we've been given the opportunity to buy a larger operation, whether it be Arrowhead, Beecher, or Wright. I would tell you this, if there is a so-called difference, I know we've been asked this question a number of times over the quarters, the only difference really in our mind is we have considered and subsequently done these three larger acquisitions. The analysis of the people, the way they work with the sellers, the way they treat their teammates, the way they treat their clients, how they interface with our carrier partners has not changed.
We are looking to invest across the spectrum. As I've said before, the price of poker, particularly on larger transactions, continues to have upward pressure on it. There's a point at which it doesn't make financial sense. I would say that is the first part. The second part of your question was again?
Yeah. Ken, this was around terms or structuring of the deals.
Financing.
The financing of those. I guess what we've seen over the recent past is the terms of the deals are becoming probably more aggressive than what they historically have been. That's really due to the fact that many of the businesses, they have some sort of advisor wrapped around them. They've either got a business advisor, they've got an investment banker or financial advisor, whatever. They're helping to influence that price of poker that Powell talks about in there. I think what we see now is there's more pressure to ask for more money up front than what we have in the past. We try to balance that off with earn-outs on the back end. At the end of the day, we're going to still make sure that we do the right trade-off. We're not paying $1.00 on the dollar up front.
We won't take on that type of risk. We balance these through all of them. We haven't fundamentally changed how we do our deals, how we structure them, or how we pay for them. We like to pay for things in cash. We don't pay for things in stock. We think we've got adequate capital out there when and if the right deal comes along.
To be specific, the opportunity could be, one, financed through cash from operations as we look at it, we generate our free cash. Two, we use our revolver, which is now paid down to zero, which is $800 million.
On that, given the low interest rate environment, do you see yourself using that revolver and whether it's for stock buybacks or deals, whichever become available and are attractive, then essentially paying that revolver down so you can reload it?
Yeah, we don't look at the revolver as a permanent source of financing. I think it's a pay it down once we use it.
Okay. Very good.
Ken, hold on a second. Ken, I want to clarify something, though. You asked about would we use the revolver for stock buybacks. We wouldn't say never, but that would be extremely unlikely that we would do a levered stock buyback in all of it. Our goal is to make sure that when we're evaluating the deployment of our capital, we do the right thing for our shareholders, which includes all of us as teammates and balancing off of there. We do want to make sure it's got good cash flow. As Powell said, we want to use that as a spring up and down but not permanent capital for the organization.
Great. Thank you.
Okay.
One other question I have is on the pricing commentary and given where you expect it to go. From a growth standpoint, how many of your customers would you say are under-insured at this point in the cycle, and that they may use any continued price weakness to maybe buy more coverage that they may have given up over prior years?
Well, Ken, I think that under-insured would be it might be different in the eyes of the purchaser and us. What I would say is this. Remember, we're in the solutions business, we're trying to present our clients with solutions to the risks that they have. Some of those they may decide to self-insure. As long as they're comfortable and knowledgeable that they have that exposure, that's a separate issue as opposed to not recognizing the exposure and then potentially having an uncovered loss, and they weren't even aware of it. As it relates to where I think you're going, uptick in purchasing, we talk about that carefully internally, the reason I say that is this. When we're talking to our clients, we're thinking about property and casualty, we're thinking about employee benefits, we're thinking about personal lines.
We may only handle one of those three for a client at the present time. Whether the market cycle is up, down, or sideways, we're always trying to think about how we can continue to sell more products and services to our clients to benefit them. I wouldn't say it's more uptake. I just think it's more filling out needs that they may have that we may be capable of solving for them.
Well, maybe another way to ask that, based on your answer, is how many of them have self-insured some of that risk that identified that how low will pricing have to go before it may make sense for some of them to go back and not self-insure that risk?
I would say, I don't know the answer. It's more because it's client by client, and we don't have it tracked where it says we have 8,000 clients that don't buy umbrellas. On a very local level, our leaders and our sales teammates are talking with clients all the time, but I can't quantify the question as you've asked it.
I understand. The last question I have, this is just to clarify your comment on the employee numbers. You may hate that you actually gave that number out because my question is, you said you had about 7,700 employees now and just annualized revenue number of about $1.6 billion, and you say you're going to need approximately 3,000 more to get to the $2 billion in revenue. Can you explain, maybe I'm just misunderstanding, essentially, you're going to need to increase almost 50% just to get another $400 million in revenue? I mean, am I reading that right?
