Brown & Brown Inc (BRO) 2017 Q2 法說會逐字稿

Good day, and welcome to the Brown & Brown, Inc. second quarter earnings call. Today's call is being recorded. Please note that certain information discussed during this call included information contained in the slide presentation posted in connection with this call and including answers given in response to your questions may relate to the further results and events or otherwise be forward-looking in nature. Such statements reflect our current views with respect to further events including those relating to the company's anticipated financial results for the second quarter and are intended to fall within the safe harbor provisions of the security 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 statement 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, that is 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 as those results 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, further events or otherwise.

In addition, there are certain non-GAAP financial measures used in this conference call. A reconciliation of any non-GAAP financial measures to most comparable GAAP financial measure can be found in the company's earnings press release or in the investor presentation for this call on the company's website at www.bbinsurance.com, by clicking on the Investor Relations and then Calendar of Events.

With that said, I will now turn the call over to Powell Brown, President and Chief Executive Officer. Please begin.

Thank you, Tracy, and good morning, everyone, and thank you for joining us for our second quarter earnings call. I'm on Slide 4.

For the second quarter, we delivered $466.3 million of revenue, growing 4.4% in total and 1.6% organically. Our EBITDAC margin decreased 120 basis points from Q2 of '16. Andy will provide more color on our revenue and margin movement later in the presentation. Our as reported earnings per share for the second quarter of 2017 decreased to $0.46 from $0.47 in the second quarter of '16. When excluding the change in estimated acquisition earn-out payables for both years, our adjusted earnings per share remained steady at $0.49. Overall, Q2 was a good quarter and we're pleased with the overall performance of the -- for the business year-to-date.

I'm on Slide 5. The second quarter looked much like the first quarter from an economic expansion perspective. Across most industries and geographies, we experienced continued slight growth in exposure units, which is we've mentioned in the past is the key driver for organic growth. In the first quarter, we talked about optimism regarding the potential for health care reform. As we mentioned, that optimism slowed during the first quarter and it's continued to slow during the second quarter, and when we talk with our customers and potential customers, they feel relatively certain that any changes in health care will more than likely change how they look at or approach health care coverage for their employees.

There are many possible outcomes that could have an impact on employers and their plan designs, the most significant would be if the deductibility for health care cost was materially reduced or eliminated. We're also keeping an eye on what changes could occur to Medicaid reimbursement and what this might mean at a state level as well as if there is any impact upon community rating. At the end of the day, there's a lot of confusion and unknowns. If this change occurs, it provides an opportunity for Brown & Brown to work closely with our customers to help them understand what the changes might mean to them and how they can navigate those changes.

The amount of available capital and appetite to deploy this capital has not slowed and remains relatively constant with prior quarters. Risk bearers continue to look for creative ways to retain their renewals and drive new business. Previously, we talked about how we've generally been experiencing consecutive decreases in premium rates across most lines. In the first quarter, we mentioned that coastal property rates were down in the range of 2% to 10% as compared to the first quarter of '16. We cautioned that 1 quarter doesn't make a trend. In the second quarter of this year, we saw coastal property rates down 5% to 15%. Second quarter was a big property renewal period, so we wanted to see how rates were trending. While rates were down 5% to 15%, this is still better than the prior year when rates were decreasing in the neighborhood of 5% to 25% down.

As a general statement, we're seeing some carriers starting to draw a line regarding how much further they will lower their premium rates. This is not true in all markets and specifically, Southeast Florida remains very, very competitive. As it relates to other lines, commercial and personal auto continues to increase 1% to 5%, which is being driven primarily by the frequency of claims and distracted drivers. For most other lines, rates are generally flat to down slightly.

So now let's talk a bit about the performance of our 4 divisions. From a Retail perspective, we grew 1.1% organically. As a reminder, we mentioned in the first quarter that we had about 100 bps of timing benefit that was expected to be recognized in the second quarter. During the quarter, we continue to realize solid new business, good retention, excluding some larger one-off losses that were primarily related to customers being acquired and our employee benefit business grew nicely again.

