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Brown & Brown Insurance (NYSE:BRO)

Q1 2012 Earnings Call

April 17, 2012 8:30 am ET

Executives

Hyatt Brown – Chairman, President, Chief Executive Officer (acting)

Cory Walker – Senior Vice President, Chief Financial Officer

Analysts

Adam Klauber – William Blair

Mark Hughes – SunTrust

Ray Iardella – Macquarie

Sarah Dewitt – Barclays Capital

Brett Huff – Stevens

Meyer Shields – Stifel Nicolaus

Matthew Heimermann – JP Morgan

Operator

Good morning and welcome to the Brown & Brown Inc. Earnings conference call. Today’s call is being recorded. Please note that certain information discussed during this call, including answers given in response to your questions, may relate to 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 laws. Actual results or events in the future are subject to a number of risks and uncertainties and may differ materially from those currently anticipated or desired or referenced in any forward-looking statement made as a result of a number of factors, including those risks and uncertainties that have been or will be identified from time to time in the Company reports filed with the Securities and Exchange Commission. Additional discussions of these and other factors affecting the Company’s business and prospects are contained in the Company’s filings with the Securities and Exchange Commission.

With that said, I will now turn the call over to Hyatt Brown.

Hyatt Brown

Thank you very much, Nicole, and welcome everyone to our first quarter earnings call, and I’ll now turn it over to Corey for the financials.

Cory Walker

Thanks, Hyatt. Our net income for the first quarter of 2012 was $49.4 million, and that was up 6.8% over last year’s first quarter. Correspondingly, our net income per share for the quarter was $0.34 – that’s a 6.3% increase over the $0.32 that we earned in the first quarter of 2011. From the revenue standpoint, commissions and fees for the quarter increased 13.4% to $296.5 million. That’s up from the $261.5 million we earned in last year’s first quarter.

Included in our press release is our normal table that summarizes our total growth rates and internal growth rates from our core commissions and fees, which excludes the profit sharing contingent commissions and now excludes the guaranteed supplemental commissions – GSCs – as we’ll discuss in a minute.

We received $24.2 million of profit sharing contingent commissions, which represents a net decrease of approximately $4.7 million from the $28.9 million we received last year in the first quarter. Of this $4.7 million net decrease, roughly half of it was attributable to a lower profit sharing contingent commissions in the retail division, and the other half approximately from the program division that was really relating primarily to Proctor Financial and our public entity operation with lower profit sharing.

Our best estimates of how much profit sharing contingent commissions we will receive for the remaining part of 2012 – and this is based on just what we received this quarter plus our discussion with the various carriers – is that we think we may receive between 14 and $17 million through the second through the fourth quarters. We think that for the second quarter, we’ll receive somewhere between 2 and $3 million, in the third quarter we should be around 10 to $11 million, and the fourth quarter we could get somewhere between 2 and $3 million.

Now additionally, we did accrue $2.6 million of guaranteed supplemental commissions – GSCs – in the first quarter of 2012, and that is $712,000 less than the $3.3 million that we accrued in the first quarter of 2011. Now this reduction is due to the fact that of the five carriers that pay us GSCs in lieu of profit sharing contingent commissions, two of them have reverted back to their profit sharing contingent commission contracts beginning this year in 2012. The cash from the GSC contracts that we accrue during the year is still received at approximately the same time period that we received the profit sharing contingent commission, which for these commissions would be in the first half of 2013. Therefore, there is no substantial change in the timing of the actual cash flows from the two programs. As you know, Brown & Brown would much rather have the standard profit sharing contingent commission arrangements as we believe that it more appropriately aligns the interests of the clients, the insurance carriers and us as the insurance agent in enhancing the safety and loss control systems. Since we believe the remaining carriers will eventually move back to the profit sharing contingent commission arrangements over the next few years, we will begin to treat the GSCs similar to the profit sharing contingent commissions with respect of excluding them from our internal growth rate calculation and just including them in the reconciliation below, so you’ll see with complete transparency the actual numbers of both the contingents and the GSCs each quarter.

Now looking at the internal growth schedule, we had a positive internal growth rate of 0.9%. For the first quarter of 2012, our core commissions and fees increased 19.3%, and that is $43.6 million of net additional core commissions and fees; however, within that net number, we had $41.5 million of acquired revenues. That means that we had $2.1 million more commission and fee revenues on a same store sales basis. We had positive internal growth in three of our four divisions: the wholesale brokerage division, the national programs, and the services division. Our national program division had the best negative internal growth rate they’ve had in many, many quarters, and that was only a negative $1 million or negative 0.7%. Hy will talk about the activities in each of these segments in a minute.

Looking at our investment income, it decreased slightly by $100,000 mainly just due to the low rate environment. The other income increased by $5.3 million, and that was mainly due to aggregate gains of about $3.1 million from the sales of certain books of businesses, and then we also did have a $2.2 million settlement from an enforcement of our non-piracy agreements.

Our pre-tax margins for the first quarter of 2012 was 27.4%, and that’s compared to our last year’s first quarter pre-tax margins of 29.2%. That’s a 1.8 percentage point differential. 1.2 of that percentage point came from employee compensation and benefits, to where the compensation benefits line item as a percentage of total revenues was 49.5%, and that was an increase from the 48.3% cost factor from last year. The total dollar increase on a net basis in the employee compensation benefits was approximately $23 million, and that was an 18.2% increase. But of that $23 million, $20.4 million was attributable to just new standalone acquisitions since last year. Therefore, excluding the impact of these standalone acquisitions, we had $2.6 million of additional compensation kind of on a semi-same store sales basis because the fold-ins are still included in that number.

