Brown & Brown Inc (BRO) 2012 Q2 法說會逐字稿

Good morning, and welcome to the Brown & Brown, Inc. second-quarter 2012 earnings conference call. Today's call is being recorded. Please note that certain information discussed during this call, including your answers given in response to your questions, may relate to future results and events or otherwise be forward looking in nature and reflect our current views with respect to future events including financial performance. Such statements are intended to fall within the Safe Harbor provisions of the securities law.

Actual results or events in the future are subject to a number of risks and uncertainties and may differ materially from those currently anticipated or desired or referenced in any forward-looking statements made as a result of a number of factors, including those risks and uncertainties that have been or will be identified from time to time in the Company's reports filed with the Securities and Exchange Commission.

Additional discussion of these and other factors affecting the Company's business and prospects are contained in the Company's filings with the Securities and Exchange Commission. With that said I will now turn the call over to Mr. Powell Brown, our President and Chief Executive Officer.

Thank you, Lisa; good morning, everybody. We are here this morning in lovely San Diego with our Board visiting Arrowhead. And so it is 5.30 local time and we are glad everybody can join us. I will turn it over to Cory for the financial report.

Thanks, Powell. Now that we have two straight quarters of positive internal growth we at least have the beginnings of a trend. Our net income for the second quarter of 2012 of $42.5 million was up 14.7% over last year's second quarter. Correspondingly our net income per share for the quarter was $0.29, which is 11.5% over the $0.26 that we earned last year in the second quarter.

From our revenue standpoint, commissions and fees for the quarter increased 17.9% or $289.9 million, that's up from the $246 million that we earned last year. In our press release is our normal table that summarizes our total growth rates and our internal growth rates from our core commissions and fees, which excludes profit-sharing contingencies as well as our guaranteed supplemental commissions or GSCs.

Relative to our profit-sharing contingency commissions, we only received $1 million this year, which is a $1.3 million decrease from the $2.3 million that we received last year. The vast majority of this net decrease was from our wholesale brokerage division.

We still estimate that we will receive around $10 million to $11 million of profit-sharing contingencies in the third quarter and then for the fourth quarter of 2012 we may receive between $2 million and $3 million as long as there are no hurricanes that hit Florida this year.

Additionally, we accrued $2.3 million of guaranteed supplemental commissions in the second quarter of 2012 and that is about $600,000 less than the $2.9 million that we accrued last year in the second quarter. As we mentioned in our first-quarter conference call, this reduction is primarily due to the fact that several of our insurance carrier partners have reverted back to their profit-sharing contingent commission contracts beginning in 2012.

Now looking at our internal growth schedule, we did have a strong positive internal growth rate of 3.2%. For the second quarter of 2012 our total core commissions and fees increased 20.5% or $48.8 million of net additional core commissions and fees. However, within that net number was $41.1 million of acquired revenue.

That means that we had $7.7 million of new commissions and fees on a same-store sales basis. And that is the first time -- first time in a long time that we've had positive internal growth in each of our four divisions. Powell will talk about the activities in each of those business segments in a minute.

Our investment income decreased by approximately $200,000, but correspondingly our other income increased by roughly $300,000. Our pre-tax margin for the second quarter of 2012 was 24.5% and that is compared to our pre-tax margin of 24.9% in the second quarter of last year, so a 40 basis point differential.

The employee compensation benefits as a percentage of total revenues was 51.8%, that is an increase from the 51.0% factor we had last year second quarter. The total dollar increase on a net basis in employee compensation benefits was approximately $24.9 million or a 19.8% increase.

Of that amount $19.2 million was attributable to just the new standalone acquisition since last year. Therefore if you exclude the impact of these standalone acquisitions, we had $5.7 million of additional compensation on kind of a semi-same-store sales basis because obviously we do have roll ins that include that number.

Of this increase we had -- $1.5 million was due to the new one time 2012 additional producer commissions that are going to be paid to our retail division commission producers for their growth of their 2012 production. In addition to that we had another 300 -- miscellaneous $300,000 of other production bonuses that were paid out this quarter.

We also had about $200,000 of new salaries for new producers that joined our system. We had $600,000 with an increase due to just our group health insurance costs and then we had roughly about $360,000 of additional payroll taxes relating to increased compensation and others.

If you take these four incremental compensation and benefit costs, they added about 110 basis points to our ratio of compensation and benefit expenses as a percentage of total revenue.

Additionally, as we discussed in the first quarter, we have a subsidiary, a new acquisition called ICG, which has a very unusual revenue recognition policy that delays the revenues for almost a seven year period because that we have fairly high compensation cost in the meantime relative to the revenues. And that added about 40 basis points from an incremental basis to our employee benefit cost percentage. And as we talked about in the first quarter, that will continue until the fourth quarter when it will be comparable comparisons fourth quarter to fourth quarter.

