Brown & Brown Inc (BRO) 2004 Q2 法說會逐字稿

Welcome to the Brown & Brown second-quarter 2004 financial results conference call. This call is being recorded. Conference calls and/or webcasts may contain certain statements relating to future results which are forward-looking statements. These statements are not historical facts, but instead represent only the Company's belief in regarding future events, many of which by nature, are inherently uncertain and outside of the Company's control. It is possible that the Company's actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements.

Further information concerning the Company and its business, including factors that potentially could materially affect the Company's financial results, are contained in the Company's filings with the Securities and Exchange Commission. Some factors include general economic conditions around the country; downward commercial property and casualty premium pressures; the competitive environment; the integration of the Company's operations with those of businesses or assets of the Company has acquired or may acquire in the future and the failure to realize the expected benefits of such integration; the potential occurrence of a disaster that affects certain areas of the states of Arizona, California, Florida, New Jersey, New York and/or Washington where significant portions of the Company's business are concentrated; the actual cost of resolution of contingent liabilities and those factors relevant to Brown & Brown consummation and integration of announced acquisitions including any matters analyzed in the due diligence process, material adverse changes in the customers of the companies whose operations are acquired and material adverse changes in the business and financial condition of either or both companies and their respective customers.

All forward-looking statements made during any conference call or webcast are made only as of the date of this conference call and webcast and we do not undertake any obligation to publicly update or correct forward-looking statements to reflect events or circumstances that subsequently occur or of which we hereafter become aware. And now for opening remarks and introductions I would like to turn the call over to Mr. Hyatt Brown. Please go ahead, sir.

Good morning, everyone. We have in the room Jim Henderson, our President and Chief Operating Officer; Cory Walker, our Chief Financial Officer; and Tom Riley, who is our Northeast Regional Executive Vice President. So I'm going to now turn over the first portion of the meeting to Corey.

Thanks, Hyatt. We had another good quarter, but even despite the fact that our contingency income for the quarter was $6.7 million less than last year's quarter; our net income increased 15.1 percent to $32.2 million. From the revenue standpoint our commissions and fees increased for the quarter 14.2 percent to $156.7 million. That's up from 137.3 of the second-quarter last year. Included in our press release is, again, our table -- it summarizes the total growth rates and the internal growth rates from our core commissions and fees which exclude the contingent or profit-sharing commission as well as any of the revenues from businesses or programs sold or discontinued during the quarter.

The schedule reconciles back to the income statement. As you can see from the current year quarter, commissions and fees on the reconciliation -- the bottom part of that schedule -- for the quarter were only $3.5 million which was $6.7 million less than the 10.2 that we received in the second quarter of '03. And as you recall, in the first-quarter conference call, the vast majority of our contingency income for this year came in the first quarter, whereas last year it was a little bit more evenly split between the two quarters. However, with that said, contingency income for these six months of 2004 was actually about $1 million more than the first six months of 2003.

Our best estimate of how much our contingency income should be for all of '04 is still in the range of $31 to $32 million for the entire year. So that means that we do expect generally about $2 million for the last six months of the year as long as there's not a hurricane that hits Florida. Probably that 2 million will be somewhere around 700 to 800 in the third quarter and somewhere around 1.2 million hopefully in the fourth quarter, which is -- that's the portion that's subject -- that if there were a hurricane what 1.2 million will probably go away.

The other reconciling item on that internal growth schedule is the revenues from the businesses that were sold since the third quarter last year. In particular, during the second quarter, we sold all four of our offices in North Dakota. The sales of these offices resulted in a net loss of about $1.25 million after taking out the goodwill relating to it. That's a little over 1 cent per share there. Additionally we sold the last portion of our medical TPA business which was based in Louisiana.

The reason why we sold these businesses is as we march towards B40, all of our offices must demonstrate the ability to move to 25 percent margin which we expect and also show that they can have a continual improvement from their Board (ph). Right now I think, with those sales, we look very comfortable with the offices that we have and, as you know, our offices do have the highest margins and things look very good from that respect.

Now so the revenue from these operations as well as the prior year revenues from books or niches that we sold from third quarter, they come out of that schedule and you can see those numbers that reconcile and then will (indiscernible) to the income statement on the commissions and fee line.

But now moving back to the top portion of that internal growth schedule, you'll see that total commissions and fees for the quarter increased 24 percent or $29.4 million of new commissions and fees. On this total 23.1 million of the revenues were generated from businesses that we acquired since last year. Therefore the remaining $6.3 million of revenue was therefore internally generated organic growth and that reflects a nice 5.1 percent growth rate. And then I have got to talk specifically about those growth rates in each of the business segments in a second.

But moving forward and looking on other revenue line items, there really wasn't much change in the investment income line item for the quarter. And then on the other income for the quarter we had a net other operating income of $860,000 which includes the sale of the medical TPA as well as a loss from the North Dakota offices and various other books of business sales that are kind of done on a normal course of operation.