Now, kind of breaking down where that $2.6 million was, we had essentially about $2.9 million of additional cost. The largest portion of that was $1.3 million, and that was due to a special one-time program that we will pay our retail commissioned producers an extra 5% of their book production that they had for the year of 2011 if they can grow that book production during 2012 by at least 5%. So if they grow it by more than 5%, then they’ll get 5% commission paid at a one-time basis in the first quarter of 2013, based on their 2011 book. So for the first quarter, that amounted to an additional compensation expense of $1.3 million.

Additionally, we had $600,000 of new salaries for new producers that we brought into the system. We also had about a half a million dollars of an increased cost on our group health insurance cost and another $500,000 in related additional payroll taxes. So the four of these additional compensation benefit costs added about 100 basis points to our ratio of total compensation expense as a percentage of total revenues.

Now another item that added an additional 30 basis points to our ratio of compensation benefits to total revenue was our November 2011 acquisition of ICG. Now, ICG is a property tax payment tracking and processing company that we acquired in order to assist Proctor Financial in handling the larger banks and mortgage services related to lender-placed insurance marketplace. The accounting treatment required by the SEC generates kind of a unique GAAP – which is generally accepted accounting principles – results on this operation. For the first quarter, ICG had recorded revenues of $811,000, but the compensation benefit cost of $1.3 million and $500,000 of other expenses for a net operating loss of $1.7 million.

Now the costs of this operation are accounted for just as a normal accounting basis as payroll is paid – everything is expensed as incurred; however, the revenue recognition is much different than the actual cash that we receive on this operation. To explain that, when one of ICG’s customers wants us to track and process the property tax payments of one of their loans, we will generally charge and all upfront fee of somewhere between 80 and $100. But let’s just say for this example that it’s $84 and we get that all upfront $84 to track this loan for the entire life of its loan. Now, we currently think the average life of all the loans in ICG’s portfolio is roughly seven years, so even though the vast majority of the cost that ICG has is in the providing of the initial tax payment research and the computer setup cost of this particular tracking for this tax payment, the ongoing annual charge to manage that account on an ongoing basis is generally only about 2 to $3 per year on an ongoing basis. But because of the SEC rules with revenue recognition on this line of business, we have to recognize that $84 over the entire life of the loan on a straight line basis, so basically we only get revenues at $1 per month in that example, so that’s $84 divided by seven years divided by 12 months. So for this month in this example, we basically only got $3 of revenues, but the full cost.

So it’s going to take a couple years under this very conservative GAAP revenue recognition policy to kind of build the normalized profit margin in this particular case, but in the meantime this one operation accounts for about 30 basis points of that increased compensation and benefit as a percentage of total revenue line. So if you exclude those two items that we just talked about from 2012, the employee compensation and benefit as a percentage of total revenue was really about 48.1% in 2012, and that’s compared to the 48.3% first quarter of last year.

So with that, let me keep going on to our non-cash stock-based compensation, and that cost went up on a net basis about a million dollars, and that’s really just due to the new stock grants—stock incentive plans grants that we gave during the first part of 2012, of which the majority of them went to the Arrowhead employees and management team. In the current quarter, our other operating expenses increased as a percentage of total revenue by 50 basis points to 14.3% of total revenues from 13.8% in the first quarter last year. Now other operating expenses from a dollar standpoint increased $7.3 million, and that’s a 20.2% increase over 2011 quarter. However, if you take the new standalone acquisitions, they amounted to $8.1 million of all those new costs during the quarter, so therefore if you just take kind of a semi-same store sales basis approach, those existing offices really had a net decrease of their expenses by about $800,000. Now, there were some items that were up and down, but the biggest single change was again we get a continuing cost savings in our rent occupancy cost office space, and that by itself was just an $800,000 reduction in the current quarter. So if you exclude the operations from the standalone acquisitions, our other operating expenses as a percentage of total revenues decreased to 13.5% from the prior year factor of 13.8.

Our amortization and depreciation in aggregate was up $2.6 million from last year, and that’s obviously just due to the newer acquisitions. Our interest expense was up $500,000 over prior year, and that’s primarily as a result of borrowing the additional $200 million that we borrowed on the Arrowhead acquisition. Then, of course, our line item that changed in acquisition earn-out payable first quarter this year was a credit of 388 versus a credit last year of $99,000.

Our effective tax rate for 2012 is currently expected to run at approximately 40.3%, and that’s primarily due to the higher state income tax rate because of the large California exposure from our new Arrowhead acquisition.

So really just to conclude, it was a very, very good quarter. We’re very happy with the positive internal growth, and our net income of $49.4 million was a nice increase of 6.8%.

So with that, I’ll turn it over to Hyatt.

Hyatt Brown

Very good, Cory, thank you. Good report. Getting into what’s happening in terms of pricing and et cetera, first of all, a general statement relative to personal lines across the U.S. Home owners which have been unprofitable for several years are moving up 2 to 5% - now in some places, a little more, in some places a little less. If you’re getting into coastal areas, it’s more; but if you sort of average it across the U.S., 2 to 5%. Auto—personal auto, however, is flat to down, and in some places down as much as 10%. So that’s kind of what we see on personal lines across the U.S., and personal lines is somewhere around $70 million—65 to $70 million of our total revenues.

