Good morning, and welcome to the Brown & Brown Incorporated earnings conference call. Today's call is being recorded. Please note that certain information discussed during this call, including answers given in response to your questions, may relate to further results and events or otherwise be forward-looking in nature and reflect our current views with respect to future events, including financial performance. Such statements 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, including those risks and uncertainties that have been or will be identified from time to time in the company's reports filed with the Securities and Exchange Commission.
Additional discussions of these and other factors affecting the company's business and prospects are contained in the company's filings with the Securities and Exchange Commission. With that said, I would now like to turn the call over to Mr. Powell Brown, our President and Chief Executive Officer.
Thank you, Rochelle. Good morning, everybody. Our goals in 2012 were to grow organically and incrementally improve quarter-over-quarter. We're pleased with our fourth quarter results of 5.4% internal growth. We had positive organic growth in all four divisions of Brown & Brown. With that, I'll now turn it over to Cory for our financials.
Thanks, Powell. It was a very good quarter. Our net income for the fourth quarter of 2012 of $42.6 million was up 16.8% over the fourth quarter last year. Correspondingly, our net income per share for the quarter was $0.29, and that's 16% up from the $0.25 from last year's fourth quarter. Really more importantly, when you exclude that ridiculous line item change in acquisition earn-out liability, our net income per share for the fourth quarter of 2012 was $0.30 versus $0.23 from last year's fourth quarter, and that's a nice 30.4% increase. From the revenue standpoint, our commissions and fees for the quarter increased 24.4% to $30.3 million. That's up from the $241.4 million in last year's fourth quarter.
Included in our press release, as always, is our normal table that summarizes the total growth rates and the internal growth rates from the core commissions and fees, which excludes profit sharing, continued commissions, and the guaranteed supplemental commissions, the GSCs. We did receive $6.3 million of profit sharing continued commissions, which represents a net increase of approximately a million and a half dollars from the $4.8 million that we received last year's fourth quarter. The vast majority of this net increase was from our FIU operations. Additionally, we accrued $1.9 million of guaranteed supplemental commissions in the fourth quarter, which is $522,000 less than the two and a half million that we accrued last year in the fourth quarter.
Referring to the internal growth schedule, we had a positive internal growth rate of 5.4%, as Powell mentioned. For the fourth quarter of 2012, our total core commissions and fees increased 25.7% or $59.6 million of net additional core commissions and fees. Within that net number was $47 million of acquired revenues. That means that we had $12.7 million more commissions and fees on a same-store sales basis. The real strength of this internal growth is the $7.8 million, of that, $7.8 million of the $12.7 million was generated from our retail division. Our wholesale division continued to have strong new growth with $3 million, which translated into an 8.3% internal growth rate for the fourth quarter.
The services division had an excellent quarter also, and it was primarily due to our flood claims operation, called Colonial Claims. Colonial's internal growth rate was $1.6 million of the division's $1.8 million total. It's important to note that Colonial Claims joined us on December 23rd, 2011. This internal growth rate only reflects the last eight days of 2012. Relative to our Arrowhead's operation, we have treated their entire operation during 2012 as acquired operation, and thus, they are not reflected in our internal growth numbers. On a standalone basis, their internal growth rate for the fourth quarter was 24.1%, but that included four and a half million dollars of new revenues that were generated from the new Zurich Auto Aftermarket program that was started in October.
Excluding the Auto Aftermarket program, their standalone internal growth rate was 6.8%, and this growth came primarily from the Earthquake DIC program, the Personal Property program, and the Workers' Compensation program. Moving on, both our investment income and other income had minimal decreases around $100,000 each. Our pre-tax margin for the fourth quarter of 2012 was 22.9%, and that's compared to our pre-tax margin of 24.5% in the fourth quarter of 2011. When you exclude the line item change in acquisition earn-out payables, the 2012 fourth quarter pre-tax margin is 23.4%, and that compares to 23.3% in last year's fourth quarter. Employee compensation and benefits as a percentage of total revenues was 52.3%.
That's a decrease from the 53.0% cost factor in the fourth quarter last year. The total dollar increase in employee compensation benefits was approximately $29.1 million, of which $23.5 million was attributable to the new standalone acquisitions that we acquired since last year. Therefore, excluding the impact of these standalone acquisitions, we had $5.6 million of additional compensation on a same-store sales basis. Of this increase, $2 million was due to our one-time 2012 producer bonus paid to our retail division's commission producers for the growth of their 2012 production in excess of 5% of their 2011 production. $2.7 million was due to increased salaries of new producers and staff teammates. $800,000 was due to increase in commission expense due to the increased revenues to our commission producers.
$600,000 was due to increased profit center bonuses, another $600,000 was a result of higher matching contributions by the company to our teammates' 401 and profit-sharing plan. If you exclude the standalone acquisitions that were not with the company last year in the fourth quarter, plus that extra $2 million of one-time retail commission producer bonuses, as well as about $622,000 of new salaries for just new producers that we're training, employee compensation benefit cost as a percentage of total revenues, would've been 51.7%, that's a decrease of 1.3 percentage points from the 53% cost factor last year in the fourth quarter. Our non-cash stock-based compensation cost was up on a net basis, $1.6 million. Of course, that was due to the new stock incentive plans, primarily for grants we gave to the new Arrowhead teammates.
In the current year, other operating expenses as a percentage of total revenues increased 70 basis points to 14.9% from 14.2% ratio last year's fourth quarter. From a total dollar perspective, other operating expenses increased $10.4 million or 30.1%. However, if you look at the new standalone acquisitions, they added approximately $10 million of new costs for the quarter. Therefore, our existing same store offices had a slight net increase in their expenses of about $400,000. This increase primarily relates to approximately $1 million in higher inspection and related fees, and costs on just new businesses that we've written. $500,000 was increase in data processing costs. Those costs were then partially offset by about $500,000 lower insurance cost, $400,000 in lower legal and claims expense, another $200,000 in cost savings from occupancy and office rental cost.