Well, what I would say is this. If you think about it, we right now are in the trailing. We are generating about $200,000 of revenue per employee. Okay? Over that, but let's just say roughly. If you look at the larger firms that might be similar in terms of business mix, that number typically looks around 185,000 to 200,000 per employee. If you want to be technical, if you take $2 billion and you divide it by 185,000 or 190,000, that's probably the number of people in a steady state environment that we'll need at $2 billion of revenue. Having said that, there may be some businesses that we are in that need more people, and there may be some that need less people.
Yeah.
That's how I would say it.
Okay.
Yeah. Ken, I think just one thing about that, when Powell talks about that 3,000, that's a gross basis. That's how many new teammates we need to attract to bring into the organization over the coming years. We will have retirements out of the organization. We'll have attrition inside of there. That gets back to we're going to look at it from a net basis and make sure that we're growing the business profitably. It does give you an idea of how many new teammates we have to attract.
Let me make one comment, Ken, so we know. I just use that number because it shows, I believe, to you and everybody else the order of magnitude that we're talking about.
Yes.
We think of our business. We're not just thinking about next quarter or next year. We're thinking about what it looks like when we have 10,000 teammates or when we have 15,000 teammates. It's something that we're trying to get our arms around in a way that would be meaningful. That's how we came up with that number. That is not a science. I haven't come up with that and said, specifically, "Here it is. Oh, by the way." That was sort of a gut feel based on kind of knowing what I know about our business.
Excellent. Well, thank you for taking my questions.
Yeah.
Sure. Thanks, Ken.
Thank you. We'll go next to Sean Dargan of Macquarie.
Thanks. Good morning. I have one housekeeping question about non-cash stock-based comp. I think last quarter you suggested that it would be in a range of $6 million-$7 million going forward. It was a little light of that this quarter. How should we think of that going forward?
Yeah. That run rate, and we talked about this back at the second quarter earnings, Sean, is that really drives based upon the number of participants that we have in the plan. That run rate right now is still probably a pretty good run rate at this stage. We normally will grant new equity in Q1 for any new teammate, so we'd expect to see an uptick in that next year a little bit.
Okay.
Historical flow.
Yeah. Remember, I just want to clarify one thing. The last large grant that we gave across the board was in July of last year.
Okay.
That, in recollection, seemed to catch some people off guard, and we will continue to give good clarity around when and if we're going to do another large grant. When Andy says that the new people, we're not talking about a full-scale reload of everybody. That's not what we're talking about. We're talking about people that qualify to get into the program. That's a separate issue. Just a distinction there because it is very important.
Yeah. The January of 2015 would probably be very similar to our January of 2014 on it, Sean. Call it a BAU approach.
Okay. Thank you very much.
Sure.
Thank you. We'll go next to Mark Dwelle of RBC Capital Markets.
Just one small clarification on the guidance you gave related to the quarterly interest run rate. When I multiply back 3.07% through the amount of debt that you've got outstanding right now, I get a little bit lower run rate, closer to more like $9 million. Do you factor in some amortization or other, just something else that's in that figure?
No. We can follow up afterwards just to make sure. On that blended, we should be right around $10 million on run rate. Right now, we're running just shy of $10 million on it, Mark.
Okay. We can follow up offline then.
Yeah, we can follow up offline just to make sure that the math syncs. We go through it, we track it by every one of the issuances that are out there. We know exactly what it is.
Okay.
It's a good number.
All right. That's all my questions then. Thanks.
Sure.
Thanks, Mark. Thank you.
Thank you. We'll go next to Joshua Shanker of Deutsche Bank.
Yeah. Good morning, gentlemen.
Morning.
Morning.
Good morning. I noticed obviously that some of your peers, or maybe you don't think of them as your peers, are growing faster than you are, but you have much better margins. If you thought about the entire pool of available commission fees out there that's in your wheelhouse, is the margin on the overall business staying the same, getting greater, getting smaller? Does your growth in that situation mean, over the long term, for you to sustain your margin implies you will not grow as fast as your competitors?
Well, let's go back. The first part of the question is this: ultimately, one of the reasons that we believe that we have a different margin profile, and thus free cash flow generation profile, is because of the disciplined operating approach that we have run our business by for years and years and years, really started by my father. Number one. That does not mean that there aren't other firms that run good margin businesses that are typically private, that you might not have direct visibility into yourself, and we would only when we probably have a chance to buy them or talk to them seriously about that. If you look at it, to your point, Josh, we have been typically a slightly slower growth business on the top line, but our margin has been sometimes more than 100% higher than the publicly traded peers.
