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Edited Transcript of BRO earnings conference call or presentation 23-Apr-19 12:00pm GMT

Q1 2019 Brown & Brown Inc Earnings Call

DAYTONA BEACH Apr 24, 2019 (Thomson StreetEvents) -- Edited Transcript of Brown & Brown Inc earnings conference call or presentation Tuesday, April 23, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* J. Powell Brown

Brown & Brown, Inc. - CEO, President & Director

* R. Andrew Watts

Brown & Brown, Inc. - Executive VP, CFO & Treasurer

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Conference Call Participants

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* Adam Klauber

William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Financial Services and Technology

* Charles Gregory Peters

Raymond James & Associates, Inc., Research Division - Equity Analyst

* Elyse Beth Greenspan

Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst

* Joshua David Shanker

Deutsche Bank AG, Research Division - Research Analyst

* Mark Douglas Hughes

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Meyer Shields

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* Michael David Zaremski

Crédit Suisse AG, Research Division - Research Analyst

* Michael Wayne Phillips

Morgan Stanley, Research Division - Equity Analyst

* Yaron Joseph Kinar

Goldman Sachs Group Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning and welcome to the Brown & Brown Inc. First Quarter Earnings Call. Today's call is being recorded.

Please note that certain information discussed during this call, including information contained in the slide presentation posted in connection with this call and including answers given in response to your questions, may relate to future results and events or otherwise be forward-looking in nature. Such statements reflect our current views with respect to future events, including those relating to the company's anticipated financial results for the first quarter and are intended to fall within the safe harbor provisions of the securities laws.

Actual results or events in the future are subject to a number of risks and uncertainties and may differ materially from those currently anticipated or desired or referenced in any forward-looking statements made as a result of a number of factors. Such factors include the company's determination as it finalizes its financial results, the first quarter, that its financial results differ from the current preliminary unaudited numbers set forth in the press release issued yesterday, other factors that the company may not have currently identified or quantified and those risks and uncertainties identified from time to time in the company's reports filed with the Securities and Exchange Commission.

Additional discussions of these and other factors affecting the company's business and prospects as well as additional information regarding forward-looking statements is contained in the slide presentation posted in connection with this call and the company's filings with the Securities and Exchange Commission. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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

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

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [2]

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Thank you, Kevin. Good morning, everybody, and thanks for joining us for our first quarter 2019 earnings call.

I'm on Slide 3. For the first quarter, we delivered $619.3 million of revenue, growing 23.5% in total. Our organic revenues increased by 2% for the first quarter. I'll get into more details in a few minutes about the organic growth for each of our segments. Our EBITDAC margin was 31.8%, which is up 60 basis points versus '18. Our net income per share for the first quarter grew 25% to $0.40 as compared to the first quarter '18. During the quarter, we also completed 8 transactions with annualized revenues of approximately $36 million. Later in the presentation, Andy will discuss our financial results in more detail.

I'm now on Slide #4. Similar to what we've been experiencing for a number of quarters, the economy continued to expand in Q1 of '19 with many of our customers investing in their business, hiring more people and growing organically. While overall premium rates remain competitive, during the first quarter, we did see some upward pressure in certain lines, including coastal property, both wind and earthquake, also in automobile, employee benefits and general liability. The main line where we're seeing rates consistently down across most regions is workers' compensation. Most other lines of coverage are flat to up slightly, 0% to 5%, with commercial auto up 7% to 10%.

As a result of losses over the past couple of years, there's a lot of discussion that risk bearers want to increase rates, most pronounced in the London markets. But we're hearing this in other markets as well. Where there's a lot of -- while there's a lot of talk and desire for higher rates, there's still a lot of capital in the market. Therefore, we see some insurance companies tightening underwriting guidelines. The loss-free accounts remain quite competitive. We're pleased with our investments in technology, innovation and new programs, and we're starting to realize some of the initial returns that we expected.

I'm on Slide 5. Let's talk about the performance of our 4 segments. In Retail, we delivered solid organic growth of 3.6% in Q1 with most lines of business growing through new business activity and growth on renewals of existing customers. We're pleased with the performance of all of our new acquisitions in Q1. Hays positively impacted our margins, and it's performing in line with our expectations. Please remember, we expect higher revenues and margins in the first quarter due to the amount of employee benefit, combined with the new revenue recognition standard that went into effect last year. That's relative to Hays. During the quarter, we completed 6 acquisitions and realized approximately $95 million of year-on-year revenue growth from acquisitions completed within the last 12 months.

Our National Programs segment decreased 2.3% organically. This was primarily impacted by less flood claims processing revenue as compared to the prior year. We also experienced some headwinds in our lender-placed business due to the continued improving economy and some bank consolidations that are impacting our customers. Commercial and personal automobile continued to challenge all of our carrier partners. We have several programs that are auto focused. We're watching our retention of existing business and new business closely. During the quarter, we realized good growth in our earthquake, all risk and wind programs, just to name a few.

Our Wholesale Brokerage segment delivered organic revenue growth of 3.3%. This growth was impacted by renewal timing for a couple of larger accounts, where the accounts are renewing in Q2 and Q3 as opposed to Q1 in prior years. If those accounts have renewed in March, like they did in 2018, our organic revenue growth would have been over 4.5%. Therefore, our organic growth will be slightly higher for Wholesale in the second quarter.