Excluding the operations from these new standalone acquisitions, our other operating expenses as a percentage of total revenues actually decreased to 13.7% from the prior year's 14.2% factor. Amortization depreciation in aggregate was $3 million, which was expected from last year's fourth quarter, that's obviously due to new acquisitions. Our interest expense increased $700,000 over the prior year, that's as a result of the increased borrowings from the $200 million we borrowed on the Arrowhead acquisition at the beginning of the year. Our change in estimated acquisition earn-out payable was a debit or an expense of $1,552,000, versus last year we had a credit of $2,862,000. Therefore, the change between last year's fourth quarter and this year, that's $4.4 million of GAAP income, that's almost $0.018.
Our effective tax rate for the entire year of 2012 was right at 40%, but since the final true up of the annual tax rate falls in the fourth quarter, the quarterly tax rate was 38.4%. We do expect that the 2013 annual tax rate to be between 39.5% and 40.5% rate for next year. To conclude, we did have a great finish to a year that was marked by a significant transition in the direction of the U.S. economy and the P&C industry and the insurance agency in general. With that financial overview, I'll turn it back to Powell.
Thank you, Cory. Great report. In retail, we were up 5.6% versus up 1% in Q3. In Florida, specifically South Florida, property business on large habitational accounts are up 5%-10%. Commercial business other than habitational is flat to down slightly. GL is flat to 5% up. Auto is flat, and work comp in Florida effective 1/1 is up 6.8% as an average on the entire book. Exposures in South Florida are flat to up very slightly. You are seeing some large carriers, national carriers pushing for more rate on automobile. Typically, when push comes to shove, it stays pretty flat. We are starting to see habitational projects that were on hold that are now coming back online. Many of those are rental properties. We're seeing them also at builders risk in the wholesale division, which we'll talk about in a little bit.
In the construction area other than habitational in South Florida, there's not a lot of backlog. As we've said, in Central Florida, property is up 5%-10%. GL is flat-ish. Auto is flat to up 10% based on losses. Basically, exposures, both sales, payrolls, and other, are flat to up 5%. In North Florida, property is up 5%-10%. GL is flat to down, everyone wants rate at first, so they quote an increase on GL, and then they move back to flat. Auto is up 2%-5%, and exposures are generally flat. There's a lot more rate pressure on personal lines in the Panhandle now. In the Southeast, excluding Florida, property is typically up 3%-7%. Liability is flat to up 3%. Auto is flat to up 5%. In the automobile area, we're not seeing net new autos.
We're seeing new exchanged for old. That's a common theme across the country. Work comp, depending on the state, is 3%-10% up based on losses. In Louisiana, we're still seeing RMS 11 driving the E&S market north of I-10. Texas is seeing a bit more rate pressure than the entire Southeast, and exposures were up on average about 5%. In the Northeast, property is up 5%-10%. GL is flat to maybe up 6%. Auto is up 2%-5%, and work comp is up 5%-7%. Exposures in the Northeast are typically flat to up very slightly. There's a lot of tough underwriting going on in workers' compensation, not just in the Northeast but around the country. States are seeing a jump in E-mod calculations due to split point rating.
Government contractors are seeing increase in payrolls 5%-15%. Other contractors in the Northeast seem to be pretty flat. Midwest, property is flat to up 6%. GL is flat to up 3%. Auto is up 4% or 5%, and work comp is up 3%-8%. We're starting to see manufacturing payrolls up slightly, 5%, maybe 8%, 10%. Construction is just getting started, so we haven't seen any uptick there yet to speak of. Regionals continue to be the most aggressive on pricing. National carriers are continuing to push for more rate. It's usually slightly less or significantly less than some of the national carriers. On the West, property is flat to up 5%. GL is flat to up 4%. Auto is flat to up 5%, and work comp is up 4%-5% excluding California.
On the payrolls and sales, you're seeing up, it's flat to up 10% on exposures. California work comp is going up substantially. We're seeing 10%-20% rate increases or more with losses. Most markets are re-underwriting their books. There are one or two markets that continue to be out there that are very aggressive, which are able to price at expiring or even under-expiring, but it's a very small group. DIC coverage for flood and quake is tightening, specifically Oregon and Washington, where lower limits are being offered and the rates are going up. In the employee benefits area, small group is up, that's under 50 lives, 4%-10%, and large group is 5%-12%. Obviously, if you have losses, you can have much higher increases than that. I did want to take a moment to talk a little bit about exchanges.
We are working with exchanges now. We will have additional exchange-based solutions for our clients by 2014 as other health carriers are added to the state-specific platforms. More to come on exchanges. From a wholesale standpoint, we were up 8.3% versus 2.8%. In the fourth quarter, property in the Northeast was generally flat after Hurricane Sandy. However, we're now starting to see deductible changes. Obviously, flood limits that were offered are being reduced and substantially in some cases. In the Mid-Atlantic, Maryland to north, there are changes. Typically, where deductibles were 1% and 2%, they're going to 3% and 4%. Rates are flat to up a couple of points, 2%, 3%, 4%. Virginia, south to Texas, carriers, this is fourth quarter, want a 5%-10% increase. They're not seeing it, so they're typically getting flat.
There are some new markets coming into this space looking to grow. As I said, we're seeing new builders risk submissions starting to come online. On a general liability standpoint and wholesale, rates are flat to up 5%. Certain classes are presenting difficulties. Condominiums and large apartment schedules, there's a lot of upward pressure on those two classes. Construction rates are flat. In the binding authority business, we're in a transitional period. The property market seems to be constricting. In coastal areas, you might see up 10%, 15%. Inland, it's flat. GL is flat except on the hard-to-place condos that I referred to earlier. On the professional side, D&O, private company D&O is flat. Public company D&O on the primary limits are up 5%-15%, but that is sometimes offset by reductions in the excess pricing.
