Brown & Brown Inc (BRO) 2002 Q4 法說會逐字稿

Good morning and welcome to the Brown & Brown fourth quarter and year-end 2002 financial results conference call. Today's call is being recorded.

Before we proceed, we would like to inform you certain of information that will be 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. Some statements fall within the Safe Harbor provision of security laws. Actual results or events in the future are subject to a number of risks and uncertainties and may differ materially from those currently anticipated or desired or referenced in any forward-looking statements made as a result of a number of factors, including those risks and uncertainties that have been or will be identified from time to time in company reports filed with Securities and Exchange Commission. Additional discussion of these and other factors affecting the company's business and prospects are contained in the company's filings with the Securities and Exchange Commission. Listeners are cautioned any such forward-looking statements are not guarantees of future performance and that actual results and events may differ from those indicated in this call. Such differences may be material.

Mr. Brown, I will turn the conference over to you.

Great. Thank you, Brenda. Welcome, everyone. We have here in Daytona, Cory Walker, our Chief Financial Officer. By telephone from Los Angeles airport is our President Jim Henderson. We are going to go in rotation here. To start off, I would like to Cory to review the numbers.

Before I review the numbers, I know a lot of you were surprised on the quick notice on the conference call. We were going to do it next week, but over the last weekend we thought we might be ready to do it this week. We had prepared a tentative press release and given it to our wire service to have out there ready to issue if we decided to accelerate it. They were given strict instructions to sit on it until we called. Yesterday morning about mid-morning, my heart dropped through my stomach when I looked at Yahoo and the notice had been issued we were going to have a conference call today. So, we went on and said we are ready, so we might as well do it instead of delaying it. Sorry about the inconvenience that caused.

Now, to look at the fourth quarter, which was a very good quarter. If you look at what really highlighted the quarter was starting out with having outstanding firm of Cal Insurance from Southern California join us in November. With the earnings they brought in for the two-month period, it helped us hit top end of earnings projection. Then, at year-end, we had an adjustment to income tax provision to bring down the overall effective tax rate, giving us another bump over our expected earnings for the quarter and for the year. So, that will summarize the whole aspect of it.

That ended up with earnings per share for the quarter of 31 cents, up 29.2% from the 24 cents we earned in the fourth quarter of 2001. From the revenue standpoint, commissions and fees for the quarter increased 23.4%, up to $117.4 million. That was compared to $95 million we earned in fourth quarter of 2001.

In our press release, we again put our table in there that summarizes our total growth rate and our internal growth rates from the commission and fees. You know that excludes the profit sharing contingencies revenues, as well as any revenues from the few offices and programs that we sold or discontinued during the year. We refer to that base number as the core commission and fees.

Just for your reconciliation purposes, during the fourth quarter of 2002, we had about 3 and-a-half million dollars of profit sharing contingencies, compare to the $3.2 million that we had in the fourth quarter of 2001. Additionally, we had about $1.1 million of fourth quarter 2001 revenues that were generated from the offices and the programs we sold or discontinued since fourth quarter of last year. So, we took those numbers out of 2001 base because they were divestitures. So, with those three numbers, you should be able to help reconcile.

We did have in the first quarter this year, we had $1.5m - of one-time accelerated commissions from one of our workers Comp carriers and we had to take the money and spread over the three quarters. So, that ended up being $497,000. That got added to 2002 base in order to get back to the commissions and fee line on the income statement.

If you look at that internal growth schedule, total core commission and fees for the quarter increased 26.1%. That equates to about $23.6 million in new commission and fees, net new commission and fees. Little bit over half of that or about $12.1 million was generated from businesses that we acquired since last year. The remaining $11.5 million of that revenue, therefore, was internally generated growth. That reflects $12.7% internal growth rate.

If you look at the schedule to summarize it, 88% of the total internal growth dollars really came from four of our business segments. Florida and Western Retail, the special national programs and brokerage unit. Hyatt will go through each segments and talk about the operations of the business a little bit later.

The only other really significant revenue item in the quarter was that we had in our other income and loss column, around a $1m. Around $900,000 of that were gains on the sale of various books of businesses.