When we look at our performance for the first 6 months of this year, our average organic growth rate between the first and second quarter is about 2.5%. This compares with an average organic growth rate of 1.3% between the first and second quarter of 2016. So we're pleased with our improved performance and are working towards making it even better. Regarding our 5 for 5 Incentive program, there's a lot of positive energy related to the program and our producers are working really hard to deliver the best results so they can achieve their targets. It's still too early to determine exactly how things will ultimately turn out for the year, but at the midpoint of 2017, the program appears to be performing in line with expectations.

The performance for our National Programs division was in line with our expectations led by strong growth in our lender-placed business, our earthquake programs and our all-risk program continues to build momentum. The growth from these and other programs were substantially offset by continued downward rate pressure on our coastal property programs and the impact related to carrier changes for a couple of our programs. As we mentioned previously, when we have a carrier change, retention normally decreases, new business slows and margins decrease. Then, once the new carrier is in place, revenue will stabilize and then start to grow. The margins will begin to increase. Remember that these changes will result in decreased revenues for National Programs in 2017 of approximately $5 million to $7 million for the full year versus 2016. The largest part of this impact will be in the second half of this year. Later in the presentation, we'll talk about our new core commercial program with QBE, which started this month, July.

Our Wholesale business had an excellent quarter, growing organically 6.2%, driven by strong new business and despite continued declines in coastal property rates. During the quarter, we again realized growth across almost all lines of coverage and most of our businesses. Our Binding Authority and personal lines businesses performed really well again this quarter. Our brokerage business has continued to improve nicely as we wrote more new business, and rate decreases were less than the prior year.

The Services division experienced slightly negative organic growth this quarter. Our advocacy in workers' compensation claims businesses grew nicely during the quarter, but this was more than offset with the lack of claims related to storms as there was minimal activity in the second quarter of this year as compared to the prior year.

In summary, we're pleased with the performance of our 4 divisions for the second quarter and the first 6 months of 2017. So now let me turn it over to Andy, who will discuss our financial performance in more detail.

Thank you, Powell, and good morning, everyone. I'm over on Slide #6, which presents our GAAP reported results. For the second quarter, we delivered total revenue growth of 4.6% -- excuse me, 4.4% and organic growth of 1.6%. Our income before income taxes decreased by 90 basis points and our diluted earnings per share decreased by 2.1% to $0.46 versus $0.47 in the second quarter of last year. These financial metrics were impacted by our change in acquisition earn-outs, which we're going to discuss on the next slide.

Our weighted average number of shares increased by 1.1% due to shares issued as part of our long-term equity plan and our Employee Stock Purchase program. Our goal, each year, is to minimize the impact of these programs, via periodic stock repurchases throughout the year. During the second quarter of this year, we repurchased approximately 260,000 shares. And lastly, our dividends increased just over 10% for the quarter.

During the first quarter, we also successfully -- during the quarter, we also successfully completed an amendment and extension of our bank credit facility. The new agreement is for 5 years with a term loan of $400 million and a revolving credit facility of $800 million. In the past 3 years, we paid down the original term loan by $125 million with $68 million of this paid at closing in June. The terms are relatively consistent with the prior agreement and therefore, we do not expect any material changes to our interest cost. We continue to like the structure of this facility as it gives us the capital capacity and flexibility to support the growth of our business. We'd like to thank all of our banking partners for their ongoing support.

I'm going to move over to Slide #7. This presents our adjusted numbers after removing the impact of the change in acquisition earn-out payables for the second quarter of each year. Since these items are noncash and can increase or decrease by quarter, we believe it is helpful to evaluate the business excluding these adjustments. For the quarter, our income before income taxes and EBITDAC increased by 50 basis points and our net income grew by 1.2%. The higher growth rate of adjusted net income as compared to adjusted income before income taxes was driven by a slightly lower effective tax rate this quarter of 38.8% versus 39.3% in the second quarter of last year. The lower effective tax rate was primarily impacted by the new accounting treatment for stock compensation that we discussed in the first quarter of this year plus a few discrete items.