Overall, you're seeing flat to up slightly on non-financial institution public company D&O. Financial institutions, lots of markets are getting out of the space, 10%-20% increases on primaries. On the EPLI side, you're seeing generally increases 5%-15%. Retentions are up and claims are up. E&O, non-medical, and non-real estate are flat. Real estate's up 5%, and medical E&O is typically flat. I would say that there are several large national carriers that seem to be re-underwriting their books in the professional liability space. Excuse me. In national programs, we were up 20 basis points versus down 3.3%. Proctor, American Specialty, and FIU were up nicely in the quarter. Arrowhead, as Cory said, grew 6.8% without the Auto Aftermarket in Q4, but they're not counted in our internal growth until after January 9th. In the services area, services are up 11% versus up 7.7%.
Colonial Claims had a very busy quarter. They did $7.4 million in Q4, and we believe the impact on Colonial Claims will continue to be seen in Q1 and possibly into Q2. In the fourth quarter, we closed $20.7 million of acquisitions, and that brought our annual total to right at $150 million. We're quite pleased with all the new entities and teammates that joined our team in 2012. As always, the acquisition pipeline is good. Cory and I, along with several other senior leaders, exercised 10-year options that came due at the end of December of 2012. The options price was paid by exchanging existing shares we owned in our personal portfolios. In conclusion, we had a good fourth quarter. We hope that the economy continues to grow in the middle market as we are intrinsically linked to it.
New business sales and what happens in Washington will also impact our growth in the future. With that, I'd like to turn it back over to Rochelle to open it up to questions.
Thank you. The question and answer session will be conducted electronically. If you would like to ask a question, please press star followed by the digit 1. If you are on a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, star 1 to ask a question. We'll first hear from Greg Locraft with Morgan Stanley.
Hi. Good morning. Nice growth in the quarter. Congrats.
Thank you.
Just wanted to ask on Arrowhead, you mentioned it's included after January 9th. Could you just refresh us, what has that growth been since you joined it? Then also, where's it going to come through in your reported financials? Or where is it today? Just which segments?
Well, Greg, first of all, the Arrowhead is primarily in the national program section, with the exception of ACM, which is their claims management. ACM has roughly
25
$25 million in total revenues. The rest of it-
That'll be in services.
Yeah.
That's in services. Okay.
Yes. ACM is in services. Right. If you look at the entire year, Arrowhead's internal growth was roughly 9% for the whole year when you exclude the automobile aftermarket. When you include that, the automobile aftermarket added about $2.5 million in the fourth quarter. When you include that, it's about 13.4% for the year, 9% without it.
Okay. Net Auto Aftermarket's also going to come through in the organic growth beginning June 10, I guess, forward.
January 10.
I'm sorry, January 10. Yes. Okay, perfect. Second is just, what are you guys going to do with the broker incentive program this year? Are you going to continue it? Was it a one-timer? How do you think about that cost?
If you remember, Greg, I said that that was a one-time only incentive program. We obviously thought it was very beneficial to the team, and I personally reserve the right to put in force at any time in the future an incentive plan or something else to drive the desired results, which is grow our business organically and profitably. That's a long way of saying, no, we're not doing the same incentive plan this year.
Okay, great.
For the whole year, that entire program amounted to right at $7 million.
Okay, great. That's $7 million that does not recur this year. Okay. On the cost side. Great. Last from me is just, you were giving us a lot of details you went through, but you were sort of calling out the flood business. I wrote down, it was eight days, it contributed over $1 million, and it's going to continue in the first quarter, as you said. We're going to pick up another mid-teens millions of dollars that's coming at us from that business in the first quarter?
What I would say is, what we believe is that it'll be roughly $8 million or more in the first quarter. That's what we're anticipating, but obviously, we're not there yet.
Okay. That's helpful. Thanks.
Next, we'll move to Sarah DeWitt with Barclays.
Hi. Good morning.
Good morning.
First on the organic growth, what's changed in the last three months that drove organic growth from 1% last quarter to 5% this quarter? Should we think about that 5% level as sustainable going forward?
Well, remember, Sarah, as you know, we don't give internal growth estimates. The internal growth in retail is highly dependent on three things that we talked about. One, the economy and the middle market. It also depends on what's happening in Washington and will continue to happen in Washington. Third, new business sales. We feel good about our new business sales, and we're continuing to push and push and push. Some of those things are a little bit outside of our control. Once again, we say that hope and a prayer is not a good business strategy, but we're quick to identify that the economy in the middle market and what goes on in Washington will impact our internal growth.
Okay. Maybe you could just give us a sense of within that 5% organic and how much was pricing versus exposure versus new to lost business.
Yeah. It depends on where you are in the country, as I sort of summarized in terms of rates and exposures. I would say as a general rule, we've said all along that exposures have the biggest impact on our business overall. Having said that, when we are in areas where there is rate pressure, that can help us, but we have said over the past that two-thirds to three-quarters of the negative downdraft was exposure units, and the updraft, I would say, would be similar. It depends on the office and the classes of business that they're writing. As I said, Southeast Florida habitational is one thing versus construction in Phoenix because of exposure units. That's kind of how we see it.
Generally, two-thirds of the organic growth this quarter was from exposure growth. Is that where you're trying to go?
That's what we typically say. Once again, I'm just kind of trying to help you through the last five years and what we've said all along. One, that was what we saw in the downdraft. I think that in the updraft, I think the exposure unit has helped more to increase, and we're writing a lot of new business than rate increases, although rate increases are helpful. If I were hedging, which I'm going to hedge on this, I would say it's slightly more impact on the exposure units than the rates.