So if you exclude -- again, if you exclude those items on a cost differential basis, our employee compensation and benefit cost as a percentage of total revenue would be 50.8% in the 2012 second quarter and that is comparing to the 51% in the second quarter last year. So a slight improvement excluding those items.

Our non-cash stock-based compensation cost was up on a net basis $1 million, which was due to new grants under our stock incentive plan. The majority of these were grants under the -- for the Arrowhead acquisition.

In the current quarter other operating expenses increased as a percentage of total revenues 30 basis points to 14.5%, and that is from 14.2% last year in the second quarter. Other operating expenses increased $7.2 million and that is a 20.7% increase. However, if you take just the standalone acquisitions, they added about $7.6 million to these net costs and therefore, on an existing semi-same-store sales basis, they had actually net decrease in other operating expenses of about $400,000.

This net decrease was primarily related to $700,000 in cost savings from our occupancy and office rental costs. Excluding the operations from these new standalone operations, other operating expenses as a percentage of total revenue decreased to 13.7% versus last year's 13.8%.

Amortization and depreciation in aggregate went up $2.6 million and that is primarily due to acquisitions. Our interest expense increased roughly $400,000 over the prior year as a result of our increased borrowings of their $200 million that we borrowed for the Arrowhead acquisition.

Our change in estimated acquisition earn-out payable was a credit of $603,000 this quarter versus a debit of $1.6 million last year in the second quarter and thus there is a swing of a $2.2 million differential there. Our effective tax rate for 2012 is expected to continue to run at approximately 40.3% and is primarily due to our higher state income tax rates on an aggregate basis.

So to conclude, we ended up with net income of $42.5 million and that reflects a very nice 14.7% increase over last year's second quarter. So with that financial overview I will give it back to Powell.

Thank you, Cory. Great report. We are very pleased with our organic growth in the second quarter. Some carriers are increasing rates, 10% 15% regardless of loss experience; this is not the norm but more on isolated instances. Regional carriers tend to be seeking slightly less increases than national carriers and we closed $11.8 million of annualized revenues via acquisitions in the second quarter.

In retail we were 30 basis points positive versus negative 70 basis points in Q1. Kind of going around the horn, Florida property is up, it's really up -- it is flat to up 10 points; GL is flat to up 5; auto is flat to up 5; exposures are flat to up slightly; GL construction rates are down 5 to up 5.

RMS 11 continues to impact different carriers differently both in the standard markets and the E&S markets. We are seeing the impact in Tier 2 counties as much if not more than in Tier 1 counties -- that's not just in Florida, that is in most cat prone areas.

In the Southeast other than Florida property is flat to up 5; GL is flat; auto is flat to up slightly; exposures are up slightly. Comp is under pressure -- South Carolina up a couple points; Tennessee up 8, 10, 15 points; Georgia is flat to up 5.

There are certain -- there's a certain carrier or certain carriers that are committing to drive their -- committed to drive their rates on their book up 10% and they are willing to stick by it. Regional carriers are typically a little bit more -- they are a little more flexible.

I would say that property -- in the property arena underwriting approach is firming, as you can tell, and construction has to be there for an individual market to go up or give on price. So something that -- it's just more stringent underwriting guidelines at the present time.

In Louisiana and Texas property is plus 5 to plus 10; GL is flat to up 10; auto is up 3 to 8; work comp is up 5 to 10; exposures are flat to up 10. The marketplace continues to be similar to what I said in the southeastern states; construction rates are up 5 to 10 and exposures are up 5 to 10 in construction.

In the northeast property is -- property GL and auto are all flat to up 5% and exposures are typically flat to up slightly. The marketplace update -- New York City construction rates are going crazy. GL rates are up 25% to 40% and umbrellas are up more. There are some three-year policies on non-construction business that are coming up and those are up plus 10 or more.

In the Midwest property is up 1% to 8%; GL is plus 2% to 5%; auto is flat; work comp depending on the state is 0% to 8%; exposures are pretty flat; rates are up 5%, but exposures in construction are down 20% to up 10%. Regionals continue to be strong in the Midwest; they are seeking typically less rate than national carriers. Work comp is tightening, national carriers are trying to get rate and they're trying to stick to it.

In the west property is flat to up 5%; GL and auto flat to up 5%; exposures out here in the west are down 5% to up 5%. The work comp line led by the wonderful state of California, as you know, had a 122% combined ratio last year. Rates are easily up 5% to 10% or more depending on the class of business. Construction rates are up 0% to 5% and the theme in the west is work comp is tightening across the board.

In the wholesale arena we grew 7.9% versus 5.5% in Q1, brokerage property rates are up 5% to 15%, it's very model driven. RMS 11 has continued -- it's not just starting but continues to have a major impact on pricing and aggregate distribution. GL rates are flat, not many reductions, habitational rates particularly on frame garden style apartments are going up, losses are catching up with the carriers. We are seeing more construction accounts in the E&S arena than we have in the past.

