Brown & Brown Inc (BRO) 2003 Q3 法說會逐字稿

Good day, everyone, and welcome to the Brown & Brown, Inc. third-quarter 2003 financial results conference call. Before we proceed today, we would like to inform you that certain information that will be discussed during this call, including answers given to your questions, may relate to future results and events or otherwise be forward-looking in nature and reflect our current views with respect to future events including financial performance -- and that such statements are intended to fall within the safe harbor provisions of the 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 when referenced in any forward-looking statements made as a result of a number of factors, including those risks and uncertainties that have been or will be identified from time to time in the Company's report filed with The Securities and Exchange Commission. Additional discussion of these and other factors affecting the Company's business and prospects are contained in the company's filing with The Securities and Exchange Commission. Listeners are cautioned that any such forward-looking statements are not guarantees of the future performance and the actual results and events may differ from those indicated in this call. Such differences may be material. With that said, Mr. Brown, I will now turn the conference over to you. Please go ahead, sir.

Thank you very much. Good morning, everyone. We have Jim Henderson, our President and Cory Walker, our Chief Financial Officer, here with me this morning. And I would like to turn the first part of the conference over to Cory to talk about the numbers.

Great. We had a very good quarter where our earnings per share increased 31 percent to 38 cents per share. For the quarter, our total revenues increased 20.7 percent to $133.5 million -- that was up from $110.7 million in the third quarter of last year. The largest part of that, I would say, is the commissions and fees which increased 20.4 percent to $132.1 million. Attached to the press releases are internal growth schedule. And on that schedule, you'll see that our total core commissions and fees for the quarter increased $24.1 million in total. And of that total, $20.5 million of that -- that was generated from businesses that we have acquired since the third quarter of last year. So, therefore, the remaining 3.6 million of that was internally-generated revenues that reflect a 3.4 percent internal growth rate.

Now, as always, Hyatt will talk about each one of those divisions or business segments. But I will give a brief overview of what those percentages are for that schedule. Wherefore our retail again had strong and consistent growth at 9.2 percent. Natural retail had a little bit of a backing up where they had a -1.9 percent internal growth but that reflects -- if you take their total growth less their acquired revenues in the national programs, the net loss is really about $610,000 -- that reflects that 1.9 percent lower revenues. (indiscernible) retail grew to 2.0 percent. Professional programs -- core commissions and fees -- they were lower by about $118,000 which represented a 2.8 percent decline. And that was primarily related to lower commissions in our lawyers program. Again, also on our special national programs -- our core commissions and fees were also slightly lower but this was only by about $65,000 on a net basis. And that related primarily to a (indiscernible) change in one of our programs. The brokerage division led the company with a 14.0 percent growth rate and our third-party administration services group had a 4.2 percent internal growth rate.

Moving down, our investment income obviously is lower this quarter because of our -- the yields on our primary investment vehicles that we have with our cash which is short-term, tax-free municipal bonds -- was lower. Our other income is about $1.1 million for the quarter, and that related to the sales of certain books of businesses that we have had. And, over the last three years, on an annualized basis we averaged about $1.5 million of gains from these various books of business sales. So, we should be near that historical average this year.

Looking at the expenses, while our total revenues grew by 20 percent our total expenses grew only by 19 percent. The largest line item is the employee compensation and benefits which equaled 50.1 percent of revenues. This percentage is slightly higher from the comparable quarter last year but it is lower on a year-to-date basis. The reason why it is up slightly for the quarter is that our profits and our bonuses have increased due to a gentle rise of many of our offices to a higher tier on our bonus table matrix. Additionally, during the year, we've also been hiring more producers and more marketing managers as a direct result of our increased commitment to our one-percent people allocation charge.

Looking at our non-cash, stock grant compensation, line item, we normally run about $700,000 - 750,000 a quarter, because that charge is fairly fixed until our stock price gets over -- gets to a $42 average share. In the third quarter, we had the elimination of certain accumulated PSP charges for people who have left the Company or our related to some those books to businesses that we sold. So that comes back off our books -- if they don't leave -- don't stick around for the full vesting period. Last year's charge of almost 1.5 million, if you remember, was also impacted because we did have some unfortunate deaths that created a larger than normal charge in the third quarter. The rest of our expenses really are reasonably consistent and are increasing at a slower rate than our regular revenue growth. Therefore, our pretax margin continues to increase, and for the current quarter, was 31.2 percent. That was up from the 30.2 percent third quarter of 2002. After our normal income taxes and tax rates, our net income for the third quarter was $26.1 million up from the $20.2 million last year. And that is a nice healthy 29.1 percent increase.

Looking at the nine months ended September 30th, we had total revenues of $416.1 million up 23.6 percent. Our nine-month pretax margin for 2003 was 32.5 percent -- again up from 30.5 percent from the 2002 year-to-date. The year-to-date net income for 2003 was $84.5 million or 36.9 percent over the prior year. We ended up, for the nine months -- that $84.5 million also represented more net income dollars than we earned all of 2002 -- which was a nice move. Therefore, our final net income per share for the nine months ended was $1.23 or 35.2 percent increase over the 91 cents since we earned in the first nine months of 2002.