For the year, we had net gain of about $.5m. The first 3 quarters we had a couple losses in there. Overall the year-to-date $.5m is down from the historical average of anywhere from about $1m to $2m.

Flipping down and looking at the total expenses were, the revenues had grown by 24.3%. If you take the two big large accounts that we have, our expense line item of compensation, employee benefits and other operating expenses, the two of them combined totaled $26.3%.

Compensation and employee costs were 50.5% of revenue during the fourth quarter, slightly up from the 49.1% last year. In the fourth quarter is when we true up for profit center bonuses. As you know, as I get to later, the operating margin on a year-to-date basis is about 34.5% .

So, that is the average. Therefore, we have got half of our office above the number and half below it. So, what happens with a lot of offices below it, put the pedal to the metal and they hit their profit goals and are able to book relevant contingencies and profit center bonus on that. So, some of that fell through in the fourth quarter of this year.

The other line item of other operating expenses, it includes a $1m contribution to a nonprofit organization in Florida that provides educational scholarships to underprivileged kids. If you exclude the million dollars from other operating expenses, we really would have been at 15.4% of total revenue, which would be improvement over the 16.6% in the fourth quarter of last year. The nice part about helping these kids is the State of Florida strongly encourages this type of contribution by giving companies a substantial tax credit for it. So, later on when I talk about the income tax line item, there is a hefty state income tax credit that helped lower our overall effective tax rate because of this contribution, both for the quarter and the whole year.

The other major line items of expenses really are the amortization and depreciation expenses which really move in tandem with the activity with the acquisitions during the year. The amortization expense, you have to keep in mind, too, comparable to last year, to the fasb (PH) rules stop the amortization expense on the goodwill component of the acquisition. So, that is the main reason why overall it is down.

For the quarter, our income before income taxes and minority interest, what we call pretax, was $31.9m, or 23.2% higher than the $25.9m we earned in the fourth quarter of last year. The operating margin for the quarter was 27.6, but if you exclude the donations that I previously mentioned, we were really at about 27.6 up from the 27 last year.

Looking at the effective tax rate, we were reviewing our income tax provision and the 38.5% effective tax rate we used during the whole year, the previous three quarters, and during the discussion with new auditing firm, it was decided we needed to tweak down that effective tax rate to 38% or a little bit less. And so, we therefore in the fourth quarter made the adjustment to take that down and along with that state income tax credit that I mentioned, it substantially lowered the overall tax expense for the quarter and really added about 2 cents to our quarterly and year-to-date earnings per share. On an ongoing basis, though, I think the use of 38% effective tax rate is the right number to use.

You know that I like to point out to everybody what our earnings are in terms of cash. If you take our non cash expenses, which are amortization, depreciation and the non cash compensation stock grants in the fourth quarter of 2002, that was around $6.6m, which equates to about 9.5 to 10 cents per share. Take that and add to the 31 cent GAAP earnings, it gives us almost 41 cents cash earnings per share for the quarter.

If you look at the combination of all quarterly results for the year, and look at the year-end numbers, our total revenues moved up to $455m, up from the $365m we had in '01. Our internal growth rates really for the 4th quarter ranged from the 11% to the 13% and we’re fairly consistent within that range during the whole year. Our total expenses for the year ended up being about 70.5% of total revenues. The important part of that, pre-tax margin was 29.5% for the year.

As we said in the press release, we achieved our goal set four years ago to reach pure 28% pretax margin. On first blush, that looks like we blew through that goal, but keep in mind that the fasb (PH) helped out those earning by eliminating in 2001, the goodwill amortization and in year 2002, that equated to about $4.2mthat we expense in 2001. So even if you take another $4.2m off of our pretax number, that would still put us at about 28.7% margin on a apples to apples basis. So, we are happy we have been able to plant the victory flag in that goal of project 28. And now, we are continuing on with the new goal of the 40.

If you look at actual operating margins we refer to on year-to-date basis, that is before interest, before amortization, before non cash compensation stock grant, our margin for 2002 was 34.5%. Then, of course, if you take out depreciation, which is the only other component to get to what most people refer to as EBITDA, that was for the year 36.1%. We finished the year at $1.22. Of course, that was with the 2 cent bump on the income tax expense, and that ended up being 43.5% total increase over the 85 cents earnings per share for the whole year.