Looking at our expenses -- because of the magnitude of the contingent income that we receive in any one quarter can have on the percentage that a given expense line item has to the total revenue and the fact that the contingent income is really not very good for the 2004 quarter as compared to 2003 because of the difference in the way it fell in -- to look at these expenses we really need to look at how the expenses look on a 6 months basis as a comparison. So if you look at the total expenses for the six month period as a percentage of revenue, we actually had an improvement of 1.5 percentage points which obviously equates to the increase in margin for the six months basis.

The components of that on -- if you look at employee compensation, that improved about 20 basis points over last year. And again, that improvement in the compensation really is just a -- the continual, gradually efficiency improvement that all of our very hard-working, dedicated employees focus on at our decentralized operations. So that was a nice little improvement there.

The other line item that had the biggest drop is other operating expenses and that had about a 90 basis point improvement over that six month period. And again, the main reason for this decrease is pretty much just the economies and the scales of being able to keep expenses increased and at a slower rate than the revenues increase. And so there's no one line item that makes a major improvement other than our insurance costs and our professional fees probably had -- probably increased, but all the other detailed line item expenses like rent and supplies decreased as a percentage of total revenue for those reasons.

The other expense line items for the year are really fairly consistent with last year and don't need any real explanations. So really to conclude on the income side for the six months ended, we ended up with net income of $68.5 million which was an increase of 17.2 percent over the net income last year of 58.8 million. So from a quarterly statement and a year-to-date we ended up having a good quarter.

One last item, just looking from a balance sheet perspective. Most of the items there -- probably the only item that will really jump out at people as it reflects -- is a borrowing that we have, the current portion of long-term debt. And that reflects our borrowings of about 50 million of our $75 million bank revolving line of credit. And this borrowing was a result of our increased acquisition activity, and Jim's going to discuss that a little bit later. So really with that financial overview I'll just turn over to Hyatt.

Thanks, Cory. Good report. Let's talk a little bit about what's happening in the regions. First of all, Florida retail, the internal growth rate was down from 7.7 percent to 3.7 primarily driven by property rates. Property rates in Florida are going down as are rates eroding in Florida generally more than I think they are on the average throughout the rest of the United States; partially driven by large habitational -- anything that's wind exposed we're seeing and have been seeing property prices going down 25 to 30 percent.

If you look at workers comp it's flat; general lines are trending down. We are writing new accounts at 15 percent less than expiring. So we're back in the heat again. We have good new business flow and we also noticed that the contractors market, the number of companies willing to write contractors in Florida is shrinking. And that's sort of a malaise that started in California about maybe 5 years ago or 6 years ago and has come all the way to the East Coast now.

So Florida is going to continue to do well, but there's going to be a lot of pressure on pricing. In the national retail -- very good trend there. The fourth quarter of last year, national retail was a -7 percent. The first quarter of this year it was a -3.1 percent. And the second-quarter, the quarter we're reporting on, it was a +1/10 of 1 percent. So it's a nice trend.

Cory mentioned that we sold the offices in North Dakota. Last year towards the end of the year we made a decision that we're not going to have anything that doesn't make, on a regular and contingent basis, a 25 percent margin and can grow. And therefore we have made some changes and that's just part of our culture. We have good new business flow in national retail and the economy is getting better. It is possible -- it is possible that towards the end of this year that we might see AP's -- that additional premiums on audits -- where as we've been saying RP's -- return premiums on -- across not just national retail but across all of our retail offices.

In western retail at a nice growth -- from 5.1 percent to 9.7 -- it's the largest internal growth out there in recent times. Las Vegas, Phoenix, Tacoma, Seattle, very nice increases; good new business flow and employee benefits. The employee benefits and particularly in maybe the Las Vegas area appears to be benefiting from increased employment over the last six months to seven months. The rate decline or erosion in property and casualty is not as aggressive as Florida but it's there. It's there around the United States. The only place we see what I would call flat and maybe upward a little bit would be casualty rates in the New York City area.

Professional programs was from 9.3 percent last quarter to 4.0 percent. CalSurance had nice growth. Lawyers was off a little bit. And the dental was up 7 percent. We now have, I think, two quarters in a row where our dental program revenues have grown and, quite frankly, I think we had about 8 years of decline. So that's nice. And special programs, we've gone from a -6.2 to a 1.3.

One of the interesting pieces in that is we have a profit center in St. Louis called Parcel Insurance Plan, and it basically has a special program in writing parcel post, our cargo insurance, on shipments from B2B, business to business, not B2C, business to consumers. And starting about 4 years ago we saw those shipments start to erode, erode, erode. Last quarter it was kind of flat and those shipments were up about 8 to 10 percent. So I think that is a reflection of the economy around the United States recovering. So that's good.