From our balance sheet perspective, our financial strength continues to get stronger. We have almost $69 million of unrestricted cash currently. We also have re-established our five-year, $75 million revolving-line of credit with our current bank. These -- the new loan have terms that very similar to our previous $50 million line of credit we had with the same financial institution. So, our -- the strength of our balance sheet continues to be very strong and will be very important for us in the future. So, without that financial overview, I will turn it back to Hyatt.

Thanks, Cory. Very good. I'm going to talk a little bit about some of the segments then I am going turn it over after that to Jim to talk a little bit about mergers and acquisitions and some other general remarks. And then he's going to turn it back to me to talk about the really -- generally what's happening in the marketplace and where do we see all of this going. First of all, relative to Florida retail -- the third quarter, we're up 9.2 percent internal growth. That is up from last quarter at 8 percent and so we wrote some more new business. And Florida economy is good.

National retail was down 1.9 percent from a 2.4 percent growth rate during the second quarter of this year -- meaning just last quarter. I might say also something about Florida retail -- that there's been several comments or questions before about workers' compensation in Florida, and we have -- I don't know -- possibly $25 million or so of commissions in Florida in workers' comp -- maybe it's 28 or 22 -- somewhere in a neighborhood. Anyway, to give all the analysts an idea, in fourth quarter of '02, workers comp rates went up 2.3 percent. Now these are averages. On 4/1 of '03, workers comp rates went up 11.3 percent. And as of 10/1, just a few days ago, as a result of the change in the laws in Florida, the rates were rolled back by 14.3 percent which ISO says is a reasonable rate based on the changes in the law.

So, where we are is kind of back to where we were -- about flat with the end of last year. Also, we find that coastal property rates are flattening. And renewals are flat to up five percent, and then if there is competition, it's probably going to be less than inspiring, unless it's that loss ratio. Now, in national retail what we have there is the economy has affected our renewals. If you look about where we are in national retail, starting in the East -- upstate New York, Ohio, Pennsylvania, Indiana, Illinois, Minnesota, etc., etc. -- those states, the economy is not so good in terms of the middle the market accounts that we're writing. We do have a lot of smaller manufacturers. We have a lot of smaller businesses and the -- there are more RP's, return premiums on audits. then there are AP's -- and that is additional premiums on audits. So that affects the income flow.

And then on renewals, what we're seeing is that companies are reducing payrolls, reducing fleets and etc.. Prices in some places are up 5 to 10 percent. But, when you talk about the reduction in coverage, they are back to -- the premiums are back to flat or maybe down a little bit. Now, bear in mind, in that area that I just outlined -- that's the vanilla (ph) middle market -- is controlled by regional carriers -- carriers that are not publicly-owned for the most part and are mutual (ph) in many cases but soft-controlled companies also. And they never raised their rates as much, and so now they are happy with their results and are being pretty doggone competitive.

And western retail -- it is a little bit hard to put your hands on that because certain parts of California are doing well and certain parts are not doing very well. Then you go up into Washington state and certain areas there are 16 percent unemployment and other areas are doing pretty well. So, it's kind of hard to put your hand on that exactly. But we are concerned about California Work Comp Fund. Now the good news is that we don't have a heck a lot of our revenue in California in that fund because we have a large amount of revenue coming from professional liability and other areas. But, the California Work Comp Fund which has 60 to 70 percent of the workers' comp in the State of California was paying 10 percent commissions. And they are now down to 5 percent and 1 percent on accounts that don't have good loss ratios. And it is expensive as heck to place business because they are placing all sorts of roadblocks to try to discourage the placement of the business. So, you know -- unfortunately, there are a couple of companies that are coming in and starting to write some business. So, that is going to be kind of a battle royal for awhile.

We do see less loyalty in some of the western states than we do -- this is client loyalty -- primarily because there are just so many new people out there. In professional programs -- we have had a reduction in commissions on our lawyers program. That's basically what is happening with us there. We also have had difficulty -- we have the opportunity to write a substantial amount of additional dental insurance in the State of California, and we have for 5 months now have been unable to get the filing approved. There's nothing wrong with the filing. It's just -- gosh -- very difficult to get it through the bureaucracy. So, we are pleased about our programs going forward. It's just that when we have a commission reduction obviously we're going to have less revenues on lawyers. The premium on the lawyers is going up. And that commission reduction actually was effectuated on 4/1 and really started to impact around 7/1. By 4/1 of next year, of course, we will be back to the same commission level, meaning that the commission level that was on 4/1 will be the same that will be on 4/1 of next year.

In special programs, you will see that's down to a - .9 percent. And that was down from 11.5 and that is due to two areas. We have a special program in our Bethlehem office -- the name of our wholesaler is called AFC. And they have a specialty in social service agencies. Those would be alcohol and drug abuse and mental health and retardation and meals on wheels, etc. etc. etc. That's been a very successful program. It has been growing because other markets have been receding. It was with Kempus (ph). And, of course, Kempus was part of Kemper. And, of course, they got in trouble. So starting in late January, we had to move quickly to change carriers. We did change carriers. That was effective July 1. And, unfortunately -- and it was AIG, which is a very fine carrier -- but unfortunately because of the time frame, AI G was only able to give us non-admitted paper as opposed to non-admitted and admitted paper on the program. And it severely constrained our ability to write -- or to handle our renewals and to get new business in July -- which is by far the biggest month in that program -- and also August and September. We now have the admitted paper, and we feel that we're going to be back to normal operations by the 1st of January -- because there is a 60 to 90-day flag. Also, in special programs -- FIU, which is our condominium here in Florida -- the prices were flat on the renewal and there was some lost business.