For the full year, we continue to expect our effective tax rate to be in the range of 39% to 39.3%. In a few slides, we're going to walk you through the primary drivers of the margin changes. Over to Slide #8. We're going to walk through the key components of our revenue performance for the quarter. Starting with total revenues. Our other income increased by $800,000. Our contingent commissions and GSCs increased $4.7 million as compared to the second quarter of last year. This growth was driven primarily by incremental contingents in our programs division, resulting from book growth along with the receipt of certain contingents that we did not qualify for in the prior year due to previous loss experience.

Our total core commissions and fees increased by 3.3% year-over-year. When we isolate the net impact of our M&A activity, our organic revenue growth was 1.6% for the quarter. We move over to Slide #9. Similar to the first quarter, we thought it'd be helpful if we include a walk of our quarterly EBITDAC margins from last year to this year and highlight the main drivers. We do not anticipate providing this level of detail each quarter unless it is beneficial to understanding of our numbers.

On an as-reported basis, our margins decreased by 120 basis points year-over-year. We had the premium tax refunds that were recorded in the second quarter of last year, which resulted in a 60 basis points decline as compared to 2016. Then we had an $800,000 gain on the sale of a book of business in 2016 that increased the prior year margins by 20 basis points. We view these first 2 items as nonrecurring as they only impacted the prior year.

For the current quarter, the impact of our investment in technology was about 70 basis points. As it relates to the investment in technology, the programs are progressing along as expected. We previously mentioned that we anticipated the largest incremental year-on-year increase to occur in the second quarter of this year. This is due to the fact that we had minimal investment in the second quarter of 2016 and then our investment began to increase in the third quarter of last year. For the full year, we still estimate the margin impact will be in the range of 40 to 50 basis points versus 2016.

Next is the impact from the new 5 for 5 Incentive Plan within Retail. As Powell mentioned, this program is still in the early days, but it is performing financially how we thought it would base upon the results in the first half of the year. The impact of the quarter is up slightly versus the first quarter as we have some producers on pace to deliver higher performance for the full year. We're accruing the cost based upon full year projection of growth by producer and as a result, there will not be a direct correlation of the expense to revenue in each quarter. As a reminder, we anticipate this program will impact our margins the most in 2017, less in 2018 and then it will break even in 2019.

Within other is the net effect of the increased contingents and guaranteed supplemental commissions, the continued impact of leveraging our revenues and the results of our strategic purchasing and cost management programs. We move over to Slide #10. We'll look at the performance of each of our division's little more closer. We're going to go ahead and start with Retail.

For the second quarter, our Retail division delivered total revenue growth of 1.9% and 1.1% organic revenue growth. As mentioned in the first quarter of this year, there was approximately 100 basis point benefit of revenue that we expected in the second quarter of this year. Our income before income taxes was down $1.2 million due to higher year-over-year acquisition earn-out adjustments of $1.1 million; a prior-year gain on a book of business sale of $800,000; the incremental expense associated with our 5 for 5 Incentive program as well as our technology investments. These items were partially offset by lower intercompany interest charges.

Retail's year-over-year as reported EBITDAC margin decreased by 180 basis points, primarily due to our incremental investments and the 5 for 5 Incentive Plan as well as technology, and we also had the prior year's gain on the book of business sale.

Moving over to Slide #11. For the quarter, total revenues for our National Programs division increased by 4.5% and 70 basis points organically. During the quarter, we received new or increased contingent commissions due to an improved performance for a few of our programs. As a reminder, we expect material downward pressure in the second half of this year on organic revenue growth related to carrier changes and the $8 million of incremental storm claim revenues we recognized in the second half of 2016. Later, we're going to talk about the revenue and income impact of our new core commercial program.

For the quarter, income before income taxes increased by 5.4% due to lower intercompany interest expense charges. Our EBITDAC decreased by 3.5%, primarily due to our flood insurance program receiving onetime premium tax refunds of approximately $2.8 million during the second quarter of last year. This was partially offset by increased contingent commissions during the second quarter of this year.