Again, looking at the yearly cash earnings, we ended up having about 36.8 cents of non cash expenses or about $25.1m and that equated to about 37 cents earnings per share. So when you add that to $1.22 and we really had about $1.59 of cash earnings for the year. If you take those net cash earnings and you back out the capital expenditures we had for the year, about $8m in dividends we paid out, around 13, that gave us free cash flow of $86m for the year. We think next year we should have free cash flow in excess of $110m. The quarter was very good. We look forward to 2003. With that I’m going to turn it back over to Hyatt.

Thanks, Cory. Good report.

Looking down the internal growth schedule and looking at our various divisions, you can see that Florida Retail was up about 12.9%, which continues to pump along as we expected. One thing that we had hoped for, for January 1 of '03 was an increase in Workers Comp rates in Florida. And that did not happen. There was an increase approved and it has been delayed until April and there is a commission studying it. So, as far as we are budgeting for next year, we are budgeting flat rates on Workers Comp.

National Retail, as you can see, continues to struggle a little bit in terms of growth. And it is twofold. First, we are doing integration in the Midwest. But the second thing is that we are seeing impact here and there as regards the economy, and specifically upstate New York, among our contractors and among business generally. We have a substantial chunk in upstate New York and we’re also seeing it in Ohio, Indiana, etcetera, Michigan.

In Western Retail, it continues to move up and the operating margins were up very nicely in Western Retail. Of course, we have a very high quality firm that came on board in Santa Barbara as of 1/01, about $12.5m in revenue. And the biggest bear in the woods in that area.

Professional Programs was flattish. We did finally get, believe it or not, one month of increase revenues in the dental program, which we hope is an indication of what will happen next year. Special programs those really go along very nicely. That would be our FIU and RMAPFI programs. Brokerage, and that’s E&S (PH) Brokerage. That is gangbusters.

Can it continue to grow at 75%? No, I don't think so. It could grow 40% or more. TPA Services continues to stream along. For this particular quarter we are up about 12.7%.

Normally the last quarter of the year is a little more difficult quarter than normal. We made our earnings just a little easier, seemingly, this quarter. Don't know exactly why, but it seemed a little easier.

I would say that looking into next year, we're thinking that internal growth would be in the neighborhood of 10 to maybe 12%. Reason for that is there have been a lot of increases that have been absorbed. Some of those won't be repeated.

In the vanilla market, there has always been underwriting profit. We are seeing renewals at 5 and 7 and 8%. So, is that across the country? No, it varies by line and state. All over the block. Anyway, 10 to 12%.

That assumes that the economy is flat. If the economy goes south, then that number would go south some.

I would mention that we think that the acquisition activity is continues to be maybe even more robust. So, I am going to ask Jim Henderson to discuss acquisitions, as well as our new regional executive vice president. So Jim, it’s all yours.

Thank you, Hyatt. Good morning from Los Angeles. If you hear some public announcements in the background, I am at the airport.

The acquisition activity continues to be very good. Both as to the number and perhaps even better as to the quality of acquisitions that we're looking at. In 2002,we completed 19 acquisitions with $62m in revenue associated with those acquisitions. 2001, which was a year we did have pooling, there was 26 acquisitions involving some $143m in ultimate revenue with the acquisitions. The activity continues in that one to 10m revenue size. That really is our cross-hairs, our systems, our people, our management is very comfortable with taking those acquisitions on with low degree of risk and a high initial award with respect to the margins off the bat.

The one acquisition this past year, larger than that average was in fact the Cal Insurance acquisition, here in Los Angeles and that was some $27-28m in look-back revenue for last year.

We have also made an addition to the acquisition team this next year, John Connelly, who was with Connelly and Associates in Clearwater and joined us in 2001. John has agreed to move over and work on acquisition activity full-time in 2003 and beyond.