Okay, great. That's helpful.
I don't know the exact number.
Just lastly on the margins, I am surprised that 5% organic growth wasn't enough to expand margins this quarter, even when you exclude the acquisition payable. What's driving that? If you were to continue to see 5% organic growth, should we expect some margin expansion or no?
Sarah, on the margin growth, you really have to kind of get more into the detail by segment. We talked a little bit about this in the third quarter where we kind of showed the differential on the revenues and then the EBITDA impact. When you get to the K, you'll maybe able to see some of this difference. On the retail side, when you squeeze out the EBITDA impact, basically, we believe that there was about a $1,000,004 increase in the EBITDA dollars when you take out the differentials. Where the compression occurred is primarily in the program division and the service division. Overall it was relatively flat. We've always said the margin leverage is going to show itself fairly strongly, which I think it is in the retail division.
Okay, great. Thanks for the answers.
Brett Huff with Stephens Inc. will have our next questions.
Good morning, Powell and Cory.
Morning, Brett.
I just want to make sure I'm getting this right. In the organic growth, I'm trying to make sure what's in and what's out of the organic growth in the fourth quarter. Zurich, I think before you guys had thought that Zurich, the cost would come on, and then you weren't sure if the revenue would really start really coming on until 1Q. We got some revenue to the tune of $2.5 million from Zurich this quarter. Is that right?
That is correct.
Okay. What part of that was in internal growth, I guess is my question?
None of it.
None of it?
This shows you how conservative we are on our internal growth. The Zurich Auto Aftermarket program was basically new business developed by Arrowhead. Since we kind of stick with the traditional, anything that's in Arrowhead for the first 12 months that we own them, they're excluded. That $2.5 million was lumped into Arrowhead numbers, and so it was excluded from internal growth. Beginning next year, that will be part of internal growth because we'll be comparing that to Arrowhead's normal January, February, whatever. That was $2.5 million excluded. From a standpoint of the expense, essentially, if you look at all of Auto Aftermarket, the net, basically operating profit for the months that they were in 2012, there was really only a down swoop of about $108,000, $110,000 from net cost versus net revenue.
I know that there was some talk out there that there was going to be a much bigger startup cost, and I'm not sure where that all originated, but the fact is it was pretty much a flat operation for the 2012. When you go into
into 2013 from a budget standpoint, we're budgeting probably about $21 million in total revenues, the operating profit right now is only budgeted about $1.5 million to maybe $2 million. It's consistent with the 10%-12% operating profit that we thought. That number will continue to grow as we grow the program from the $140 million that Zurich currently has it at, to where they want it to grow to well over $300 million.
Okay, that's helpful. Just go through the Colonial Claims again, the flood stuff. That's also coming from Arrowhead, also not included?
No. Colonial Claims is an acquisition that we acquired on December 23rd of last year, it's a separate standalone operation, and they do a great job. With Sandy, they've had a huge amount of claims that they're servicing, their revenues were very substantial. The last eight days was $1.6 million increase over the minimum of 12.
That 1.6 was new organic?
Correct. For 2013, in the first quarter, we're expecting, as Powell mentioned, a little over $8 million of new revenues. Last year, they only had about $1 million in the first quarter in 2012.
Okay, that's helpful. Just looking at your, as you guys look at the pipeline, Powell, you talked a little bit about the M&A pipeline. Are you seeing price changes? I know that you all are typically pretty conservative in what you pay, but are you seeing increase in prices, particularly in benefits businesses or any of those businesses that seem to be coming under higher rate pressure, and sort of what's your take on that?
I think that there is some upward pressure on pricing, Brett. That's a broad statement. We've always said that it's six to seven to slightly higher times in operating profit. I think it depends on the size of the business, where it is, how it's growing. There's a lot of variables, but what we're focused on is finding the right people, and that's what anybody that does acquisitions is trying to do, but we're very focused on it. We think that there's a lot of opportunities, as there always are this year, that'll present themselves, and sometimes you just never know when they come about. It's hard to budget for you, I know, but that's how we view it.
Okay. That's what I need. Congrats on a nice quarter, guys.
Thanks, Brett.
We'll move on to Michael Nannizzi with Goldman Sachs.
Thanks. Just one follow-up on the Colonial Claims. You said $8 million in the first quarter. Is there a way that we can try and run rate that? I mean, is any of that expectation still impacted by Sandy activity kind of after the fact, or is that kind of more of a normalized number?
No, that's Sandy impact. Once again, it is a very busy time for Colonial Claims, and Doug and his team are doing a great job. No, I don't want you, Michael, to think that's a normal run rate. That is because of activity that occurred in the later part of the fourth quarter.
Obviously, Colonial Claims is obviously dependent upon how many flood activity, flood catastrophes occur during the country. Given there's always normal some flood around, but for the whole year, right now we're only budgeting probably about $13 million for Colonial Claims for the whole year. If you read that all of a sudden the Midwest has a bunch of flood claims come April, May, then you'll have to adjust it, but it is dependent upon catastrophes.
That should burn down, kind of normalize after first quarter or get closer to it then, it sounds like.
Yes.
Okay. Great. Thank you so much. Then, just trying on the retail side, just obviously organic has kind of inflected over the last four quarters. Acquisition growth seems to have gone the other direction. Is there something there that we should understand that's changed, or is that just lumpiness or the lack of finding the sort of people fit that you were talking about before?
Yeah, you don't need to read into anything there, Michael. We're actively talking to people all the time. At the end of the day, as we said a year ago in October, we need to grow our business organically. That's what we did in 2012, and I and Cory and all the other senior leaders are very proud of all of our teammates for what everybody did. I think lumpiness on acquisitions and just good doing it in retail, and writing a lot of new business and retaining our customers and all of that stuff helps add up on that internal growth.