On to Slide #12. The Wholesale division delivered total revenue growth of 17.5%, driven by acquisitions, and organic revenue growth was 6.2%. Our income before income tax margin increased by 130 basis points, just 27.9%. This was driven by increased organic growth and continued control of expenses. This increase was partially offset by higher intercompany interest expense. Our EBITDAC margin increased 190 basis points to 34.7% for the quarter. This increase was driven by the same factors we just mentioned, excluding the impact of intercompany interest expense charges.

On to Slide #13. The Services division's revenues were down slightly versus the prior year due to lower storm claim activity. For the quarter, our EBITDAC margin increased by 260 basis points, primarily due to managing our expense base and growth of our advocacy businesses. The incremental increase in income before income taxes was driven by lower intercompany interest expense. We do not expect this level of margin increase every quarter, but we are very focused on operating highly efficient claims businesses.

With that, let me turn it back over to Powell for closing comments.

Thank you, Andy. Great report. Before we get to closing comments, we wanted to talk about our new core commercial program that we've launched in partnership with QBE. This is now our third list out of a program. In 2012, we lifted out the automobile aftermarket program from Zurich. In 2013, we listed out the non-standard auto program from Everest. We believe it is our proven track record of running efficient programs, our underwriting capabilities, our technology, distribution and our talented teammates that enable us to help our carrier partners seek better returns on their programs. We're excited about the potential for this new program, as it gives us a broad-based business owner policy and a commercial package policy. This program will be licensed in all 50 states and will generally target middle-market companies with annual premiums of $100,000 and below.

We've also increased our nationwide independent agency distribution, and we've added more than 50 new teammates. As part of that list out, we have a long-term commitment from QBE as they like the business and the potential outlook. From a financial standpoint, we will recognize revenues of about $6 million to $8 million in the second half of 2017, and we'll have a net P&L investment of $1 million to $3 million. In 2018, we expect the revenues will increase to about $15 million to $17 million, and our net P&L impact will be an investment of $2 million to $4 million. During this time period, we will be building our technology to support that program. Then when we transition off QBE's technology platform, the margins by the end of 2020 will be in line with the overall margins of our National Programs division.

In closing, we remain optimistic about the outlook for the remainder of the year. The economy appears to be moving upwards slightly, and rates appear to be moderating slightly. Our new core commercial program will give us some organic growth in the second half of this year to help substantially replace the CAT-claim revenue from 2016. We're working hard to get a lot of our core technology programs done by the first quarter of next year and further work to implement our uniform Retail agency management system.

We were successful in closing a couple of acquisitions before the end of the quarter, and we continue to look at a number of transactions that can help us grow -- further grow and expand our capabilities. We have a lot of great activity going on throughout the company and are making progress in many of our initiatives to drive the business forward. I'd like to thank all of our teammates for their efforts. We appreciate everything they do each and every day for our company and our team.

With that, let me turn it back over to Tracy for our Q&A session.

(Operator Instructions) We will now take our first question from Elyse Greenspan from Wells Fargo.

My first question. So going back to Powell, some of your comments on the Retail organic growth. I mean, I know some part of the slowdown in the quarter was due to timing, but going back to the first quarter, at least to me, it seemed like if you x out timing-wise, would have, no more or less than looking for growth to kind of stay stable or pick up from there, given the Retail comp program. Can we just get a little bit more color on what role the sequential slowdown? And then would you expect, I guess, growth in the second half of the year just based off of how you see your business now to be stronger than what we saw in the first half of the year?

Okay. So Elyse, as you know, we don't think one quarter, you can have ups and downs in a division or in our business. Having said that, as you heard me say, the average for the first half of the year was 2.5% organic growth versus 1.3% organic growth last year. So we are pleased with the overall performance, Retail and the direction that it's going. We were down a little bit this quarter, and so if you -- in your vernacular, we grew 3% in Q1 and we grew 2.1% in Q2. As you know, we don't give organic growth guidance and we haven't in the past. We've said that we believe that the business is a low to mid-single-digit organic growth business and a steady-state economy, but I know you're looking for some nugget of information and there's not really a nugget. When I say that, it is, we are continuing to execute the plan. We are doing better by a factor of almost double, this time this year versus this time last year and we continue to work to improve it. So there's not one thing. It's just we are down a little bit versus the first quarter in Q2.