In addition, Jay Adams will continue his activity on acquisitions in 2003 and beyond. So, it gives us additional hand with the acquisitions. John has a long history and relationship with a number of agency organizations throughout the country and we are excited about his role in the capacity.

The balance sheet, the cash position continues to be very strong. We have not deployed the $150m on the fall-along (ph) offering from 2001. We believe we will in fact deploy that cash sometime in 2003, by the end of 2003.

If I can turn now to the two original executives we added at the end of 2002, Charlie LineDecker in Daytona Beach office, and Powell Brown in Orlando office, were asked to step forward and take over regional responsibility. Coupled with that, there are new offices assigned to them. We go now from six regionals to eight regionals. Of those, four report directly to Hyatt, three regionals, plus my own, report through me. And this really gives us both the additional organization staffing to continue the acquisition activity, and also gives us the opportunity to remain on the ground in the offices visiting the offices and making sure the operating side and acquisition side continue with the hands on approach we have always used. I think there is going to be 2003, we really see continuation of 2002, with the acquisition activity. And certainly the organic growth as Hyatt mentioned, much in the same as 2002, that is very positive.

Hyatt, I turn it back over to you.

Thanks, Jim. Actually with the expansion of our two new regionals, we will then have the ability as we grow to have people to whom new offices will report and have the time to be in their offices and their sales meetings and in their faces and pushing and shoving and yanking and jerking and all those things we do, to a, drive margins and b, drive the top line.

Our progress toward the B-40 goal is moving along nicely. B-40 is $1b of revenue and 40% operating margin, as Cory defined it. We are about 5.5 points off of the operating margin. We think that is within the sight of our horizon. We also feel that this year it was important for us to focus on another issue, which we have always focused on, but decided to put additional money on that. This year being '03, is that we have had a pot of money, which is one half of 1% of revenue to go out and hire people that we don't need. The way we do it and have done in the past, 40% of their cost is taken by corporate if they are approved, the first year. 30% the second year and 20% the third year, and that’s assuming they make their goals on a quarterly basis. If they miss two quarters in a row, they are off the dough. We have increased, we have taken our corporate overhead charge down from 4% to 3%. We have increased our allocation for "people" to 1%. So, this year, probably that will be $5.5 to 6m.

We have also increased the allocation on an annual basis so that the first year someone is hired, they would get, the profit center would receive 50% back. The second year another 50%, but assuming they made their goals on a quarterly basis.

We feel this is absolutely imperative that we step up our efforts to find high-quality people. One of the areas that we are expanding is we are looking now for more and more people with substantial technical background, insurance technical background, for the simple reason this year and for the next couple of years, it is not a prospecting business, it’s placement business. Those who have a, the technical expertise, and b, the relationship with the companies, are going to do very, very well.

So, it is already started to work in the second half of last year and the number of new high-quality people we hired has increased. We will increase them this year. The pedal is to the medal in this particular area. At the same time, our total cost of people as a percentage of revenues we anticipate going down. The goal, of course, [inaudible] for cost of people is 46%. The goal for the total other expenses is 14%. So, we are about 3.5% off on people at the moment. So, I think that pretty much gets the information we want to talk about up front. Brenda, we would like to open the floor for questions.

The question-and-answer session will proceed electronically. If you would like to ask a question a may do so by pressing the key, followed by 1 on your touchtone telephone. If you are on a speaker phone, please make sure your mute function is turned off to allow your signal to reach the equipment. To ask a question, press 1 at this time. The first question comes from David Louis with SunTrust Robinson Humphrey.

Good morning, Congratulations on a fabulous year.

Thanks.

I need a little more clarification if I could on the tax rate, Cory, maybe explain this donation to me and how quickly and what kind of tax benefit we got. If I calculate off your pretax earnings you reported in fourth quarter of $31.9 million and take 8 points off, I come up with 3.7 cents per share, not 2 cents per share. If you could maybe help me with the math.