In brokerage, there is continued moderation. You can see it's up about 14 percent, and it was 16.1 percent in the second quarter. So it's down just a little bit. We're seeing some -- just a little -- movement back to standard markets. And of course, TPA's just keep taking along. So, the question is what is our best estimate for internal growth for the fourth. And our best estimate is 0 to 8 percent. So you might say that's a big kind of difference. And so we have been surprised during the last two quarters, and so we're giving all of you intelligent analysts the ability to pick from 0 to 8 percent as to what you think it will be. As regards to '04, we are right now in the budget process, and we really don't know. We're not in a position to talk about '04. So, having said that, I would like to turn it over to Jim to talk a little bit about mergers and acquisitions and some other issues. Jim?

Thank you, Hyatt, and good morning. To talk about the Brown & Brown acquisition activity -- and I'd like to kind of go back and look at some of the history of our activity -- some of the current activity, some of the aspects of that activity and talk about factors that may, in fact, impact some future activity. The historical growth of the top line of our company over the last -- if you look at a 5 year - 10 year period plus. It typically has been driven by a -- approximately a 1/3rd increase in internal growth -- or organic 1/3rd -- and approximately 2/3rds by acquisition activity. This formula for growth has not changed materially really since adopted and implemented going back into the early 1980's. If you look at the top line growth, for example, in the first nine months of 2003, the top line growth is 23 percent. This consists of approximately a 7 seven percent -- just under 7 percent organic growth and approximately 17 percent net-by-acquisitions. The activity for the year and the first nine months of 2003, we have acquired 13 agencies, representing some 34 million in revenue. If you add the 25 percent of the FIU acquisition, this would drive the total equivalent top line to approximately 40 million year-to-date. The same nine-months period of last year, we acquired 14 agencies -- 14 acquisitions that the revenue for those last year was 26 million versus some 40 million this year. The fourth quarter -- we have heavy activity discussions going on. We're looking at a very attractive fourth quarter and, frankly, beginning our first quarter of '04.

Our bread and butter on the acquisitions continues to be the 1 to 10 million in size. Although we would comment that there is several agencies that we're talking to that would be larger than the 10 million. Our formula continues to be a cash acquirer. And the purchase-price earnings based on earnings delivered, continues to be the basis under which price the acquisition. As to geographic spread, again, there is no geographic preference. It has a lot to do with people -- with opportunity and not geography. We would update you as to -- following Florida, California now is our second-largest state in terms of revenue-generation. This would be followed by New York State, Arizona, and Texas.

As Cory mentioned in his opening comments, we have renewed our line of credit. If you take the line of credit-- if you look at some 68 million plus in cash on hand and the annual cash flow generated from operations which is 100 million plus -- we're obviously in very good shape to continue with the cash activity for acquisitions. As to balance-sheet leverage, the debt to our total capital continues -- that ratio continues to come down. Currently, that is less than 15 percent debt-to-total-capital of the Company.

To highlight some acquisitions in this past quarter, we completed three transactions. One in Southern California -- a retail operation that was a fold into our existing office in Orange County. The other two acquisitions were in Washington State, and they were in the public sector -- public-risk sector. That's a very growing, attractive part of our company. This followed an acquisition we did in the second quarter in that same -- in the public-risk sector adding onto the operation we have in the Southeast.

In the recent quarter, we have also experienced what we can best describe as an increase in the number of agencies that have, in fact, come to us or have contacted us -- they have an interest in joining Brown & Brown or finding out more about us. We believe this activity -- this interest increase is, in part, due perhaps to changing market conditions. The agencies are looking at tomorrow and believing that if things are going to be -- are they flat or they are going to be worse or going to be better? Therefore, at least I need to engage in activity in terms of my planning and perpetuation. And we believe this is a factor in causing this activity to increase.

The second one is a number of agencies have -- their books of business are displaced because of the rating issues with different carriers. Some of those agencies, frankly, need another partner to help them go from where they're at to the next level to secure an agency plant and perhaps that might be an opportunity to join Brown & Brown. One word to characterize the current environment definitely is "caution" -- going to be very careful about acquisitions. If, in fact, there is a possibility as to what you acquire, has the possibility of shrinking -- we believe that our purchase-price formula, which is a pricing based upon actual earnings delivered, is a good cushion to deal with the changing market conditions. And we will certainly continue to use that formula. So, we are pleased with the activity. It is business as usual. Caution is the highlight. And at this time, I would like to turn it back over to Hyatt to talk about some industry market conditions.