Looking at Florida first of all, let’s split Florida into three layers – first of all south, and then I4 which would be Daytona to St. Petersburg, and then the northern tier, which would be Jacksonville west. First of all in the south, the economy is starting to move up. Foreign capital coming into Dade Broward, things are coming along, except for an outlier and that’s Naples. Naples is still questionable, flat to down in terms of the economy. Property rates are up 2 to 5%-plus. Condos are up 10%. There are lots of gaming—there is a lot of gaming going on in condos relative to appraisal values, so if the rate goes up 10%, then if you can get the value—the appraised value of the condo down 5%, then it’s only a 5% increase. Well, lots of pushback from the risk-bearers and et cetera, including citizens. GL and auto is flat. Umbrellas are flat to up 2%, and then workers’ compensation. Now a general statement – workers’ compensation across the entire states, all the states in which we are doing business, is going up anyplace from 2 to 3 to 4 to 5 to 6 to 7%, except for Nevada where it’s going down zero to minus-5%. One of the reasons there is because apparently the law is very favorable to employers. And the other state where it may be flat – workers’ comp – would be in Oregon. Not exactly sure whether that’s more of the economy or whether it’s more of what’s going on in terms of pricing. But workers’ compensation across the United States, it’s under the most pressure and it is also moving up 2 to 4, 5, 6, 7%.

Now the question then is, is what about payrolls? Payrolls vary, and we’ll talk about that a little bit as we get into more of the other parts of the United States. Payrolls in south Florida are up slightly except for contractors. Now again, underwriting across the United States is starting to play a part, and that means that underwriters are looking at loss ratios, and if it’s a bad loss ratio then the numbers that I’ve been talking about are way too low. So we have actually seen in the case of some workers’ comp accounts where existing companies simply wouldn’t renew, I haven’t seen that in six or seven years. Now, able to get other carriers on, but sometimes at a consensus rate which is substantially higher.

Employee benefits – now, employee benefits in the southern part of Florida is up 5 to 7%, but we’re starting to see some accounts coming in at flat. If you move into the I4 corridor, workers’ comp again is up 5 to 7—2, 3, 4, 5, 6, 7. Property up 2 to 4 or more. Condos up 10% or more. GL and auto is flat to a negative 2%. Now, in the property markets, and this is true throughout Florida and it’s also true throughout all the cat areas that I’m familiar, from Texas all the way around Florida, all the way up to probably Virginia, et cetera, there’s always an outlier property market. So just at the moment you think that there is a 10% rate increase or a 5%, or 12% rate increase, someone will come in at flat sort of out of the blue. However, that is getting to be less and less and less. Again, underwriting is sort of taking over.

The economy in central Florida is flat to slightly up, except Orange County, and Orange County is up nicely. RMS11 – I’m sure you all have heard about that, and that is having a substantial impact in central Florida because RMS11 is focused on individual risks and then what is the PML on those individual risks, and in some cases the PML has doubled over what last year was considered to be the PML. So that’s having an impact also on capacity and pricing, particularly for some of the both admitted and non-admitted companies.

Employee benefits – you know, in south Florida, up 5 to 7; central Florida, up 2 to 3 and a large risk bearer has told us that probably starting July1, there are going to be accounts that will be renewed at credits, meaning down. Haven’t seen that in, gosh, I don’t know when. If you go to the northern tier of Florida, employee benefits – now, this varies. You know, larger accounts which are loss rated and have good or bad loss ratios will vary, but talking about those that are anyplace from 25 to maybe 250 employees, those in the northern tier would be flat to sometimes down 4 or 5%. Looking also at the northern tier, property – habitational, condominiums, et cetera – is up 5 to 10%. The citizens in Florida is pretty much up 10% except for those condos that are 10 million or more in a tower; and so those are up more. In the northern tier of Florida, unlike elsewhere, admitted markets are still writing risks. Occasionally in central Florida, an admitted market will write a property risk, but it’s pretty scarce. Auto and GL in the northern tier is up—well, actually, GL is up 2 to 3%, but auto is really flat to down. Workers’ comp – I’ve talked about that.

Now there are some higher mods coming on also, and umbrellas are flat; so generally speaking, D&O is flat, EPLI is up – employment practices, et cetera – is up 2 to 5, and when you get out into the west, particularly California, it’s 10 to 15%. The surprise in Florida is the employee benefits, which seems to be trending to the positive side, meaning that instead of large rate increases they are much smaller and there are a few at zero and a few at credit. So that’s kind of interesting.

In Georgia and South Carolina, again, workers’ comp firming, payroll stabilizing, GL and auto flat, property 2 to 3% except coastal – coastal, 5 to 15. Inland condos up 5%, much tougher underwriting. Again, talked about personal lines – generally, exposures are flattish to up a little bit, and the economy seems to be getting a little better. And generally speaking when I’m talking about the economy, I’m talking about general business excluding contractors, and there are certain classes of contractors who are starting to do some business – you know, the refurbishment contractors, et cetera, but other than that, really not much. Employee benefits in the Georgia-South Carolina is up plus-6 to plus-8, and still having reductions in coverage.

Virginia-Delaware, again, workers’ comp as we talked about, property is up 3 to 5 non-coastal. If you get into the coastal areas, it’s a different ballgame – 10 to 15%. GL is up a little bit – 2%. Autos are flat. Autos as kind of flat, really, to down throughout the U.S. The economy is getting a little better. Marine is flat to down 5%. Employee benefits – flattish, maybe down just a little bit. Wonder why all that’s happening?

In New Jersey, New York, Pennsylvania, again, employee benefits there is up 3 to 5% if it’s over 50. If it’s under 50, it seems to be kind of flat – under 50 employees. Property in those areas is up 3 to 5%. Everything is kind of tightening in terms of underwriting. Payrolls seem to be moving up. You know, the northeast seems to be—the economy seems to be doing better, and that’s very positive. There is one little difference in workers’ comp – in Pennsylvania, the state really has decreased the rates but the credits are going away; so rates going down but the loss cost modifiers are changing so that the price to the consumer is actually going up.

