Brown & Brown Inc (BRO) 2005 Q1 法說會逐字稿

Good day everyone and welcome to the Brown & Brown Incorporated first quarter 2005 financial results conference call. This call is being recorded.

Before we proceed we would like to inform you that certain information will be discussed during this call, including answers given in response to your questions, may relate to future results or events or otherwise be forward-looking in nature and reflect our current views with respect to future events, including financial performance, and that said statements are intended to fall within the Safe Harbor provision of the securities laws. Actual results or events in the future are subject to a number of risks and uncertainties and may differ materially from those currently anticipated or desired or reference 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 reports 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 filings with the Securities and Exchange Commission. Listeners are cautioned that any such forward-looking statements are not guarantees of future performance and that actual results and events may differ from those indicated in this call. Such differences may be material.

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

Thank you Rochelle, and good morning everyone. We’ll open up the conference call and I’ll ask Cory to talk about our financials.

Well thanks, Hyatt. We had a great quarter. We were very fortunate to have a little bit more profit sharing revenues this quarter than we thought that we would receive. As a result, our earnings per share for the quarter was $0.62, up 17% from the $0.53 we earned in the first quarter of 2004.

From a revenue standpoint, commissions and fees for the quarter increased 21.9% to $200.3 million. That was up from $164.3 million we earned last year’s first quarter. Included in our press release again is a table that summarizes our total growth rates and the internal growth rates from our core commissions and fees, which as you know, excludes our profit sharing commission, as well as the revenues from offices or books of businesses or programs that we’ve sold or terminated since the second quarter of last year.

We’ve also included a complete reconciliation of that internal growth schedule to our total commissions and fees line item in our income statement. As you can see, the only reconciling item for 2005 is the profit sharing commissions of $27.8 million, which, when you add it back to the commissions and fees, will agree with the total of $200.3 million of total commissions and fees on the income statement.

Now, that $27.8 million of profit sharing commission that we received in the current quarter, it represents around $2.5 million more than we received in last year’s first quarter. Florida retail actually did a little bit better in this department than we anticipated in that they were only down by approximately $2.5 million after those four devastating hurricanes. In fact, every office in Florida received less profit sharing commissions than they received in the prior year, except for three offices.

This expected downturn in the Florida Retail was more than offset by an approximately $5 million increase in the profit sharing revenues from our National Retail Division, and of that $5 million increase in the National Retail Division approximately $3 million of that profit sharing revenues came from offices that we acquired in 2004.

And our best guess of how much profit sharing revenue we should receive for all of ’05 right now is somewhere between $30–$31 million. On a quarterly basis, our best guess right now is that we’ll probably receive between $2–$2.5 million in the second quarter of this year, which would be compared to the $3.5 million that we received in the second quarter of ’04.

For the third quarter, we’ll probably receive less than $0.5 million this year versus $1 million we received in the third quarter of 2004. And in the fourth quarter we right now are only expecting probably less than $200,000. But overall, for the whole year we expect our profit sharing revenues to be flat relative to 2004.

Looking back at our internal growth schedule, our total core commissions and fees for the quarter increased 26.7%, or a $36.4 million of total new commissions and fees. Now of that total, $31.6 million represents the revenues from acquired businesses since last year. The remaining $4.8 million of revenue is therefore internally generated organic growth, which reflects a 3.5% overall internal growth rate. Hyatt is going to talk about the activities in each one of our business segments in a minute.

However, moving on, looking at the investment income line, investment income increased by about $277,000 and that was due to the higher cash investment that we had available from our debt offering last year mainly during the month of January and February because it fell off in March due to our initial cash payout due to the Hull acquisition.

On the ‘other income’ line item we had approximately $1.1 million and in addition to just miscellaneous income items that come every quarter, we did have some small gains on some sales of various books of businesses.