Thanks, Jim. Generally, what's happening in property and casualty and employee benefits. PNC, first -- it is a choppy market. It is a placement market, as regards agents and brokers, as opposed to a prospecting market. Almost anyone will talk to someone -- a new agent or broker. The question is, can you get placed on the terms and conditions and pricing that it's going need to be placed at in order to move the account. And toward that end, about a year ago, we started an intense recruitment of very high-quality, marketing managers. Now marketing means placement -- it doesn't mean marketing in the sense of where you're advertising products, etc. And so we have been able to bring on board four so far during the year. And we're in the process of -- apparently in the process -- of acquiring three more of these kinds of people who will be in strategic locations in our offices. An example would be one in Las Vegas and another in our Houston offices to name a couple.

Employee benefits, which is -- this year will be about $60 million of our revenue -- and so it will be 11 or 12 percent -- or 10 percent, or whatever it is. Those prices last year this time were going up 20 to 25 percent. They've moderated, also, 7 to maybe 15 percent. But head counts are down. And, in addition to that, employers are reducing benefits so that, in many cases, the premium on which commissions are paid is also reduced. There is a substantial concern among agents or brokers about carrier ratings. It's a little scary out there. Royal just left the United States and went back to England after having been here for 100 years or something. We have $55 million of premiums in Royal that we will have to move on (indiscernible). One might say, well, Travelers is going to pick that up. And the answer is Travelers is going to pick some of it up. They're going to pick exactly what they want to pick. And we've got to take care of all of it.

So, the good thing is as regards our books of business -- the largest single carrier that we have has less than 4 percent of our total volume. So we're certainly not in a position where we have a lot of our eggs in one basket. Another carrier that has just recently been downgraded -- Atlantic Mutual is B+ to B++ -- even after having sold their inland and ocean marine to the Travelers -- it's a good company. We don't have a lot of business with them but, nevertheless, another concern. And I mentioned already about our concern about Cal work comp. One little caveat here is that interest rates are at an all-time low, and everyone knows that. Frankly, anyone who gets into cash flow underwriting -- it's suicidal. However, for those who have strong balance sheets -- and there are those -- this is a happy hunting ground.

We are also seeing Bermuda start-ups. Now these are companies that may have started up 3, 4, 5, 6, 7 years ago. They have come on onshore -- (indiscernible), etc. etc. And they started at the top-end of the market -- the largest accounts and getting big chunks of premiums. Those now are starting to become much more competitive, and they are moving into the middle market. And we are finding additional capacity and some good things that those companies are doing for us. And we think they are bringing about a new model. They are going to be highly-concentrated, meaning 100 or 200 people in one or two offices in the United States, making a bunch of underwriting decisions with a limited number of agents and brokers. And they are going to be dog-gone aggressive.

The PNC carriers who don't have old-reserved efficiencies, meaning back in the '60s and '70s they were not loaded up with the potential for asbestos or environmental. They are pretty happy right now. I will also mention that back in the markets of '96, '97, '98, '99, it was not unusual to get bonus commissions on accounts -- that might be 2 percent or 2.5 percent because it's a particular slice-of-business or a particular account that a company might want. And just last week, I've heard about the first account since the year 2000 where a bonus commission was paid to one of our offices. So, all in all, we're headed into choppy waters but, quite frankly, that's where we really do operate best. So we're kind of sanguine about the future and looking forward to it. Now, Lisa, I want to give you a clear verbal signal that we are now open for questions.

Thank you. The question answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) David Lewis, SunTrust Robinson Humphrey.

Good morning, and I have a couple questions. First, I am going to put you a little bit on 2004 internal revenue growth. And I know you don't have the budgets ready but can you give us any thought -- I mean, once you kind of work through the workers' comp issues both in Florida and in California -- kind of would you -- kind of just state something in the low single digit range?

Well, you know, it's very, very difficult to estimate at this time, but based on the current outlook, what you're suggesting would not be unreasonable. But until we -- see, what we do, as you know, we are a really all over our budget. So the first cut is due right shortly. The second cut will be due in November, third cut on the 15th of December, and then last cut is going to be due the last week of December. And we will have 11 months actual. And hopefully an estimate that is accurate for December. At that juncture, David, we would be able to tell you. My sense is, is there may be a little bounce in certain areas because I don't think that the national companies are going to be able to engage in a lot of price competition based on what I see right now. So, I just don't know how -- we don't know how all that's going to shake-out.

One of the issues that, I think, is pressuring the overall internal revenue growth is the fact that you're moving business from Royal to somebody else. And Royal may have paid you a higher overall commission, and therefore, you're moving to somebody else that's paying you a lower commission. That's going to (Multiple Speakers) next year.

That's true. Although we don't like to move it to someone who pays us a lower commission. And we have been fairly adroit at that most of the time. But let me tell you what does happen. When you do have that movement, there is some lost business. That is a problem. And we fight like hell to make sure that we don't lose any but occasionally it happens and particularly in a choppy marketplace.

Final question, any change in your long-term outlook of 15 percent plus EPS outlook?

No, no change.

Thank you very much.

Next question. Lisa, are you there?

Yes, just a moment. Nick Fisken, Stephens Investment Bank

Good morning, everybody. Kind of following on the last question about the 15 percent EPS growth -- if you -- let's just say, you end-up the year at 550 of revenue and you assume a 2.5 percent internal growth rate -- that makes you guys much higher dependent on acquisitions to hit that 15 percent growth rate. My question is A, is that right? And B, are you going to forsake some type of pricing discipline? Or are you going to get more aggressive on the acquisition side to get to that 15 percent?