Okay, great. And then in terms of the outlook for the contingents, they were higher this quarter than last year. Do you have some visibility into how those will look in the back half of the year?

Elyse, it's Andy here. No. As we've really said on the previous calls, we don't have that level of visibility. We would expect them to continue to probably be flattish, just based upon kind of what we know out there. It just depends upon performance of the individual carrier partner and how it's kind of going underneath on there, so they do kind of moderate up and down.

So then, I guess, going back when we look at the pushes and pulls on that Slide 9, when you showed the EBITDAC margin and obviously, the biggest, that 90 basis point really stemmed from the change in attendance year-over-year. I guess, if we're thinking about the back half of the year, most of the margin delta between '17 and '16 would really just be reflective of the IT investments and the Retail incentive plan. And then just also some of the color you gave surrounding the programs division.

Yes, those would be the 3 main areas. Just again, keep in mind the programs and as we mentioned before, when we are going through the carrier changes as well as the flood claims, those generally come with higher margins associated with them so that will put pressure on the margins in the back end of the year.

Okay. And then as we think about 2018, I know you did provide some commentary about the Retail comp program still impacting margins then. When you guys gave us the outlook for this tech program, it was a 2- to 3-year investment horizon. Are you expecting the program to impact margins when we get into 2018? Or should we look for less of an impact on your margin from the tech program next year and just be thinking about that Retail program still impacting margins?

I think it might have 2 topics inside of there, Elyse. So let's start first with technology. As we said, that was probably a 3-year investment program. It's continuing to move along the path the way that we anticipated, so there will probably be some impact in 2018. As we get towards the back end of the year, we'll be able to give a little bit better guidance as to what that looks like. The main piece that we're focused on next year is, the unified platform for Retail agency management, so we're going to work through that. And then Retail, as we mentioned before, the largest investment is in 2017, then that investment starts to shrink in 2018 and then it breaks even in 2019, okay? So said differently, there will be less margin impact in 2018 than what there was in '17, okay?

We will now take our next question from Kai Pan from Morgan Stanley.

First question on the 5 for 5 Incentive program. Can you give us a little bit more detail about how the program have been progressing? What was your producer behavior under the new program? And what's your 40 to 60 basis point impact on the margin side? What's that imply in your estimate, how much that will help on the organic growth side?

Okay. So first off, we're very pleased with what's happening with our producers across the platform. So that does not mean that they weren't working hard before because they were working really hard before, but there's also a monetary reward attached with a desired performance of growing their book on a net basis, 5% or more. So we're very pleased with that, number one. Number two, as it relates to the organic growth and what we think it would be purely speculative right now versus what the actual outcome is, Kai, for the year. Here's what I would say when we went in. There are some producers that grow their book substantially every year. So I don't think that the additional incentive is going to drive a different behavior, it will reward them more for that desired behavior. Then there are other producers who may not be able to grow their book as much each year, which it may give them further incentive to do so, and ultimately, only time will play that out, but you can have somebody who has had their book flat or just up slightly or down slightly over the last couple of years for a whole bunch of reasons and maybe that helps them drive their book forward to get some additional growth. And so we have -- we do not talk about the anticipated organic growth associated with it, just like we don't give organic growth guidance on our business. I will say, you could draw a parallel. I'm not saying you should, but you could draw a parallel that our average organic growth in Q1 in Retail is 2.5 this year versus 1.3 last year. That might be something you could do, but I'm not saying you should. But ultimately, at the end of the day, our goal is to grow our business more rapidly organically and profitably, and we believe this is part of the solution to doing that. We're very pleased with it.

So the -- that's great. The margin impact for next year and breakeven in 2019, assuming the program will continue in the current form.

That's -- yes. We -- it is intended and will be an ongoing program. And you're correct in how you stated that, yes.

Okay, great. Second question on QBE potential growth opportunity there. You mentioned by 2020 will be similar margin to your National Program division. So what assumption you're assuming on that basically in terms of the top line? How much contribution could be coming from the -- how fast can the business grow?

