Brown & Brown Inc (BRO) 2018 Q3 法說會逐字稿

Good morning, and welcome to the Brown & Brown Inc.'s third quarter earnings call. Today's call is being recorded. Please note that certain information discussed during this call, including information contained in the slide presentation posted in connection with this call and including questions given in response to your questions, may relate to future results and events or otherwise be forward-looking in nature. Such statements reflect our current views with respect to future events, including those relating to the company's anticipated financial results for the third quarter, and are intended to fall within the safe harbor provisions of the securities laws. Actual results or events of the future are subject to a number of risks and uncertainties and may differ materially from those currently anticipated or desired or referenced in any forward-looking statements made as a result of a number of factors. Such factors include the company's determination as it finalizes its financial results for the third quarter; that its financial results differ from the current preliminary unaudited numbers set forth in the press release issued yesterday; other factors that the company may not have correctly identified or quantified; and those risks and uncertainties identified from time to time in the company's reports filed with the Securities and Exchange Commission; [its] relevance to Brown & Brown's consummation and integration of the acquisition from Hays Companies.

Additional discussion of these and other factors affecting the company's business and prospects as well as additional information regarding forward-looking statements, is contained in the slide presentation posted in connection with this call and in the company's filings with the Securities and Exchange Commission. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In addition, there are certain non-GAAP financial measures used in this conference call. A reconciliation of any non-GAAP financial measures to the most comparable GAAP financial measure can be found at 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 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. You may begin, sir.

Thank you, Hanna. Good morning, everyone, and thanks for joining us for our third quarter 2018 earnings call.

Before we get into the results for the quarter, I wanted to make some comments regarding our announcement yesterday about the pending acquisition of the Hays Companies. Hays is a $200 million-plus broker based in Minneapolis, Minnesota. They started de novo in 1994 and have grown organically almost exclusively. Their team is led by Jim Hays and Mike Egan. Over half of their business is in the employee benefits area, with the remaining in commercial and personal lines.

You've heard us regularly talk about the importance of cultural fit. Both our firms share a deep commitment to serve our customers' best interest, and we both understand that our teammates are our most important differentiator. We collectively are committed to a decentralized sales and service model. We'll get into more detail about the transaction later in the presentation.

I'm now on Slide 4. Let's get into the results for the third quarter. We delivered $530.9 million of revenue, growing 11.6% in total and 1.4% organically. Excluding the impact of the new revenue standard, our total revenues for the quarter grew 6.5%. I'll get into more details in a few minutes about the organic growth for each division.

Our EBITDAC margin was 33.5%, which is flat versus the prior year, but benefited from 300 basis points from the new revenue standard. Andy will discuss the movement of our margins later.

Our net income per share for the third quarter of '18 increased to $0.38 from $0.27 in the third quarter of the prior year, driven by an ongoing benefit from federal income tax reform and the impact of the new revenue standard.

As we've said in the past, we do have fluctuations quarter-to-quarter in our organic revenue or margin, but over the year, the ups and downs typically net out. Our third quarter results are a good example of this, where organic revenue growth and margin came in slightly lower than previous quarters. Based upon what we can see right now, we expect Q4 to be more in line with our performance on a year-to-date basis, excluding the impact of storm-related activity. We're very pleased to have completed 10 acquisitions with annual revenues of approximately $47 million during the quarter and have closed over $98 million of annualized revenues year-to-date prior to yesterday's announcement.

Two weeks ago, our Board of Directors approved our dividend increase of 6.7% for the 2018/'19 year. This represents the 25th year of consecutive growth in our dividend, something we're very proud of. We had top line and earnings per share growth for the quarter and have a lot of momentum across the business. Our newest teammates that joined us via acquisitions will help us expand our capabilities and increase our geographic footprint, and most importantly, deliver more creative risk management solutions for our customers. Later in the presentation, Andy will discuss in more detail our financial results, excluding the impact of the new revenue standard.

I'm on Slide 5. Before we get into detail of our divisional performance, I want to make some comments about exposure units, rates, storm claim activity, capital in the market and our investment initiatives.

First though, our thoughts and prayers are with everyone affected by Hurricanes Florence and Michael. As we've done in the past and will do in the future, we're focused on helping our insureds work through these challenging times.

Consistent with what we've been seeing for a number of quarters, the middle-market economy continues to do well. Our customers are feeling good about their prospects going forward and are continuing to invest in their businesses.

We're monitoring the continued rise in interest rates and whether this will affect the positive momentum, especially in portions of our business tied to construction and housing. While we're not seeing something specific today, if interest rates continue to increase over the coming quarters, we expect there will be additional volatility in the market that will cause some slowdown in exposure unit growth.

Rates, as you know, and we've talked about for most lines, continue to be flat. That means for any one account, you can have a slight increase or a slight decrease. The exceptions continue to be with commercial automobile, which is up 3 to 7; and all-sized employee benefits accounts, which continue to experience some upward rate pressure.

The line we consistently see down is workers' compensation, which is generally down 1% to 3%. Cat property rates for the quarter remained generally flat with some downward pressure on the best accounts and upward pressure on those with poor loss experience.

As we've mentioned previously, carriers don't want to lose renewals but are willing to walk away from them if the pricing doesn't match their risk appetite.

We're not seeing a significant number of claims in our Wright Flood business related to Hurricanes Florence and Michael, and therefore, are not expecting claim revenue to be anywhere near the levels we realized last year. We will see some claim activity within our services segment in the fourth quarter as there are some wind-related property claims.

We mentioned earlier that we're pleased with our level of acquisition activity for the third quarter and the first 9 months of '18. We've been very -- we were very active last year and remain very active this year. We've not changed our metrics or what we're willing to pay. The overall landscape remains very competitive, and as of now, we don't see a significant change in the level of capital flowing into the market. We are pleased with the progress of our investments in technology in our core commercial program. As we've mentioned previously, Q3 represented the continued investment phase for our core commercial program, and we continue to expect margin improvement for this program in Q4.