Directing our attention now to just our expenses and our pre-tax margins, there was a full 1.1 percentage point reduction in our pre-tax profit margin from 35.9% last year to 34.8% in the current 2005 quarter. Interest expense alone increased 1.4 percentage points due to the additional $200 million of the private placement debt. The good part about that is that our interest rate on that $200 million is a little bit less than 6% and we put a lot of that money to work already for acquisitions that are earning in excess of 30 percent operating profit margin.

Additionally, we did talk last quarter about our change in our accounting estimate of reducing our amortization period for purchased customer accounts from a 20-year period to a 15-year period. This change does add another $1.5 million of additional amortization expense each quarter.

So, with those 2 items, just as a point of reference, and I want it to be known that I hate using the term ‘EBITDA’, but with that said, our EBITDA margin, which will exclude that interest and the amortization impact, and even when you pull out the impact of our profit sharing revenues, that margin improves from around 37.3% in 2004 for the first quarter to this year to 38.1% in the first quarter of 2005. That’s approximately about 80 basis points.

Now, that margin improvement came primarily from our compensation and benefit expense line and increased at a slower rate than our commissions and fees revenue line increased. Now, there’s no one item that overwhelmingly accounts for that improvement. However, as you know, our bonus system in general requires a 5% increase over the prior year operating profit before there is even $1 more of bonuses that are paid out.

Now, in addition to that, we did have approximately $500,000 less in 401k expenses and administration fees due to the forfeitures.

On our other operating expense line item, they increased approximately 50 basis points over the 2004 quarter and that was primarily due to increased Professional fees.

So, therefore, we really are proud of our folks for generating a pre-tax income of $70.5 million, which is an increase of 18.8% over the $59.4 million that we earned in the first quarter of 2004.

Our effective tax rate for 2005 has increased to a little under 39%, which is a full 1-percentage point higher than the rate used in 2004. This increase is due to the fact that more of our income, which is mainly due to the acquisition, are being earned in states that have a higher state tax rate than Florida. So, we believe that the 39% effective tax rate is what we will incur for the entire year of 2005.

So to kind of conclude on the income side of the press release, we ended up with net income of $43 million, an increase of 18.4% over last year’s net income of $36.3 million. So, a pretty good quarter.

On our balance sheet we have approximately $85 million of ready, non-cash -- non-client cash at March 31, 2005. Now, that includes $50 million of short-term borrowings from our $75 million line of credit. So, if you add in the other $25 million available on our line of credit, we essentially have over $100 million of available cash.

Additionally, we generate a little bit over $12 million on average of free cash flow each month, so should additional acquisitions present themselves in the coming months we’ll use these funds, obviously, for those purposes.

We also believe that our lower-than-industry-average debt to total capitalization ratio of 33 percent still allows us to borrow additional funds, again, if the right opportunity came along.

So, with that financial overview I will turn it back to Hyatt.

Thank you, Cory, good report. Getting into our operational areas, first of all, Florida Retail, internal growth was about 6.7%, down from 8.4. Florida is sort of a mixed bag in terms of the marketplace. Worker’s Comp, there are several new entrants into the market, therefore, more competition. There’s a lot of competition on accounts with a more than quarter-of-a-million in premium and up. And on the smaller accounts, less than a quarter-of-a-million, there are several Specialty carriers that are filing additional dividend plans, which will make them more competitive.

So, that area, that’s good for the consumer and good for us too because I suspect around 25% of our business in Florida is Worker’s Comp.

The standard companies, and when I say that I mean its National companies, really aren’t particularly competitive in this area at the moment and I presume that’s because they really aren’t sure exactly whether or not they want to play.

Property -- pricing is going down except in the tri-county area, which is Broward, Dade, Palm Beach. Wind-only coverage is going up very substantially and that’s where the insurance is placed for all perils excluding wind, and then we go to a Specialty carrier for the wind and those things are going up a bunch.

The frame and joist and masonry risks around Florida, many of those, which are only going to be insured by the citizens, which is to say not an insurance company, are going to see a pretty chunky rate increase some time later in this year because the citizens had a very substantial loss during the windstorms.