In the binding authority arena Florida rates are up 10% to 20% primarily driven by RMS 11. In the Midwest rates are up 5% to 7%. The regional markets, meaning standard markets, are still very competitive and are a big competitor versus the binding authority E&S. Exposures are up slightly. The northeast rates have been up about 5% but are now flattening or we think potentially decreasing through the end of the year, reinsurance rates were flat in Q2.

In the programs arena, programs are up 7.1% versus up 60 basis points in Q1. Professional programs are plus 1.5% versus plus 40 basis points and special is up 9.3 versus up 70 basis points. FIU rates are flat to up 10%. Admitted market continues to be very competitive, one in particular. They typically have different wind deductibles than we have. CalSurance and professional rates are flat to down slightly, dental rates are flat, lawyer rates are zero to 10% up.

In the services arena we are up 10.1% versus up 5.6% and Q1. NuQuest, led by Tracey Lazzopina, our Medicare set aside business and Advocator Group led by Mike Crowe, our Social Security disability advocacy firm, both had great quarters and hats off to both of them, thank you.

From an acquisition standpoint we did $11.8 million in acquisitions year to date. There are lots of discussions going on, inventory is good and I'm pleased on where we are year to date.

In conclusion, national carriers are pushing rate the most, although regionals also want it. Work comp seems to be running a temperature everywhere. Last year in the industry was at 118 combined which is the highest it's been since 1994 excluding 2001. The acquisition landscape continues to be active as there are lots -- there's lots of speculation around future tax changes.

And finally, we are very pleased with our 3.2% internal growth in the second quarter. Every division of our business grew organically. Retail went up 30 basis points positive. Please remember, retail is our largest segment. This is the first time it's been positive in a long time. This will improve as the middle market improves. With that said, Lisa, I would like to turn it back to you to have questions.

(Operator Instructions). Keith Walsh, Citi.

It's great to have you back, Powell. First question for Powell just on the economy. I guess we keep seeing mixed signals in the news. But what would have to happen in the macro economy for exposures to really retrench from current levels in retail? And I've got a couple follow-ups.

Well, that is a good question. I think our business, as we've always said, is a proxy of the middle market economy. And so what we are seeing, Keith, is our clients are cautious about increasing exposures on renewal even if they know that they're going to be up. So we've talked about that in prior calls.

So I think that there is lots of uncertainty, particularly as it revolves around an election year; I think certainty is better than uncertainty. I have basically said that I think there are two things that overhang the economy -- I've said this for the last 18 months -- that are unusual and different. One, it is here in America one is not.

I've always said that I think that the environment in Europe is worse than it seems in terms of the banking situation and that could have a blow back onto our economy in the United States and impact our business.

The second thing is I still think that there is a propping up of the real estate market. I don't know the solution, but in terms of Fannie, Freddie, Sallie, in terms of mortgage environment. So there is a lot of work being done there as well.

We still see pockets in our business which are very tough operating environments, places like Naples, Florida, which you probably wouldn't think of and yet you would think of Las Vegas or Detroit. And so, I wish that I had a crystal ball, Keith, on the economy, but we watch very closely and we are trying to do -- obviously do what's in the best interest of our customers and sell a lot of new business.

Okay, and then for Cory. Maybe you could just give us an update on Arrowhead. Are you still on track for your accretion targets?

We are. They are proceeding on their goal, as we have mentioned, that we expect for the whole year they will be at $40 million of EBITDA. So they are doing very, very well.

And then just lastly for Powell, you have mentioning RMS 11 the last few calls and it seems like there is more runway here. Can you just comment on that and where specifically are you seeing this regionally? Thanks a lot.

Sure, Keith. Let me give you an example just to kind of give some color around it. Certain carriers are being driven by their reinsurance carriers to adopt it carte blanche. Certain carriers are adopting it partially because they are looking at a blended model with AIR, the other model that is used frequently.

And so, if you have a carrier, a standard carrier that has to adopt it carte blanche across the board and all of a sudden, as an example, they -- when they model things let's just say in Orlando, Florida, so it is 60 miles to the coast east, maybe 45 at the closest point, and it is 70 miles to Tampa. And so the model all of a sudden shows that their rates go up in that particular instance 40% to 400%, one carrier.

So what that means is all their business in Central Florida is going to go away. That is not indicative of every carrier, please don't take that out of context. What it is though is indicative of a carrier or one or two carrier, and so there is a movement in this marketplace.

And so I think that a model is probably never actually perfectly correct, you could run 10,000 Monte Carlo simulations and you're going to come up with all kinds of different scenarios based on very few variables. I think what it is is there are some companies that are being driven by their reinsurance carriers to act and adopt it more strictly than others, that is how I would view it. Lisa?

Yaron Kinar, Deutsche Bank.

A question on the retail space. Congratulations on turning into positive organic growth first time in several years. But at the same time I guess 30 basis points -- with the competition going on now to grow your organic base by at least 5%. Maybe it seems like a little bit light, but maybe you could give a little more color on why we should expect those kinds of numbers or maybe what the trajectory would be from here?