I'm going to now Slide 6. Let's talk about the performance of our 4 segments. We mentioned earlier the lumpiness we can experience in organic revenue growth in certain quarters, and we experienced that dynamic in the Retail segment in the third quarter, which grew 2% organically. We experienced some incremental lost business for this quarter and our new business was not as high as anticipated. We believe this is in an isolated incident to the third quarter. This is why we often look at year-to-date results to gauge our performance, as any 1 quarter does not make a trend.

On a year-to-date basis, our organic growth in Retail is 2.8%, which is 30 basis points higher than the same period for the prior year.

Our National Programs segment decreased 3.3% organically. This was driven by approximately $5 million of claims processing revenue recorded in the third quarter of '17 with a minimal amount of claims processing revenue recorded in Q3 of this year. Isolating this change, our organic revenue would be flat to slightly positive for the program segment.

As we've discussed in our Investor Day last month, for the quarter, our lender-placed business experienced a slowdown in organic revenue due to continued improvement in the economy and we have a couple of programs experiencing downward revenue pressure due to changes in risk appetite by our carrier partners.

Our Wholesale Brokerage segment had another strong quarter with organic revenue growth of 7.7%, driven by the expansion in all lines of business. We continue to be pleased with the consistent organic growth of this segment. Way to go, Tony Strianese and the entire wholesale team.

Our Services segment delivered 2.1% organic revenue growth for the quarter and we realized growth across most businesses. We did experience lower claims processing revenue compared to 2017, which has partially offset organic revenue growth experienced by other businesses in this segment.

Let me now turn it over to Andy, who will discuss our financial performance in more detail.

Yes. Hey, Hanna, by chance, is there a background noise by you that someone can mute there? It's overriding part of the call, please?

Your line is the only line open, sir. Thank you.

Okay, all right. Perfect. Thank you. Appreciate it, pal. Good morning, everybody. On the following slides, we'll discuss our GAAP results and then our adjusted results, excluding the impacts of acquisition earn-outs and the impact of the new revenue standard.

As a reminder, we've excluded the impact of the new revenue standard for the calculation of organic growth in order to provide a better comparison with the prior year. We plan to use this format for the remainder of 2018. Then in 2019, we'll be on a comparative basis.

Over on to Slide #7. This presents our GAAP and certain non-GAAP financial highlights. For the third quarter, we delivered total revenue growth of 11.6% and organic growth of 1.4%. Our income before income tax increased by 14.5% and our EBITDAC grew by 11.8%, both of which were positively impacted this quarter by the new revenue standard. Our net income grew by 39.8% and our diluted net income per share increased by 40.7% to $0.38 versus $0.27 in the third quarter of last year. The growth in our financial metrics, except organic revenue growth, was impacted by the adoption of the new revenue standard this year. We'll discuss more of this in a few minutes.

The growth in net income and diluted net income per share in excess of revenue growth was primarily driven by our lower effective federal tax rate that resulted from tax reform last year.

For the quarter, our effective tax rate was 25.5% as compared to 39% last year, with our effective tax rate benefiting from the 14% decrease in the statutory federal corporate income tax rate.

For the year, our expectation is for our effective tax rate to be in the range of 26% to 26.5%.

Our weighted average number of shares outstanding decreased approximately 1% compared to the prior year. This was driven primarily by the share repurchases we initiated last year and completed in the first quarter of this year.

And lastly, our dividends per share increased to $0.075 or $0.10 (sic) [10%] compared to last year.

Over to Slide #8. This slide presents our results after removing the change in estimated acquisition earn-out payables for both years and the impact of the new revenue standard, which results in the most comparative basis.

For the quarter, our revenues increased by 6.5%, income before income tax decreased by 3.6%, and EBITDAC decreased by 2.9%.

Our net income grew by 17.7% and diluted net income per share was $0.31 as compared to $0.26 in the prior year, growing 19.2%.

In a few slides, we'll talk through the components of our margin change year-over-year. For the quarter, the impact of the new revenue standard was higher than we estimated, driven by the timing and size of renewals along with a onetime adjustment. Later, we'll talk about the fourth quarter and full year expectations for the new revenue standards.

Moving over to Slide #9. This slide presents the key components of our revenue performance. For the quarter, our total commissions and fees increased by 11.6% as compared to the prior year. Our contingent commissions increased $10.8 million as compared to the prior year, which was driven almost entirely by the adoption of the new revenue standard.

As a reminder, we'll now recognize contingent commissions upon the effective dates of the underlying policies throughout the year rather than when received per our previous treatment.

For the fourth quarter, we're not expecting any changes to the range of expected contingent commissions versus what we communicated last quarter. Guaranteed supplemental commissions were up slightly year-over-year and were not impacted by the adoption of the new revenue standard. Core commissions and fees increased by $43.8 million.

When we isolate the $28 million impact of the new revenue standard, $14.4 million of which impacts core commissions and fees, and excluding the net impact of M&A activity, our organic revenue growth was 1.4%.

Moving over to Slide #10. To provide some additional insight into the components of our EBITDAC margin, we've included a walk of our quarterly EBITDAC margin from last year to this year and highlighted the main drivers. The new revenue standard positively impacted our current quarter margin by 300 basis points. As we discussed in previous quarters, we're in the investment phase of our core commercial program that we launched in July of 2017. The investment this quarter impacted our margin by approximately 20 basis points, which is in line with the expectations we previously communicated. We expect slight margin improvement in the fourth quarter of this year.

As we mentioned during last year's third quarter call, we experienced a onetime benefit associated with foreign exchange within our wholesale segment. This represents about a 20 basis point impact on the prior year.

During the quarter, we realized about a 30 basis point impact to our margin as noncash stock-based compensation costs have increased due to our continued incremental financial performance and higher retention of teammates. While both of these are beneficial, they will continue to increase stock compensation cost over the coming quarters.

For the current quarter, the impact of the net change in gains or losses on disposal was about 60 basis points related to the sale of certain offices, where last year there was a gain, and this year, there was a net loss.