In the G/L and Auto area, Auto is getting very soft. Kind of strange. Again, new entrants trying to write Auto insurance -- and these are fleets I’m talking about now, small and middle-sized fleets -- and one carrier is cutting fleet Auto just right out of the bucket, 25% over expiring.

D&O continues soft. Contractors, residential exposure, very tight. Other contractors, the prices are softening some, but not like some of the other areas of risk types. Benefits in Florida continues to grow, so overall, Florida is Florida and we obviously have our largest market penetration there and we have the deepest culture, and of course, we are exporting leaders constantly from Florida to elsewhere to carry the culture.

National Retail, let’s look at that for a moment. We grew only 2/10 of 1%, down from an internal growth of 3.8%. Regional -- and we’ve talked about this in the past -- are going after accounts with a vengeance. We’re seeing renewal prices 20–30% less than -- this is packages now -- less than expiring. WC is dicey, and don’t forget when you’re talking about National Retail you’re talking about everything other than Florida and west of Colorado, so there’s a great diversity of states, but Work Comp is dicey in some of those states.

Auto fleets are flat to down 5%, so you can see that’s different than it is in Florida. The construction business is just suffering heck it’s just habitational. Umbrellas are flattish. New York City market area is probably the most, in most cases, is probably the area where prices are less apt to go down substantially.

National Retail again is going to struggle with internal growth and I think it’s primarily because of the fact that at the Regionals, of which we do a lot of business, are being very, very competitive, and, of course, they’ve been very profitable too.

Western Retail had another sinking spell. They were down 4.4%, down from 3.8% last year -- or last quarter, and it’s really basically a very, very competitive marketplace. There is just aggressive competition all over the place.

Renewal decreases of 30% are not unusual, and again, Auto out west is very competitive. Many companies, just like in Florida, filed for lower rates. Property is not so soft, but Property in the west represents a much smaller percentage of premiums because you don’t have, other than the quake, of course, which generally is separately insured, Property doesn’t have a huge catastrophe exposure.

Worker’s Comp continues to be more competitive in California, and that’s good. GL on habitational contractors is flat. Now, we write a bunch of that out west and if you take Nevada, California, and Arizona and Colorado, there’s a lot of business here that we write. And those prices are not going down.

So, in the west I think we’re going to do a little better this quarter. Company-wide we did have a particularly good January/February in terms of new business, but we did have a good March in terms of new business.

Moving over to the Professional Programs, down 2% from a plus-9.1. Calsurance, which is the largest piece of Professional Programs, just had some pricing pressure and they were down about 2%. Lawyers was also down about 2%, which was basically due to a difference in commission income. Dental was up 8% and so Dental continues to grow. I think that’s now the third, maybe the -- I think the third quarter in a row that we had a positive growth in Dental, so that’s good.

Special Programs is up nicely, 14.9% over a 5.3% plus number for last quarter. The (Indiscernible) Washington FIU and PRU (Indiscernible) Underwriter, lead the pack. And Brokerage Services and now on an annualized basis we have about $125 million of Brokerage business. Now what that basically is, it’s jumped substantially because of the Hull merger. And Brokerage continues to be doing very well. They’re up 20.5% and some of this is in pure Brokerage and some of it is in Binding Authority.

Binding Authority, of course, are smaller middle-market accounts, harder to grow it and it’s also -- it’s resistant somewhat to the downtrends, although we are getting substantial decreases in Property, and have for a couple of years in that area. Peachtree is the leader. BMB Re (ph) did very well. Energy and Marine in New Orleans did very well.

The areas in which we’re growing is lots of Construction, lots of Property, and some Professional coverages. And we think Brokerage is going to continue to do well. TPA, well, what can I say. They’re just there every day, chugging along, grew 11.3%, down from 13.2, and their margins continue to grow nicely.