Our Services segment delivered organic revenue growth of 50 basis points for the quarter. As we mentioned during the year-end call, we expected lower claims in our social security advocacy business, resulting from the completion of advocacy work on a book of business in the prior year. Isolating this impact, the majority of businesses in the Services segment grew nicely. During the quarter, we completed an acquisition of a Medicare set-aside business that will be complementary to our existing New Quest, Medicare set-aside business. Overall, it's a good quarter and we're really pleased with our results.

Let me turn over to Andy to discuss our financial performance in more detail.

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [3]

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Thank you, Powell, and good morning, everyone. Consistent with previous quarters, we're going to discuss our GAAP results and then our adjusted results, excluding the impact of acquisition earnouts.

I'm over on Slide #6. This slide presents our GAAP and certain non-GAAP financial highlights. For the first quarter, we delivered total revenue growth of 23.5% and organic revenue growth of 2%. Our income before income tax increased by 25.4% and our EBITDAC increased by 25.8%, both growing faster than revenues due to leveraging our expense base. Our net income increased by $23.1 million or 25.4% to $114 million, and our diluted net income per share increased by $0.08 or 25% to $0.40.

Our effective tax rate for the first quarter was 23.3%. Remember that the first quarter of each year, we normally have a lower effective tax rate due to the tax benefit associated with divesting of stock grants to our teammates. With our changing tax footprint by state and corresponding apportionate, we expect our state tax rate to be slightly lower. As a result of this last item, we are projecting our expected full year effective tax rate to be in the 25% to 26% range versus our previous guidance of 26% to 27%.

As a result of our share repurchases, we've been able to maintain a relatively flat weighted average number of shares outstanding as compared to 2018. This is offsetting shares issued in connection with our equity programs and for the acquisition of Hays. Lastly, our dividends per share increased to $0.08 or 6.7% compared to the first quarter of 2018.

Moving over to Slide #7. This slide presents our results after removing the change in estimated acquisition earnout payables for both years. This approach provides a more comparable year-on-year basis. Since there were minimal changes to our estimated acquisition earnouts for both years, our diluted net income per share increased by $0.01 for each quarter and therefore increased by 24.2% versus the first quarter of 2018.

Moving over to Slide #8. This slide presents the key components of our revenue performance. For the quarter, our total commissions and fees increased by 23.4% and our contingent commissions increased $3.6 million as compared to 2018. We'll give further clarity on contingent commissions later in my comments. This amount was impacted by recent acquisitions and instances where the final cash settlements were slightly higher than the amounts that we accrued in 2018. Our core commissions and fees increased by $113 million or 23.2%. When we isolate the net impact of M&A activity, our organic revenues increased by 2%, driven by the items that Powell described earlier.

Moving over to Slide #9. To provide additional insight into the components of our EBITDAC margin, we've included a walk-through from 2018 and 2019. In summary, it was a quiet quarter, so there is not much to break out. Our margins were impacted negatively by 60 basis points due to the year-on-year change in the gains or losses on disposals of businesses. Hays positively impacted our margin by approximately 70 basis points for the quarter. This resulted from the higher revenues and margins in the first quarter, driven by the amount of employee benefits business and how revenues are realized within the accounting rules. We'll discuss the results of Hays in more detail later in the presentation. Other reflects the underlying margin improvement we experienced across our business as we are beginning to realize some returns from our previous investments in teammates and technology and leveraging our expense base. This expansion was partially offset due to higher non-cash stock compensation cost.

On the following slides, we presented the results of our 4 business segments. We are going to start on Slide 10 with the Retail segment. Our Retail segment delivered organic growth of 3.6% for the first quarter of this year and total revenue growth of almost 40% driven by acquisition activity, contingent commissions and good organic revenue growth. As mentioned during the Q4 2018 earnings call, we expected the Retail division to have slightly lower organic revenue growth in the first quarter of this year as compared to the second quarter of 2019 due to impacts of the New Revenue Standard in the prior year. While we did see this, the effect was less than anticipated due to higher incentive commissions received in 2019 from amounts earned and accrued in 2018. Our EBITDAC margin for the quarter increased by 210 basis points driven by higher contingent and supplemental commissions, the performance from Hays, leveraging our cost base and realizing some benefits from our previous investments. Our income before income tax margin declined by 120 basis points due to higher intercompany interest expense and amortization associated with our acquisition activity.

Moving over to Slide #11. Our National Programs segment decreased 2.3% organically. This was driven by approximately $3 million decrease in flood claims processing revenue as compared to the prior year as well as some headwinds experienced in our lender-placed business. EBITDAC decreased $3.1 million or 8.6% primarily driven by lower organic revenues and decreased contingent commissions. Income before income taxes declined by 7.2% primarily due to decline in revenues but was partially offset by lower intercompany interest expense.

Moving over to Slide #12. Our Wholesale Brokerage segment delivered organic revenue growth of 3.3% and total revenues increased 6.7% as a result of acquisitions completed within the past 12 months and an increase in contingent commissions. The EBITDAC margin increased 190 basis points as a result of higher contingent commissions and leveraging organic revenues. Our income before income taxes increased faster than revenues due to the estimated acquisition of earnout payables that were recorded in the prior year.