Now condos in New Jersey and some areas of Pennsylvania – these are smaller and middle-sized condos now – many were on a three-year rate guarantee and so those are coming off, and those condos are going up in the neighborhood of 15%. Again, the payrolls are starting to move up just a little bit as reflective of the economy.

If you go into the northeast, which is Connecticut and Massachusetts, again the economy is getting a little better. Property – 2 to 3%. It seems that any place along the east coast and all the way down and over to Texas, there is this constant push-push on property, except right on the coast which is more than the 2 to 3%. Once you get interior, once you get into middle America, then property is flat to in some places down; in other words, the push seems to be more along the east coast because of the catastrophe exposure and the fact that modeling now seems to suggest that there is a greater potential for loss inland—farther inland than was considered in the past.

Looking into the midwest, which would be Michigan, Indiana and Illinois, again workers’ comp in all areas is moving up, and so the payroll in these areas is kind of flattish. Now, in some of the areas, the economy is not doing as well either. GL and auto is flat. Med mal is flat to a negative 5, and of course property in those areas is going down – flat to minus 5%. Underwriting getting tighter.

Looking into Texas and Louisiana, the oil patch – now, the oil patch, the economy is there, it’s doing well. Property – and I’m thinking now of the Houston area – property in Houston, part of Houston is considered to be Tier 1, which is coastal, and part is Tier 2. And so the windstorm pool in Texas is only available in Tier 1; in Tier 2, it’s not available. The situation is that in Houston, actually property is going up 10 to 20% in the city, whether it’s in Tier 1 or Tier 2. Also, payrolls are going up. Payrolls are up 5, 10, in some cases 15%, and of course—it’s kind of interesting, again, but workers’ comp rates are flat but credits are disappearing. So even though the rates either are flat or down, the credits are disappearing which means that the price is going up. GL and auto is varied. In some cases it’s flat, and in some cases it may be up as much as 10%. Employee benefits is 3 to 5% up. We’re not seeing flat there at the moment.

Looking into the west – California, Nevada, Arizona, Oregon, Washington, Colorado – I mentioned that workers’ comp is up in all those states. California is probably maybe the one that’s been under the most stress, except of course I mentioned Nevada. It’s down probably as much as negative 5. Of course, there’s no workers’ comp in Washington. EPLI in southern California and really middle California is up 5 to 15%. Umbrellas are down 5. Exposures seem to be stable. Property is flat there to down. The economy is getting a little better in most areas in the west, except Nevada and maybe Oregon. If you look at Arizona, the property there is – GL, property, auto – everything is flat to down. It’s still very, very competitive and the property rates are $0.02 and $0.03, and $0.04 is not unusual in Arizona, the Phoenix area.

Arrowhead, as you know, is one of our most recent large acquisitions and they are doing very well. Last year, they grew 5 to 6 to 7% organically, and this year they’re continuing on that same rate; and of course, that’s not included in our organic growth schedule because they haven’t been with us a year. Some of their programs are growing a little more than others, workers’ comp being one. They’re looking also at several areas. One thing is some new programs and expansion of existing programs, potentially quake in California. And we’re also looking at the fact that their platform, their IT platform, maybe something that we want to adopt in our wholesale area. They’ve got—they’re pretty doggone good in that area, so we’re very pleased with what’s going on there.

Looking at wholesale – now wholesale is reflective of what’s going on in retail, but really when we think of wholesale, we think of property—well, no, we think of transactional and we think of binding authority. So let’s talk about binding authority first because it’s a little easier.

Binding authority is primarily smaller property and casualty accounts, and these would be, oh, 500 and $1,000 of premium to maybe 10 to $15,000 in premium. And those property rates and prices are going up pretty much 5 to 15%, and one of the reasons is this is grey or not eligible for standard companies, or standard companies are moving out of this area, particularly if it’s grey, and therefore this 5 to 15 is sticking. Casualty, however, is pretty flattish to maybe up a little bit, and professional liability, again, is plus-5 to plus-15. That’s moving up in binding authority.

Now let’s get into the transactional, and of course that’s where there is some variation. Anything that is coastal which has a cat exposure, and that’s Texas all the way around Florida to New Jersey, property is moving up 5 to 20%. Now, there are some changes in coverages, and sometimes that affects the actual total premium paid by the insured; however, on very large accounts, big schedules of apartments and et cetera, large, large condominiums that are not necessarily good construction, those can be up as much as 10 to 40%. It depends on the model – RMS having a big impact there. Casualty, of course, in the transactional is pretty flat, not much there. Exposure units are slightly up, and so if you look at non-cat property in transactional, that’s flat, maybe a little, little up – no, really not much at all. But there is a lot of pressure in wholesale. I would say the pricing pressuring wholesale is greater than the pricing pressure is in the admitted markets.

Looking at programs, FIU – those are our condominiums on the sand in south Florida and elsewhere, and it’s pretty much kind of a 10% increase. That’s kind of the way it is. In the case of Proctor, a comment on that – I think as people know, Fannie Mae is now coming forward with some recommended changes that they want to have instituted for anybody, any bank or servicing company that’s handling Fannie accounts, and there are several things. Of course, we were very much involved in discussions with Fannie and right on the cutting edge of what their requirements appear to be. They’re talking about policy forms, which is coverage, and the coverages they’re talking about pretty much are in line with what we’re doing today at Proctor. Rates probably down some, but well within our comfort zone. There are several kinds of things that are being discussed relative to how the coverage is placed – you know, the three letters to the borrowers and then all of that sort of thing. They’re talking about maybe seeing if the private insurer would want to continue the coverage, even though it’s either foreclosure or it’s not occupied. And then they are talking about requiring admitted paper versus surplus lines. Now, in some cases we find surplus lines pricing is lower than admitted, and so not exactly sure how all that will work; but the companies that we have that are currently writing both admitted and non-admitted, some are going to make filings to—are in the process of making filings in order to comply with what Fannie is going to require, and those companies would be Marquell (phon), Lexington. Lloyd’s is looking at a fronting arrangement.