Well, remember, any time you have a transition when it comes from a carrier and/or platform, there is a little bit of transition time. So ultimately, I believe that there -- we're not talking about the growth numbers just like organic growth, but we do believe that the business can grow, and we're excited about their risk appetite and working with the independent agents that they have actually already developed a really, really good business with. This business is primarily based up right outside of Madison, Wisconsin, and so we have a bunch of new teammates that have joined there. And once it gets into our system, we'll be able to comment on growth and how it's doing just like if we were talking about those that contributed in the program space, like lender-placed and earthquake, this particular quarter.

And Kai, when you're thinking about the out years and our comments on margin, is most of that is actually associated with moving onto our technology platform. That's where we get the benefit out of. It's not off a significant growth in the revenues.

That's correct.

Okay, great. If you can comment on it, just wonder, given your investment of fixed sort of cost structure and technology platform and the people, how much sort of what's kind of run rate revenue core commission to fee [and] will sustain the similar margin as your National Program?

Sorry, Kai, can you repeat that one more time for us?

Yes, sure. If you say, like given the investment you're making, sort of run rate expenses, in this new platform, what kind of like revenue top line would result in that similar margin as your current National Programs?

Basically, it would be very similar to what we've said, which we're expecting next year, full year revenue of $15 million to $17 million. So stated more simply, with little or very little or moderate growth in the program, we think that, that occurs (inaudible).

Okay, so because of leverage on the (inaudible)

Correct. Exactly.

Okay. Great. So last, if I may. You saw the sort of recent acquisition by USI of the Wells Fargo's brokerage business. I just wonder from industry perspective, do you think they're becoming a strong competitor in both organic growth as well as for additional acquisition in that space.

Well, since as you know, they're private equity-owned, we don't have a good visibility into their organic growth profile. I don't know what that will be. Obviously, they bought, I think it was 40 businesses or 40 offices out of Wells Fargo before and I think that, that has been successful for them or was successful for them. Obviously, enabling them to pay whatever they did, which was a big number for the Wells Fargo business. And so only time will tell. I would think that they're going to have quite some time to integrate that, but I could be wrong. We run into them periodically in the acquisition space, just like a number of other firms. There's about 26 private equity back firms as you know, Kai. And on any given day, any one of those people can pop their head up and pay a big number for an opportunity. But once again, banks, depending on how it was run in the bank, there will be probably a transition. And how they did it at Wells and how they're going to do it under Mike Sicard and the rest of their leadership, probably going to be a little bit different. So they're going to have to just work through that.

(Operator Instructions) We will now take our next question from Sarah DeWitt from JPMorgan.

Just following up on the Arrowhead QBE deal. Could you talk a little bit about how that deal came about? And are there any opportunities to do more similar deals with other carriers going forward?

Okay. So what I would tell you, Sarah, is in each of the list out opportunities and everyone's a little different, but we were talking with our carrier partner and they had been evaluating either the cost structure, the profile of the business, the direction of it, whatever -- it could be a bunch of variables and they basically said, "Would it be better for us, as the carrier, to actually partner with somebody like Arrowhead, Brown & Brown, in order to distribute this and be more efficient across our system? Can we get better results partnering with Arrowhead than we can ourselves?" So having said that, that's how each of these, in different ways have sort of come about. Also, and I can't stress this enough, the quality of our teammates in Arrowhead and across programs, we believe it's second to none, number one. Number two, our technology, we believe, is second to none. Number three, we've done several of these, so we have a history of doing these successfully, which is unique. And to your second question, we believe that as a result of all the other capital -- I don't even call it alternative anymore, other capital out there and the way carriers are thinking about trying to write new business, that there are a number of carriers that have very high fixed expense structures, which we'll have to evaluate other opportunities in the future. So do I think there's an opportunity for us in the future? Yes. Do we know of one? No. Do we have one right on deck? No. And if you think about it, they've happened like once every couple of years. And so it's a long process. This isn't like something -- somebody just decides to do this. It's an incredible amount of work that goes into doing what we've talked about. And I'll tell you, I talked to 6 or 7 of our teammates yesterday that were directly involved in the heavy lifting of this partnership with QBE, and they did an exceptional job. And so like I said, we look at it as an opportunity. We've done this now 3 times. This is the third. We would like to think that there are opportunities in the future, but only time will tell.