Well, what we did is the -- you know, we have been accruing or having the provision at 38 and-a-half percent, really for the last couple of years. As we went through it, at year-end audit you start looking at the entire provision and what the current provision is preferred provision. Based on what the ending balance of the various liability accounts needed to be and adjust it, we had to book to that number. So, the overall effect of that is that the effective tax rate needs to be lower. We had to bring back in essentially that income tax expense. So, that was net of the net impact of it. Really, it was just an over accrual over a period of time to what it should be. Now, on the tax credit, what that is is a Florida State tax credit that if you give a donation to the certain organizations, the state gives you 100% tax credit. You have to show it for GAAP purposes, instead of just netting it against the taxes, you got to show it as a donation up front. Then, you get a tax credit on it down below. So, that is why it reduces it further.

So, we put a million and a half into -- what would it be, other operating expenses?

Well, a million dollars. Million dollars in other operating expenses in the fourth quarter. So, the $19 million 381 really is $18 million 381. Then --

Operating expenses and a million out of taxes?

Exactly right. On top of that is the true-up in the fourth quarter on the income tax provision.

True-up is because that you have been over accruing by half a point, you said 38% is the run rate?

Exactly. We have always been conservative and pretty much held true to 38 and-a-half percent. But, we decided it's too much of accrual and we need to start backing that down.

Okay. What is kind of the move-up in the compensation employee benefit to commissions and fees, that moved up to probably the highest level. I know you have to adjust. A lot of people may have hit bonus objectives in the fourth quarter. Is that strictly what that is and that will probably move back in to the 49% to 50% range as we come into '03?

Exactly. The normal run rate is in the 49% to 50% range.

Okay. And I will let others ask questions. Final question, would you or Hyatt like to give us additional guidance on 2003? You indicated probably 10 or maybe as much as 12% internal growth. What kind of acquisition revenue would you anticipate if you really plan to put $150 million dollars to work, which is probably a bit faster than what you did in 2002. So, overall, we probably can look at something in excess of $1.50?

Well, I think $1.50 is not a bad starting point. The answer to the question, David, on the acquisition is we really don't know. The bottom line is that we are not going to make an acquisition unless it meets our guidelines. We are not -- we do not feel an undo amount of pressure to make acquisitions for acquisition sake. We are only interested in can we get the right quality of people and if we have the right quality of people, can we get the margins right out of the box. That takes a lot of work. It is a lot of brain damage that goes into that kind of M&A activity. Since our approach is that once Jay Adams or John Connelly or anybody else finds a candidate, we immediately hook them up with the person to whom they would report. So, that from the get-go, there is a thorough understanding of it wasn't that I said this and he said that or she said that or who struck John. Here is the way it is. Here is our approach. Here is our cookie-cutter system. Here is this or that. When we finally do it, the people are happy because on the day after it is exactly as we told them. How much would we expect? I would expect we would do about as much as we did this last year or a little more.

That was just, roughly $30 million added? Or 32, maybe?

Wasn't it $60 million?

Yeah, because we had --

Acquired or added revenue? )) CORY WALKER: For the acquired revenues we had in 2002 it was annualized at about $62 million.

All that didn't flow in.

Any of the acquisitions we made in the previous year flowed in, too.

Now the [inaudible] which is the Santa Barbara office that I mentioned, that came on board on 1/1 of this year, '03. That is about $12 and-a-half million. I think that is the first one.

If you look at those internal growth schedules for each quarter, that shows you what the acquired revenues from the previous 12 month for this particular quarter that wasn't there in the previous comparable quarter, how much came in each quarter. You can add those up.

Great. Thanks very much.

Now, we will go to Barry McCarver with Stephens, Incorporated.

Good morning everyone.

Is it Barry?

Yes, Barry. You can talk a little bit about what is going on at Workers Comp area? I think you said the increase got approved, but not expected until April, does that happen often?

Yes, it is political football. There was a rate increase of 11 or 12%. It was put off because the governor wanted to appoint a special task force who then is going to report to the legislature and is reporting now or soon. And they are supposed to take action on some tort revisions this year, meaning in February, March and April. So, I don't know what that means.

Generally speaking, however, when the legislature meets, it means if there is tort reform, there is generally a rate decrease. So, I wouldn't be too bullish on the pricing.

Can you remind us how much workers comp for revenue for you guys?

Approximately 20 to 22% of revenue base in Florida and the revenue base in Florida is $135 million. Whatever that is, $25 million.