Other is a combination of onetime items, business mix, some timing and a lower organic growth for the quarter. Similar to our earlier comments, we can have variability on a quarterly basis.

As a reminder, we had approximately $5 million of additional claims revenue in the third quarter of last year, which had above-average margins.

And finally, as we mentioned during our Investor Day conference, certain of our recent acquisitions will initially be slightly dilutive to our margin, which we experienced during the quarter. Consistent with our historical performance, we'll work to increase the margin for these acquisitions over time.

On the following slides, we presented the results for our business segments on an as-reported basis as well as excluding the impact of the new revenue standard. A reconciliation by segment is included in the appendix of the presentation. We're going to go ahead and start on Slide #11 with Retail.

The primary effect for the third quarter of adopting the new revenue standard was an increase in contingent commissions of $3.5 million. For the third quarter, our Retail segment delivered total revenue growth, excluding the new revenue standard, of 9% and 2% organic revenue growth.

As discussed earlier, the quarters can be lumpy at times, and therefore, it's helpful to look at a year-to-date organic growth, which is 2.8% versus 2.5% for the same period last year.

Our EBITDAC margin for the quarter, excluding the new revenue standard, declined by 280 basis points, driven by increased intercompany allocations for technology as well as our investment to upgrade our agency management systems. Both of these initiatives are in line with our expectations.

Also, we mentioned earlier we recognized increased noncash stock-based compensation costs as our equity plans are performing higher than expected, and the lower organic growth and some onetime items impacted our margins for the quarter.

Over to Slide #12. For the fourth quarter, our total revenues increased by 12.4% in our National Programs segment. This growth was primarily impacted by the new revenue standard. The impact was the recognition of approximately $6 million of revenues and profit related to contingent commissions in the third quarter that otherwise would have been recognized in other quarters.

We also had a nonrecurring adjustment of $8 million related to the new revenue standard. Excluding the impact of the new revenue standard, total revenues decreased by 1.2% and declined 3.3% organically.

As discussed earlier, the organic revenue decline was primarily due to approximately $5 million of lower flood claims revenue recognized this year as compared to last year.

During the quarter, we recognized minimal revenue associated with Hurricanes Florence and Michael. Based upon what we know right now, we expect a minimal amount of revenue from these -- from claims in the fourth quarter of this year. This will probably be in the range of $500,000 to $1 million.

As a reminder, we recognized approximately $22 million of revenue in the fourth quarter of 2017 associated with Hurricanes Harvey and Irma.

Excluding the new revenue standard, EBITDAC decreased by 6.5%, impacted by the lower claims processing revenue, which have higher-than-average margins, the continued investment in our core commercial program and the loss recorded associated with the sale of a small program. Excluding these items, the segment delivered underlying margin improvement due to continued disciplined management expenses.

For the quarter, our income before income tax increased 45%, impacted by the new revenue standard and lower intercompany interest expense and partially offset by the EBITDAC drivers we just mentioned.

Moving over to Slide #13. The impact of the new revenue standard on the wholesale segment was minimal for the quarter. Excluding the impact of the new revenue standard, the Wholesale Brokerage segment delivered total revenue growth of 8.8% and organic revenue growth of 7.7%. Our EBITDAC margin, excluding the new revenue standard, decreased by 60 basis points for the quarter.

As discussed during the earnings call for Q3 of last year, we recognized a onetime benefit related to foreign exchange. Excluding this item, we delivered underlying margin improvement, driven by strong organic revenue growth and disciplined expense management during the quarter that offset increased expenses associated with intercompany technology allocations and noncash stock-based compensation costs.

Our income before income tax margin increased by 30 basis points, impacted by the same factors contributing to the EBITDAC margin, along with lower intercompany interest.

Over to Slide #14. The Services segment, excluding the new revenue standard, delivered revenue growth of 12% and organic revenue growth was 2.1%. The incremental increase in total revenues was driven by an acquisition we completed during the quarter. Our organic growth was driven by performance in most of our businesses, which was partially offset as we recognized minimal claims revenue associated with Hurricanes Florence and Michael as compared to the same period last year.

Based upon the claims we received to date, we do not anticipate material revenues from these 2 storms in the fourth quarter of 2018 and would expect our organic revenue growth to be impacted by approximately $3 million year-over-year.

For the quarter, our EBITDAC, excluding the new revenue standard, decreased 1% due to new client on-boarding costs, lower claims activity and a new acquisition that has a margin lower than the divisional average.

Over to Slide #15. We've included an updated outlook for the fourth quarter and the full year associated with the new revenue standard. As a reminder, the implementation of the new revenue standard will primarily impact our Retail segment on a quarterly basis, as we used to recognize revenue based upon the latter of when billed or effective. Topic 606 requires a company to recognize revenue when earned.

For the third quarter, we estimated the positive impact upon revenues to be in the range of $4.5 million to $8.5 million and the actual impact was $24.5 million. This difference was driven primarily by the timing and size of renewals within the Retail segment and the adjustment we mentioned earlier within the National Programs segment. We estimated the impact upon income before income taxes to be in the range of $7 million to $9 million and the actuals were $23.4 million. Our updated outlook for the fourth quarter is a decrease in revenues of $3 million to $7 million and a decrease to income before income taxes of 0 to $5 million.

As we mentioned earlier, we are not projecting any change to the estimated impact upon contingent commissions for the fourth quarter versus what we communicated last quarter.

For the full year, we expect revenues to increase $17.5 million to $21 million and the income before income taxes to increase $16 million to $21 million as a result of implementing the new revenue standard.

With that, let me turn it back over to Powell for closing comments as well as comments on our pending acquisition of Hays.

Thanks, Andy. Great report. We'd like to share some additional information about the Hays Companies and the financial structure of the deal. The Hays business is a very -- is very diversified across many industries and over 50% of the revenues are from employee benefits.