Over to Slide #13. Our Services segment's organic revenue increased 50 basis points for the quarter driven by growth in most businesses, but was substantially offset by lower social security advocacy claims. Total revenue growth is due to acquisitions that we completed in the last 12 months. From a margin perspective, EBITDAC grew slower than total revenues due primarily to a gain on disposal in the prior year. Isolating the impact of the gain in the prior year, EBITDAC margins expanded nicely for the quarter. The lower growth for income before income taxes was driven by incremental intercompany interest charges associated with the acquisitions.

Moving over to Slide #14. We wanted to provide an update on the Q1 performance of Hays, which is in line with our expectations. Consistent with our disclosure for larger acquisitions, we plan to provide quarterly updates on the performance of Hays through the end of the first year post acquisition. Total revenue was in the expected range while expenses were slightly better primarily due to the phasing of expenses associated with ASC 606. Please remember that a larger portion of the annual revenue and profit will be recorded in the first quarter due to the higher percentage of employee benefits business. We continue to believe that Hays will deliver within the previously communicated full year range of revenue and profit. Please refer back to the year-end earnings deck for the remaining quarterly estimates, which have not changed.

A few other comments on the quarter and outlook. In order to turn some of the borrowings for the Hays acquisition and further stagger our maturity ladder, we issued $350 million of 10-year public bonds with a coupon of 4.5% in March. We're really pleased with this interest rate as we issued 10-year bonds in September of 2014 at 4.2%.

We also want to talk about our cash flow from operations this quarter as there was a material movement as compared to what was generated last year in the first quarter. As reported, net cash provided by operating activities is $5.4 million for the first quarter of this year and was $79.5 million in the first quarter of 2018. There are 2 main drivers, which are timing and nature. The first relates to premiums payables to insurance companies, which decreased $56 million as compared to the year-end balance. In the first quarter of 2018, the balance increased by $14 million. This represents a $70 million change in cash flow generation during the quarter. This account represents pass-through funds through risk barriers and therefore we can have large swings in the balance based upon remittance to carriers during any one quarterly period, which we've realized movements like this in the past. The second item relates to the timing of working capital settlements for recent acquisitions. This is temporary and will revert to normal timing over the next quarter or 2. This timing negatively impacted our cash by about $30 million this quarter. Both of these items are timing and will reverse over the coming quarters. Therefore, we continue to feel comfortable that our industry-leading cash flow conversion ratio will remain over 20% for the full year.

While Q1 in total was a good year -- was a good quarter for contingent commissions, we did see a $3 million decrease for National Programs. We expect this trend to continue for the remainder of the year as we know of certain contingent commissions that will we will not qualify for in the back end of the year. For the full year, we're estimating our contingent commissions in National Programs should be down about $12 million to $14 million. The remaining decrease should be recognized about evenly over the remaining quarters. This decline will be substantially offset by growth in Retail. We expect wholesale to be flat to down $2 million for the full year 2019. For the full year, we estimate contingent commissions for the company will be down about $2 million to $4 million as compared to 2018.

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

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [4]

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Thank you, Andy, for a great report. As a diversified insurance broker, we have 4 distinct divisions that enable us to serve numerous customers across the United States and the world.

There seems to be some excitement around possible rate changes. First, I'd like to iterate, there's a lot of capital out there chasing a finite number of risks. Thus, we believe much of that rate pressure will be mitigated. There may be certain areas that see some more than others, but I'm saying as a broad statement that we mitigated.

Second, we're believers and supporters in the U.S. economy and want to see it expand further. However, we're always watching for signs of a potential slowdown and then how that might impact our business.

Third, we tried to present a clear picture of our business to everyone, analysts and shareholders. Our interests are aligned with long-term investors. We know there will be peaks and valleys, but we're investing for the long-term. There are acquisitions we could do, but choose not to because of the price or lack or not a cultural fit. Culture is an intangible thing that makes some companies great and others average. As we crossed the 10,000 teammate threshold, we think about how we cultivate and drive our culture as we move towards our next intermediate goal of $4 billion in revenue. To get there, we need to hire or acquire or some combination of the above around 10,000 more teammates. It's an exciting time at Brown & Brown and we have a lot of momentum. We have great teammates dedicating to serving our customers. The acquisition pipeline is good.

And finally, we know a balanced approach to organic growth and margin expansion will deliver long-term value creation. And Q1 was a good start to the year.

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

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Questions and Answers

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Operator [1]

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Thank you. (Operator Instructions) We will now take our first question from Michael Phillips of Morgan Stanley.

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Michael Wayne Phillips, Morgan Stanley, Research Division - Equity Analyst [2]

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Thanks a lot for all the commentary. They're very helpful, and congrats on the quarter. The first question, I just want to drill down a little bit more on margin and those there. I guess the bottom line of question is do you think we're kind of in an inflection going forward. There's a couple of things or possibly headwinds, some headwinds this year for margin. So maybe you can give little details on kind of the plus and the minuses on margins and kind of what you think going forward, whether or not we're actually in an inflection point. And I'm not talking individual segments, just kind of corporate way.