Yaron, can you -- I want to make sure I understood that about the others. I heard your question, but did you talk about somebody else trying to grow towards 5%, is that what you are saying?

No, but if I remember correctly, you put in place a competition -- or I think you called it a competition between your retail producers to grow at least 5% organically.

Right.

And it seems like you have some expenses coming from that --.

That is correct, I got it.

So why wouldn't we see more organic growth to go along with that?

Right. So basically depending on where you are in the country, what offices, we are seeing more growth in certain offices. Some offices it is just like anything else, in a larger organization you can have offices that have really good quarters and -- or be down a quarter or revenue can shift from one quarter to another.

What I would tell you, Yaron, that we are pleased about is the trend, assuming that the middle market economy continues to improve, is moving in the right direction. And that is the growth engine of our business because you know 60% of the revenue last year. So I would say that we continue to look for incremental improvement in the retail space and we are working towards that in the next -- in the future.

And Yaron, I think you've got to kind of reflect on retail was. If you go all the way back to 2008-2009 we are a negative 8.7, then we were a negative 4.8, and then in 2011 we were a negative 4.2 and now we are just basically back to flat with the retail division.

So it is trending in the right direction and, as you know, we are very tied to the middle market economy. And even though the middle market economy, it just seems like it's found its feet, it's not necessarily going to move up quickly but we think it will be a gradual comeback. And I think that is positive because that is the largest division and I think there is real potential there.

Got it. And a couple of follow-ups on that point. So, would it be fair to assume that roughly 50% of the eligible producers were able to achieve growth similar to last quarter? Just -- because that number seemed similar.

Well, Yaron, I would think you might have seen our schedule and it really hit very close to 50%.

Okay, okay. And could you give us some -- somebody else said what portion of -- the 50% that actually made that 5% target, what portion of their growth came from new business?

Well, we track new business and we are making -- we set up accrual on a quarterly basis and we can't answer that right now because it will look at the end -- we'll look back on it at the end of the year. But a lot of it.

Don't forget, retail in total is just marginally up which is a little bit of exposure in rate. So just naturally those 50% that did exceed it generally are still playing in the same realm and are getting the same kind of price increases. So the majority of it is new business.

Okay, so when I think about next year then that extra 5% bonus goes away and then the compensation metric moves down from 40% to 20% as it becomes renewal business?

That is theoretically correct the way you are thinking about it.

Okay, thank you.

Sarah Dewitt, Barclays.

Now that organic growth is firmly in positive territory when do you think we could see margin expansion?

Well, if you remember, Sarah, we talked about -- I specifically said in October on the call that I was prepared to take the margin down slightly or keep it flat to grow the business organically. We know that we can grow our business organically and increase the margin.

The great part about it, as you know, is on every incremental dollar of revenue on an existing account that can be very profitable into our business units. Meaning, I'm talking about exposure increases, I'm not talking about new business that's on top of it. And so we are working very hard to grow our business organically and improve our margins.

Okay. Is there a level of organic growth at which point we would expect margin expansion and at what point we should expect margins to be flat?

Well remember, as Cory articulated so nicely earlier, we have some additional expenses that are flowing through right now which I'm perfectly comfortable with. And I've said that we are going to do things that will stimulate growth and reward performance. So that is a nice way of saying, we said this is a one year sales contest and that is exactly what it is. But we may do things in the future that will continue to stimulate growth.

But no, there is not a stated internal growth number where margins expand. I know that you are referring to someone else that said that that is how it works for them. But we feel good about our business in a normal steady-state; when we grow our business organically we believe we can get margin expansion.

And, Sarah, as I tried to explain is that if you take those four or five items that are relatively newer cost, basically that is 1.1 percentage points on the margin. And then that one operation we have, ICG adds another 40. So that is 1.5 points on the compensation and employee benefit line and that basically moves us down to -- just without anything else that is roughly 50.3% versus last year's same quarter at 51%. So that in itself is a margin improvement.

We do have a couple other unique things, for instance like Procter and they do an exceptional job in their area. But to compete with the big 800 pound gorillas in that space, several years ago we have beefed up their IT and they provide really superior service in that area to the smaller mid-sized banks and mortgage bankers.

And for instance, they grew year to date roughly $2.2 million from new accounts that they had picked up. But at the same time they are having to beef up their IT area and really very much some of the best systems in the industry. But they have added $1.6 million of employee costs and benefits relative to that.

So that is part of their growth plan and so that's even excluding the differential that I just explained to you. So overall margins will continue to increase; this is just a transitional year. And we are just focused on internal growth in the short-term right now.

Okay, great. Thanks for the answers.

Ray Iardella, Macquarie.

I guess first, Powell, I know you mentioned $11.8 million of revenues closed year to date in terms of acquisitions, that inventory is looking pretty good and potentially the tax situation later this year could lead to some more opportunities. But maybe you can talk about the appetite for another larger deal similar to an Arrowhead.