Combined, we'll have an employee benefits business with annualized revenues of approximately $430 million to $440 million in revenue, increasing our employee benefits business over 35%. The business operates in 21 states with 32 locations and has a team of over 700. Their largest offices are in Minneapolis, Milwaukee, Boston, Kansas City and Dallas. The addition of these new teammates will give us a great Midwest presence, help us further increase our organic growth, increase our capabilities and provide additional solutions for our customers. The Hays Companies serves customers in all segments, but primarily focuses on the upper middle market. They have a proven track record of starting new businesses, developing talent, growing their business organically. This year, they're projecting to deliver revenues of approximately $205 million.

With the addition of Hays, the revenues for our total company will increase over 10% and the total revenues for our Retail segment will increase approximately 20%.

From a leadership perspective, Jim will become our Vice Chairman of Brown & Brown and join our Board of Directors. He will report to me. Mike Egan will become a senior leader of Brown & Brown and continue to lead the Hays Companies. We're really excited to have both these talented gentlemen join our senior leadership team.

I'm on Slide #17. Let's talk about our strategic rationale of why we're purchasing Hays. This is a growth business that helps us accentuate our offerings in the upper middle-market accounts base. Their average organic growth for the past 5 years has been approximately 6%. They have over 700 excellent teammates with a strong leadership team. Their footprint is very complementary to our existing footprint as we did not have a large presence in the Midwest.

We also have the opportunity to combine resources in order to enhance our capabilities and provide more solutions to our current and future customers.

With the acquisition of Hays, we also increased our capabilities within the employee benefits, data and analytics and certain industry segments. Our cultures are very similar. We have an entrepreneurial spirit and we sell and service locally, but also leverage the capabilities of the broader organization.

We believe the combination of Brown & Brown and the Hays Companies will allow us to deepen our carrier relationships and scale our operating platforms. All of these will help us drive additional growth and margins over the coming years.

From a financial standpoint, we're paying $705 million at close with $605 million in cash and $100 million in common stock and the equity will have a 5-year holding period. There will also be a potential $25 million earn-out that's based on the attainment of certain revenue and profit targets. We plan to buy back shares to offset the dilution associated with this transaction over the next 3 years. We will finance the transaction initially through a combination of cash as well as debt from our $800 million revolver. Then we expect to term a portion of the initial purchase price on a multi-tranche debt.

Our projected gross debt-to-EBITDA ratio for 2019 will be 2x.

As we stated during our Investor Day, we're comfortable with up to 3x gross debt-to-EBITDA ratio. Therefore, we still have sufficient headroom as well as access to capital for future acquisitions. We anticipate paying down any floating interest debt with the cash generated from the business over the coming years in order to lower our interest cost and increase the earnings per share impact.

We anticipate incurring onetime integration costs of $8 million to $12 million spread over the next 3 to 4 years in order to deliver incremental value and improve our combined margins. We're targeting to deliver combined annual EBITDAC synergies in the range of $10 million to $15 million over the next 4 to 5 years. They're a combination of revenue and expense synergies with scaling of our operating platforms.

For 2019, we anticipate the revenues generated from Hays will be in the range of $210 million to $220 million and will generate approximately $47 million to $53 million of EBITDAC. The addition of Hays will drive incremental revenue growth of over 10% and EBITDAC growth of over 8%.

In summary, we're pumped about the addition of the Hays Companies to the Brown & Brown team.

In closing, we have good momentum in the business and I want to thank our 9,100-plus teammates for all their efforts and look forward to welcoming all of our new teammates at Hays. The economy remains positive and there's a lot of hiring in most communities across the United States. This is a good thing for Brown & Brown.

With the latest interest rate increase and talks of further rate increases over the coming quarters, we're watching closely how this may impact the growth of exposure units.

As we head into the fourth quarter, we expect overall premiums to remain flattish, a technical term, except for the lines we have discussed previously. There's still too much capital seeking investments in the insurance market.

On the M&A front, we would expect it to remain very competitive. We have had and continue to have good inventory of acquisition candidates. You've heard me say this before. We remain optimistic that we'll be able to acquire more firms that fit culturally and make sense financially. Please note, we continue to be actively involved in the M&A space now and moving forward. No one on this call or anywhere out there should think because of the Hays acquisition, we're slowing down.

Investment in long term, profitable growth of our business remains a key focus. We discussed during our Investor Day how innovation, technology, Insurtech will be key parts of our strategy in the future. So our technology investments and launching our new core commercial program are just several key examples to this strategy.

Lastly, we're really excited about the combination of Brown & Brown and Hays and what we can do together. Our combined team will create an even more powerful group of almost 10,000 teammates that will be able to deliver industry-leading solutions for our current and future customers.

With that, let me turn it over to Hanna for the Q&A session.

(Operator Instructions) Our first question is from Elyse Greenspan from Wells Fargo.

To start, I have a couple of questions on the Hays acquisition. You guys gave us a lot of financials, which is very helpful. First off, the accretion figures that you guys provided, the $0.02 to $0.03 per share, I guess, Powell, I think you said that you guys are going to buy back the stock that you issued over 3 years. So is that assuming 1/3, 1/3, 1/3 in terms of when you're going to kind of buy back those shares that are issued there?

No.

No, I think we'll just -- we'll buy them over the 3-year period, Elyse, but we're not scheduling to buy it at a pro rata amount.

And by the way, that accretion, as you know, is GAAP accretion, not just cash.

It's important.

Yes. And then just in terms of some of the other financials, the revenue and expense synergies there, can you break down kind of where you think it might skew one way versus the other? And then the integration costs, I'm assuming you guys are going to pull that out of adjusted earnings. Can you just verify that, Andy?

Yes. Let's touch on the expenses first and we'll come back to the synergies. Yes, we'll call those out over time if, in any 1 quarter, they're material. Again, we're looking at the integration cost. It will be more heavily weighted from years 2 through 4. We'll have a little bit in 2019. But consistent with what we've done on other larger acquisitions, we normally only break things out for the first year. But if it's so warranted, we'll call that out for the impact on the margins. And then on the synergy or the benefit front, it's really weighted, both combination of revenue and expenses.