Well, Nick, you know us pretty well. We have not changed since 1982, and we ain't changing next year either. So, whatever our discipline is, that is what it's going to be. So I don't know whether to 2.5 percent is reasonable or unreasonable. We're going to grow as rapidly as we can. But the bottom line is, as you seem to notice, as we grow, our margins continue to grow also. And we would see that that would probably also continue.

You know, what our intermediate goal is B40. And the 40, though, is not the pretax. That is operating. And I think, Cory, aren't we at about 36.2 or something like that? So, we're moving. And the bottom line is that, as Jim said, our sweet spot is in the $1 to $10 million area. Quite frankly, that size agency is experiencing in this choppiness more angst than you might believe because when they have five companies and four of them really are kind of not maybe writing a lot of new business. And they are losing accounts to companies that they can't represent because they don't have enough business -- that means that we are very attractive. And one of the things that's happened -- and this has been really kind of pleasant for us -- a lot of agents and brokers around the country owned Brown & Brown stock, and of course -- and they've owned it for several years. So, we're getting people who come to talk to us who know a heck of a lot about us, and they have also participated in some of the equity growth. So, they are thinking that this might be something that would be best. And these are high-quality people. You know, one of the things that you must recognize is that we are pretty dog-gone careful about our new acquisitions and mergers. And we're not going to change that.

Okay, if I was look to the year-to-date acquisitions, you did 24 million and then 2 million and then 8 million in the first three quarters accordingly?

If that's 34 million -- plus you got to add on the credit for FIU. That would be about 39 or 40 million, I think that's correct.

You know, in order to hit that 15 percent growth, even if you get 100 basis points increase in margins, you are going to need to have roughly $45 to $55 million of acquisitions actually hitting the books.

That's not unreasonable on that.

Okay. One question for Jim. Last quarter, you said that the M&A pipeline was up big. And that's a -- the slowing rate environment has led you guys to have a longer due diligence period. Is that the case why we still haven't seen the M &A pipeline turn into M&A transactions?

No, I think that -- I didn't mean to imply the pipeline was -- the due diligence was clogging that. I think the activity has certainly increased. But along with that, you've got to go through and really weed out what is, in fact, long-term sustainable quality earnings. There's just no doubt with the level of activity out there, as you will know, you can spike the top line very dramatically if you choose to do that. The balance there is selecting the best quality of earnings that fit and earnings that you can compound growth from that level.

What I was really trying to relate is that we have had a couple of agencies that have, in fact, returned calls back to us saying, well, you know I talked you a year ago or two years ago, and I would really like to get back up to speed with you, tell you what we're doing, and take a harder look. That is, I think, created by the fact that all of a sudden, life is not looking so rosy for that agency because, perhaps, of the market change or because their growth maybe has slowed. And so they really need to entertain some other avenues at this point. And, in fact, they may not have a perpetuation game plan. They were simply riding the horse as long as they could. So, a combination of these -- we are pleased with the activity. We're certainly very aware of the activity levels to get to 15 percent. But we don't really feel pressure that we've got to do something short term to alleviate that.

And one last question for Hyatt. You said that you think rates may bounce because why again? I didn't catch that.

Well, I'm just trying to think about how I would be thinking if I were the CEO or responsible for a major national company who thinks about the accident year numbers looking great and the calendar year not so damn good. And you can't get into a price war and fill up those holes -- they are still biting. Therefore, I think that probably there's going to be some fairly strong-willed people in terms of resisting getting into continued reduction of prices, unless it is in a specific area where they really know that the margins are there. That's what I was saying.

Okay. Thanks so much.

Hugh Warrens, J.P. Morgan.

Good morning, everybody. Jim, quick question for you. On the M&A side, we've done a lot of work over the last couple of weeks, talking to private people. You know, I would just applaud you guys for not being aggressive right now. I think these guys are asking for extremely unrealistic multiples on peak earnings so -- (Multiple Speakers)

We would agree with that, Hugh.

And, you know -- I mean I don't like management to comment but is that something that you're seeing as kind of the key stumbling block right now -- is people just have unrealistic expectations?

Well, I think that certainly is a factor because they've enjoyed a significant price run-up, and so they want tomorrow to be priced based upon yet another run-up. And, perhaps, it will not be there. So, again, the fact that we're buying based upon actual earnings delivered, causes probably our technique to be a bit more severe, meaning that it has to fit our model and you have to get someone who's going fit culturally with us. So we're continuing to look at those best opportunities.

We recognize the role that you and others have with respect to how can they put -- how can you put your hands around the level of activity that we're going to generate in a given quarter or a given six months or a given year. And, frankly, we don't know how these, in fact, the timing -- by the time you initiate a relationship and it's really about 20 percent numbers and it's about 80 percent "people issues" surrounding M&A activity -- that you've got to let that incubate to make sure you know all the factors when you come together that you hit the ground running. We've always done that. We really just don't feel pressure that we've got to do something to maintain your confidence that we can deliver those acquisitions. We know we will.

If I can just chime in from the peanut gallery, I would much rather see you on the sidelines than paying (indiscernible) multiples. And I know you won't do it, and I think the investor base will feel the same way about it. I think there is a lot of multiple being thrown around right now in specific sectors of the brokerage business which just doesn't make sense long-term.