PGCS, that’s about a $3–$4 million, maybe $5 million of revenue, which specializes in a public entity work, their margin is already just slightly above 25%. USIS, who has the biggest chunk, about $20 million last year, continues to do very nicely. They’re operating just around -- just above, I believe, 22% and they’re headed towards that 25, which is, as you know, the minimum.

So, we’re kind of pleased. The 3.5% overall growth is in line with the 0–5% internal growth that we talked about. And so now, I’m going to turn it over to Jim to talk about M&A and several other issues. Jim?

Thank you Hyatt, and good morning. We’re obviously very pleased with the merger and acquisition activity in the first quarter and this past year. Very proud of the high-quality organizations and people that have chosen to join Brown & Brown. The quality just continues to improve. The day-one margins of these businesses certainly meet our expectations and join the margins expected by Brown & Brown.

These businesses are sustainable, frankly, for the long run. One of the questions often asked us is how is the pipeline? And we would tell you it’s very busy. It’s really the best of opportunities, and likewise, it may also be the most challenging of opportunities from a merger and acquisition standpoint.

The best of times is the number of deals and the average size of those deals. Looking at the market is perhaps as strong as ever we have seen. Frankly, many of these deals have very, very good numbers.

It is our intention to pick the best of those opportunities, in fact, we feel that’s where our strength continues to show. We’d like to pick those businesses that fit best in our core business plan and that is, in fact, the middle market customer. People always make the difference with respect to acquisitions, those with the same culture, those that in fact that they come with us and we change the least their operation to join us.

To exercise the discipline to continue to probe and to look at these businesses, realizing the last several years that they’ve been bolstered by a premium tide that in fact has kind of elevated all shifts and we need to pick the best of those opportunities that are recurring revenues going forward.

Post the recent activity in acquisitions, our product mix will be relatively the same, with the Retail continuing to represent close to 70% of our business mix.

Turning now to talk about people and our bench, talk about Brown & Brown University, which we’re very pleased with the progress there, with identifying and training future leaders. We have expanded the number of classes taught and have entered into a 5-year agreement to grow the program on a national basis.

The new business produced and the leadership positions assumed by the graduates of B&B University is very encouraging. We have hired some outside talent, but feel that we need to continue to reinvest to grow our own talent. This coming year we will allocate -- we’ll continue to allocate 1% of revenues for people that are not in the budget. This will represent some $8 million on a go-forward basis.

Bench strength is a very important priority at Brown & Brown. To execute a plan of continuous improvement requires bench strength and frankly leadership mobility to replace leadership that may want to retire or seek other opportunities.

Our operating strength and discipline in the foundation allows Brown & Brown to find and execute and integrate acquisitions, so it in fact that it is this bench strength that allows us to take on these new opportunities.

The continuous improvements that we make in our operation is, in fact, predicated upon having leaders willing to step in and go to the next level with operations. In this past year we’ve upgraded a number of the offices from retirements of those who would like to move on and today we have the fewest number of Profit Centers operating below the 25% margin, frankly, in our history. Most of these units operating below 25% are new ventures that present outstanding growth capability.

Lastly, I’d like to go back and touch on the underwriting profit sharing results for the first quarter of this year. Cory had touched on this previously.

We are very pleased that the underwriting profit commissions received in the first quarter of this year actually exceeded ’04 by some 7.7%. This increase occurred despite the fact that hurricanes resulted in a reduction of profit sharing some $4.9–$5 million that would have been this year without the hurricanes.

We’re also very pleased with the 141 different carriers paid an underwriting profit commission to Brown & Brown in the first quarter. This was paid to 111 different Profit Centers.

Based upon our best knowledge, all of these profit sharing commissions are for at-risk underwriting results produced to our carrier partners. And first we must produce an underwriting profit, and secondly, there are certain performance criteria that will enable us to secure payment.

Lastly, I would like to extend a very special congratulations and thank you to some 4,600-plus employees that made the outstanding results possible. Our employees truly are our strategic advantage. And thank you very much for all you have done.