Sure, the $11.8 million, just as clarification, were closed in the second quarter. And as you know, Arrowhead was the largest acquisition that we have ever done and we are very pleased with the teammates. I've met a large number of our teammates; of the 520, I have met probably 480 of them here in San Diego and we are very pleased with the team here.

That said, there aren't many Arrowhead's out there, meaning there is only one and we purchased them. I had said to the team here, and I would say it to the team or everyone on the call, that if there was another Arrowhead out there or something similar tomorrow we would buy it.

And so we have always said it is all about the people because good people develop and grow good businesses and attract more good people. It sounds kind of trite, I understand that. It sounds sort of basic, management 101, but we really believe that.

And so we continue to look at acquisitions of all sizes and shapes and there is lots of speculation by people on this call and others about all kinds of things that could happen in this industry. That said, the great part about it is we feel really good about our company and we are committed to keep doing what we're doing for a long period of time and acquiring strategically good partners.

Okay, that's helpful. And then I guess maybe talk about organic growth at Arrowhead. I think you had mentioned on track to reach the sort of the $40 million of EBITDA, but is organic growth still is as strong as it was in the first quarter?

Yes.

Around the 7% to 8% range if I recall?

Yes, 6% to 8%.

Okay, that's helpful. And then lastly, I don't know if you guys talk about this metric or use the metric, but organically has the producer or agent count increased year over year or has that been pretty steady against trying to strip out acquisitions? Has that been a pretty consistent number or as that been going up or down?

Well, we consistently, as you know, we invest -- we allocate 1% of revenues into a people category in which we invest in high-quality new people who are not originally in budgets. And so we supplement that expense or offset a portion of that expense at the local level in sort of a partnership or a cost sharing basis to the local offices.

So we are looking to organically grow that number and invest in our teammates around the country in different -- in all four segments of our business. But, no, we haven't given that metric in the past, but that is what we are doing.

Okay, that's helpful. Thanks again and best of luck.

Matthew Heimermann, JPMorgan.

A couple questions. One, just if we think about in retail the slight growth we are seeing this quarter, could you give us a sense of what that looks like by products? In other words, if I am a retail agent and let's say in San Diego, I mean how much of -- if I am up 0% to 1% what's -- how much is work comp contributing? How much is GL, auto, property, construction, kind of the normal classes that you talk about rate change in and exposure change in?

Matthew, take this in the spirit as intended, it is very different for every producer. Some producers are specialists where they will write just construction or just healthcare, just as an example. And inside of healthcare there would be a focus on nursing homes or assisted living facilities or hospitals. And in the construction business it might be residential or in habitational it is condominiums and apartments.

And so what you find is -- and then you have, conversely you have people who are more generalists and they write different kinds of businesses all over the place. So you could have a manufacturing operation and a construction firm and -- and a beer distributor. And so that is a hard answer to give. We don't track it that way in terms of what really makes it up comp over property over whatever the case may be.

I would say that if you look inside of the books of business with the production force at Brown & Brown and you listened, as I know you did, closely to what I said on rate, you hear a recurring theme of comp pressure and property pressure. Those are the recurring themes. And so different states, as you know, handle work comp differently.

And Florida is a state where you have dividends and loss sensitive programs but the rates are fixed. In a state like California there is rate variability so you can go up or down due to the deviating of the rate. And so you have more discrepancies in rates in California versus in Florida, but I would contend that the buyer ultimately gets the same benefit long-term if they are profitable, meaning if they have low losses.

All right, that is fair. Just figured I would take a shot. Just in terms of -- one of -- the comment that stuck out to me in your prepared commentary was just the comment that in the northeast you have got some price -- I think you said GL, but that was looking like it was starting to roll over.

And I guess the question is, when you think about what you are seeing with price on the carrier side, do you think the underwriting approach is to kind of look at this in terms of get what you need today? Or do you feel like people have kind of a multi-year rate need and are addressing the market as such, kind of taking it as they don't want to push too hard and they would be willing to get it over one or two years?

Well, I think that the answer is sort of a bifurcated answer. There are certain carriers that are sticking to their guns. Most of those are national carriers more so then regionals, but both regionals too. And I think that we all know that the industry is over capitalized to the tune of probably $550 billion, that was as of the end of last year.

And so you have -- it sounds good to have rate pressure, upward rate pressure for the near to intermediate term, but the reality is will it stick? And let me elaborate.

I have said and will say today and in the future that I think that rate increases in the current -- rate increases in the near to intermediate term can continue to go up. I think that the rates at which they go up moderate, that is a broad statement.

On a specific statement, if you look inside the Excess & Surplus lines market, specifically the property, the cat property providers, if in fact there is no wind event this year, so by December 1 if there has not been a wind event - nothing comes into Harris County in Texas, nothing rips into Florida or Louisiana, nothing comes in to the coast up in the Mid-Atlantic -- I would tell you that I think there is going to be downward pressure on those rates next year.