Remember, they have been investing actively in their business like we have, so growth opportunities and production. And once again, we're excited about the ability for us to leverage some of their capabilities and them to be able to leverage some of our capabilities. So that's a good thing, Elyse. We're really pleased about that.

Yes. And we wouldn't want anybody to think that we're doing the transaction for cost synergies. That is not why we're buying the business. This is a high-growth business and we're looking to continue to see that growth in the future.

Okay, great. And then in terms of, Powell, you kind of alluded to in a couple of sections of your remarks about higher interest rates and the impact that, that could have on the economy. What about higher interest rates and the impact that, that could potentially have on private equity interest in the brokerage space? Have you seen any kind of slowdown as you've looked at deals more recently? Or do you expect to see a slowdown if interest rates continue to rise?

Well, that's a logical comment, Elyse, and I'd like to think that we're logical and you're logical, but not all -- PE is not always logical. It would seem to indicate that would happen if, in fact, there was continued upward pressure or increases in interest rates. PE continues to be a very active in the space. You've heard me say before, I think there will always be an element of PE in our industry. I believe, at last count, there's 29 PE firms that are in the space. So there's lots of people that are trying to get in and be in and then flip things and blah, blah, blah. We don't -- we know that hope is not a good business strategy, but I would say that if, in fact, interest rates go up, we would think it would actually change some of their buying patterns. But until and at which time we see that, I don't believe it.

Okay, great. And then one quick question on the quarter. You guys alluded to timing in your Retail book and pointed us towards the year-to-date figure for -- thinking about organic. Did you see timing impact more on the employee benefit side or in the commercial side? Or was that -- is that a comment that you would make towards both of those businesses in the quarter?

I would say it was both of the businesses during the quarter, Elyse. And at the end of the day -- and I know I alluded to this, but we had -- we're not making any excuses, but we had some business that just didn't close and so we anticipate good new business in Q4. But once again, we got to be in Q4 to see that happen. But yes, I think it's in both businesses, benefits and P&C.

We will now move to our next question from Mike Zaremski from Crédit Suisse.

Okay, great. I had a question on thinking about the margins directionally. If we kind of think out to 2019, not -- I think previously, investors were biased, maybe a little upwards due to less headwinds from the -- you guys have talked about the IT investments and then also the new compensation program won't be a headwind anymore. And I know Hays, if we can think about -- excluding Hays, I know Hays will be very material and have an impact, but ex the Hays acquisition, is that still the right way to think about the business in terms of margins directionally for next year? Because I know there's a lot of moving parts.

Well, I think -- the short answer is yes, I think that's the right way to think about it, but I would say it's important to know that how we invest in businesses today and going forward will impact the overall trajectory. And so you said that Hays is a material part of Retail. It's $200 million part of $1 billion. So it's going to be $1.2 billion of revenue, so it is meaningful. And we're looking for businesses, as you've heard us say, that fit culturally and make sense financially. We cannot stress that enough. And remember, we're doing this forever. The private equity is short term. So they don't care about the cultural implication. They just get it together and try to spin it. And so in the case that some of the businesses we buy will have higher-than-average margin -- our average margins, some will have lower-than-average margins, but each of them will add to our capabilities and our talent, both in production, service capabilities, marketing and leadership.

That's helpful. The next question is, thank you for pointing out the potential impact for rising interest rates on the construction industry. Could you, at a very high level, maybe size up what percentage of your, I don't know if it's maybe revenues, is construction related?

Yes. The answer is we haven't given out specific industry types and breakout, but I would tell you, and this is purely off the top of my head, it's probably somewhere in the 6% to 10% of our Retail business.

Okay. And then lastly for Andy. The tax rate's coming in about 1 point lower than the prior guidance. Just curious, is this a kind of a sustainable level as we're thinking long term or it'll kind of fluctuate a little bit up and down?

Yes. Thanks for the question, Mike. So for the quarter, we ended up at 25.5%. That was impacted by a true-up that we did on our foreign repatriation. Like many companies, everyone was doing their best estimates at the back end of last year. That was about $1.6 million or so. So if we take that out, our effective rate would have been kind of in that mid-26% range. That's why we're kind of thinking 26% to 26.5% now on a full year basis. We think that's a pretty good number, but one of the areas that we've got to continue to look at is exactly what Hays will do for our taxable footprint across the United States. And then we continue to have states that are raising their rates as was indicative of New Jersey this year, making a retro back to 1.1. Maine has also changed their approach on unitary. So we continue to watch those. There'll be some movements underneath, but I think, at least from our standpoint, 26%, 26.5% is a pretty good marker right now.

Our next question is from Kai Pan from Morgan Stanley.

First question on Hays. Just this is the largest deal in your history. It's 10% of your revenue. So [what] do you think this deal different from your private -- previous deals? And can you comment on potential opportunity for this deal and the potential execution risk such as sort of the system integration or revenue -- any revenue overlap between offices? And also, can you comment on the valuation of the deal as well?

Okay. So that's multiple questions. First of all, as I said, we're pumped about Hays joining our team. And as we said, they're really an upper middle-market business. They have great capabilities in both employee benefits and property and casualty. And so number one, I will tell you that we have some things that we think can help them in some of those businesses. And they definitely have some things in the employee benefits and some of their capabilities that can help us. So number one, I think this is a 1 and 1 equals 3 or more. That's the goal and I do believe that is the case, number one. Number two, they have an enormous number of talented people that bring additional collective learning or knowledge to our system. And so when you work with Brown & Brown and our companies, we're trying to leverage that knowledge to the best interest of our customers and/or our prospects. So it enhances, quite honestly, our institutional knowledge. That's number two. Number three, they operate in -- most of their offices are in places where we don't have offices. And so it's very complementary. And particularly in the Midwest, as you've heard me say, we don't have an office in -- we have a small office in Minneapolis. We don't have an office in Milwaukee. We don't have an office, retail office, in Kansas City. We don't have an office in Dallas. So all of a sudden, we're expanding into markets that we want to be in that we haven't been in, in the past. As it relates to the valuation, I think it -- everyone on this call will have their own perceptions of what we have paid for this transaction. Let me make an observation as it's stated and then let me make an observation longer term. Number one, the market drives the price and so one might say this is a full price for an acquisition, and it is a very high-performing, high-quality fit, cultural fit, for Brown & Brown, number one. Number two, we don't think about it in an isolated period of time in 1 year or more. We're thinking about what 1 and 1 means 3 years and 5 years and more down the road. And not unlike some of our other larger transactions, each one of those brought new capabilities that made us a better organization and made it -- helped us build out our offerings to our customers. So I can't stress it enough to say that we're very pleased that the Hays team and Brown & Brown are coming together, and I look forward to meeting all of their teammates in short order. And we look forward to welcoming them onto the team officially sometime early -- well, sometime next month, subject to HSR approval.