Everybody has a different profile, but if you're putting us in with the other publicly traded brokers, we think about it from a standpoint of how can we continue to generate more free cash to reinvest in our three segments of the business that we've talked about earlier. We want to grow our business organically and profitably, and we're not going to sacrifice and do something that is a very low margin in the short term or the long term to do that. We're building it, and we're a built-to-last company, and we're focused on that.
Josh?
Yes.
If I can, let me see if I can clarify a couple other things. One of the things that I guess probably worth everybody taking a look at is definition around organic growth. There's, I think, a few of us in the marketplace that lay it out quite clearly exactly how we calculate organic. That's probably good for apples to apples. Then when you look at it's important you take which businesses are inside of there. As an example, I think when Gallagher reports their brokerage revenue, they combine retail and wholesale together, right? We've had that question in the past as well, "Why isn't your retail growing as fast as theirs?" Well, put ours together, now you've got apples to apples. I'd leave that one for you.
Two is, I think BB&T just came out with their earnings last week and reported, I think, about 9.5% on what they call like sales. What's hard to tell underneath of there, and you guys can do your research on it, is if that's true organic the way that the rest of us define it, don't know. That's to leave it for you guys that are out there. What we do know is there were a couple acquisitions that they made during the second quarter, and it's not clear how they're broken out. I just want to caution you that when we do this or when you guys ask the question, please make sure it's on comparative, if you would.
Well, that sounds very reasonable. Just coming back to the main point, do you think if you compare the industry to where it was five years ago, the margin profile of this industry is similar to where it was or has anything really changed?
I think that I would say that as a general statement that businesses across the board are better run as a whole today than they were five and 10 years ago. I might say that we have seen an uptick in the overall operating efficiency. That said, that is very firm specific, and it could be location specific within the firm specific. You could have offices in one area of the country and offices in the other, and they might have a different margin profile even though they do the same type of business. Overall, I think they're a little bit better run relative to overall efficiency, but it depends on the organization, and it depends on location.
Okay. Well, thank you for running the call along. I appreciate it.
Yeah.
Yeah. Thanks, Josh. Thanks, Josh.
Our next question comes from Elyse Greenspan of Wells Fargo.
Hi. Thanks. I just had one quick follow-up numbers question. In terms of the Wright, I know you guys pointed out that some of that CAT processing claims about $6 million and $0.02 per share might come off into Q4, I guess, from what you had previously projected.
If we're looking at where you break down by the quarterly EPS impact that you expect from Wright, I guess on slide 14. Now, that says $0.02 in the fourth quarter. Assuming that we lose about that $6 million of revenue, are you assuming that Wright will be about breakeven in the fourth quarter? Is that the right way to look at it?
It is. Yep. Good way to look at it, Elyse.
Okay. Just one last question in terms of, I know you guys do use the Liazon platform for your private healthcare exchange offering for some of your clients. Can you, I guess, provide us some more of an update? Have you seen more of your clients choose that offering over the past year? Has anything kind of changed? I know Towers Watson did acquire Liazon earlier this year. Has anything changed with that relationship? Just kind of if you want to update us on anything that's going on on that front.
Yes, Elyse. Number one, there are more clients that are looking at it as an option. I will tell you that we do have an arrangement with Liazon, but we do also work with some other platforms as well, depending on the area of the country or the office. I would tell you that we believe that private exchange option is an option. That's exactly what it is. It's not necessarily the solution. It is a solution. We're talking all the time with our clients about the possibility of some type of private exchange as they manage their healthcare costs and their offerings to their individual teammates. We think it's going well, and the idea that Towers bought them is they have assured us that they will keep the information separate, and they've assured their other clients that they're going to do the same thing.
We believe them, and we have a contract stating as such. In the event that something changed, then we'd have to evaluate that. We don't anticipate that.
Okay. Thank you very much.
Thanks, Elyse.
Thank you. We have no further questions.
Thank you, Deanna, and thank you everyone for your time today, and we hope that you have a wonderful week and a good quarter, and we'll talk to you next time. Good day.
Thank you.
That does conclude today's conference. Thank you for your participation.