Downward may not be all negative, it might be just flat, but I don't think it goes up as much because of the amount of capital that is chasing it.

Now I would like to clarify for you, Matthew, one other thing. The comment that I made was in the E&S market and it was in binding authority specifically. So, that is one place very isolated in a northeast region and so that could change depending on the experience of that particular market or those markets. But as a general rule we are seeing flat to upward pressure on rates everywhere for the near term.

Okay, fair enough. And then just one last question on how should we think -- you have done a pretty good job of laying out the -- kind of the expenses and how we should think about adjusting for comps there. But I am just curious, when we look at the services revenue given the very quick ramp we have seen in growth off the Medicare and Social Security disability programs, should we think about that kind of being a disproportionate one-year growth bump that then moderates? I just want to get my arms around that.

Yes, I think that the way I would want you to think about services is not unlike the acquisition landscape. I think that it is kind of lumpy -- not bumpy, lumpy. And so I don't -- I think that you should -- I don't think you should think of it as a just a one-year event, but I'm saying I think it could be up, but up less in the future or it could be up more. It just depends because of the opportunities and the services that they are providing to their carrier partners.

Okay, fair enough. Thanks much.

Meyer Shields, Stifel Nicolaus.

I was just hoping to run through a couple of quick issues. One, is it fair, Powell, to infer that more business that you are placing is going to the regionals, if they are being less aggressive on pricing you can get a better deal for your clients that way?

We, Meyer, do a lot of business, as you know, with regional carriers already. And so that is going to occur on an office by office basis. Regional carriers typically don't have large property capacity or they may have constraints relative to the limits that they put up even on a liability basis. So you could draw that conclusion, but I don't think that's categorically across the board fair.

Okay, no, that's helpful. When we look at the trend for other income it actually came down. Is it fair to view that as a positive because it means that fewer producers are leaving you and buying books of business?

Well, remember we don't, as you know, when we invest in someone, an agency, we intend for them to be part of Brown & Brown for the duration. And as you know, sometimes people's attitudes or views on the world change and maybe they would be better served being part of a different team.

We don't like people to go to other teams, but sometimes it is better for both parties involved. So like I said, on $1 billion, $150 million base we are going to have some people leave periodically and we will have some dispositions.

And, Meyer, I would warn you too that as a general rule we don't feel like we lose that many producers that we won. And not all the businesses that we sell is -- some of the businesses we sell are people that we have asked to leave too.

Understood, okay. Last question if I can then. There has been a lot of I guess political rhetoric about (inaudible) housing rates. Is that a threat to Proctor going forward?

Sure. You know, what you've got is you've got an environment that is very unclear as yet. And so you've got an environment that is probably going to be more highly regulated and absolutely could be a threat.

Okay. Is there any way of quantifying that or you just have to wait and see what happens?

Well, we don't know, that's the thing. I mean once again someone may -- somebody may dictate the rates that they charge or -- we don't know. It is unclear as of yet and as that information becomes available we'll provide it.

Okay, great, thank you very much.

Mark Hughes, SunTrust.

Any noticeable trend through the quarter in terms of the tone of business? How did trends look as you exited 2Q compared to when you started?

Well, like I said, I would tell you that we were pretty darned pumped about a 3.2% internal growth, and the fact that we had growth in all four of our divisions was good. So I would say that is good and a lot of people feel really good about it, and it is not just me. So I know that is not a very scientific answer. But I would tell you that I think the trend is positive.

Okay, good. The -- Cory, the 1.5 points of extra expenses on the comp line, as we look at Q3 is there any reason why that might be a little bit higher or a little bit lower? And I will sort of ask a question again; how much more organic would it take to kind of overcome that -- say your pretax was down 40 basis points year over year, how much more organic would it take to put you in flat territory?

On the first question, I think it is probably fair to go on and assume about the same level, given all of the same fact patterns that they reoccur, and it should be relatively consistent on that. So, with that said, when you pull that out, I make the argument that you basically do have margin improvement even at this level.

Keep in mind the retail only grew a total of $400,000 net, 0.3, and I think that is an even stronger engine for the margin side of it. So, again, I think outside of these items I have listed, our margins will continue to improve.

So, assuming incremental improvement in the retail, then we should get -- the margin picture should be better, obviously.

As internal growth gets stronger, yes, from here.

Okay, thank you.

Adam Klauber, William Blair.

Wholesale clearly had a good quarter. Rates are beginning to go up. Are risks beginning to flow back in that market, also?

What is interesting, Adam, as you know we have talked about the three kinds of risks that exist. You have those that are always in the standard market, those that are always in the E&S market, and then you have the tweeners. And the tweeners actually tend to tilt towards the E&S market.

I would tell you that a lot of that tweener business had gone into standard markets for a period of time, and I do believe some of that is starting to come back, not -- this is not a gusher. I don't want you to get that impression. I am just saying I think that the E&S marketplace is seeing more and more business opportunities today than ever before.