And I have a few follow-up questions. Number one is National Programs organic growth underlying is flattish. You cited a few headwinds. Do you see the headwind persist or you can see improvements in term of like organic growth in National Programs?

Kai, it's Andy here. Yes, we're anticipating headwinds in the fourth quarter. If you remember back to our Investor Day, we had made comments on the front, specifically on 3 areas. One is make sure to take into the consideration the year-on-year impact of lower flood claims. And we mentioned earlier in our call, we have about $22 million last year. We're only anticipating $0.5 million to $1 million fourth quarter of this year. The next item was around our lender-placed business, and again, that's countercyclical. So as the economy continues to improve, that business won't see the same level of organic. So that will have some downward pressure. And then we had also mentioned that we have a couple of carriers that are changing risk appetite for 2 of our programs. That will persist for probably a couple of quarters and then we'll work through that. So we would definitely expect negative organic growth in the fourth quarter for National Programs, okay?

Okay, great. My last one, on the new accounting standard. Seems like the number just keep moving around, understanding it's a new standard for everybody. But if you look at full year, our regional expectation is that will not impact the full year earnings, just moving among the quarters. But now your forecast is that a full year pretax earnings is going to be anywhere between $16 million to $21 million. So that's pretty meaningful. So I just wonder, could you give a little bit more color on that? And is that a run rate that is now pulling forward for next year, or next year's results we're building on top of this?

Yes. I think good point on it, Kai, of -- around the complexity of this standard. And probably not dissimilar to a lot of companies out there, is there was a tremendous amount of effort put into it and there were estimates based upon the best information at the time as we went through it. One of the items that we talked about this quarter was an $8 million adjustment that we had in National Programs, and that was just as we kind of continued to learn more. That we would not expect to continue on. We had also estimated what we thought the contingents would be for the year. And again, we just have -- we have to estimate what we think they're going to be 12 months from now, not knowing the actual loss experience underneath. So as that continues to develop -- and I think we'll get better on that refinement over time. But no, we would not expect on a regular basis, once we kind of get this embedded, that we would have that level of uptick each year. So I think this is just part of kind of this first year of implementation.

And so to be clear, is that there will not be any sort of like a reversal in 2019?

No. We would not expect anything of materiality, reversal or even positive, year-on-year.

We will now move to our next question from Greg Peters from Raymond James.

I wanted to follow up on the Hays Companies acquisition. It has to have been a very coveted M&A target in the marketplace. So Powell, maybe you can talk a little bit about the process and how competitive it was and how many other players were interested in the company. So give us sort of a lay of the landscape there.

Okay. Well, I think the first time that we met Jim was 18 years ago and our Chief Acquisitions Officer, Scott Penny, met him then. And then I met Jim and several of the senior leaders several years ago and have spent time socially around each other in business settings and kind of been talking over the last couple of years. And so at the end of the day, culture is equally as important to them as it is to us. And so when you really get right down to it, I always tell people, "If you're thinking about selling your business, go out and talk to some people who you think might fit, find the one that there's a cultural fit and then go get in a corner and negotiate what a fair price is." And that would be a good way to describe what this is. And so we have -- I mean, I can't speak upon the number of people that have called them because number -- lots of people call them all the time and talk to them about their business. But at the end of the day, this was not a traditional process with a banker. And we cultivated this over the last several years and we feel really good about it.

Color. And the -- so just as a follow-up, if I look at Slide 17, and you provide some benchmarks of performance for 2019 and you include integration costs to be spread out over a couple of years in combined synergies, when I think about the combined synergies of $10 million to $15 million, should I assume that those are reflected in the EBITDAC guidance for '19? Or is that $10 million to $15 million to be realized over a multiyear period?

It's the latter.

Yes. And Greg, we'll have -- most of those, they're more weighted out towards kind of years 3, 4 and 5. It'll take a while to build into those.

Right. So the final question on the Hays Companies is, and I know some of the previous analysts had, had questions about your consolidated EBITDAC margin and underlying EBITDAC margin, it looks like this transaction is going to cost maybe up to 100 basis points of EBITDAC margin near term. Am I missing something there? Or should I start benchmarking my margin off of this lower level?

You're -- that's 100 basis points in Retail.

Right.

But yes, the answer to the question is you're thinking about it correctly, that's correct.

Perfect. And Powell, I can't help myself. Do you guys think you might change your reporting structure? Are you going to drop this all into Retail and just let it rip?

No, I don't anticipate us changing. I want to make sure I understand what you're saying...

Well, the reporting -- the 4 segments that you report, I mean, now that you've got a substantial benefits business, maybe you might want to break out your benefits business on top of the other pieces?

Yes. No, we're not planning on that.

No, this will just be -- this will be a region inside Retail.

Okay. And then I just wanted to -- one follow-up on the Retail segment, and I was looking at your commentary you provided on Slide 11. And one of the items, when you talk about the revenue results, it sort of caught my attention, was the last 2 words of the statement there was, "lost business." Could you provide some color around that? Because it's -- that's usually not something I would associate with Brown & Brown. So maybe you can bridge the gap there.