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [3]

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Sure. All right. So Michael, as you know, one, the margin is impacted by several things: one, the businesses operating more efficiently going forward, and that's a result of really high-quality teammates; and two, the acquisitions that we make. And if some of those are slightly lower margins and then they continue to improve as they're part of our team. So do you think we're at an inflection point? We believe that we are, without something that we don't see or know of today. That's number one.

Number two, there are lots of opportunities for us to invest in our business. I know we've talked about this in the past. The biggest area or one of the most important areas is just new people, whether we hire them from another firm, we hire them from another industry, we bring them in. Second would be M&A, and third would be return to shareholders. That first bucket, we think there's going to continue to be lots of opportunity to hire high-quality people in the near to intermediate term because there's lots of disruption in the industry, and there are some people out there that have worked for firms that maybe they aren't pleased with the new firms they want to work with. That does not mean we're going out and trying to hire a bunch of people from other firms. What it means is, there will be some high-quality people that become available in the next 12, 24, 36 months. And how we invest in those people may also have a short-term impact on margins. But long term, it's increasing the capability of the team and positioning us well for the future.

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [4]

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It's Andy here. I would add a couple of things on it just to remind you from our comments at year-end. I think the inflection point is spot on. That is pre the impact of Hays this year, because we said that Hays would have a negative impact on margins this year. So keep that in mind. And then the other piece we had talked about was the $8 million onetime adjustment that we recorded in the third quarter of last year in National Programs. And so those accounted the 2 big items out there. And then we've -- we talked about the fact that we are -- we're at full investment on where we've been with the technology, et cetera. So a lot of those headwinds are behind us, and we'll slowly start to recognize benefits from those over the coming quarters.

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Michael Wayne Phillips, Morgan Stanley, Research Division - Equity Analyst [5]

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Okay. No, great. That's helpful. I guess second question then is a little bit more detail on some of the rate commentary. You mentioned comp, and I was just curious on, specifically on workers comp, whether that's accelerated or decelerated in terms of decreases there from what we saw last quarter.

And then I believe you mentioned in your commentary that GL was up, and I was wondering if you could provide a little more detail on where that is. The press or in your slide deck mentioned that professional lines is down. So what pockets of GL would be up?

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [6]

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Okay. So relative to workers' compensation, there just continues to be pressure. This is a broad comment. So I don't think it's so dramatic -- drastically different than it was in our last earnings call. So I'd say it's similar. But you just need to be aware that if you've been in the business as long as I have, we've seen the -- that line of business be a very difficult line and now it's seemingly more of attractive line, which I think is really interesting.

Liability in terms of -- there are some carriers out there that are trying to figure out or they're actually making money in liability, long-tail liability, not just short-tail liability. And so with that, I would tell you that it could be any account, whether it be a manufacturer of a product or exposure like habitational, we have apartments or anything in between, so you can have premises or a product exposure, carriers are reevaluating that. That does not mean we're seeing high rate pressure. It is very spotty on certain accounts. So you might say, "Like what?" Well, if you look at certain habitational accounts, particularly in things that might be HUD housing or things that are tougher classes of business, there may be continued rate pressure or changes in the terms and conditions or both. But we just mention it because there are people talking about it. We're not seeing rate increases sticking more broadly across the market as you might think based on the amount of chatter on it. That's the important distinction.

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Operator [7]

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We will now take our next question from Mike Zaremski of Crédit Suisse.

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Michael David Zaremski, Crédit Suisse AG, Research Division - Research Analyst [8]

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I'll start with a pricing question, a P&C pricing question. In the depth of talks about upward pressure on certain lines, watching reinsurance rates, could you maybe help us understand if there any nuances in your book in terms of if reinsurance rates do continue to harden? Are you guys more levered than -- to that than maybe other brokers? I believe you have more of, potentially, a Florida component than others, and I'm not sure if that's more in the Wholesale or the Retail. So maybe you could flesh that out more.

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [9]

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Okay. So as you know, if in fact, you hear about and/or reinsurers are increasing pricing, that does not necessarily mean that, that price, dollar for dollar or percentage for a percentage, will be passed through by the primary carrier. That's number one. So the price, which is borne in the marketplace, is set by the marketplace. It's not set by individual insurance carriers. There can be some that actually write a lot of the class of business. And if, in fact, they change, that may trigger a change in others. But -- so I don't want you to think that if you reeval reinsurance rates going up x amount, that means that you should automatically assume that primary pricing is going to go up. That's number one.

Number two, as it relates to living in Florida, Mike, when I joined the team now 24 years ago, our concentration in Florida was -- I think it was 60% of our revenue. It was significantly different. So we do have a large Retail presence here. We do Wholesale business here. We do Program business and Services business here. Those areas that typically would be most impacted by, if you're asking about a potential rate changes, would be property-driven accounts in Florida. So we write a lot of habitational and other property across the State of Florida. However, we're continuing to hear a lot of talk about it, as I referenced in my -- our comments, from London and domestic carriers, but we're not seeing it stick all the time. So I would caution you about trying to draw a direct parallel and saying, "Huh! Brown & Brown's business, which is now maybe, all-in, 10% or 15% of our revenue overall versus maybe 40%, 50%, 60% when I started at Brown & Brown, it's so heavily dominated in Florida, so therefore if there's a change, it's going impact their business dramatically." I would caution you about that, number one.