Well, and we think that, too, Hugh. One thing that is very apparent to us is that some of the best agencies -- it takes a long time for them to incubate and a very good example is our Santa Barbara operation. That was effective January 1 of this year, '03. And the first time that there was a contact and a serious discussion was two and a half years prior to that. So, it took two and a half years to get from the conversation to actual becoming part of Brown & Brown. Now we're have had others like that. And then there are some that it's relatively short period of time -- you know, 90 to 120 days.

Hugh, I would comment that we've had John Connolly -- that really joined our acquisition team. John ran an agency for really -- for all of his life in Clearwater. And this past year, he said I think I would like to help us find partners out there. And he began that process really towards the second or third quarter of '03. We are very pleased with those we're talking to as a result of John's relationships in the past and that continues with Jay Adams. Jay continues very active. One time, Jay thought he was going to retire. This year he said, "I'm having fun, I want to continue this as long as I can." So, we've got just a world-class team out there, with people that other agencies can talk to. And, in fact, they are part of someone else and then part of us, with a high degree of confidence that what they see is what they will have delivered in the future. So, we're very pleased with that situation.

One of your comments that I was surprised by -- in understanding how we feel about the market at this point and looking at our expectation for pricing -- you mentioned that you're looking at some larger businesses. I think -- to me it seems more intuitive that the smaller guys would be having more difficult times from a placement standpoint than the larger guys. Why do you think more larger guys are starting talk to you on the $10 million side?

Well, I think the larger ones have the same issues. On top of that, their options are more -- probably less than the smaller ones, meaning that how many out there can really acquire $10, $15, $20 million operations and paying the multiples of the revenue that need to be paid.

In cash.

In cash.

Okay. Cory, I just have one quick question for you. On the non-cash stock grant, does that return to a more normalized number next quarter?

Yes. Given the activity of people leaving, our stock price is moving. But it is a relative stable number, like I said.

We had some modest -- you know, we look at margins on EBITDA basis. And we had some modest EBITDA margin compression. I may have missed the comment during -- as I was taking notes -- but why was the comp and the benefits line up a couple of points year?

Well, we had the total profits in our bonus tweak up, and that was really because we have more offices. Their bonus structure as they graduated -- amount where it starts out as 18 percent of operating profit and moves up. So we had more offices that are moving up in the tiers and improving their operation.

Is that an accrual for the nine months?

Right. It's a constant accrual every month. It accrues to whatever their income is year-to-date.

So should that -- if we stay at the same level, that should probably normalize a little bit?

Yes, I think that the more normalized average is -- is why I pointed out that the year-to-date number of 48.4 is a more appropriate number to look at on a long-term basis. The other part of that was also producers' and marketing salaries were up because we are -- like I had mentioned, we've increased our people category by funding one percent of our revenues for new people that we don't really exist -- and need right now. So, that's tweaked up a little bit.

Just from an accounting standpoint, the marketing people, Hyatt, that you talked about hiring -- is that an expense against each profit center they're sitting in or is that a different account now?

No. No, the way that works is, is that we're -- and these are people whose incomes would be higher than you would expect a marketing department manager necessarily to make. And that idea is that they will come in and prove their metal in the marketing department for a couple of years. If they are able do that then they would have the opportunity to go to someplace and be a head of office. So, the way we are working that is half of that is borne by the profit center and half is borne by our people category. You know, we have 5.5 million, or whatever it is, in the people category to finance people.

Great. I have other questions but I'll let other people jump on. I will just follow-up.

Andy Denhowl (ph), Endeavor Capital.

Good morning.

Who is that? I didn't get the name.

Andy Denhowl from Endeavor Capital.

Okay. Andy.

Hyatt, you were on CNBC this morning. I just wanted to confirm what you said. I believe you said that primary insurers will increase their commissions paid to the brokers as rates moderate in order to attract more business.

That is true. [Laughter] Yes. That's why you heard me mention about the bonus commission --?

Correct.

Well, that's what happens. And so, what happens is, is that -- and we have fought -- you know, it's sort of like in the lawyers program where we had a commission reduction. There is pressure on that. And so once the companies start to open up as the (indiscernible) are, they will increase commissions. And that forces everybody else -- I mean, this is a competitive marketplace. But we don't see that as something that is going to happen next month. I don't want you to think that, Andy.

Okay.

And the easy way to look at it is -- you know, when the markets start to restrict, there is less carriers that give us an opportunity to go to, and therefore, those carriers have more the equilibrium to their side. And they can demand lower commission rates. When the market opens and we have more carriers that we can market the business to, obviously those carriers now have to give us more commissions to try to entice us to make sure we're putting it with them. That's the easy way to look at it.

Thank you.

Adam Klauber, Cochran, Caronia.

Good morning. That's Cochran, Caronia. Could you expand a little on the security issue? RSA and Atlantic are two companies that you mentioned. Obviously, they have had some issues for awhile. Could you tell us how -- over the last six - twelve months, knowing that these companies have issues -- how did you handle those on your prove list?