Sure. Well, let's put it this way. You would -- I think you would agree that you would think brutal honesty when you think Brown & Brown. So we're not trying to make any excuses. We lost some business in our businesses, and that can be either through acquisition, it could be a decision, a loss of relationship. It could be all kinds of different things, Greg. But at the end of the day, we just call it what it is and so we didn't grow the business. We didn't write as much new business and/or we lost a little more business than we thought we would lose. So we lose business just like any other broker. We try to, obviously, work really hard not to lose business and we want to keep the customers that we have. But don't -- I don't want you to take something out of that like we're trying to foreshadow something. I think it's more brutal honesty. It is what it is. We lost some business and it impacted our numbers. That's how I'd want you to think about it.

So it's more of an anomaly rather than some broader trend. So I think that's the message you're trying to deliver, correct?

That's exactly right. Based upon what we can see, it's a Q3 thing, and we're on to Q4 and we're doing our thing.

Greg, we've had these in previous quarters where just 1 quarter, you'll have it. So just nothing unusual on trend or anything.

We now move to our next question from Mark Hughes from SunTrust.

Two quick ones. The fourth quarter claims revenue from last year, was it $22 million in national accounts and then $3 million in Services, so $25 million total?

Yes, so it's $22 million in National Programs and then we had a little over $4 million in Services last year. So we have about $26 million in total. We think we'll have half...

And then the...

Yes, go ahead, Mark.

Very good. Then the technology investment. In the EBITDAC walk, you don't refer to the technology investment, but in a number of the segments you point to it. Was there some offset somewhere or how should I think about that?

Yes. So the offset was in corporates. That's why we -- it's allocations between corporate and the divisions because we had built the investment cost up in corporate now, getting that out to the divisions of the segments. And then we did not call anything out for the third quarter in the walk as the impact on technology was minimal. So again, it's just kind of performing right in line with what we had expected as well as what we had talked about on previous calls. We've had a little bit of downward pressure on margins versus second quarter. We said it'd probably be around flat for the third quarter with a little bit of lift in the fourth quarter and minimal impact on the full year. So we seem to be right in line.

We will now take our next question from Yaron Kinar from Goldman Sachs.

A couple of questions on the Hays acquisition. So first, when you talk about revenue growth there, are you expecting any revenue creepage from the deal? Any maybe slowdown due to execution? Or do you think that the 5%, 6% growth rate over the last few years can be maintained over the next 3 to 5 years?

Well, we would sure like to see that be the case and we're not anticipating it slowing down, but Yaron, I'm sorry. We don't -- we feel good about the trajectory and what's going on, barring something we're not aware of.

Okay. And then on the margin side. So once you get past this initial 3, 4 years, do you think that the Hays business can achieve the margins that Retail is currently generating?

The answer to the question is, true middle-market retail is a higher-margin business than upper middle market, and more specifically, large accounts. And so the answer to the question is, over time, their margin will go up because they will become even more efficient because they've invested in production talent and service and marketing talent, which is not at full capacity today. Having said that, we look at the business holistically. And as we said earlier, it's going to have approximately a 100 bps impact in year 1. And then over time, as we achieve collective synergies, then the overall will improve. So we feel good about the margin trajectory going forward. That's how we'd answer that question.

Okay, I appreciate it. And then maybe one final one. Can you talk a little bit about their IT and systems? I know you guys have been investing a lot in improving and updating your systems. Do they need additional work on their systems today? Is it easy to integrate your existing systems with theirs? Any color on that would be helpful.

Sure. So the short answer is they have a very talented group of IT people on their team, number one. Number two, they are currently on the agency management system that we are converting Retail to. That does not mean that they're on the same version, I don't think, but they're on the same agency management system. So that's a positive. Number three, just getting converted over -- I know this sounds like basic things, but to Office 365 and some of our systems, it takes time. But what I would say is if you're asking the question, are they in the Stone Age relative to IT, the answer is no, they're not. And so we're excited about some of the things that they've done and how we can learn from them and vice versa in that particular space.

Okay. So whatever investments in systems they may still need is already part of your integration cost estimates?

That is correct.

Our next question is from Josh Shanker from Deutsche Bank.

I just wanted 2 questions. One was a follow-up on Kai's. You mentioned $8 million of unexpected revenue associated with the change in revenue standard in the National Programs business. I was just trying to better understand what that was. And you say that, that should be $8 million, that increases at a normal CAGR in the 3Qs of the [fewer] -- I just want to understand exactly what was going on there.

Yes. No, that was just a onetime adjustment that we had based upon estimations [underlying] on the billing of customers. Do -- definitely do not anticipate seeing that next year. That is a onetime item.

So there's a $8 million headwind to think about in 3Q -- in '19 modeling, that's right?

From a total revenue, that did not go into the organic calculation though.

Okay. And then on tax, obviously, there's some discrete tax items in the quarter. Do you have any thoughts on 2019 tax rate?

Not right now, other than the comments that we made earlier. What we'd really like to do is get through year-end and figure out exactly what kind of our footprint looks like with Hays coming in and doing kind of all of our year-end true-ups. And then once we release earnings for the fourth quarter, we'll give an update for '19.

Our next question is from Bob Glasspiegel from Janney Montgomery Scott.

Just a couple of tag-in questions on the Hays deal. Whenever you buy something, you're going to be buying companies that have lower EBITDAC margins than you, given your best-in-industry margin. What are some of the things you could point to besides scale that's inherent in their current run rate of margins? And what's the path to -- how long does it take you to get it traditionally, with a company this size, which I guess you haven't done this big, but how long does it take to get the company to the margins where you want it to be?

Well, let me back up for 1 second. This is a business that, as I said, grew pretty much organically from 0 to $200-plus million since 1994. So that's very impressive to us and I think it would be to anybody, yourself included, relative to just growing a business, just going out and getting the right people and getting new customers and doing the right thing. So that's number one. Number two, we don't want to do something that actually changes their ability to continue to grow. We want to do things to enhance their ability to grow as part of our organization. So as I've said earlier, we like to think about you sell and service locally but you leverage the capabilities of the organization nationally to the benefit of our customers. What we typically see, Bob, is generally speaking, in a -- in any kind of earn-out, you have a kind of a float up over time of some efficiencies that they achieve. That might be a possibility of purchasing power as a combined business, in some instances, whether it be technology or something else that we're doing, supplies. It could be something that we can do 1 and 1 equals 3, where we have a product where they may be able to sell more business than they had previously in a certain industry type. There can be a whole bunch of different ways to do that. But we think it's just like anything else, it's over a couple-of-year period that they actually improve and we do, too.