Okay. Finally, can you talk little bit about special programs and in the brokerage business. They have had strong internal growth.

Correct. First of all, in the special programs, we have RMATFI, which is a specialty operation which does small and middle size municipalities and government entities, which would be all kinds of taxing districts, school districts, etc. What is happening in that area, prices are going up. We have expanded substantially our penetration in Florida and we have an office in San Antonio that is doing Texas and some other states. We have penetration starting in Georgia, South and North Carolina and we have some pretty aggressive plans for that area. So, that looks like that is going to continue to grow. Some of the traditional markets on that kind of business have not done well. They are either backing out or quitting or going away or dying or something. In the area of the second special program we have FIU. FIU, obviously is our condominium program. It continues to go along nicely. And then we have AFC which is located up in Bethlehem, Pennsylvania. That is a program for social service agencies. Social service agencies are things like alcohol and drug abuse and association for retarded people, meals on wheels, etc. These are almost all funded by federal and local funds. We've long done a lot of that business in the retail area, now we are doing that in the wholesale area. We also have parcel insurance plan, PIP, in St. Louis. That is a program that does basically parcel insurance, parcel post. It is small package business up to about I think $25,000. So, that's coming along nicely. It is not growing as rapidly as the others are because shipments are down this year generally speaking. In the ENF business we continue to do very well there. And we have several different ENF operations. We have McDuff in Daytona Beach and McDuff in Saint Petersburg. We have [inaudible], we have WholeStar up in Rochester. We have Bartlesville, Oklahoma, we have I think Peachtree in Atlanta. We also have reinsurance division or profit center, which is growing nicely. It is coming along very well. So, in that area, you know, these are all really humping along well. We expect them to continue, although I don't expect they will grow at 74% rate. But, a lot of business is moving from the regular standard business into ENS. One reason is it is unregulated. Second reason is there is capacity. When you have companies like Kemper, who have downgrades. There will be some business that doesn't move from Kemper to travelers. It moves from Kemper to a non admitted carrier.

Thanks.

Now, to Hugh Warren with J.P. Morgan.

Good morning, Hyatt and Cory. I just have one quick question. I think in most of the commentary, when talking about 2002 acquisitions, you were saying something where total announced estimated full revenue of about $62 million. When we charted it all up, we were coming up with something over $75. I just was wondering where the big difference would be?

I think what the difference is is MSCV, which came on board on January 1, it was a done deal this year. We didn't start getting revenue until 01/01. And that’s $12.5 million. If you add the $12.5 to the $63, I think that is $75.

That’s really our first acquisition for ’03 because it was effective 1/1. .

Okay. I think we beat the tax rate issue to death, I think we understand the employee benefit side of it. Hyatt, is the program the $1 million dollar donation, is that something that is ongoing program that you would be looking at?

Yeah, we think so. What this is, it is really kind of a no-brainer. It is a very good program. It is that for any child in Florida who is eligible for the school lunch program, which generally means they have family income of $20,000 or less, if they want to get out of the school they are in, then they would apply to individual free standing in Florida, individual freestanding entity. These are trusts, not for profit trust, that then qualify them for up to $3500 dollar contribution towards the tuition to go to another school. Now, if they are transferring out of one public school district into another public school district, they would pay up to $500 for transportation. If it goes to a private school, up to $3500. There is about $48 million dollars in Florida that has been contributed by various corporations. The other good thing about this, those trusts in the four areas of Florida that are set up to distribute these scholarships, they must raise their own money. They have really two people on each staff of four places. They must raise their own money because 100 cents of each dollar goes directly to either a school system, public or to a private to pay for this child's education. So, it is damn good, yes. As long as they continue to do it on that basis and we get 100% tax credit, we will continue.

Cory, one quick question on amortization side. Was there any change from the calculation of amortization, it is a little higher than I thought it would be, based on the M&A volume. Still doing 50% of the excess purchase price being amortized intangibles?