We also have our social service appetite is basically growing and our AFC brokerage up in Bethlehem, Pennsylvania. In the brokerage division we're from 12.8 percent to 16.1, nice increase. We have new locations that started really the end of last year. Las Vegas, San Francisco, Los Angeles and Peachtree also had a very good quarter which is -- and I'm thinking of the Peachtree offices now more in the eastern part of the United States. Then we also had TPA services were up about 22.9 percent versus 13.3 and that's pretty dog on good. We're pleased about that. USIS and PGCS had nice growth and a good outlook.

Now relatively speaking, one other thing that I might want to mention is that in the first six months of last year the employee benefits revenues -- those are commissions -- in the entire company was $29 million. This year for the first six months it's $41 million. That's good news for a lot of reasons. Number one, we are growing benefits; number two, our new acquisitions have a larger percentage of benefits; and number three, benefits as a segment across the U.S. is the second-highest retail margin to personal line. So that's positive. Then the next question is what's the internal growth projection? And the answer is same as it has been, 0 to 5 percent. Having said that, I'll now turn it over to Jim Henderson who will talk about M&A and other matters.

Thank you, Hyatt. The first quarter of 2004 was one of our most active quarters really in the history of the company. We've had -- since the first quarter we've completed some 10 acquisition for some 38 million in forward revenue. This couples with the first-quarter activity of some 21 acquisitions -- sorry, 14 acquisitions combined for a total of 21 for the six-month period, a total of 86 million for the year. The distribution of those acquisitions of note is that we completed two program acquisitions. Those two programs represent 21.5 million going forward. There was one brokerage operation for 5 million, the balance, the 18, were retail on a -- really spread on very much a national scale. The average size of the acquisitions in 2004 year-to-date is some 4.1 million. This compares to last year 2003 for the year of about 3 million.

Now addressing really the quality of the acquisitions, and I think these continue to be very pleasing as to both the numbers and also the people that have come with these acquisitions. The margins from day one on this class of 2004 compare very favorably with the high margins we expect at Brown & Brown. So if you look at the margins and the year-to-date we've not done diminished by the acquisitions; as a matter-of-fact, they've been very much a fit with what we have.

Leadership perhaps even more an important, and the leadership that had come with these acquisitions we spent a lot of time making sure that we tell the story, they understand our story and the people that have joined us come with a long-term commitment on focus and on culture that is a part of Brown & Brown and we feel like we've got the people talent to take this operation forward for years to come.

2004 also marks really two new states; part of an acquisition that Tom has executed. We are now in the states of New Hampshire and also Massachusetts and very pleased to be there. A high-quality acquisition with the McDuffee agency. I wanted to also relate to you that if you look at the acquisitions for 2004, one of the things that we feel like is very much a strength at Brown & Brown is the depth from which the acquisitions are originated. They're sponsored; they're reviewed and ultimately managed by the depth really of our 8 regions. In the first 6 months of this year we had 7 different regions; find, cultivate, complete and integrate acquisitions. And this is a very, very special talent.

This broad based management involvement allows Brown & Brown to complete the high volume of moderate sized acquisition that's very much characteristic of the middle market brokerage business and somewhat, I believe, sets us apart about the focus to stay in the domain we're at. I think looking at the opportunities of a lot of the middle market agencies, really high-quality, high earnings to join the Company.

The activity in 2004 has not diminished the pipeline. We are very pleased with the current level of activity. As to the quality, we continue to be focused acquisitions and operations with this. And so, we continue to see the possibility of a very active second half and certainly going into 2005. We have the opportunity to bring some very, very high-quality people to Brown & Brown.

As we've mentioned before, we really do not establish a budget for acquisitions. It's one of those that we don't feel like we're under the gun, that we have to go out and make the acquisitions. It is a part of what we do. There is a need in this industry to bring together some agencies with us.

With respect to the aspects of terms and pricing and competition, I would say that no news is good news. These factors are similar to prior years. Our game plan remains very much intact with respect to forward earnings. The competition is no -- especially no more keen today than it has been.

Turning now to something that Cory mentioned, and that is that we have loaded the cash account with the completion of a private placement of long-term fixed-rate coupon debt. And this was completed in recent weeks. On July 15th we will take receipt of the first 100 million in financing. This is at a -- it's a 10 year money and just over 6 percent interest rate coupon for that period of time. And then we've also staggered later in the year another 100 million that will be received on September 15th, and this is about 5.5, 5.57. And this is 7 year money and this will allow us certainly a spread of time to deploy the money.

The question pops up, do you have something that's big in the wings, are you about to close it? And the answer is, we really -- this borrowing was not to execute a specific large acquisition. It is to deal with the ongoing activity, the anticipation of this activity will not diminish; in fact, it may pick up. And so we certainly have the dry powder to grow in a favorable basis for the Company.

If you take this 200 million, our cash flow currently for this year is some 120 million plus, 124 million. And this is net of, in fact, debt payments for earnout payments which are non-recurring. So, our cash flow obviously is greater than that number. So, wrapping up the acquisitions, we're very pleased with the earnings, with the quality of the people. I think the sustainability of those earnings, which is a major factor, and we look forward to an active second half as well. So Hyatt, turning back over to you.