Mike, I think it's important to realize that neither one of those items, internal growth or acquisitions, are mutually exclusive activities. We're burning it hard at both ends, and Scott Penny heads up the acquisition group and is doing a great job. We're talking to a lot of people. When we make an acquisition, we're very disciplined in it, and it has to be the right cultural fit. I can tell you that we've had a lot of opportunities where we could have had a lot of revenues, but we've walked away from them because it's not a long-term cultural fit, and it's not good for our shareholders in the long term. We're going to continue to focus on just the right acquisitions.
Great. Thank you.
Next we'll move to Matthew Heimermann with J.P. Morgan.
Hi, good morning, everybody.
Hey, Matt.
Hey, Cory. Just wanted to clarify, you said that Zurich was margin neutral this quarter, and then you're still sticking with the 10-15 kind of 2013 impact?
That is true.
Okay.
Like I said, it's really probably right now, budgeted wise, closer to the 11%-12% range than the 15%.
Okay. All right. That's fair. Then, Powell, could you speak to just give a little bit more color on your exchange comments in your remarks. In particular, I'd be curious just what the conversation is like with the small to mid-market employer about what they're doing with their plans, and practically speaking, how that transition might work and from your end, and what your role will be and kind of what partners you need to see. I guess, sorry for the run-on way in which I'm asking this, but I guess I'm also curious in terms of whether or not you see yourself working with consulting partners to kind of create exchanges for these employers or disproportionately will be using the state exchanges.
Okay. First of all, I think that a broad statement, Matt, is that one exchange will not fit all the needs of all clients in a given territory state area. As you're aware, in exchanges today, many of them, not all of them, but many of them have one risk bearer. As other risk bearers, and I alluded to this, are added, there will be more choice on those exchanges. Several of the clients that we have written in exchanges so far are association type business, so they could be larger accounts, or they could be two, eight, 12 people. What you're really referring to is there is a calculation, and the question is, do you go into an exchange? How much does it cost to pay to play? There's all these scenarios.
What we've got to do is bring good options to our clients, which is what we're doing. I would tell you that in different states, there's a different level of how I would say this, some states are far more advanced in where they are, as you know, in exchanges than others. Ultimately, exchanges will probably need to be run at the state level. Those that are currently bucking that trend are, it's my understanding, they're going to push it back to the federal government, which would be a stopgap. We're focused on bringing more opportunities to provide health coverage and related ancillary coverages to our clients, and the exchanges may be one of those.
I didn't mean to walk around it, but saying it could be a private exchange, it could be a state exchange, or in some instances, it could be a national exchange. We think it's-
Okay
ultimately on a local level, though, meaning state-
Okay
Even more specific than that.
You might work with an HR consulting company that has a Southeast regional focus to deal with that area of the country to potentially address the private aspect of the solution, for example. As you think about that suite of products, is that how you actually create those options for customers?
The answer is that might be one way. There are lots of people out there talking about technology as a delivery of some of these services, sometimes there are different technologies desired by different customers to do this. Here's what I would back up, Matt, and say this. In a place like the Midwest, they may have several up and running, the level and the in-depth conversation about the options might be different than it would be in Florida, which is just getting started. In New York, and that's my understanding, New York State, there are exchanges that have multiple health carriers in them. If you wanted ABC company and I wanted XYZ company, we could still get them through the exchange. I don't think it's dependent so much on external parties.
It's dependent on, one, what we see that's currently available in the marketplace. Two, where can we have a relationship outside that market area that might be able to bring a solution in there prior to it actually being used in that area? How do we talk with our risk-bearing partners to continue to be on a cutting edge of developing that stuff along with them? Ultimately, in 3 or 4 years, the exchange may be only one of the solutions, and there may be something totally different that we're working with in addition to the exchanges in local areas. Health insurance is very local, as you know. There's not one solution for the entire Southeast, and there's definitely not one for the entire country.
All right. Appreciate the color. Thanks.
Yeah.
As a reminder, it's star one to ask a question. Next, we'll move to Doug Mayweather with SunTrust.
Hi, good morning. Most of my questions have been answered. I just had two, I guess, broader questions in opposite ends of the country. First, I noticed that you don't break out specific sub-segments in retail, but would you characterize the Western, what used to be called, I guess, the Western retail segment as still underperforming the overall retail group? Or with the improvement in the workers' comp market and the construction market out there, would you think it's starting to catch up or even outperform the broader retail group?
Remember, we don't break out segments of the country. I would tell you that in the West, just like in Florida, we're starting to see more positive things with our customers. That's exposure units. My instinct is that it performs in line with retail.
Okay, back to Florida. Again, even more broadly than that, you're so involved in so many aspects of that economy. Where do you think Florida is in general in terms of its economic turnaround? Is this just the third inning? Do you think a lot of it's played out? Do you think that there's a risk of it stalling? Do you think there's going to be a lot of follow-through in 2013?
Doug, I think that we're still early in the game. The reason I say that is if you go to Southeast Florida, there's a lot of noticeable uptick. If you go to Southwest Florida, it's still challenging. You go into Central Florida and North Florida, there are pockets of good things, but lots of contractors other than habitational are just sitting tight and just, when they look into their pipeline of jobs, they don't have any work after six and nine months, and that makes them nervous.
Okay. Their nervousness sounds like there could be some risk to this, but do you think that they're just unnecessarily nervous and that they could see some follow-through? I just wanted to get more context on your-
Yeah, I think that, once again, I would tell you that there are several businesses that are in the financial institution space that have reported on their results in Florida and have commented on a broader uptick. I would tell you that we haven't seen that yet in businesses. The reason I don't think we've seen that, Doug, is, as we've talked about before, if you had a business that had $15 million of sales three years ago, and 15 went to 13, and 13 went to 10, and then we're getting ready to renew, and they know they've got a big account or contract in place to do at least 12, when you meet with them, do you actually get 10 on the renewal or 12? I would tell you, we get 10. If a bank or a financial institution is there, they're going to say what?