So there will be changes, and I think about half of our business has some Fannie exposure. There will be some changes and we think that will all end up being for the best interest of the consumers, and so we’re all for that.

Looking into public entity, and I’m thinking more of public entity in Florida than I am in the midwest and the northeast, or in the far west like out in Washington. Those renewals, property renewals I’m thinking about now, which come up July 1—well, June 30, July 1 and October 1, there’s going to be some fairly chunky increases on those. Still not quite—we’re still not quite—we are not really sure exactly what they are going to be, but somewhere in the neighborhood of maybe 15 to 20%, maybe a little more on property. In USIS, payrolls, those are starting to move up a little bit, like 2%. That’s the first time we’ve seen that in about four years, so things are coming along not bad.

If I was going to give you a broad general synopsis, I’d say that for the first time, there is constant and consistent pressure in many areas of the U.S. to increase property rates, and some other rates like EPLI, et cetera, some in B&O, but also consistently workers’ comp going up – consistently. So that’s a little-that’s different. That’s different.

Now on the good news side, Powell will be coming back to the office on Wednesday – that’s tomorrow, and we’re very pleased about that. Been talking to him on a daily basis for the last 60, 90 days, and a couple, three weeks ago he started talking to Cory and getting information and then hooked into our email system, and he’s been talking to the senior leaders so he’ll be back, and we expect him to be at the retreat, the annual Board retreat which starts Monday and at the annual shareholders meeting Wednesday, and we would expect that the Board would reinstate him as the CEO and he’ll move forward just as before. I’m kind of pleased about that because I can go back to being non-executive Chairman. So that’s good news.

Having said all that, Nicole, we’ll now open up the phone to any questions.

Question and Answer Session

Operator

Certainly and thank you. Ladies and gentlemen, if you would like to ask a question at this time, please press star, one. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, that is star, one for any questions.

Our first question will come from Adam Klauber with William Blair.

Adam Klauber – William Blair

Thanks. Good morning, Hyatt, how are you?

Hyatt Brown

I’m fine, Adam, how are you?

Adam Klauber – William Blair

Great, thank you. Great to see the wholesale business is turning around. Of the growth, how much of that is driven by higher rates versus more submissions with the standard carriers being pulled back?

Hyatt Brown

It’d be kind of an educated guess. I would say about two-thirds is higher rates, or maybe 75% higher rates and 25% movement. We think there’s going to be more movement because underwriting is continuing to get front and center.

Adam Klauber – William Blair

Okay, okay. Thank you. And also in retail, obviously we’re seeing good movement, and you talked about a lot of different factors helping that segment out. How about net new business trends – are those improving also?

Hyatt Brown

Yes, they are, Adam. One thing – I’ve been to this picture show before about five times, and there is something different about this time. What it is, is this – the risk bearers have a lot more capital and therefore dry powder this time than in the past. Number two, there are fewer risk bearers – and I’m talking about standard risk-bearers now – and therefore there is a lot more pressure to get the returns on capital up, which is pushing them. So whereas in the past when you have a market change, all of a sudden it’s 20 and 30% or more, which is just—you know, it’s awful. This time, it’s not happening that way and is it going to continue? Is this, you know, the 2, the 3, the 4 – it seems like it is, and if it does, then this is really a much better thing for the industry because people are able to accept small rate increases because lots of things are going up, particularly when we show them how they five, six, seven years ago they paid X, and last year they paid like 55% of X, and now you’re paying 60% of X. That’s very acceptable, and we are in both wholesale and retail – but really more in retail because that’s where the rubber really meets the road – we are being very, very careful about making sure that our customers and clients remember five years ago, when it was maybe almost twice as much as the price was last year.

So all of that is kind of positive.

Adam Klauber – William Blair

Great, thank you very much.

Operator

Our next question will come from Keith Walsh with Citi.

Hyatt Brown

Keith, are you there? Hello?

Operator

Hearing no response from Mr. Walsh, we’ll move to Mark Hughes with SunTrust.

Mark Hughes – SunTrust

Yeah, thank you. Good morning.

Hyatt Brown

Hey Mark.

Mark Hughes – SunTrust

Hey. The margin outlook when you take all those factors you discussed, Cory, and given the fact that contingents look like they’ll be steady to probably up in Q3, what do you think the year-over-year margins are going to look like next couple of quarters? Any initial thoughts?

Cory Walker

Well, my gut reaction is the margins in general will improve. You know, the two things that we tried to highlight on this call does skew the absolute numbers a little bit, and the ICG operation has an unusual item and since we bought it in November, basically it will be three-quarters of that. And then like I said, that special program that we developed this year for retail commission producers is going to add some extra compensation expense for this year because this year is going to be a challenging year for them, and we wanted to incentivize them for this year to really grow the business. Remember, third quarter we talked about the fact that we had—Powell had mentioned that we were planning to give up margins on a temporary basis to have growth, and that was kind of the program that we were thinking of.

So when you take those two things into consideration, I believe the margins will continue to improve for the rest of the year, with those two exceptions.

Mark Hughes – SunTrust

Right. Is the 1.3 million, is that on a run rate to assume that everyone this their 5% target?