Well, we were watching. That's how we handle them. And so you know, "hope springs eternal in the savage breasts." And so everybody always wants them to make it because we don't want to have to go through the pain of making all these changes. And so, in the case of the Royal, that was a little -- that took us -- we knew they had problems but we thought that they, by selling the excess and surplus company, that solved it. Apparently, it didn't. That took us a little aback. But we had already had plans as to what would happen if, in fact, they were downgraded. And, in this case, what happened was Travelers is going to write about half the business based on what I am guessing. And the other half we're going to place elsewhere, and so we just have to get moved. And, in the case of Atlantic Mutual, that's a fine company. And I really feel badly that they were downgraded. So we don't have a lot of business with them. So, we are just going to have to work through it.

There are probably a list of three or four other significant carriers that potentially could be downgraded. And it's always tough to predict that. Are there other companies that you are worried about -- are you reducing -- I'm not asking for names, but more just sort of your actions in the market? Are you reducing volumes at some carriers? Or I guess, what's your practices?

No. No, we're not. And what you're saying is that if we think company A might be moving in the wrong direction, are we writing less new business and (indiscernible) renewals? The answer is no. So A- or above -- we are anticipating the sale will go forward and do well.

And I would say on new business, that the buyer -- and we -- probably do a more thorough evaluation as to the status of that company. So, if there's really any smoke around that company, meaning that there is an S&P downgrade or a best inquiry or a best comment -- that is an item that really will not set well with the buyer or with us with respect to certainly at the time you're looking at a new piece of business. I think that does impact those companies and sets the stage for the issues that they run into.

Okay. And one more question. You mentioned that the national companies are continuing to be responsible in the markets, and after a very tough time in the late '90s -- which is potentially still sitting on their balance sheet -- they're likely to continue to be responsible. Could you maybe really try to frame "responsible" or just give us a guesstimate? Does "responsible" mean for next year price increases still in the 10 to 15 percent range or does that mean rates increase moving more towards single-digit to flat range?

Well, you know, Adam, first of all, what they want and what they get are two different things. So, if you're Travelers, let's say, and you want a 12 percent increase on a package account in upstate New York or Indiana or Illinois or Ohio. And, let's say, Auto Owners is willing to write the same coverage, and it's flat or even down 5 percent, then that means that Travelers is going to have to figure out -- are they going to reduce the price or are they going to lose the business? And they have been and others have been willing to lose the business in consideration of getting the price up. Now there comes a time when that starts to -- you know, the rubber meets the road. And so the national companies have been pretty responsive on trying to get their prices so they can get their balance sheet right. And next year I don't know. I just don't know where that is. I would not expect them to be irresponsible though, I can tell you that.

Thank you.

Ken Zuckerberg, Stadia Capital.

Okay. Good morning. Just following-up on the comments on the nationals and their behavior. I was intrigued about your comments regarding the Bermudians coming onshore. I guess, would it be possible, just in terms ranking 1 to 10 -- 10 being most aggressive, 1 being less aggressive -- just in terms of the Bermudians' appetite to grow onshore? And then the second ranking of whether or not their behavior is price aggressive or price responsible?

Well, they are going to be aggressive. But let me tell you what, there is two pieces to it. First of all, they're a new paradigm. The advantage is that you have one or two offices with highly-qualified underwriters who deal with a few agents and brokers, and they deal they give immediate answers -- yes, no. And that is a paradigm that is very, very user-friendly. And one of the problems that all companies -- national and really regional -- are having is, is that there are an awful -- a tremendous number of cases across the country -- and it's the same in every state -- where we don't get the renewal pricing until the day before or two days before or three days before, the dog-gone renewal date. And these folks -- the Bermudians, if you want to call them that -- they are able to respond more quickly. And sometimes the response is no. And we want to know -- if they're not going to do it, tell us, don't string us along. So they are going to be more competitive from that standpoint, and in some cases, they are more competitive on prices.

Great. Thanks very much.

David Lewis, SunTrust Robinson Humphrey.

Thank you. Cory talked about, I guess, the comp going down a little bit due to some producers leaving or retiring, etc.. Can you talk about producer counts? I know you have tried to bring on some additional (indiscernible) producers. What's happening with your existing force? Are you seeing movement within the industry? And then second, can you talk about any developments on the (indiscernible) side?

I don't think Cory talked about producers on workers' comp. (multiple speakers)

No -- (Multiple Speakers)

Well, his first comment was, that comp went down because of --

David, on that PSP charge, most of those related to -- either related to people who had left when we sold them the books of business back or people who just didn't make it. We had one prop-center (ph) manager leave and go somewhere else. And so those DSP charges had been a true -- we don't ever assume that there is a termination rate in our DSP calculation. We assume everybody is going to make it the entire period. So, when somebody leaves, their accumulated cost comes off the book. So if you have somebody who has a lot of PSP, it will come off. So it's not a lot of people. It's more people who have some heavy PSP. And it's only about -- it was only about $250,000 -- you know, $300,000 worth of that.

Yes. And David, relative to going out and getting heavy-hitter producers, we are very, very sensitive and nervous about that for a lot of reasons. We know that a lot of folks have moved from (indiscernible) teams, I am talking about, to other regional and local and other brokers. And they bring with them books of business, which is being recorded as new business -- internal growth, organic growth. We are very concerned about that because -- number one, we don't hunt in teams. Number two, we are concerned about the culture that the people bring with them. We are concerned about the loyalty that we can create within our organization. So, we are trying to be more careful about those people that we bring on board and trying to grow our own internally.