Thanks, Jim, very good, report. One thing I might add that's kind of a bit surprising to us, but I guess it's not surprising if you think about it -- I mentioned it on nationwide TV this morning -- is that in the last 30 days we've had 2 or 3 or 4 folks that we've been talking to raise the specter of the fact that if Kerry elected probably they think that the capital gains tax rate will immediately escalate. And therefore maybe now this year is a better time to look about maybe selling their agency than next year. So I was kind of surprised and I hadn't thought about it, but it kind of makes sense. So having said that, Michael, we'll open up the phone lines then and we'll take questions.

(OPERATOR INSTRUCTIONS) Nik Fisken, Stephens.

Jim, if I look at the acquired revenue; you guys did 62 million in '02, 39 last year and, as you said, 86 million year-to-date. Can you kind of walk us through why you're winning more deals and why -- you said that you expect deals to continue, but is there any reason why the deal should -- deal volume would slow?

Nik, we've -- good question and I think that probably the outlook for the market may be different. I mean, we've -- a number of these acquisitions that we've made in the last 6 months and last 9 months we've worked on perhaps the last two years. So timing is one that's kind of a -- it's jagged anyway with respect to when it really happened. Outside of that, I think there is -- seems to be a more -- there is greater commitment to come to the table and close and move forward because many have been sitting on the sidelines waiting for the fact that, gee, the market has been -- I've been caught in the tailwind. Maybe the tailwind is not there. Perhaps this is really a time I need to go ahead and to make a move. I think if there's any one condition that's probably out there we've seen that.

But Nik, I'll tell you, the other thing is it's really about people and we have -- or our acquisitions are really done on a regional basis by the local folks and our regional EVP's. And they get to know the people. And if you're a fast-paced entrepreneur, you tend to like the decentralized environment like we have and where they run their own operations. So it's really kind of the culture to attract like type people and they know their purchase price is based on how well they can deliver their earnings and they like that approach.

And as you said, Jim, the margins continued to -- the margins of the acquired properties continue to be similar to BRO (ph). So on a go forward basis we would expect margins to continue to go up and not suffer any kind of slow down because of M&A?

Well, that's certainly our game plan. And if we continue to have the opportunity to pick and choose among the highest quality that we've seen, I think that's a reasonable game plan. Now, there's a lot of remodeling up front that we go over with those who join us saying here is how we go forward and this is how we operate. So that's part of the doggedness to getting in and understand tomorrow and tomorrow. So yes, we're pleased with the ability to continue to buy high-quality earnings.

Well, I think there's one other thing, Nik, that you've got to understand. Forget all of the acquisitions for a moment. If you look at what our operating margin is, it's somewhere at 37.5 percent, maybe 38. So that's the average, that's the average. And so as people below average move to average then all of a sudden that will make our margins better. So if everybody less than 38 got to 38 then -- you're an analyst, you can figure out what that means.

So we are taking some hits on expenses on new acquisitions that are one time -- in other words, during the first 12 months -- that is unavoidable. But that's part of the game plan. So we are very assiduous about talking to all of the people that merge into our company and become part of the team, about how we will operate starting day one. And we have it all in writing; we have a very well-defined budget. And so we don't have many mistakes, but even in our ongoing operations we have some bob ups on expenses that we don't expect from time to time.

The last question I've got kind of focuses on internal growth -- your favorite topic. How do you guys -- how did you determine to stay at 0 to 5 percent guidance?

Well, we prayed over it a while and it came in a vision in the night. I mean, Nik, we do have budgets done from the ground up at each of our profit centers. And so, we know what the budgets are, but we've got a bunch of salespeople out there and salespeople are optimistic and they think they're going to kill the world. So we take that as a basis and then look at it on a go forward basis.

Now, this quarter was probably one of the more difficult quarters of the year in terms of internal growth because you'll remember the second-quarter last year we had double-digit internal growth. It was the third quarter that we dropped down to 3.6. So the third quarter, when you're comparing the third quarter of '04 to the third quarter of '03, you have a little bit less of a hurdle from a percentage standpoint. So I think we're still comfortable at the 0 to 5 percent range with that, so --.

And the assumption on the economy and seeing positive signs kind of offset by Florida rates kind of putting all that together?

Yes, Nik, what happens in Florida will spread. I mean, nobody is kidding anybody about this think. And so everybody likes to be hyper optimistic and, of course, we're salespeople. But let me tell you something; you've got to look at it as it really is and we're looking at it as we really think it is, and 0 to 5 is about where it is.

Nick Pirsos, Sandler O'Neill.

Two questions. First is, just looking at the sentence in the press release that talked about continued rate erosion which was possibly offset by increases in exposure units. I guess the word I'm intrigued by is possibly. If it wasn't exposure unit increases, what else could you talk to?