12. I'm not saying that it's just there has been so much downward pressure that people would rather have an additional premium than a return premium 12 months from now. I don't think all of the clients in the entire insurance base are accurately predicting their exact revenues, and they may be underestimating just for a conservative nature.
Okay. That all makes sense. Thank you very much for your answers.
Great.
We'll move on to Joshua Shanker with Deutsche Bank.
Yes. Thank you. I just want to talk about the Proctor revenue recognition, second quarter versus third quarter versus fourth quarter. I have in my notes that there was a $900,000 shortfall last quarter that was going to be earned out this quarter. That's correct?
We said that we thought there was going to be some of the down swoop in the third quarter would come in through the fourth quarter, and it did. Arrowhead, I'm sorry, Proctor did increase in the fourth quarter about $500,000.
Okay. Look, it's a great quarter, great growth. You guys should be very pleased. It makes it look like even more so that National Programs is kind of lacking on internal growth generation. Is that just lumpy? What needs to happen? Obviously, you're going to have Arrowhead come through next year, but what about the non-Arrowhead growth? What's going on there?
That's actually this year, Josh. Arrowhead.
Yeah
Came online on the ninth of January.
Right. I'm saying that if I look at back half 2012, internal growth at National Programs wasn't very good this second half of the year. Obviously, it's going to look good next year.
Right.
I want to know what, ex Arrowhead, what's going on in the business?
Got you. Josh, one of the, as we had talked in the second and third quarter, obviously Proctor was a little bit lumpy during the year. Overall, it finished okay for the whole year. We also had Acumen Re, which
Lost a fairly large group of accounts, and it had a substantial down swoop, and it was down another $700,000 in the fourth quarter. They expect next year to be back up over their 2012. Cal-S urance was also down a little bit this quarter, it was about $400,000. That expects to be up slightly in next year. If you go back to the second or third quarter, we give details of where the down swoop was in the program business. It continued that down swoop in the fourth quarter. We believe that most of the programs are now going to be generally up for the rest of the year.
We think Proctor may be a little bit down for 2013, and I think Cal-S urance and one of our public entity business may be down for the whole year, maybe $100 million to $1.5 million on a combined basis. Generally, the rest of the programs will be generally up.
Okay. It's actually much easier to forecast Arrowhead growth than it is the non-Arrowhead growth. That's kind of what I was looking for. I appreciate it.
Right.
The other thing I noticed that you had, obviously, a negative hit from higher earn-outs on acquisitions, and that's two quarters in a row after four quarters of it being, I guess, paying out less than you thought you'd have to. Is there something going on that we should expect that the acquisitions you've made last year are turning out much better than thought now, and although it's great that they're growing, we should model maybe a soft drag in 2013 because the growth is happening and profitability is happening? How should I think about that?
Well, there may be a little bit to that. I can tell you that this is one item that just sticks in my craw, is that line item is something to be just ignored because it truly is dependent upon not really how well they've done or how badly they've done. It's really what is our estimation, or really more specifically, how good of an estimator am I on day one that we make this acquisition, trying to predict three years from now the exact dollar that we'll pay out in an earn-out. If I predict the absolute max, okay, we set that entire maximum up as a liability. Anything that they basically don't do from that level, they come down, is an income item to us. It's crazy to think that that's part of an earnings culmination process.
To say that, well, you had to take income in on that, and therefore you didn't pay as much liability. That acquisition didn't perform as well as you thought they would. That's not true. They could be performing well, it's just that I overestimated it. That's why I'm saying you can't read too much into it just because we had an expense, we ended up paying out more, therefore they're doing better. It's just we try to predict out so that it is close to zero. The only thing that line item is telling you is, yes, we did not predict as much on the earn-out as we thought we'd do, but that is not necessarily that they did better or worse than what they should have. If you understand what I'm saying, it's just
Yep
it's not a good measure to say that's how their operation was.
Josh, I want to make sure you know that.
I understand it. One thing I learned, though, just to be clear, that number is more or less a cash number. It's not like in year one after an acquisition, you revisit that number and estimate it up because you think it's going to change. That's only a three-year number. You don't make a change after underwriting.
No. Part of GAAP is that we have to constantly make modifications to that. I'll tell you, this quarter, we did have to move up the earn-out estimate on Colonial Claims because it was very well definitive that with Hurricane Sandy, they hit a home run. As a general rule, we try to look at it every quarter, and so it's moved up and down. It's not purely a cash number. It is a constant moving so that as you get closer to the earn-out at three years, hopefully, we've kind of constantly adjusted the liability so that at the very end, there's not going to be a lot of uncertainty left. Every month you go along, you have one less month of uncertainty.
Josh, as you can see, Cory doesn't feel very strongly about it.
Yeah, no
It is a ridiculous statement because it's just noise in the income statement, and I just-
No, it's not, but if we're looking for signs
I don't want you guys to interpret too much from it.
Well, I'd like to interpret that things are getting better. I'm sorry I can't.
I understand.
Thank you very much. Congratulations.
Thanks, Josh.
We'll move on to Meyer Shields with Stifel Nicolaus.
Thank you. Good morning, everyone.
Good morning.
Hey, Meyer.
Can you take us through the mechanics of Colonial? When they've got this that's a bad choice of words. When they've got increased claim activity, does that disproportionately impact the margins for the services unit as well?
It has very high margins, it does impact it to the positive, yes.
Okay. Can you talk a little bit, I'm switching gears, a little bit about the expected impact on organic revenue growth from the fact that the bonus program is not going to be renewed in 2013?