Yes, every deal is a little bit different because you do have to -- we have a model we run out the cash flow. Then, discount it back. Generally, every deal seems to have come in in the 47 to 52% range of expiration. If you get a deal that has a great, great deal in terms of the purchase price, you could see a higher percentage of it going to expiration. Generally everything falls in that 47 to 52% range.

Final question. Jim, if you are still with us.

Yes, I am.

Can you give us an overview, with the new role of M&A side, what are you seeing out there in form of interest level? Can you update what the smaller people are saying these days in the $1 to $2 million size? Is competition getting tougher on them, can you give us an overview?

Competition is getting tougher because their market may disappear because of the company or perhaps another may not be there. You continue to have the aging of the population base where you have 50-something year olds who do not have an exit plan. The activity is there. On top of that, you have those who feel they are at the top of the loop in terms of pricing and what happens tomorrow, if in fact you run into a cycle where it goes the other way. Do I do it now or later? I think that is creating more activity than perhaps we have seen in 2001 and prior. So, rather brisk numbers of acquisitions, as you well know, getting this qualified, each one is brain-damaged because it is so very personal. You are buying people's history and family history. That is encouraging and we are pleased with the activity there.

Thank you.

Next we will go to Nick [inaudible]

Good morning, Two questions. Hyatt, when you were talking about economic outlook, you didn't reference California this time. I think that in the third quarter you felt it was softening. Can you us an update there?

Yes, I can. We have an office in Oakland that has felt the softening for years. The office in Nevada seems to be not particularly affected. In the Los Angeles area, we have basically three offices. One is a medical mal specialist. They are doing quite well, gang busters. We have another located in Thousand Oaks. It is focused on the upper personal lines and they are doing quite well. And then Cal Insurance and Cal Insurance is really their business is California. But, it is really all over the United States because of the program. The $4 million and half, $4 and-a-half million of retail revenue in the Orange, California Cal Insurance office, the type of business is not particularly affected at the moment.

Great. If you can also update -- about a year ago you started a reinsurance unit, can you give us it’s outlook for '03?

Jim, do you want to talk about that?

Yes. The revenue base for 2003, we are studying this and it is approximately $1million 5 from budget standpoint. We feel like that is probably modest. There is some opportunities beyond that. So, again, it is going to be only a marginal contributor. It is becoming a very helpful piece dealing with the program division, retail in terms of relationship and capacity to open doors to do products for other areas within the company. So, that piece is really a hidden bonus not sitting inside of B&B, it is sitting inside the other divisions.

Great. Thank you.

Now, Steven Gabio with Dreyfus.

Thank you, good morning gentlemen. I want to talk about the compensation question again. Tell me if I understood you correctly. More of your producers kicked their buts in the fourth quarter to achieve their goals. Therefore, that caused higher bonuses required in fourth quarter?

No, Steve. Producers don't participate in the profit center bonus. The way it works is that each of our profit centers has basically the same equation to propel a pot of money that is a percentage of the operating profit of that profit center. So, as you know, we are constantly pushing up on the bottom level. So, until someone gets in the above 28 to 30% margin, the bonus doesn't really start getting really, really sweet. For those people that for the beginning of the year were being budgeting to be at a operating profit of 25%, they basically would have a lower pot of money. So, then when the fourth quarter comes around, they actually were able to do better in third and fourth quarter than they expected. Therefore, the additional accrual for that pot all hit in the fourth quarter. It has nothing to do with individual compensation.

Okay. I should have said profit center. The profit center was budgeted for 25. They worked hard and got to 28. So, that required you to -- more bonuses required?

That is correct. They are at levels. They may have been at a level that gave them a 5% bonus. If they hit certain operating profits, then they might move up to 8% bonus mark. Well, the 8% is on the whole year, you know, so you get that incremental push.

All right. Here is my question. You know, given the ingrain culture and philosophy of the company [inaudible]and all that, you know, you clearly are driving people to exceed their budgets. How do you -- it seems like you are not accruing for that.

You mean not accruing at beginning of the year?

Throughout the whole year. You are having to come in at fourth quarter to true-up because people's deep expectations, that is what’s on the cover of the annual report. I am trying to understand that.