Number two, as it relates to us versus other brokers, we can't -- I can't comment about their books of business. Although we want to and do write a lot of business in coastal areas, Texas, the Gulf Coast, Florida, up and down the East Coast and we run a lot of quake in California, Oregon and Washington, and so having said that, we start to see some pressure, slight pressure, in earthquake on some of the bigger limits. As you know, it's been a long time since we've had an earthquake of any magnitude. And it's not a question of if, it's a question of when. So like I said, we are -- we're trying to be cautious and manage your expectation about what other carriers are saying or brokers about the marketplace as we're just not seeing it yet in terms of pricing sticking.

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Michael David Zaremski, Crédit Suisse AG, Research Division - Research Analyst [10]

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Okay. That's helpful. And a follow-up for Andy on the tax rate. I know there's been a lot of changes to the tax regime over the last couple of years. So just curious as -- do you think 25% to 26% or maybe a 25% to 27% range is the kind of the new normal for thinking longer term beyond 2019?

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [11]

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Yes. A -- the 25% to 27% is probably a good range on it for the company, I think barring what happens down at the state level and if there's any modifications in their approach. But with our overall footprint today, it probably wouldn't move significantly, that's out there.

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Operator [12]

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We will now take our next question from Greg Peters of Raymond James.

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Charles Gregory Peters, Raymond James & Associates, Inc., Research Division - Equity Analyst [13]

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A couple of questions. First of all, on -- I guess it sort of dovetails the earlier questions. But you talked about how -- in your closing comments, about the opportunity to hire a bunch of new teammates. I look at your revenue and EBITDAC margins when you're $1 billion and then compare it with where you were when you hit $2 billion of revenue, EBITDAC margins still industry-leading, but down 40 -- 4%, 5% from what they were when you were smaller. When you think about getting bigger, do you think your margin profile is going to take another downward tick?

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [14]

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Well, let me back up and say that I think that we, as an organization, have continued to evolve as -- going from $1 billion to $2 billion, that means that we have additional capabilities to serve different segments of the marketplace. In some of those segments, the margin profile is a little different than what we were doing predominantly as a $1 billion company. That's number one.

Number two, we have made investments and we'll continue to make investments in things like technology, which will help us scale the business. As Andy said earlier, we believe we're at a technology spend that is good now, but we're always, always evaluating that. And that technology spend, as you know, is not just the infrastructure, but security. And so as we continue to look at the business, we have to continue to think about things that maybe we didn't think about as much when we were a $1 billion or a $800 million company versus $2.3 billion or $4 billion company on the way to $4 billion.

So that's the long answer to saying, based upon what we know today, Greg, and without an unknown event or events that we do not see coming, i.e., like cybersecurity, we think that the margin profile, assuming we make acquisitions that are similar, going forward in the next 5 to 10 years, we think the margin profile is going to be very sound. So I think that it's -- it is obviously speculation on our part because we don't know the opportunities that will be presented to us long term. But as you know, we are focused on growing organically and growing our margins so we can reinvest that money over time. So cash conversion is really important to us so we can reinvest it in our team. So that's a long answer to your question.

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [15]

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Greg, a couple of other things just to keep in mind. When you look back over time, keep in perspective what's happened with contingent commissions. As those move up and down, so do the margins in the organization. And we've been on a downward trend over the past number of years just due to profitability on the carrier side. That's part of a cycle that's out there. We've -- we said publicly that we believe low 30s to mid-30s, that's a really good range for our business.

And if you look back over the last 10 years, we've been able to double the business and still stay north of 30%. That's really good. But to Powell's point, cash conversion is what we think matters at the end of the day because you can't count anything else other than cash. And the fact that we run north of 20% and we generally average somewhere around $0.23 of every dollar's free cash flow, and that's twice the average of the industry. We've been able to do that for a really, really long time. That's what drive our free cash flow yield.

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Charles Gregory Peters, Raymond James & Associates, Inc., Research Division - Equity Analyst [16]

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Great. I had 2 other questions on -- another big picture question and then a small, nitpicky question on a comment you guys made. So let's -- the other would be around the benefits business.

There's been a lot of news in health care in the last couple of months. One of your competitors, Willis, made a major move by buying TRANZACT and then, of course, entering the protocol environment, and there's discussion about Medicare for all. And I'm just curious about how you guys are thinking about your benefits business in the context of all these prevailing news items that are out there.

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [17]

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Okay. So number one, just to give you kind of a background. About 34% of our Retail business is employee benefits, okay? That's just to give everybody a baseline. Number one, we have small, medium and large accounts benefit business. Number two, if, in fact, you look at the number of uninsured people prior to ACA, then during ACA and then in this period of continued change, it's interesting to see that it was maybe 43 million people prior to ACA, goes down to I think 28 million, Andy?

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [18]

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29.

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [19]

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29 million and kind of hovered in that 29 million person range right now. So having said that, we take the discussions very seriously. However, we believe that the financing of Medicare for All would be, let's call it, cost-prohibitive. And there is probably a place for -- we believe that there's absolutely a place for private insurance. And in doing so, if there is something that is drafted, i.e., ACA again or ACA 2.0, then there's going to be further complexity in that, which creates more demand for someone to interpret those rules and regulations and then giving customers solutions to address their health care costs. So having said that, we, number one, watch it very carefully.