Sure. As you remember, we have a stock incentive plan in place with all of our teammates that have certain size books. This particular one-year payout did not in any way, shape, or form affect those. Those are, as you may recall, over a five-year measurement period. If you're a producer, half of that is focused on earnings per share growth, which is what the senior leader bucket is, and that's 7.5% or more compounded annually. Then they have to grow their books of business. All of a sudden, I think that the fact that we incrementally got better all year is a positive. I think that the fact that there was this payout in recognition of a very difficult operating environment over the four or five prior years was very well received.
As I said earlier, if we were to do something in the future, it would continue to have a longer-term nature of it, kind of like the SIP that I'm referring to. We are focused on building the wealth of our teammates, and so we're always looking for creative ways to do that. This was an income event, as you know.
Okay, that's helpful. Last question. Is it too early to come up with expectations for contingents and supplementals in 2013?
Yes, it is. Sorry, yes.
Oh, well. Okay, thank you.
Meyer, if I can just comment on that. Remember, there's going to be a lot of impact, we believe, in Q4 from the Sandy-related losses, it's still early on knowing the true extent of those.
No, that makes perfect sense.
We'll move on to Adam Klauber with William Blair.
Thanks. Good morning, everyone.
Morning.
Hey, Adam. As far as audit premiums, were they still running flat? Just any way we should think about that going into 2013?
Adam, I think what you should do is think of it as more of a neutral today, whereas it's been a negative in the past. That's a very broad generalization. There are places in the country where they will be ticking up, and there are places in the country that are still down slightly. I would say, generally speaking, that's what I would expect. One way that you can figure that out by looking at some of the large national risk bearers, you can look at on their quarterly, when they report their numbers quarterly, you can find out what they're seeing as a percentage of additional premiums versus return premiums. That can give you a little bit of idea of what's going on out there for that carrier.
Okay, great. As far as the wholesale business, what would you say submissions were in the either third or fourth quarter compared to the first half of the year? Do you see that gaining momentum, stable, or maybe losing momentum?
Well, I think that there's a lot of activity. I'm not trying to differentiate between Q4 and Q1. I'm just saying what's new, as you heard me say, is we're starting to see some builders risk business, which is more noticeable today than it has been in the last several quarters. I don't have the exact number of submissions we've got in that space, but that's a positive sign because we're hearing about it, as I alluded to in South Florida earlier on some of this HAB business. We're telling you about it in wholesale, that could be anywhere in the Southeast all the way up the Northeast coast. Generally speaking, I would tell you that there are a lot of standard carriers that I believe will have to rethink some of their strategies as it relates to traditional property in the Northeast.
That's what Hurricane Sandy has done. I was reviewing last night the loss estimates by carrier, that gives you only part of the story. What that doesn't give you is, are they putting out lower limits? Have they stopped providing flood? Are they all going to E&S if they have it? Are they letting their standard property go E&S and just keep the rest of the business? There's still a lot to be flushed out, personal lines is going to be a big issue in the Northeast.
Okay, thanks. One other question. When you think about the business, you've done a fair amount of acquisitions both in the retail, obviously with Arrowhead and Colonial, you've done some non-retail acquisitions. I guess, could you let us know how you're thinking about just mix-wise or opportunity-wise going forward, retail versus non-retail?
Sure. Adam, first of all, we're looking to invest in all of our four divisions of our business. As we've said before, it's all driven and contingent upon high-quality people who find other quality people and run good businesses. Having said that, obviously, when you make $100 million-plus acquisition in Arrowhead, that tilts the mix a little bit further towards non-retail than it has been historically. I would tell you this, if there were two other Arrowheads out there today, which they're not, we'd buy both of them.
Having said that, we typically think that our business would be 60%-70% over an extended period of time, retail.
Okay. That's very helpful. Thank you.
Next, we'll go on to Raymond Vandetta with Macquarie.
Thanks, and good morning. Just wanted to have a quick clarification on one of your comments, Cory. I think you had mentioned when you're talking about sort of the margin picture between some of the segments, that the services margin was actually weaker in the fourth quarter. Yet, Colonial Claims, I guess, might have helped margins. I'm just trying to get a little bit more color on that.
Yes. Colonial Claims did help a lot, but we also did have some extra expenses in there relative to our The Advocator Group, where we're staffing up for growth there. That helped pull that out. Now, don't forget, in the analysis that I was giving to you, what I do is I pull out acquisitions as a separate component of the growth of the revenue. I've isolated Colonial Claims, even though, for instance, in acquisitions for the fourth quarter, we basically had about $16.1 million of new revenue. That created roughly $5.1 million of additional EBITDA that I add to last year's fourth quarter EBITDA of $4.8 million. What I'm doing when I say that it squeezed out, or the margins were actually a little compressed, it's really looking at what was there in the fourth quarter. Do you see what I'm saying?
Yes.
Colonial Claims is considered acquisition in that kind of analysis. Most of that a little bit of pressure on the margins in services was really because primarily The Advocator Group was staffing up for future growth.
Okay. No, that's helpful. I guess, is that staffing done with, or do you expect that sort of to continue in the first quarter?
I think we're going to see much more of a similarity quarter-over-quarter after starting in 2013.
Okay. Thanks so much.
I wouldn't be there.
Great. Thanks again.
Bye.
We'll move on to Mark Dwelle with RBC Capital Markets.
Yeah, good morning. A number of people have asked questions related to the Sales Incentive Program this year, I just want to take another try at that, because, this was a fairly unique program for Brown & Brown. I guess what I'm trying to gauge is, how do you measure the ultimate success of that? You mentioned $7 million of expense in the quarter. Could you describe maybe how much incremental revenue you think you drove out of that program over the course of the year or the quarter? I'm really trying to get your kind of report card on how this program performed relative to your expectations. We can see in the numbers that internal growth ultimately rose. I don't know that that should be the only explanation for it being a good program or not a good program.