Part of that is driven by this risk appetite, part of that is also driven by some exposure increases in certain classes of business, i.e. some areas of the country that are seeing some construction improvement. So I would tell you that they are seeing a lot of accounts. I would say that is driven on a tweener class, but I don't think it is a gusher yet.

Okay. And on specialty programs, I think you mentioned it was up 9%. What was driving that?

Proctor was big. Cory, what else?

Adam, that grew roughly $2.2 million and Proctor was about $1.2 million of that. And then the other $1 million really came from a lot of all of the other different programs in $200,000 to $300,000 each chunks. So overall programs are all moving well and there is very few that were really negative.

Okay. And then finally the acquisitions. I think you mentioned pipeline is pretty good. We have heard from a number of sources that the market is also pretty robust -- there are properties out there. Any reason over the next 12 months we wouldn't see -- I know the acquisition business is lumpy, but any reason over the next 12 months we wouldn't see like deal flow return to what it usually is?

Well, Adam, your guess would be as good as ours on that because, as we've said, it is all about good people and the properties that become available. We are actively looking all the time. We are proactive in that process, as you know. And so we would like to think that there would be a lot of opportunities for us to consider. But it would be purely a wild ass guess on my part if in fact I said it is going to be the so-called your definition of normal. But we think it is going to be. We think it looks good.

Okay, well, thanks a lot.

Dan Farrell, Sterne, Agee.

I just want to come back on the expenses and ask you, within the incentive structure there is some parts that you are definitely trying to think about as sort of one year, like the contest for example. I am wondering what are the chances that those would be extended or become a more permanent part of the structure.

And obviously if pricing improves and the economy improves then it is easier to pull that back. But if those positives were to moderate you may face the decision further down the road of choosing between organic growth and margin expansion. And I want to just try and think -- see how you think about that decision.

Sure. Let's meet sure that we are clear. This contest is for one year. I have basically said that we want to do things that stimulate growth. In the future we will try different things and we want to reward performance. So we are more focused on margins than it seems to anybody else and we are going to continue to be focused on margins but we are going to grow our business organically. So as I said in October, I'm prepared to do things that will help drive both of those forward, Dan.

Okay, thank you.

Ron Bobman, Capital Returns.

Most of my questions were answered. By the way, good morning, everybody. I had a question, Powell, you hypothesized that if we don't have any sort of active storms that there will be rate pressure I guess sort at your hands or (technical difficulty) at some point in the near future.

And I was wondering, you know we haven't had significant storms in obviously sort of Harris County or in Florida; we have had obviously some tornadoes and hail that have been mostly sort of homeowners' events. But for the most part it has been a cat free the last few years in the US. It is really been I think sort of interest rates that have been maybe the number one thing hammering carriers. So why isn't this sort of table set for rates to just continue even in the absence of a storm?

Rates to go up, you mean?

Yes, continue to sort of lap increase that they have been experiencing.

Well, it's interesting that, Ron, is very logical and rational and I'm not saying that it is not correct. But as you know our industry, the risk bearers, that has not been the case historically. And so if you look at the amount of capital that has been destroyed over the last 20 or 25 years chasing returns, it is substantial.

And so I would tell you that I don't think the underwriting marketplace is rational all the time. And so I think that -- I have said that the best estimate that I've got is we could see rate pressure for the near to intermediate term, which I am considering for the sake of this discussion to be the next 12 to 18 months.

Would you acknowledge though that the rates that have gone up let's say the last 12 months, maybe they are picking up steam in the last three or six months, that's contrary to carrier practice in the past? And again, logical but contrary to the convention that you always need a cat to create rates or you need companies collapsing?

Well I think what you've got is there is a -- I am going to call it kind of a -- the carriers are in a conundrum. And the conundrum basically is they're looking for returns, the ROE's that would be acceptable to the investment community, that with the investment returns in terms of on their investment so low that drives that acceptable combined ratio way down.

And what you have now is you have two things that are going on -- work comp is running a temperature across the board. And number two, property losses are a little more than you might have alluded to earlier. And let me be specific. Even though we haven't had an event, if you talk to some of the large carriers I don't call it hurricane -- I mean tornado alley, I call it tornado highway.

And so all of a sudden the losses that have been incurred in Oklahoma and Arkansas and Texas and places like that are more significant than people realize. Also I point out that there are certain very fine regional carriers that have had events which are not so-called named storms over the last year or two that have just clobbered them in places like the Midwest.

And so we have seen some, I think in their vernacular, (inaudible) that are abnormal events which have impacted their underwriting results. I just don't think, Ron, when you have $550 billion of surplus and you have an industry, the risk bearers which have done a great job of attracting capital when they need it after events, they have done a great job of destroying that capital in terms of chasing market or chasing prices down and the industry has not done a real effective job of returning capital to investors when in fact they can't get an appropriate return on that capital.