We have, as of the first of October, a new position that we have created, and we have filled with a name with a man named Glen Epply (ph) and it is our headhunter. What we're going to do is we are going to find -- and he will find, for all of our profit centers, three groups of people -- A. right out of college. And he would interview them and assist and try to come up with the best people. And then if a profit (ph) center wanted to hire them, they would. Then if in fact they hired them, then at the end of 12 months, if they still were employed then that profit center would pay 15 percent of the base salary back to the profit center -- which is called headhunter profit center. The second group of people that we're going after would be folks who are officers in the military who have not been in the military more than four to six years and who are coming out of the military and they are looking for good opportunities. We think they have the discipline and the leadership that we are looking for. The third would be that -- people who are within the industry. And so we do find, from time to time, that we are able to pick up some very good people from within the industry. But that's -- we have to be very careful. And then the fourth would be looking at agents of producers who are already in the industry. As you can tell, that fourth group is the one that you are talking about. We have had not very good experience with hiring people in that fourth group so far. We have some that are very good but they are few and far between.

So what our goal is that we want to build our organization like the mighty oak. You know, it grows slowly but it is very, very strong. And that will mean that our internal growth might look like it is in the short term a little slower than others when in fact, it may not be.

And Med-Mal carriers?

And Mal carriers. Okay? Damn good question. There aren't too many left standing. We do not have a -- and haven't had a replacement for the malpractice program we had -- which has gone away. But we're still looking. Now we do have books of malpractice business in our various offices. And it's very difficult, and I don't see anybody emerging that is doing all that well. So, we're trying our best to find markets. We do have a couple of opportunities that are -- I would call them opportunities because they are not -- we can count them until everything is done and everything is signed, sealed and delivered. But these opportunities, quite frankly, would be with substantial companies who would be writing non-admitted -- through their non-admitted paper -- in certain states. That may be an opportunity for us David, but it's not -- we're having substantial conversations but nothing is nailed down at the moment.

So you're not (indiscernible) about the NS market.

Yes.

Somebody like the Marquel (ph), for example.

Well, somebody like anybody who's not admitted.

I understand. Thank you, and congratulations on a good quarter.

Well, thank you, we're very pleased. Thank you very much.

Hugh Warrens, J.P. Morgan.

Hey, guys, I will just follow-up later. It's not that important. Thanks. I appreciate it.

Okay, Hugh.

Steven Labbe, Langen McAlenney

Good morning, Stephen Labbe with Langen McAlenney. A couple of quick questions. One, I apologize if I missed this, but, Cory, what was the after-tax number on the other income?

The after-tax income?

The after-tax other income. I mean you had a 1.1 million other income gained in the quarter. What would be the taxes associated with that?

It's going to be the same. It's going to be a normal -- nothing different. It's the same effective tax rate. No additional charge to it.

Okay. And, Hyatt, I believe when you were discussing the Western retail, you alluded to client loyalty. And I was curious as to what you were specifically referencing. Are you talking about your clientele or are you talking about the insured as purchasers and what carriers or what exactly were you referencing?

Really, I'm talking about the insurer as purchasers, and in certain areas of the west, there have been just an awful lot of new businesses and new people coming in. They are not part of the fabric of a community. And so maybe we have had the account for two years and haven't during that period of time -- because they're just brand new in town -- there are no old relationships. And so they're much more willing to move an account for 50 cents or a dollar then, let's say, in some other areas of the United States where the people have been in business and it's a little more stable -- the relationship is a little more stable.

Steve, I might, fill that in too. Our retention typically runs 96 - 97 plus. And the last year, I think, that's been down a little bit. In part, that is, if you take a displacement of the carrier -- where, let's say, Royal getting off and it creates an opportunity for another agent to get in with a long-established relationship there. That may be a sub-piece of that. The other is that, in fact, over a three or four-year period, we have injected price increases into that account. And even though you have a great relationship, the customer really is not very happy about what's happened in the market over the last several years. And, so we're spending extra time, you know, petting and making sure that they recognize we're doing all we can to help mitigate that change. So, that is coming into play in -- not a major degree but the part of, in fact, sustaining those relationships today, there's another element that you've got to make sure that the customer understands that you're doing everything you can to deliver the best product to them.

Along those lines, Jim, when you say that it's down a little bit, are you talking now retention of 93 to 95 or are you talking -- (Multiple Speakers)

It may be more in that 95 range. And I don't have an exact number there to quote, obviously, on the phone. But coupled in that, though, is another factor of which really is companies that simply no longer exist. Meaning they were either bought by someone else or, in fact, they have gone out of business. And I think the market conditions -- the economic conditions this year have -- there's been an increase in that class of business as well.

Okay. Thank you very much. Congratulations.

Mr. Brown, I have no further questions at this time. I would like to turn the conference back over to you for any closing or additional remarks.

Okay. No closing or additional remarks, and we are adjourned. Thank you very much.

Thank you very much.

Thank you.

Thank you. That does conclude today's conference. We thank everyone for their participation.