Right. Let me comment on that. First, Mark, as you know, we said that if in fact we paid the maximum amount out, that means everybody hit the bogey, it would be $12.5 million. Okay?
Right.
We paid $7 million out of the $12.5 million out. I personally would love to have paid the $12.5 million out, because at the end of the day, we got the revenue with it. Having said that, what you'd say is, we exceeded, not everyone just grew 5%. There were a number of people who grew more than 5%. That's a positive in our mind, remember, we have not done anything like this before, Mark. What I've tried to say nicely, because I know several people have asked this, is you're asking, are you going to have another one? I said, "No, we're not going to have another one like that.
Well, that actually isn't what I was asking. Just to clarify my question, I appreciate very much that it was a unique program for Brown & Brown, and that's why I'm so interested in kind of the scorecard nature of, you expected A and now we have the perspective to say what we got relative to initial expectations, and if there's any way to just quantify that out, so when we look back at our 2012 full year, we can say, all right, last year there was, you said $7 million of incremental expense, so I know that that's something that won't necessarily recur. There's also a revenue part of that was what I'm trying to get an understanding of is, what was the boost? What did we get for our seven?
Yeah. Mark, let me try to say it a little different. The quick answer that I'll get to, but I want to take you back in history on part of this, is that we do not measure precisely in terms of did somebody sell that new account because they were incentivized by this program or not? Did they grow part of their 5% growth? How much of that did actually come from the rate increases of their clients' exposures actually increasing? We did not do that. We do know that roughly 54% of our commission producers hit the 5%. We had probably about 12% that were zero to 5%, but didn't get it, and a little bit less. I think it's important for you to understand the history, and I think we explained it on previous quarters.
We were talking about doing this at the end of, basically the third quarter of 2011. We knew that the market was starting to show signs of starting to turn. We thought that a lot of our competitors, who are generally more the local agents, were all out there kind of tired after five years of rates going down and consequently having to market it. We knew that if we could get all of our folks really focused on hitting the ground running on January 1st, 2012, we could have a big advantage. We came up with that one-time program, and from a motivational standpoint, it was really an acknowledgment to our commission producers that, who for five years have taken less income, not because they lost any clients, just because of their clients' exposure.
We thought that this is a great recognition of the battle-hardened producers that have gone through the trenches in the last five years, that this is a way to get a little bit back. We said, we want everybody to get it, and so this is the program we had. It was always designed as a one-year program. The idea was, is get them really focused, and then, in fact, when the market started to turn, they're paid on commissions, and then all of a sudden, just like what has happened, the exposure unit, the economy has started to move up, the pricing has started to move up. Therefore, the tide was moving up. Naturally, our producers are getting more commission dollars now that everything is rising, and it was a nice transitional program.
Now our commission producers are getting the natural lift and the natural increase in their compensation by the economy, and that was the intent. It was a transitional thing, and everybody knew that from day one. The precision as to did we get more than $7 million? I think if you just look at the internal growth, we did. Was it directly related because they had that, or was it more related to the fact that we just got great producers, which I think is probably the right answer, and how much of it was the economy and the rate? Gets all kind of blended. But the bottom line is, it worked. I think our producer group is always very motivated. They're very appreciative of that, and we're going forward, and we're going to write more new business.
I appreciate that. That's a helpful recap. Just two last real quick questions. Just from an accounting standpoint, is there any way that a producer could have front-loaded their number, which is to say, could they have booked business in December in order to hit their bogey that will be drawn away from 1Q, or do your practices and policies kind of preclude that?
The answer is, could it happen one or two places, a small amount? Possibly, don't forget, whatever happened would impact the profitability of that particular office, and you have the profit center leader and the department leaders, commercial entity, whose bonuses would be negatively impacted. Could that have happened in any widespread? No.
Okay. That's helpful. Then maybe just a last question. If you were to give the program a letter grade, kind of from an A to an F, it's clearly not an F, how would you give them a score, or give that program a score in terms of your overall reflection on it?
I would say it's either an A or no lower than a B+.
All right. That's very helpful. Thanks very much for the color.
We'll move on to Justine Maurer with Lord Abbett.
Morning, guys.
Hi, Justin.
Sorry, Cory, to beat this dead horse. I'm going to piggyback. The acceleration organic, I know, Powell, you talked to that point on Sarah's question earlier. Given that the folks knew that the program was going away, did they have the ability to pull forward some business? Just thinking about sequentially, as we look into the first quarter, just kind of apples to apples on that basis, should there be any noise from that or no?
No, we don't believe so. Whatever happens in the first quarter will occur because of policies that have effective dates of 01/01 through 03/31.
Okay. Just, Powell, you made the comment in your opening remarks about options exercise. You guys just took the stock. Was that the interpretation of that? That you just exercised and held?
Yeah. Basically, I think the answer to that is yes. Basically, I brought, and Corey brought existing shares that were exchanged for those options, and we got back a net new number-
Got it. How we did it.
Okay. Thanks a lot.
I think it's important because the reason I raised the issue, Justin, is this. It basically shows in the filing a sale and a purchase when in essence there was an exchange.
Yep.
If that makes sense. I know it does to you.
Yeah. Thanks, guys.
Believe me, it killed us to have to exchange those shares at $25.30 or something. Believe me.
Yeah. They had to be done by the end of the year. Unfortunately, Washington never got the financial cliff worked out before 12/31 and hurt us.
Appreciate the call in.
Great.
Mr. Maher, were you done with your question?
Yes.
Thank you. There are no further questions. I will turn the call back over to the speakers for any additional or closing remarks.
No, thank you, Rochelle. It was nice to talk to everybody. We look forward to talking to you next quarter. Have a great day. Thank you.
That will conclude today's call. We thank you for your participation.