Number two, we believe that it is a -- it sounds good to some people. But the reality and the application and the impact across multiple industries, i.e., just a hospital, any hospital that you would go to and how they would be paid versus private insurance, it has a huge impact. And you may have seen those articles. There was one in New York Times this weekend. There's also a lot of discussion around Medicaid and -- Medicare and Social Security and funding, i.e., there was an article in the Wall Street Journal this morning on that, and how does that currently evolve and what will we, as a country, need to do in the next 10 to 15 years to address potential funding shortfalls. So long answer to the question.

It grabs headlines, and there's going to be a lot of discussion about it in the next 1.5 years. And we're going to hear a great deal of it right here in Florida because we have a battleground state here. We believe there are some different solution if a D was elected or potentially if an R was elected or reelected.

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Charles Gregory Peters, Raymond James & Associates, Inc., Research Division - Equity Analyst [20]

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Okay. The other final question that I had, in your comments, Powell, you mentioned the changes going on with profitability in the carrier market all around auto. And you said specifically, you're watching the retention of your auto-related businesses closely. Can you talk about where -- besides your auto-related businesses, is it in the Wholesale? Which segments it's in? Give us some additional color behind that comment.

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [21]

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Sure. What I was trying to address, Greg, or what we're trying to address is, remember, we have a couple programs that are auto-focused. And you know that we have our -- we have one market. We're right on behalf of a market. And if, in fact that market -- the appetite changes or tightens dramatically, that could impact the revenue of that program.

I was specifically, not exclusively, but I was specifically thinking about Programs when I made that comment, although we do Wholesale some of that business and we also have some of that business in our Retail. That comment was directed primarily at Programs and several of our large auto-related program businesses.

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Charles Gregory Peters, Raymond James & Associates, Inc., Research Division - Equity Analyst [22]

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And so are you getting any indication from the carrier about their change in appetite?

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [23]

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Well, we always have ongoing discussions around performance of the book and particular geographic areas and states and all of that, and there's nothing that we're aware of right now that is a dramatic change. That's not what I'm trying to signal. But all I'm saying is if, in fact, you believe some of the things that people write about companies -- there's a discussion about reserves being underfunded. If, in fact, those reserves are partially attributed to auto books, then insurance companies might -- somebody might come to you and say, "Hey, this is impacting our entire book. This is what we want to do." We're not aware of that right now. All I'm saying is it -- I'm trying to say that it is possible that there could be some things that carriers do that we're not aware of that would impact our auto book and, specifically, in programs.

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Operator [24]

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We will now take our next question from Elyse Greenspan of Wells Fargo.

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Elyse Beth Greenspan, Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst [25]

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So a few questions. My first question in terms of the Retail segment. Some of your introductory comments, you guys pointed to the fact that you had said that the Q1 would be weaker, but it did come in a little bit better. Is the comment -- does the comment still hold true that the second quarter should be higher than the full year average and the Q1 weaker? Or is it going to be more kind of even throughout the year? I'm just trying to tie together some of your comments from this quarter's call and then last quarter's call.

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [26]

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Yes. It's Andy here. Yes, I think the comment is still relevant to what we made at year-end. But with the first quarter coming in stronger than what we anticipated, that gap between Q1 and Q2 will not be as large as what we originally anticipated, okay? So just probably as you think about -- and so just probably up slightly from where we thought it would've been a little bit bigger gap before. But yes, still a little bit over the average or whatever average you're estimating for the year.

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Elyse Beth Greenspan, Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst [27]

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Okay. And then the stronger Q1 growth, was that partially due to -- it seems like some type of timing related to 2018 business. Or is it also that the growth was stronger, partially reflective of a better economy, stronger exposure, growth in pricing than you might have expected at year-end?

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [28]

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Yes. I think it's a little bit of both.

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Elyse Beth Greenspan, Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst [29]

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Okay. That's helpful. And then a few numbers question, the first thing on Hays. You guys said that it was about in line with expectations for the first quarter. The margin was a little bit better, so you guys got about $0.02 more earnings this quarter than your guide. So is the right way to think that we're going to see a couple of cents lower earnings in the back 3 quarters? Or is the full year earnings guide higher?

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [30]

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Yes. Elyse, we had estimated that the full year would be $0.02 to $0.03 of contribution. And yes, we were a couple of cents higher this quarter. We had already given projection that we said the second quarter would probably be down $0.01. We still think that's probably a good range.

And then Q3 and Q4, we're basically flat on earnings per share. It might be on the round. Now it may actually make $0.01. We still think $0.02 to $0.03 is good. I mean it's the first quarter out. We just don't think we're in position where we would change a full year outlook at this stage just because we've got phasing of the 606 inside. And we'd like to see a couple of quarters under our belt to give us a better view.

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Elyse Beth Greenspan, Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst [31]

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Okay. That's helpful. And on the contingents outlook, you guys said that it would be down about $2 million for the -- $2 million to $4 million for the full year. So does that mean that you guys are going to be down around $6 million -- if my math is right, around $6 million to $8 million in the back 3 quarters? And then why -- I guess if the Q1 was stronger, why are you know looking for the back 3 quarters to be weaker relative to your prior guidance?