So Hyatt, I’d like to turn it back over to you for wrap-up and then also to open for questions.

OK, thanks Jim. Good report both Jim and Cory. We’re looking forward to this next quarter and the rest of the year as being a good year. It ain’t going to be easy. We think that pricing will continue to soften. We think that the underwriting profits, as you can see from the reports of the various risk bearers, which are a lot of them in the 90s, most of them are in the 90s. That’s in the history that I’ve been in I’ve not ever seen this kind of profitability.

Now, also, I never saw such bad losses and the problems of asbestos and other things, environmental claims. So, I think we’re going to continue to see a very touch marketplace and we operate very well in this kind of marketplace, so we’re feeling good.

So, having said that, Rochelle, would you like to open up the phone for questions?

Certainly. (OPERATOR INSTRUCTIONS)

Nick Pirsos, Sandler O’Neill & Partners.

I have 2 questions. First is on commission rates and the second on contingent commissions. On the commission rate side, are you seeing any push up so to speak on the rate level, either due to the effect of the cycle, where we are in the cycle right now, or second, just due to structural changes in the industry?

Is this Nick?

Yes, it is, Hyatt.

Okay, Nick. I guess the question is, because of the push to write more business with Company A, are they increasing the commissions, is that the question?

Exactly.

OK. I haven’t seen that yet, but that’s coming. And the second question, say again.

And then just staying with kind of the rates itself, are you seeing any changes -- well, if you haven’t seen the changes yet, then I guess you haven’t seen any structural changes, ie: the companies wanting to pay a little bit more on the front end because they’re going to pay a little bit less on the contingent side.

No, we haven’t seen any of that.

Okay. And then just a second question on contingent commission in general. Last year there was a timing impact between, I guess, the first quarter and the second quarter with more being recognized in the first quarter compared to 2003. Were there any timing issues in ’05 between the first quarter and the second quarter? Just trying to get a feel for any change?

I think it’s about the same, Nick. Obviously, what happens is we’re subject to the vagaries of the risk bearers. And sometimes they are slow sending the money. Sometimes they’re fast, but it kind of averages out when you have 141 different companies, it sort of averages out. So, we’re not aware of anything that would cause a bigger blurb in the first quarter than was expected.

And Nick, I had previously kind of thought that because of the hurricanes there might be some slowness on a carrier side, but that really didn’t show itself and so, on a go-forward basis, I think I gave kind of the estimate of from talking to the various offices who have talked to their underwriting cohorts at the Company, the projection that we got right now is probably pretty much flat, somewhere around the $30–$31 million in total contingent, so at least you have the full picture.

David Lewis, Suntrust Robinson Humphrey.

Jim, can you talk a little bit about the Brokerage side? Obviously, 15.5% internal growth is outstanding. I know Hull is going to be a big contributor coming into that operation. As the cycle starts to soften, historically haven’t we seen people loosen up on the underwriting? Therefore, the Brokerage might become a little more challenging as you move forward.

David, I think the answer to that is that typically is part of the cycle. I think we are blessed with having a significant part of our Brokerage really in the Binding Authority side, which probably is impacted less by that market change than there is in the transactional or the Brokerage, meaning the one-off placement. The 2 pieces of that business is one where it’s small items that fits into a box and we have certain authorities for the carrier to help execute that transaction. The other side, the transactional is one that’s really capacity plays. That can be impacted there. So, we have not seen that as of yet.

And Jim, does Hull & Company receive contingent commissions with its carriers?

They receive profit sharing commissions under their Binding Authority side where they represent carriers doing a lot of front-end underwriting inspection and binding policy issuance on behalf of the carrier. And if they produce profits for them they can participate, yes.

So, do they normally get paid in the first half as well and did you benefit at all since your acquisitions was just March 1st?

Well, we had -- there was some spillover -- there was some spill in March. Based upon what’s received, which is our -- the approach there is when it comes in is when we recognize it and so we had some degree of profit sharing in March. The vast majority of their profit sharing really came in the first and second month of ’05. That was prior to the acquisition date.