Okay, great. And just so I can further understand. What is it about the structure that makes this structure more cost efficient for the insurer?

Okay. So let's say that you have a large standard insurance company. You pick the name, I won't name anybody, and their fixed cost, their expense ratio is 35% to 40% or 32% to 40%, and they know to be competitive, going forward, it probably needs to be more like a 28%, I just pulled that out of the air. And so with the same amount of losses, is there a way for them to let us put it on our platform and run it more efficiently than they? So I know you know this, but home office, overhead loads and charges can rack up or erode a margin in a program in a big company. And so when you bring that to us, it's fully allocated and it operates on its own more efficiently and we can drive some of that efficiency through our technology as Andy talked about. Our investment in that technology with enable us to bring profitability of that over time, more profitability to it. So like I said, you know more about insurance company financial structures than I do, but I can tell you, running at very high expense ratios presents a challenge for all those leaders going forward and opportunities for us.

We will now take our next question from Josh Shanker from Deutsche Bank.

I have a couple of interrelated questions. So back when you guys disposed of Axiom Re, you kind of changed how you did your reporting. You made a difference between GAAP, EPS and adjusted EPS. And going forward, I guess when you have earn-outs and expectations, you're adjusting that out as well. I want to know a little bit about your change in thought process and why you used to think that GAAP was the best representation, now adjusted is better. And two, when we think about the quality deals that you're acquiring, I'm sure you think of your teammates as the kind of teammates, who will exceed expectations. To what extent are the earn-outs expected versus the earn-outs being surprising?

I'd like to just talk about that at a high level from a standpoint of -- and Josh, I think you know this, I am not a CPA, so I'm sitting next to one, but I am not a CPA. So relative to GAAP and adjusted earnings, my analysis is there have been things that have occurred in the last several years, which start to make the GAAP number a little bit more opaque than it was. So for example, a change in an estimated acquisition payable is a noncash item based on an estimate that you are putting up or making adjustments in our case, on a quarterly basis versus just putting up the entire estimated expense. And so I think it has -- that's why we moved to EBITDAC and others have moved to EBITDAC to try to eliminate that, so it's clearer for you and everybody else to see. Any time we adjust the number, and I'm the first to say, adjustments are -- what are ongoing expenses versus one-time in nature. And Andy and I and others on our team have big debates about that, when you look at other companies, I'm not talking about just insurance brokers, I'm just talking about companies in general and how they present their numbers. Having said that, we -- maybe we are the most conservative on our estimates on the earn-out payables, but we do an adjustment on a quarterly basis and maybe I should ask you the question, in all the other companies that you follow, those that do acquisitions, do they not have any adjustments on a quarterly basis? And if so, how do you view that?

Well, some do and some don't. My bigger concern is that if I vouch for Brown & Brown as hiring the highest-quality teams, shouldn't I always expect them to beat the earn-out goals and that there'd be a recurring earn-out to be had quarter-to-quarter to quarter? I mean, how did those -- being the quality teams on the books who do exceed expectations as a general business practice comply with the nonrecurring nature of the adjustment based on earn outs?

Yes, I'm going to let Andy answer the GAAP answer to that, but I'm going to answer the reality of that. When we acquire team -- organizations, we do think that they're very high-quality people, so no debate on that. Having said that, that does not mean that every single one of our transactions, they maximize the earn out. And so remember, we set the amount based on the estimate when we do the transaction and then adjust up or down on a quarterly basis. What you just described, Josh, I believe, is you've described a method, which I don't know if it's GAAP or not, we'll let Andy say that to us, but it's basically saying that all earn outs should be maxed out upfront, and therefore, in the event that they didn't exceed that amount at the end, they would actually be a credit. Am I right, Andy?

If you follow that approach.

Yes, I just want to make sure.

It would be, yes.

The question -- if I took all the earn out adjustments over history, do they net to 0? Or do they net to positive?