Because what we're saying is we don't have a way of tracking the increase in exposure units on renewals, and so we think, and this is where I and Jim and Tom and others go around at sales meetings and ask questions about what's happening. And so we get the impression that exposure units are rising a little bit. That's why the term "possibly" was used.

Great. That was helpful. And just a --.

And Nick, also we're not like Greenspan so I wouldn't read too much into specific words out of the press release because we don't -- we just (multiple speakers) kind of talk through it and say what are we going to write this time? So we're not like Greenspan.

Okay. And then just a second question. I think, Hyatt, you just said -- and I'm just trying to reconcile two thoughts that maybe this is a shift in where you're thinking these days -- I think you said the trends in Florida will spread. And I think last quarter you had indicated that you felt that whatever price declines we may encounter in the market would be relatively short-lived, so is there a change in what you think?

No, no. What I said was this, I think, is that I think that you're going to have the same kind of competitive pressures this time as we did in '86, '87, '88, '89 when things started going south in a hurry. There are several differences, however. Number one, there was no asbestos and environmental hole to fill in those days. There were some other holes and they over reserved for whatever claims that they had in the IB&R. And that over reserving is not going to occur to that extent any more because of Sarbanes-Oxley, that's number one. Number two, because of the largest national companies haven't really replenished their reserves as well as they'd like to, even though in the last quarter -- maybe it was the last six months -- I saw (indiscernible) and expense ratios that were 93.5 for the largest 20 companies. That is unbelievable. I've never seen that before in my life.

So they're right now making a lot of money, but all of that money is going to have to ultimately be used to take care of reserves that aren't really full enough like workers compensation, like are there some more A&E. So that's why I think if it starts to go south more rapidly, I think there's going to be a curving, a breaking, and those two other factors I just mentioned are what I consider to be curves or breaks.

Okay, thank you.

Adam Klauber, Cochran Caronia.

Looking at the operating margin, the EBITDA margin, if I back out contingent revenues it almost seems like the margin popped closer to 300 basis points for the quarter. Could you maybe give some reason why it jumped up so high for the quarter?

Adam, I think what you're looking at, too, is there was a net gain in other income of 860, so you'd have to pull that out too. And so if you pull that out on a core basis, which is really our core commissions and fees and miscellaneous investment income without any gains on that, we're really closer to on a year-to-date basis. And, again, that's what you've really got to look at I think as more profitable -- is more reasonable, is about 1.5 percentage points increase.

Okay, thanks. Another question. As far as dispositions, if I plug this dispositions would organic growth actually be closer to 3 percent? And also, going forward can we expect more dispositions?

The schedule, you could take those numbers and add them back in and it would be a mathematical calculation. It's probably right, but by the same fact that we take out acquisitions, again, the internal growth number, as we originally designed it, is trying to focus on a number of that you all would look at to kind of give an indication of what is the market place doing in terms of rate? And so what you've got to do is you've got to keep it as close to apples and apples.

So if you had an operation last year that had $1 million but this year you didn't have that operation and therefore there's not $1 million of comparable revenues, it gives you a skewed view of what "internal growth" is as if there was a rate decline of $1 million. And so that's why we pull out that portion to try to give you an idea of well, if you just take the normal policy to policy comparison, how much did it go up when you're really looking at individual policy count? And so, that way you can determine well, it's either rate or it's exposed units or it's net new business.

The best representation of the best same-store sales, Adam, I believe.

I'll tell you, with internal growth numbers, I think they ought put a big old red sign on it and it's "buyer beware" of -- understand there's (indiscernible) -- especially when compared to other brokers in the industry, too.

Yes, I think the answer to the second piece of your question, Adam, are there any other exposures that we're going to -- disposals that we're looking at? And the answer is not at the moment. But every quarter we sit down and look at all of our operating profit centers and try and determine how can we make them better. And quite frankly, if a profit center cannot grow it will decline. And if it declines the margins go down. We are not going to have profit centers that decline. So the answer to your question is if, as and when we find those then they won't do that.

One last question. There's a shift going on from the EMS market back to the standard market that obviously could produce higher commissions. Is that having a significant impact for you during the quarter?

You have to understand that it affects us one place positively and it affects us negatively in another place. So brokerage, if you will see, did grow but they are fighting exactly what you are talking about. What is happening is in a lot of that business is moving from the nonstandard or not admitted back to standard. It may be moving at let's say 7.5, I'm talking about retail now, 7.5 percent to 8 percent to maybe 9 percent that they are getting from the E&S broker. It moves back to where they are getting 12 to 15 but it is on a 35 percent less premium. It is a little bit of positive impact but not that much. By the same token, our brokerage is running uphill because of all of those accounts that they do not yet renewed they have to find another account to place.

Thank you very much.

David Sheusi, JP Morgan.