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [32]

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Yes. Your math would be correct on that in the back end of the year. So a couple of things that we made comments about is we definitely had true-ups in the first quarter for contingents. And as a reminder, what we have to do on contingent commissions is we're projecting what we believe that we're going to earn in the coming year that we're going to collect in the following year. So we have to make our best estimate on those. So we're almost always going to have some sort of adjustment, primarily in the first quarter, at least as we receive the final cash settlements. And so we saw those that came through.

Then as we look into the back end of the year, our commentary was primarily around National Programs. We definitely know there are some that we will not qualify for. They -- we've already been told by the carriers. And again, we're going to have a fair amount of that will be offset by a growth in Retail, but that's a pretty good view based upon everything we know today.

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Elyse Beth Greenspan, Wells Fargo Securities, LLC, Research Division - VP and Senior Analyst [33]

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Okay. That's helpful. And then just one last quick numbers question. When you were talking about free cash flow, that 20% target, that as a percent of revenue. And then you guys didn't settle the remainder of your ASR this quarter. When can you settle that out until?

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [34]

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Perfect. Yes. So when we talked about the 20%, that is a free cash flow conversion as a percentage of total revenues, okay? And then the ASR, based upon kind of where we are at this stage, it will -- it'll settle out here in the second quarter.

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Operator [35]

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

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Yaron Joseph Kinar, Goldman Sachs Group Inc., Research Division - Research Analyst [36]

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Just another couple of questions on contingent commissions. First, in the Wholesale segment, can you walk us through your thoughts there? I would think that if contingent commissions are improving or, in fact, are decreasing, it would suggest that the pricing action that we're hearing about and some tighter terms and conditions aren't necessarily manifesting themselves in better underwriting profits. Is that a fair way of thinking about that for the industry, the wholesale industry?

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [37]

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Yes. That would be a good way to think about it at a top level, Yaron. And that's really what -- if you look back to the last 3 years in Wholesale, we've seen a decline in our contingent commissions. And it's almost all entirely driven by through profitability on the carrier side. So again, while there's a lot of talks of trying to get some different rates and things of that nature, one, we'll see if that kind of really takes hold on a consistent basis. But then the question is how long does it take to get back to an appropriate level of profitability to drive those contingents.

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Yaron Joseph Kinar, Goldman Sachs Group Inc., Research Division - Research Analyst [38]

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Got it. And then if I flip that question to the Retail segment, so why are you expecting stronger contingent commissions there? Is that purely a matter of growth in the segment? Or do you expect better profitability?

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [39]

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No. That's primarily almost all driven by the acquisition activity.

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Operator [40]

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We will now take our next question from Mark Hughes of SunTrust.

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Mark Douglas Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [41]

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The interest expense, Andy, how should we look at that directionally for the balance of the year?

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [42]

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As -- the guidance we had given at year-end, as we said, somewhere in the range of $66 million to $68 million. Based upon kind of current debt outstanding and presuming that interest rates don't do any unusual, we still think that's a pretty good range. So while we issued the 10-year bonds in March, it wouldn't have a material movement on our full year interest expense and then I guess subject to if we need to -- if more acquisition activity and any borrowings, but good for right now.

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Mark Douglas Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [43]

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Okay. And then in the National Programs business, any sense of pipeline when you look at the potential opportunities, new programs, carrier appetite? Is that -- should that business grow faster than the overall environment as a whole or in line, a little slower? How do you think?

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [44]

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I think, Mark, it depends. What I would say is there's a lot of interest in underwriting MGA, MGUs out there. So there's not as many acquisition targets with size, however you want to define that, than there are in Retail. So you have a more limited scope or space, number one.

Number two, there are certain firms that are more interested in that business than other types of business, not just us. And so it depends on how the market evolves and the -- thus, the profitability on the programs that we have in terms of the organic growth on those programs. Let's just think about that. And then you have the idea of supplementing organic growth with limited or -- I wouldn't say limited but a smaller pool of acquisitions that fit culturally and make sense financially. But we're very interested in the space, and we absolutely want to invest in it with the right firm. So we're always looking for it.

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Operator [45]

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

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Joshua David Shanker, Deutsche Bank AG, Research Division - Research Analyst [46]

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Yes. Thank you for the short-term update on the cash flow items that we need to look out for. If I'm thinking longer term on the difference between your cash flow and your net income, obviously, depreciation/amortization is a big item in there. What should I be paying attention to if I'm trying to figure it out over a multiyear basis?

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [47]

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Yes, those would be the 2 main items inside there. I mean if you look at our net income -- or our pretax income, it generally runs in the range of about a 23% to 24%. And so that's kind of gotten us fully loaded. That's just kind of a metric that we look at all the time as an organization. And then it depends upon the nature of the transactions that we do and the amount of valuation attributed to amortizable intangibles where you can get a pretty good run up over time.

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Joshua David Shanker, Deutsche Bank AG, Research Division - Research Analyst [48]

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Over any materially longer than 1 year period of time, should there be any real difference in the growth rate between your net income and your free cash flow?

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [49]

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No. I don't think so. I'm just kind of thinking through your question here. There's no -- not a -- should not be a significant amount. I think the one piece to keep in mind is the noncash stock compensation. That's probably the one bigger item that's out there.