I cannot give you that answer right here on the spot, Josh, if we go back in history, but we can figure -- we'll go back and look at it. Here's what happens on all of these, and I think your point about high-performing teams is well-made. When we go through the acquisitions, we're looking at the quality of the team that we're bringing on as well as the historical performance of that business. And we're setting the expectations accordingly. One of the things we don't do is, we don't give everybody a layup when they come in. That's just not how we operate. And so as we go through, we're trying to project generally over that earn-out period, it's 2 years, 3 years, what we think that business is actually going to produce. Some businesses do come in and just absolutely crush it and they're well over our pro forma, so therefore, we take a charge to the P&L. If that's a highbrow problem, if they're well over our numbers, but we try to get that as best as we can. Sometimes we miss it a little bit on either side so, and that's why you kind of see it up and down, but I don't want you to think or we don't want you to think that we're walking away from GAAP. That is absolutely not the case. We still believe that GAAP numbers are very important. It's just these -- it can be the one area where we've got the most volatility up and down.

I hope it's mostly up for you guys. We want to see it happen. Assume it's always up, then we have a question about whether I guess, the -- we assume that you guys -- as I said, I assume high-quality delivery and wondering how that relates to making changes in the reported EPS. Great job, I'm not trying to say anything. I'm just trying to understand my own forecasting, whether or not I should say, they're going to win every quarter, as they're good, and that's what I'm trying to figure out.

Josh, the other thing we'd just clarify. The other reason why we also break this out is, I would say almost all of our analysts, can't say every one of them, but almost every one of them, do not forecast any adjustment for acquisition earn-outs. Some put some of the interest accretion inside of there, some put 0. So if we don't break this out, we're actually comparing an apple with an orange then.

(Operator Instructions) We will now take our next question from Adam Klauber from William Blair.

Wholesale is doing pretty well this year. It seems like it's running organically above last year. What's the drivers of that?

Well, remember, we have -- there's 2 parts to that business. There's Binding Authority and there's transactional brokerage, and we have a very good team of people in both segments of that business. As you heard me allude to earlier, the cat property rates are not going down as fast. They still are going down, but they're not going down as fast as they once were, and we continue to do a good job for our Binding Authority partners across the country and it's quite honestly, a lot, just getting in a lot of opportunities and binding a lot of those opportunities. I know that sounds pretty basic, but Tony Strianese and his team, Kathy Colangelo and Neal Abernathy, they've done a great job of putting a great group of people together and giving them the products to sell to their Retail customers. So we're very, very pleased with Wholesale, not only this quarter, but that's the highest growing business in our company in the last 5 or 6 years.

Yes. Yes, Tony is obviously doing a great job. So what's the level of volumes in the transactional side of the business? Is that mid-single digits or so?

Wait a minute, volumes of transactions or?

Sorry, submissions, the volume of submissions in the transactional business.

Yes, the answer is I don't know the -- right off the top of my head, the volume of submissions. I know that it is an enormous number, but I can't comment. I'm sorry, I don't know how much it's up or down. I can tell you that it is categorically up though. I could say that for sure, quarter-over-quarter, year, yes.

So the transactional side is also doing well in addition to the Binding Authority side?

Yes, they're both doing well. Remember, the bigger the premium on an account, the more attention that it attracts and therefore, I think it's fair to say it's probably under the most rate pressure. So $1 million premium is going to be different than a $4,700 premium.

Right, right, okay. On the benefits side, I know you don't break it out separately, but ballpark, is that doing on average as well as the Retail business, a little bit better or a little worse?

Well, hypothetically, we don't really give guidance, but it's doing quite well and we're very pleased with it. How's that?

Yes, that definitely helps. And then you alluded to this, but just wanted to get a better picture. So would you say that exposures are doing well? Are audit premiums up this year compared to last year?

Yes.

There appears to be no further questions at this time. (Operator Instructions) There appears to be no further questions in the queue. I'd like to turn it back to yourself for any additional or closing remarks.

Thanks, Tracy. Thank you all very much, and it's great to talk to you. We'll talk to you next quarter. Good day.

This concludes today's call. Thank you for your participation. You may now disconnect.