Just got a couple quick questions. One, wanted to hit on the mix of business. Over the last several quarters we see a positive trend on the national retail side, I wanted to get a sense of strategy. One, has there been a change in the business that is driving greater importance or is it by that ebb and flow in the E&S to primary side where there's just a change in underwriting appetite or kind of both?

Well, I think it's all of the above plus a few other things, Dave. The bottom line is that the Midwest is where we think our offices were impacted mostly by the economic downturn. We think that has bottomed out and it's headed up the other side. The second thing is that we've been pushing real hard to bring in some experienced people to help drive sales growth, and we've been reasonably successful at that. So a combination of all those things is helping.

Okay, good. And I guess a conference call wouldn't be kicked off if we didn't hit on contingent commissions. Just wanted to kind of get an update on where the investigation or view is today versus three months ago. And secondly, more on the numbers side, can you talk a little bit about accruals/expenses, where that kind of falls out on the P&L and how you look at that?

Well, I'll answer the first piece and then ask Cory to answer the second piece. There doesn't seem to be much change as far as contingent commissions and the Attorney General. Nothing in the last 60 days or so is new as far as I know about. So, Cory, do you want to talk about the expense accruals?

Yes. Back on just finishing up with Hyatt is that basically the only thing we ever hear about is what we hear from you guys. So on the expense side, generally when we get a contingency income, the only expenses that happened are is that it increases the profitability of the profit center office and therefore there's a bonus that the profit center receives on the total operating profit of the Company. So there's an accrual relative to that bonus. In addition, there are a couple other expense accruals, for instance like our E&O accrual which is a -- generally accrued for as a percentage of revenue and then reviewed every quarter. So there is some of those accounts like that that increase in accrual because contingency income comes in. So as a general rule we use anywhere from 75 to 85 percent -- probably 80 percent of contingencies typically fall to the bottom line to pretax. Does that answer your question?

It does. Thanks a lot, guys.

Matthew Roswell, Legg Mason.

I have kind of four quick housekeeping questions. First of all, in the other income line, is that both the gain on the sale of the TPA and the loss on North Dakota offices?

That's right, as well as sales of various books of business throughout the system. We probably have 8 to 10 sales of various books of business in a particular office. And so that includes those too. As well as -- and then we have some rental income where we may sublease out an office, just miscellaneous things like that.

Right. Second question is with the stock growing up here recently, when do you have to reload the non-cash comp?

Well, on that we did hit -- the average price did hit $42 a share which was the next load -- the next tranche that was hit on our big slug that we issued back in '03. And of course we have already budgeted for that expectation. We budgeted that as well as the next tranche level which would be at $49 a share. And so we expect probably the budget should be around 850 for that performance stock plan all the way up to the next two tranches. So that really should take us through at least the year end.

Plus, Cory, those shares are deemed to be outstanding.

Yes, whatever they hit, they do get added into the shares outstanding, not just on a diluted basis. So that will probably have the bigger impact. Next quarter you'll see a full three months of those tranches hit the outstanding shares.

Do you have that number handy?

You know what? I don't. But it's probably -- probably about 60,000 shares. I'm just recalling off the top of my head.

Okay, I'll go back and look in the K. I think you all had broke it out for us. And then on the debt that's come in the 15th in September, that's true debt meaning you'll have the cash on the balance sheet until you deploy it or is it a credit line?

No, it is debt. And that's why we split it up and got $100 million as a delayed take down because it's going to hit our books cash and debit liabilities.

So we should see interest expense move up a little bit.

That's correct. You can figure out what that interest cost would be based on the days we're going to get that debt.

Right. And then final question. Employee benefits. Hyatt, you were talking about it. Is that throughout the retail organization or is that in one particular area of the Company?

No, it's throughout the retail organization. And as you know, employee benefits and property/casualty works very well together in a sales organization. And so -- and as we grow a number of the acquisitions that we are acquiring do have substantial employee benefits operation, but a number of them don't. For instance, the very fine agency up in New Hampshire, the McDuffee Agency, is all P&C, about $7 million in revenue. And so there's a great opportunity there if we can bring in people who have the employee benefits expertise to cross well. That's working very well for us.

Any rough guess as to how much of the retail business is employee benefits nowadays?

Well, actually assuming that we have $80 million for the year -- in other words, I said we had about 40 million for the first 6 months, so it's going to be more than 80 million, but let's just use 80 because it's easy. And so of the retail business, let's say our retail business is about 450 million, so what is 80 million part of 450 -- I think it's about 20 percent. Is that right? 1/5? No, it would be about 18 percent.

Right, a little under 20. Okay, thank you all very much.

Matt, just to follow up, being able to take a step back, it's really about 100,000 shares was the number of shares that got issued on that $42 tranche level.

And the 49 tranche is about the same?

It would be the same amount, right. Now there's always other grants in between that, so as they hit it they go up. But those are generally pretty small.

Right. Okay. Thank you all very much.

John Fox, Binmore (ph) Asset Management.