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Joshua David Shanker, Deutsche Bank AG, Research Division - Research Analyst [50]

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And I was going to get to that item. As you get bigger and there's the hunt for better talent, I know you train your own people. Does the incentive structure change, that you have to offer better benefits and maybe an ownership awards to your employees that increases the percentage of noncash comp that's a weight on for cash flow?

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [51]

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Well, Josh, it's Powell. As you know, we believe we have an ownership culture already, and we do some of that already for our teammates. So there are ways for people to buy stock at a discount, invest in the stock if they so choose through the 401(k) and get equity grants based upon growing your books of business or running large businesses and the company overall performing well.

So it's something that we constantly and consistently think about to drive a desired behavior. But at the present time, it's not as though we think there's going to be some dramatic shift in our rewards program a year or 3 years from now. We believe that it's going to kind of grow in line with what we're doing. There might be some things that we haven't thought of or would be new that we would think about how we use noncash stock comp. But at the present time, no.

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Operator [52]

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We will now take our next question from Meyer Shields of KBW.

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Meyer Shields, Keefe, Bruyette, & Woods, Inc., Research Division - MD [53]

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One brief numbers questions to start. You mentioned that there was some Wholesale organic growth that was basically pushed out to the second and third quarters. Do the expenses associated with that come in the first quarter? Or should we expect the expenses to be deferred as well?

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [54]

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No. It's Andy here. It's -- most of the costs were borne during the first quarter. The movement around would not have a material impact on the margins.

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Meyer Shields, Keefe, Bruyette, & Woods, Inc., Research Division - MD [55]

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Okay. So yes, that sounds like good news for coming quarters. So you got the -- I find it very helpful, the waterfall, for the EBITDAC margin. I was hoping to drill a little bit better into that benefit sort of categorized as other, because it sounded -- I just want to make sure I understand it. It sounds like there's a sustainable function of recent investments. Were there any onetime positive or negative issues within that category?

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [56]

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No. No real unusual onetime item. I think our comments, it's a relatively quiet quarter. So I guess that's always a good thing compared to our previous quarters where we had a number of others that we've walked through. But no, it's just -- it really comes down to leveraging our expense base with the revenue growth. You've seen some of the margin expansion associated with the previous investments, and again, that will be just slight as we continue to move forward over time.

Then there's -- this is a piece that's may be hard to fully get your arms around. There's also business mix inside of the organization. So not all businesses are the same profitability. So depending upon how they move back and forth does have an impact on us. So again, it was -- overall, it was a good quarter. But that -- the growth that we had there still offset the noncash stock comp. So it was a really good quarter for us. We're pleased.

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Meyer Shields, Keefe, Bruyette, & Woods, Inc., Research Division - MD [57]

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No. Fantastic. That's helpful. And then final question. Is it -- you talked about adding another 10,000 teammates, obviously, no short-term timeframe for that, at least one that I saw. Is it more expensive? When you go through like the second cohort of 10,000 employees, is it more expensive to maintain the Brown & Brown culture than it was for the first 10,000?

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [58]

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That's an interesting question. I think the answer will be directly related to how those 10,000 new teammates are onboarded. So if we hire them in groups and bring them into individual offices and train them up and launch them in their careers, we do that all the time. If we do an inordinately high amount without an acquisition, we do acquisitions all the time, too. But right now, I don't think so based upon how we've done the last billion. But I'll be able to tell you better when we get there.

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [59]

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Meyer, it's Andy. Yes, you hear a lot in our commentary about -- specifically, on M&A, that culture is one of the most important things that we focus upon. And so if we continue with our disciplined approach and making sure that those organizations that come and join our team match on culture, it will make it much easier to sustain that process.

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Operator [60]

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

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Adam Klauber, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Financial Services and Technology [61]

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Hays obviously is very strong benefits to organization. What did they -- I guess what expertise do they bring to the table that you didn't really have? And how quickly can you roll that out to the rest of the organization?

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [62]

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They have a lot of strong capabilities in the middle and large employee benefits space. So I would say that's 500 lives and up, and that is already occurring right now.

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Adam Klauber, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Financial Services and Technology [63]

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Okay. And then as far as Hays, what prospect, as you go down the road in year 2, year 3, to get the margin up at that organization?

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [64]

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They have done an exceptional job of bringing high-quality talented people onboard. Some of those people were investments just like we make investments in people early in their careers, where there was not a margin, it was more of an expense, as opposed to a revenue positive and a margin positive. Those people will continue to add to a positive margin, and over time, we believe that there will be some upward increase in their margins. Remember, we've said that Hays, because of the way their business is structured, is not going to be margin profile of middle market, but it'll be somewhere slightly less. That's what we said periodically.

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R. Andrew Watts, Brown & Brown, Inc. - Executive VP, CFO & Treasurer [65]

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And then, Kevin, we -- if there's anybody else left in the queue, we'll take one final question, okay?

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Operator [66]

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There are no further questions at this time.

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J. Powell Brown, Brown & Brown, Inc. - CEO, President & Director [67]

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All right. Thank you all very much, and have a wonderful day. We look forward to talking to you next time. Good day.

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Operator [68]

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