Cory Walker

No, I tell you, that’s actually a little bit lower than kind of the average. You know, we probably have about, say, 220 to $230 million of business that’s tied to a commissioned retail producer, and so theoretically you could have—if everybody exceeded that 5% growth, you could have 10 to $12 million worth of total cost. So if you take half of that, we’re probably a run rate of more like $6 million, maybe, give or take. So that’s probably what I’d plan on at this stage.

Mark Hughes – SunTrust

Okay. Final question – share buybacks, any updated thoughts there?

Hyatt Brown

You’re probably focusing that on me, and the answer is no.

Cory Walker

You know, we’ve got a share buyback program. We have not bought any shares yet because as we had mentioned before, we primarily will buy shares back only at opportunistic prices.

Mark Hughes – SunTrust

Thank you.

Operator

Our next question will come from Ray Iardella with Macquarie.

Ray Iardella – Macquarie

Thanks and good morning. Can you guys maybe talk about—I know you guys talked about property rates being up pretty nice, particularly on the coastal side, but how much of your business, I guess, in the first quarter, how much revenue do you get from property maybe versus casualty, relative to the rest of the year?

Hyatt Brown

Well, that’s a good question, and it doesn’t vary by quarter, particularly. Property in the past has been about, if I remember correctly, about 20% of our total, and so it’s probably moving up a little now. Florida, of course, the property rates are higher than they are elsewhere, so I’d use maybe 20 to 22 or 23%, would be about what our property premiums are now.

Ray Iardella – Macquarie

Okay, and I would think second quarter might be a big quarter in terms of, I guess, property exposure. Is that the right way to think about it, or am I reading too much into that?

Hyatt Brown

No, I don’t think that the property—the amount of property insurance in terms of total insured values is going to change other than new business that we’re writing, but there is that constant and consistent push on pricing, and so the question is, is 2 or 3 or 4% going to go into 4 or 5 or 6%, and I don’t know the answer to that.

Ray Iardella – Macquarie

Okay, that’s helpful. And then I guess a lot of insurance carriers have been reporting perhaps some decline in retention. Is that something that your clients are talking about and pushing for, given some of the rate pressure you’re talking about?

Hyatt Brown

Well first of all, an insurance carrier feels that if they’re in the 80 to 85% renewal retention percentage, that they’re about in the right place; and of course in terms of us, we want at least 95% and hopefully more. So it’s kind of hard to talk about that retention thing. Now, one of the things that will occur, particularly in the coastal areas and assuming that banks will allow this, there may be a buying down of the wind coverage, so if someone had $500 million of property values and the cover other than wind was 500 million, maybe they’d buy 100 million in wind as opposed to last year having, let’s say, the total 500. So it’s very difficult to make those kinds of assessments.

Ray Iardella – Macquarie

Okay. And then one follow-up and I’ll re-queue – in terms of M&A, how many transactions did you guys close in the first quarter? Did the Arrowhead transaction kind of slow down that a little bit, or is it just sort of lumpy as you get through the year?

Hyatt Brown

It’s kind of lumpy, and we had five transactions we closed. Total of – how much was it, Cory?

Cory Walker

Right at $113 million aggregate annualized revenues, and 108 of that obviously is Arrowhead.

Ray Iardella – Macquarie

Okay. What—

Hyatt Brown

What—okay, go ahead.

Ray Iardella – Macquarie

No, sorry. Go ahead.

Hyatt Brown

Well, what I was going to say is that we are seeing some additional interest, and again inventory is about what it has been in the past, maybe a little better. But we’re seeing some additional discussions and it might have something to do with the fact that people are looking at what’s the tax rate going to be next year, and maybe I’ll do something this year. Now, how much of that is out there, I don’t know; but it just seems like there might be some of that thinking starting to accumulate.

Ray Iardella – Macquarie

Okay, thanks for the color.

Operator

Our next question will come from Sarah Dewitt with Barclays Capital.

Sarah Dewitt – Barclays Capital

Hi, good morning. On last quarter’s call, you thought the first half ’12 organic growth would be choppy. So what’s changed since then, and to what extent do you think the positive organic growth is sustainable?

Hyatt Brown

Well you know, we have a tendency to be pretty conservative and we’d much rather over-perform and under-promise. And so we weren’t really too sure that the underwriting regimen was going to continue to be front and center, and it seems to be that the risk-bearers are saying no, this is what it’s going to be. The other thing that has been interesting is the impact of RMS11, and RMS11 is impacting all coastal areas, so we were surprised that risk-bearers are following that as assiduously as they seem to be – that is, most of them. In some cases on some risks, RMS11 would suggest a PML double what the risk-bearers had in their files for last year.

So all of that kind of—we’re thinking maybe a little better in terms of pricing. That’s about as good an answer as I can give you.

Cory Walker

And Sarah, from our perspective when we were on the call, really the only thing that we really had to go on at the time is basically our detailed budgets by office, and at that time the first quarter was the more difficult quarter to get over and our budget basically had us at a negative internal growth. As Hyatt had mentioned, the pricing—we were pretty surprised at how the pricing did kind of hold up during the quarter, and that’s what really kind of helped us. The economy, we thought, was going to be flatter, which it did and so therefore we didn’t have the down-swoop that we’ve had historically and therefore the pricing in new business was able to grow it.

Basically from a budget standpoint, the first quarter was the hurdle, and as Hyatt said, there’s this gradual build that is—at least going ahead, nothing to where it’s a huge wave but at least it’s a slow build, and we think that each quarter will incrementally hopefully be a little bit better.

Sarah Dewitt – Barclays Capital

Great. That’s great. And then if the organic growth stays at these levels, where do you see the margin heading longer term? I know historically you had that 40% goal – is that something that’s achievable again?

Hyatt Brown

Absolutely it’s achievable, and so we think the cost structure and the leverage is still there, with the exception of those two highlights that I tried to explain in terms of the employee benefit compensation on the short-term basis here.