I have two questions for Hyatt. One, could you expand a little bit on the premium audits in reference of -- I'm just not really familiar with that, but it sounds like it could be positive for internal growth? And then number two, employee benefit business, what's the internal growth profile of that versus kind of the traditional P&C? Thank you.

Okay, John. Relative to the first question on audits, what that basically is there are a number of policies that we issue that are auditable. And for instance, workers comp is probably the best example and it's based on payroll. So at the end of the year there's an audit and it's payrollable after -- it's a return premium, payroll is more there's AP at additional premiums. And it appears that we're starting now to get additional premiums because of the fact that business is better and that also means that when we get those additional premiums it also means that probably the renewal exposure units have also gone up a little bit. That's the positive on that. The question about employee benefits, John, I don't know how to answer that because we don't exactly track it. In other words, does it grow more rapidly than P&C? And I can't really tell you that.

Well, is it more or less cyclical; are there any general observations you can make about that businesses versus the bread and butter P&C?

Well, it is -- the pricing is somewhat cyclical, but because the tail on that business, the time between the claim is incurred and the claim is paid, that's a short trail. By and large the great piece of employee benefits is a 90 day or a 120 day tail. So it gets paid very rapidly. So prices go up more rapidly and maybe down more rapidly. What is happening is that a number of companies have become aggressive in certain geographic areas and therefore that has driven the pricing down a little bit which gives us the opportunity to write more business and it also gives us -- and that would be new accounts -- it also gives us the opportunity to write additional coverages on our existing employee benefits businesses.

For instance, if we had group term life insurance and group medical coverage we might write -- let's say group disability coverage which (multiple speakers) additional premiums, etc. But I can't say it's going to grow 7 percent and the rest of it's going to grow 4 percent or (multiple speakers).

John, I think if you look at the medical component of -- GNP is one -- it's pretty evident as to the growth and the inflation part of medical, both technology and drugs and all the (multiple speakers) and in a way we are connected through commission back to that product. As that product grows in value we're able to benefit from that. So that component has not had the downward pressure on rates. There's been some moderation this year, meaning it's not 20 percent plus, it's back to maybe 12 to 15 or 16, but it's been a lot of years since that's been flat.

Thank you. And I have one question for Cory. Cory, I just want to understand the debt situation at the end of the year. You have the SunTrust piece which you have now which is long-term, plus you'll have the 200 million of new. The amount that's on the credit line, will that be paid down with the new financing or are you going to let that stay?

No, no, that 50 million that we borrowed, that's just temporary, that will be paid down.

So at the end of the year you'll have basically -- the 34 million I know is a mandatory paydown so maybe that's down to 30, whatever, plus the new 200 million?

That's correct. And then we have the other miscellaneous debt that is out there relating to -- primarily from the seller that we acquired from the Reedman (ph) side, the debt there. That will still be there.

Okay. But the 50 million piece will be paid?

That's right. Yes.

Thank you so much.

Glen (ph) Shapiro, Signet (ph) Capital.

My question was I had spent some time trying to model the compensation ratio based on core revenues which excludes divested businesses and continued commissions. And I had already seen you guys -- it was like clockwork. You guys always accrued somewhere around 50.5 percent. And the way I calculated it, it ended up being in kind of the 49.5 percent range this quarter. Am I not doing something right or was there a mix shift that would make you guys accrue comp differently on kind of the core organic ongoing book?

Well, the only thing that we can think of -- and this, again, might not be totally scientific -- we are increasing the amount of program revenue. Now that's CalSurance, that's Proctor Financial, that's Title Tack (ph), etc., etc. We believe that year end we'll have somewhere in the neighborhood of $100 million of program revenue. The cost of people in that segment is less; in other words, the margins are higher. That's the bottom line.

So should we expect -- should we expect to accrue comp that way going forward so it should be similar and kind of on this core book it would be below 50 percent?

I wouldn't bet on that. I'm just trying to give you a reason for it.

But if we acquire more retail in the next six months or going forward then you get back to where you were at before.

I got you. So just trying to keep it.

I (multiple speakers) suggest a remodeling of your numbers. On a true core, core basis, I mean, our compensation really would run in the 51 percent range. For the quarter it was probably a little bit less than that, but on a 6 month to date basis, which I think is a better indication, it's 51 plus or minus 50 basis points.

Okay, I had modeled it at 50, okay. So I'll just keep an eye on it. Okay, I appreciate it.

Charles Gates, Credit Suisse First Boston.

I had two questions. One, maybe you addressed this early on, but why was pricing weaker, do you believe, in Florida than elsewhere?

Why was pricing what, Charles? You've got to speak into the phone.

Why was pricing weaker by your perception in Florida than elsewhere?

Well, because of more competition. Prices are going down, it's not weaker.

But why do you think weaker in Florida than elsewhere?

Because Florida is a state that always seems to go down first. We always have had a hurricane load down here. And so when prices go up everybody figures, well, we got to add on to that hurricane load. And when prices start going south they forget that we'll ever have a hurricane again. So that's one of the reasons that it's subject to greater fluctuation.