So I am looking at something that's just to add -- this is from A.M. Best and ISO and III -- cumulative underwriting deficit from 1975 through 2011 -- 2011 -- $479 billion. Underwriting losses in 2011 totaled $36 billion, that is the largest since 2001. So there is a little bit more to that story I think, the underlying theme, than a big event coming into Houston or Miami or Tampa or New Orleans.

Thanks for expanding, Powell. Best of luck, guys.

(Operator Instructions). Brett Huff, Stephens.

One question that I wanted to tie back to the way you used to talk about the pressure that you were seeing in the business, Powell. I think you used to say it was one-third rate and two-thirds exposure in terms of the headwinds you were facing. Am I remembering that right?

You are.

It sounds to me like most of the headwinds that are abating, or at least the ones that are abating most and maybe even turning into tailwinds, is the one-third of rate. How would you characterize how far through the headwind of exposure units we are? Are we in inning two of being done with that headwind and we have yet to really see it fully get better? Or kind of how much more organic growth tailwind can we expect from exposure units as the middle market turns around?

Well, your memory is correct, Brett, number one. It was one-third, two-thirds. Number two, you have heard us talk about that our clients, and I am going to give you an example -- a hypothetical example but not too far off.

If you are a manufacturer of widgets and two years ago you did $14 million of sales and last year you did -- a year ago you did $12 million and then last year you did $10 million, and so all of a sudden you have secured a contract to provide $2 million of additional widgets which are not in the original budget and you are going to do a minimum of $12 million of widget sales in this coming year, what do you tell your insurance agent what your exposures are going to do?

I put my money on saying they are going to be flat; that means that they are going to be picked up at audit. And as we have talked about on this call before, if in fact that is occurring there can be a lag from -- it would be like a 14 to 15 month lag.

So you have people that renew their business on July 1, next July 1 when they renew the insurance carrier has 60 days, up to 90 days to audit their books and give them, if in fact they have an uptick in their business, an audit for them to pay an additional premium.

So we have talked a lot about -- and as you well know that our business is a reflection of the middle market economy. If you go out to dinner in Orlando or here in San Diego or many places in between on a Friday night you would say it surely doesn't look like the economy is in a recession or a slow down. Having said that, if you talk to those same people about their businesses I don't understand a disconnect because their businesses are still struggling.

And so, I know you heard in my comments, prepared remarks, that exposure units generally speaking are flat, generally flat. And so, there is an embedded silver lining in what you are referring to. And the embedded silver lining for Brown & Brown is exactly what you are talking about -- exposure unit increases on existing clients and new business.

So think of it this way, Brett -- when you have a retail customer and we generate $10,000 of commissions on that account and it is down from a high of $15,000 four years ago, the incremental dollar back to $15,000, we don't have to add another person, they are not going to send more mail or correspondence to them, they are not going to handle the client differently, it is just going to be incrementally up. And so that is very positive for our organization and specifically what everybody has been asking about which is the margin.

That's great. That's the only question I had. Appreciate your time.

Kenneth Billingsley, BGB Securities.

Just following up on the margin question in general. And to you, Cory, you talked about how the margins were impacted by if I'm going to take costs and if you adjust those back out they obviously will be a little bit higher.

With Arrowhead, and I understand this is still a small piece in general of new revenue. But as Arrowhead margins are much higher. Would you expect that that should be offsetting some of those differences or that -- are the margins performing in-line at Arrowhead as expected or are those down a little bit from initial expectations in December?

No, their margins are hitting the expected levels and they are in general on an operating profit a little bit higher. So that's having a marginal impact on it. I think you have got to look more to the normal nature of our retail and other businesses that have fairly good leverage complement on a go forward basis.

Would that mean then with the addition of Arrowhead and the better margins that the impact from some of these other items might be a little bit greater than they are on the surface or am I misreading that?

No, I think it's -- it is not that much greater, okay.

Okay.

So I don't think -- it is not going to have a huge impact on the margins. And there are -- there is different -- Arrowhead's margins show up in two areas -- national programs and also the services. In the national program part their margins are in the same range that our other programs are.

If you look at the -- in the service area, their margins are actually a little bit less in American Claims Management right now. So that would actually be more of a negative there. So you've got a positive and negative in two different areas.

Okay, good. Thank you.

Meyer Shields, Stifel Nicolaus.

Thanks. I apologize, I know I am beating this to death. But is there any opportunity -- again, I'm in the forced place housing realm. If that business starts to diversify from the two carriers that control most of the market now, could you see that reasonably actually accruing to your benefit?

Possibly. That thought has definitely crossed our mind.

Okay. That's all. Thank you.

And there are no further questions. I would like to turn the conference back over to our speakers for any additional or closing remarks.

Thank you, Lisa. No further comments. And we will talk to everybody next quarter. Have a great day. Bye-bye.

And that concludes today's teleconference. Thank you for your participation.