Sarah Dewitt – Barclays Capital

Great. Thanks for the answers.

Operator

Our next question will come from Brett Huff with Stevens.

Brett Huff – Stevens

Good morning, Hyatt. Good morning, Cory.

Hyatt Brown

Good morning.

Brett Huff – Stevens

One question – Hyatt, thanks for going through the detail, as usual, on the by geo and business line detail. But if we could step back, what I recall is that you all would say that about 25 to 30% of the organic growth headwind you were facing was rate, and the rest was exposure units. (NYSE:A) Is that still true, and (NYSE:B) similar to the last question, where did the improvement come – rate or exposure units, or both? Can you give us some color on that.

Hyatt Brown

Yeah, it came both, and it varies with geographic area. I believe that if you looked at Florida, it’s probably half and half. Elsewhere, it’s probably maybe a little more – and I’m thinking of the northeast now – a little more of the economy. The economy’s better up there than it is elsewhere, at least that’s what our people are telling us. So they are moving in tandem generally, except for contractors, and the contracting business – now, some particular kinds of contractors are doing okay, but most of them, chiefly home building, it’s just not there. So going forward, once we get beyond the doggone election, I think people are going to feel a lot better about the economy; but generally speaking, there is a little more uptick there and payrolls seem to be flat and up a little bit. There is this constant push to get a little more rate, and as businesses are feeling better about the fact that they can see a little growth themselves, then the pricing is a little more acceptable. But there is a lot of pushback – I don’t want to give you a feeling it’s not tough out there.

Brett Huff – Stevens

Sure. And the second question – Cory, you had mentioned last quarter that you thought about 60 to 70% incremental margins as you guys start growing again. Given the two highlights that you talked about – the comp structure at least for this year, which sounds like it’s limited to this year, and then the ICG sort of longer rev-rec accounting – is that 60, 70% number still something you feel is the right way to think about it?

Cory Walker

Well, as long as—you know, you need to probably back off 5% on that one commission, and the ICG will be back on a normal flat level by the fourth quarter. So—

Brett Huff – Stevens

It really is a this year kind of—

Cory Walker

So I would probably back it off a little bit. I’d back it off a little bit, but the basic structure is still there.

Brett Huff – Stevens

That’s mostly this year thing, not a next-year thing?

Cory Walker

Absolutely.

Brett Huff – Stevens

Okay. That’s what I needed. Thanks for your help, guys.

Operator

Our next question will come from Meyer Shields with Stifel Nicolaus.

Meyer Shields – Stifel Nicolaus

Thanks. Good morning everyone.

Hyatt Brown

Hey Meyer, how are you?

Meyer Shields – Stifel Nicolaus

I am well. Yourself?

Hyatt Brown

Good, good.

Meyer Shields – Stifel Nicolaus

One quick modeling question for, I guess, either Hyatt or Cory – when we talk about the supplemental gravitating towards profit based contingents, do we have an idea what the revenue numbers were in the last three quarters of 2011 so that we can forecast that split?

Cory Walker

Yeah, let me just give you the numbers for the first quarter amounts. If you look at—if we had left our GSCs in the first quarter of 2011, we reported a negative 2.3%, negative internal growth. Without GSCs, it would have been negative 2.4. If you go back to the first quarter of 2010, we reported a negative 8.6%, but without the GSCs it would have been lower at 8.2. So the numbers that you saw for the first quarter on the GSCs, you know, the GSCs are accrued on an actual basis so those numbers that I gave you are relatively consistent for each quarter, and so it’s not a huge differential. You can kind of figure it out—I did not do it yet for the second, third and fourth quarters, but it’s a relatively minor change. The first quarter would be representative of it.

Meyer Shields – Stifel Nicolaus

Okay, that’s helpful. I think we can work with that. Second, in the internal growth table, you showed divestitures for, I guess, the amount of business from offices or books of business that were sold over the past 12 months, and that’s been going up over the past couple of quarters. I was wondering if you could talk about whether there’s anything unusual going on there.

Cory Walker

No. I mean, we typically don’t like to sell a book of business, but if a producer leaves and it makes economic sense, we will. So in this particular quarter and in the second half of last year, we did have a couple of larger book sales that generates it and it kind of goes up and down. It is higher than it normally has. Normally it’s probably in the million dollar mark, but that’s just the nature of what’s happened in the last couple quarters.

Meyer Shields – Stifel Nicolaus

Okay. When you talk about a producer leaving, is that producer the one buying the book of business?

Cory Walker

Typically, yes, or whatever new agency he’s going with.

Meyer Shields – Stifel Nicolaus

Right. Okay, perfect. Thanks very much.

Operator

Our next question will come from Matthew Heimermann with JP Morgan.

Matthew Heimermann – JP Morgan

Hi, good morning everybody. A couple questions – one is just—just wanted to make sure there is no one-time kind of first quarter expenses associated with Arrowhead as we look at the G&A.

Cory Walker

No, there’s not. I mean, Arrowhead is pretty much a standalone organization. There was no office combinations, so most everything—the chain is really just part of the original purchase price allocation.

Matthew Heimermann – JP Morgan

Okay, and then if you guys—

Hyatt Brown

And then all—

Matthew Heimermann – JP Morgan

Sorry.

Hyatt Brown

Also one thing I would just to—we actually didn’t effectuate that acquisition until the 9th of January.

Cory Walker

Right, so technically there is nine days of revenue of January that are not included in our number, obviously.

Matthew Heimermann – JP Morgan

Okay. Then I was also just curious, if you expand their platform to the wholesale division broadly, are there any incremental technology costs that would be associated with it, or is it as simple as kind of turnkey to start putting your own information through it?