Is that a property comment therefore as opposed to casualty?

Yes, it is.

Okay, my second question. I believe one of you opined that basically the difference between the current property/casualty commercial lines environment, and that has existed back -- I believe your comment was '86, '87, '88. The fact that you thought that loss reserves were stronger back then. What is your conclusion from that comment?

Well, the conclusion is that if they were over reserved then and they could bring those reserves into earnings at a later date then they didn't have to raise prices. So if they're under reserved or inadequately reserved today they don't have that cushion.

So therefore, is your --?

That means that they can't let the price run down and have blood run down their leg for very long because they don't have the money to fill in the hole.

So therefore basically I believe that downcycle lasted some 13 years. Your conclusion is you think this one is shorter?

Well, yes. But again, that's me talking and just looking at the health of the risk bearers. And back in those days -- don't forget Kemper and Reliant and all of the other companies that have gone broke were big players and we have fewer big players. Now the strongest players from a balance sheet standpoint are companies that, Charles, you may not be too familiar with like many of the regionals that are mutual companies like Auto Owners (ph) and Westfield and on and on and on -- FCCI, etc., etc. These are companies that we represent and do a lot of business with and that are -- in the states where they operate they are very, very aggressive and they have the ability to get accounts if they want. And we're doing very well with them.

Charles, I think one of the factors we've seen too is the Bermuda Capital has -- it's more difficult for them to deploy their capital in the middle market than it is to -- tapping into that distribution system is something they're really not geared to do. So the impact of that capital we have seen less a factor of that in the middle market. In the big ticket items they're certainly -- they are in play.

Thank you.

Tricia Meave, Variant Research.

Just a quick question. I was looking at the second-quarter '03 press release and I noticed that the (indiscernible) and internal growth schedule did not have a contingent divested business showed a 0 number. And in the current press release the second-quarter '03 showed a 4 million divested business. What am I missing here?

What you're missing is that back in that quarter those offices were still part of our operations. It's only the books of business or programs that are terminated subsequent to that quarter that end up having numbers that were in that quarter last year, but there is nothing in the current year comparable quarter. Do you understand what I'm saying?

Can you repeat that again?

All right. If you're looking at -- for instance let's take -- we had a program that was in the office in the second-quarter of '03. That number is in the '03 numbers. Well, it was also in the '02 numbers. So you've gone apples and apples there. Then sometime after the second-quarter we ended up selling that book to that producer. Let's say it happened in the third or fourth quarter. Well, now when we come to the second quarter of this year, we don't have that look in our -- anymore. So there's absolutely no revenue this year. But last year it had $1 million sitting there. So now when we're coming ever here and comparing the second quarter of '03, we're going to pull out that $1 million that was in there because there's nothing in this current quarter. Do you understand what I'm saying?

Yes.

So now on a net basis, we're now back to comparing apples and apples. Now the one thing that is different is that if you'll notice there is a number in the second quarter of '04 relating to disposed businesses. That reflects actual full sale of offices and so that does reflect the revenues that were in those offices, the physical offices that we sold lump sum. And so we pulled them out completely. But typically if it's a book of business, it just ceases at the time we sell it. And therefore there's no revenue in the current quarter relating to those.

That's probably why the total core commissions and fees in the second quarter of '03 was showing a 122 -- is showing now 122 versus 127?

Exactly.

Can you give us your name? We missed it when you --.

Tricia Meave, Variant Research. Great. I just wanted to check up on that. That's all I have, thank you.

John Keefe, Ferris, Baker Watts.

A couple of questions. First, a number got past me earlier in the call, Hyatt, when you mentioned the dollar amount of employee benefits this year compared to last year.

About 41 million, that's a rounded number, for the first 6 months of this year versus 29 million for the first 6 months of last year.

Great, thanks. My second question is -- we had heard a while ago that some additional capacity was ready to move into the Florida med/mal market. Is there any update on that?

Yes, and that was CNA and it's a nonadmitted Company of the CNA group. And it moved in as of July 1 and we're writing some business. It's not going to blow the doors off, but we are writing some business and we're encouraged. Now what's happening is that CNA is trying to find their way through as to what the right price is. And obviously normally in this kind of thing pricing -- particularly in this kind of marketplace -- pricing starts out pretty high and then it has to find a level where, (A), business can be written and, (B), it would suggest a profit at that level. So we are going to write some business. It's not going to be a bonanza, however.

Very good, thank you.

Nik Fisken, Stephens.

I couldn't get myself out of the queue. I had already asked and answered. Thanks.

There are no further questions at this time. Mr. Brown, back to you for any additional or closing remarks.

Thank you all very much. And we're pleased about the quarter and we'll be talking to you in October. Have a great summer. Bye.

Thank you all for joining us today. That does conclude today's presentation. You may now disconnect.