What they do, every month they take operating profit year-to-date and whatever the expense is relative to where they would be right at that point in time, that gets booked as expense. The problem is when they hit a different profit level they get higher profit center bonus on that amount. So, that is when it hits. So, the expenses are hitting when it basically accrues.

Okay. But, you are not accruing profit center bonuses up front in anticipation of people doing what you asked them to do?

No, no, it correlates with the operating profit when they hit it. There is guarantee they will hit it next month.

Understood. Thank you.

Follow-up from David Louis with SunTrust Robinson Humphrey.

Hyatt, you mentioned that the outlook for 2003 pricing would be 5 to 8% on business.

That is correct. What I said was internal growth rate would be maybe 10 to 12. And that in the vanilla middle market, we are seeing 5 to 8 to 9%. To the extent you are looking at vanilla middle market piece of the business, yes.

What I was try tog get to, how would you have compared that to 2002?

I think slightly lower.

So maybe it was at one point maybe you were saying 7 to 10%? )) J. HYATT BROWN: Yeah, maybe a point or two or three lower.

That leads me to think if you look at the total underwriting cycle, some have speculating that the reinsures will get aggressive on pricing trying to put capital to work sometime later in '03 and dampen the cycle. What is your outlook? Are you seeing pricing coming down? Reinsures are aggressive on rate increases in the first part of the year.

We have seen some competition as of October and November. The specter of Kemper has had a chilling impact. The second thing is that you know, there are some other reserves that got people worried like the Travelers announcement, etcetera. So, I would think and I am thinking about the front side, not really about the reinsurance side. I would think on the front side you are going to have relatively conservative people because with the low interest rates they are going to have to make 96% combined in order to really start making money. And they have never, in many cases, never done that. So, I think you are going to see fairly conservative people throughout the year. Now , when you start thinking about some of the people coming onshore, the endurances and the excels and whoever else they are, Ace, I guess and others, then they are looking at the top end of the market and have been looking at the top end of the market. They want to get big chunks of short-tail business, get their money and go home. My sense is they are now probably later in the year going to start looking at middle market or programs. We are seeing some of that. That might start doing -- making for competition. But, one of the things that is beneficial to us is that when this year as more of our business, new and renewal, has gone into the E&S market, where we are getting half or two-thirds of the commission percentage that we normally would, even though the premium is up, we are getting half to two-thirds. As that moves back into the standard market at lower than E&S prices, our commission percentage is going to go up. So, that is the positive side of that.

Hyatt, last quarter you thought that some of the National Retail writers were eyeing the middle market. Do you continue to see that trend and when do you think it might shift back to a net positive flow back to the primary carriers from E&S?

Good question. We are still seeing them talking about it and seeing them trying to do some of that, but it hasn't been as effective yet as they would like. So, I just don't know. I think I would expect, though, that the National writers will be more aggressive in the vanilla middle market this year than last year.

Let's hope so. Couple other quick questions. Have you or are you continuing to find a new Med Mal carrier? When does Gippy fall off?

Yeah, that is one of the reasons our growth in the professional programs is as low as it is. We are doing well in lawyers and growing in Opto and now dental looks like it is starting to grow. Yes, we have a couple that look good, but until it is done, it ain't done. So, I just don't know how to answer that other than it is tough and we haven't got a person to replace Gippy.

When does Gippy totally fall off?

Totally in March or April or May, someplace in there.

Okay. You have time to replace him. Just a final question, Cal Insurance looking at that from my perspective, that is little different acquisition than the traditional because they had various superior margins?

Uh-huh. Actually the margins have risen in the last three years to a level that when we got into the negotiation they moved it to the next level. Which is what we do on all acquisitions, almost every acquisition we do, the level they are at and the level there is agreement with for the next 12 months is always higher.

The margins in professional programs, you know, is generally in the high 30s and over 40%. So, you know, there is still a lot of room for improvement on their side, too.

Right. Thanks very much. )) OPERATOR: There are no further questions at this time. Mr. Brown, back to you for additional or closing remarks.

Okay. Thank you all very much. We are looking forward to another good year. We will talk to you again in April. Have a good year. Thank you.

That concludes today's conference. Thank you all for your participation.