Hyatt Brown

There will be incremental cost, and there is no huge game plan on the table that will have any huge cost on it. It will just be a gradual change as it makes sense for various offices and wholesale programs.

Matthew Heimermann – JP Morgan

Okay. And then with the ICG, I guess—and what Fannie Mae is proposing in terms of changes to the force place lenders business broadly, how do you think that positions you strategically versus some of the other brokers that participate in this business, and what do you think some of the changes Fannie Mae has put forth might mean for some of the other competition in the market?

Hyatt Brown

Well, we really don’t know that via the competition. We really only know about us, from our standpoint. We’re looking at it as just another change, and about half our business has some exposure to that and half doesn’t. So probably the largest single change would be having admitted paper versus non-admitted paper.

Matthew Heimermann – JP Morgan

But I was thinking more on the technology service side. It seems like that element, what Fannie Mae is asking people to do is going up, and so I just was curious whether or not you thought you were kind of were ahead of the curve in putting that service technology in place at your business.

Hyatt Brown

I don’t know that we’re ahead of the curve or behind the curve. I think we’re about in the middle of the curve, as far as we can tell. The requirements that they are talking about, we already do for the most part; and the tweaks that they are talking about, they don’t seem to be a great deal of difficulty.

Matthew Heimermann – JP Morgan

Okay.

Cory Walker

But you know, one of the items that ICG did make sense for us is that that is now a true partner, and in certain competitive situations previously there have been other companies that provide that service, and because some of our competitors may have written more business with certain ones, we were explicitly excluded from having them give us a quote to do it as an outside service. So with a partner inside, it does give us the ability to provide that service and be able to control it, so from that standpoint it is a positive.

Matthew Heimermann – JP Morgan

Okay. And then just with respect to programs overall, I think the last half of 2011, it was really the special programs that were kind of driving improved growth. I’m just curious—well, excuse me, it was special while professional is still lagging a little bit, and you had some constructive comments that sound like from a pricing standpoint in parts of the professional lines market, some of which might flow through to that. But can you just talk about maybe on the older reporting way, kind of what the mix of growth looked like between professional and special?

Cory Walker

Well, they both grew, and from an ongoing standpoint—I mean, there was overall less offices that had negative growth than there were before. But in both sides, they did have slight positive growth. Now, from a standpoint of overall, we had talked about Proctor, and Proctor starting with the fourth quarter of last year, we now were comparing them apples-to-apples. They’ve written a lot of new business, and so from an incremental growth standpoint, Proctor was for the next really four quarters was going to add a positive growth. For this quarter alone, they actually grew in excess of $800,000 of that total, so that will continue as they kind of work through the whole Fannie Mae issue. But you know, it’s a good group of people, good business, and they do it the right way.

Matthew Heimermann – JP Morgan

Okay, perfect. Thanks so much.

Operator

Our final question in queue is a follow-up question from Ray Iardella.

Ray Iardella – Macquarie

Thanks for taking the follow-up. One quick numbers question and one broader question. First on the numbers one – on contingent commissions, did Arrowhead receive any contingent commissions in the quarter? I think in the past, you guys had talked about Arrowhead moving towards more of a fixed sort of commission structure going forward.

Cory Walker

Well, I mean, I’m not sure about that last statement, but Arrowhead did have some very minor—it was $300,000. We do expect them to have contingent commissions continue to be earned during—accrued during the year, or earned during the year. But any contingencies that they may qualify for would primarily come in the third quarter, and that’s part—part of that number, they historically have had somewhere in the 4 to $4.5 million per year come in. So could that come in in the third quarter? That was part of the number we gave you, and we’ll just have to wait to see if it comes true.

Ray Iardella – Macquarie

Okay. And then the last question I have – as far as—I think you had talked about some incremental compensation costs for some new hires. Is that something you guys plan on continuing, to look for new producers throughout 2012? Is there any particular target you guys have, or is it just finding good producers and trying to hire them when you can?

Hyatt Brown

Well actually, we really started about two years ago expanding our recruitment program, Ray, and it’s not just for the retail. It’s wholesale and it’s in programs across our whole system. There are great opportunities out there from people who have been working three, four, five, six years in another business and that business is not doing well, or it’s not there, and so we’ve been interviewing lots and lots of people. And when they meet our profile, then we try and bring them on board.

So we probably will continue to increase the number of people that we are bringing on. I know one of the things that Powell has been pushing very aggressively is recruitment, and in order to grow and to replace people who are going to be retiring and that sort of thing, we have to have new folks coming in. So there’s lots of opportunities for us, and we’re very pleased with our new people that are coming on. They’re doing very well for us.

Cory Walker

Now—and Ray, let me just add onto that, is as you know, even during, like Hyatt said, the last couple years, but even before that where we’ve had negative internal growth, that was, as I had mentioned a couple times on conference calls, that was the one line item which really never did decrease year-over-year because we continued—as Hyatt says, we were always looking for good, high-quality people, and we pretty much hire our producers and train them ourselves. So when I had mentioned that there was $600,000 again this quarter in excess, it was just to highlight the increase on that. But we do expect that to continue.

Ray Iardella – Macquarie

Okay, thanks for the answer on the follow-up, and best of luck, Hyatt.

Hyatt Brown

Thank you.

Operator

At this time, we have no further questions so I’d like to turn the call back over to our speakers for any additional or closing remarks.

Hyatt Brown

Okay, well that sounds good, Nicole, and thank you all and we’ll look forward to having another quarter. We are in adjournment. Thank you very much.

Operator

Thank you. With that, we will conclude today’s call. Thank you all for your participation. You may now disconnect.

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