And Bob, our comments -- Bob, it's Andy here. Comments we made earlier, as we said, the synergies out of this, we won't see until kind of the years 3, 4 and 5. It will kind of take that long to build into it. So wouldn't -- we wouldn't suggest that you put all those in your model in years 1 and 2, just for clarity.

Got it. And do they have a richer comp plan than yours? Or is it roughly comparable? And you will have the principals super-incentivized with your note provisions, which is a smart way to do it. So one could assume they'll be extra incentivized with the commissions plus the earn-outs over the 5-year period. Is that a fair assumption?

That's a fair assumption.

And their comp plan is reasonably comparable to yours?

Remember, they're in the upper middle market. It is similar to some of our larger account businesses, yes. That's how I would say it.

Yes. Bob, they've created a performance-based incentive plan. We really like it. We don't see any reason why to change that plan right now. Seems to work really, really well for the business.

Great. And last question. How much debt did you say you're going to put on? And what rough rates should we look to when we model?

Yes. We'll probably take on somewhere around $550 million to $600 million in debt, just dependent upon cash that's on the balance sheet and timing. And right now, we're estimating interest rate of 4 3/4%. Hopefully, we'll get less than that. Rates are ticking up right now.

And any amortization that's going to go through the -- that you could quantify or any more depreciation?

Yes. If you look back on Page 29 of the deck, we put right in there, estimated amortization. Yes.

Our next question is from Meyer Shields from KBW.

I just had a few quick modeling questions. One, given its employee benefits focus, is there any distinct seasonality in Hays revenues?

Not that we're aware of.

But just -- so as their business in general -- I think Powell's comment is, is there any seasonality? No. But keep in mind, Meyer, that the revenue recognition rules will absolutely move revenue between quarters. So what we're doing -- as we're working with their team right now on implementation of rev rec. When we release earnings at the end of the year, we will come back and provide quarterly guidance, but expect their revenues intra-year will definitely move quite a bit around. So we'll give some guidance on that, okay?

Okay, that's great. Second, on the $8 million National Programs revenue recognition issue, are there any offsetting expenses that also should not recur next year?

Nothing of material size there.

Okay. And then finally, within Retail, so there was a slowdown in organic growth, but you're still running close to 3%. Was there any unwind of compensation accruals through the first half of the year in the third quarter expenses?

No.

We'll now take the final -- my apologies, we'll now take a question from Adam Klauber from William Blair.

The $100 million of stock, how many producers is that going to? And did I heard correctly that's locked up for 5 years?

Yes. No. Number one, the distribution of that, we're not talking about openly, and yes, it's a 5-year lockup.

Okay. So if you're not talking about that specifically, how are the producers being locked up?

The senior leadership of Hays has got a plan worked out with the individuals that are driving the business forward. But once again, if we told you, then it would be in the public and our competitors would try to use that against us. So suffice it to say that we feel comfortable with the plans that they have in place to continue to drive retention of people and accounts.

Okay, that's fair. And then as far as the Hays EBITDAC margin, I think you said 22%, 24%. Typically, with the larger deals these days, investment bankers tend to add in adjustments, sort of pre put in cost savings. Is that 22%, 24% Hays' historic margin? Or does that include some of the bankers' add-back-ins or cost savings?

Well, let me make sure that we're stating the same thing. Number one, bankers are very good marketers, but we also understand what the numbers are, real or not. There was not an investment banker involved in this. So those numbers are our numbers, our collective numbers together. So if you were to go out and see a deck of something on one of these deals that somebody's pitching, they will make the margin look substantially higher than it is or could be. So any adjustments in the pro forma, we collectively, with the senior leadership at Hays, are both very comfortable with and those are real numbers.

And we have a follow-on question from Yaron Kinar from Goldman Sachs.

Just one quick one on modeling. I think you said that you'd have a $3 million headwind in the fourth quarter in Services revenues. Is that an absolute number? Or is that just a base off of which you still expect to get some offset growth? Mainly, are you talking about a $40 million number or -- as the number you should be generating in the fourth quarter in Services? Or will it be a $40 million base that will still be offset by some growth?

Yes. Think about it as the -- whatever you're projecting for the fourth quarter, then pull $3 million off of that.

Okay. And then one final follow-up. The 22% to 24% EBITDAC margin that you're expecting for Hays next year, that does not include the combined synergies. Is that correct?

As we've talked about, Yaron, is we are forecasting minimal synergies in kind of years 1 and 2, more in kind of 3 through 5. We will have some integration cost next year. Most of those will be in 2 through 4.

Okay, so...

Let me also -- let me point out one thing, Yaron, that -- I know you know this, but this is a GAAP-accretive deal in year 1 and it is an asset purchase. So there -- that is, obviously, a very positive thing for the team here. So I just want to make sure that you have that. I know you knew that, but I want to make sure everybody else out there knows that, too.

I appreciate it. I guess I'm just -- I want to make sure that I'm thinking about it correctly. So beyond the GAAP accretion, the 22% to 24% does incorporate some minimal integration costs and some minimal combined synergy estimates in it for next year?

No. It has a little bit of integration cost. It has no synergies or benefits in it.

Ladies and gentlemen, that now concludes our question-and-answer session. So I'd like to turn the conference back to you, Mr. Powell, for any additional or closing remarks.

Thank you, Hanna. We appreciate everybody's time today. We're excited about the Hays transaction, and we look forward to talking to you again after Q4. Good day. Bye-bye.

Thank you. Ladies and gentlemen, that now concludes today's conference call. Thank you for your participation. You may now disconnect.