Okay. So, it would be a bigger better factor in ’06.

Correct.

Hey David, just to correct the record, I think I had said 20.5. It’s correct at 15.5 growth.

Okay. And I guess back to Jim, Palmer & Cay obviously acquired by Wachovia a few weeks ago, do you think that the banks become more aggressive acquirers in the Brokerage area? I know it doesn’t affect the smaller acquisitions, but what’s kind of your thought process there?

Well, this is certainly in line with their announcement that they wanted to go out and buy an operating unit that was a bigger platform perhaps more in the risk management area and moving in that direction, which is different than what we -- our game plan. So, the number and quality of those continue to -- that would be attractive to the bank --

I think, in general, what our friends at some of the consulting firms have provided is that the banks in net slowed down the last 2 years. So, this transaction is a little bit of an exception to that. So, it’s amazing too, we don’t seem to run into a lot of banks with many of the opportunities that we’re looking at.

I think also, David, in terms of the bank, for a bank to look at a $5 or $10 million operation, particularly when you look at the size of the bank like Wachovia, I mean, they almost can’t even see that. So, they’re really wanting to have some big chunks so they got a bunch of revenue all in one glob.

The banks I’ve talked to clearly want to have a major platform to work from and I would even think Wachovia would want to continue to expand on their platform and may even bring into some of the smaller publicly traded companies.

Dan Thompson, Citadel Investment Group.

I want to make sure I have the math here right on the National Retail. It sounded like of the 5 million increase in profit sharing commissions three was acquired, two was organic. I guess, if I do the math, that would mean that organic revenue, excluding profit sharing, would have been down about 4%. Is there any way that you’re able to get your hands around how much of that was price-driven versus, say, production-driven?

Relative to the internal growth --

Well, on the contingent commissions, we don’t -- we exclude that from internal growth. Internal growth is trying to focus on what is the insurance rate environment doing and this is based on profitability, so it’s hit or miss. Yes, of the $5 million of other net increases, about $3 million of it came from acquisition-related entities.

For instance, like we bought back in March Florham Park. Well, that’s 9 months, so they generated an additional one million of contingent commissions of that three million. So, if you want to call that organic or acquired, then that’s it. Does that answer your question?

I guess it really doesn’t matter. The issue isn’t really about the contingent. It was more or less when you look at the organic on the National Retail side are you able to discern or even have a feel for what prices then to that, essentially zero than organic number and how has that changed, say, over the last two or three quarters?

No, we basically talk about the general rate environment, as Hyatt had mentioned, each of the business segments in terms of what Worker’s Comp is doing, what Property is doing, and there is no way of calculating on a precise basis how much is rate out of that growth versus exposed unit growth versus new business.

And the other thing that makes it even more difficult, Dan, don’t forget there are a whole bunch of states and they are very diverse. You start out in New Hampshire and it goes down through New York and Pennsylvania and over to Michigan and Minnesota and Wisconsin and then down to Texas and Arkansas and Oklahoma and Georgia and South and North Carolina and Virginia, et cetera, and so every one of those is a discreet market really. Hard to put your finger on.

Sure. And then one sorry for the basic question, with your profit sharing, is it important to make distinctions between those that are derived from Brokerage versus appointed, or agency-type relationships?

I don’t think so. Basically the profit sharing in the Brokerage area comes from the Binding Authority business where we have a matrix of when we get a risk and it falls within that matrix, then we do the underwriting -- make the underwriting decision. And so that’s really where the contingent commissions for profit sharing come in.

And, of course, under that Binding Authority, that’s basically where we have the pen and the profit sharing arrangement is even more important because they need to make sure that the program is profitable. And this year with the hurricane, we had -- that’s probably where a large significant drop in the profit sharing commissions came from.

Dan Farrell, Fox-Pitt Kelton.

Just a couple of questions. Firstly, can you just review your rate assumptions going forward for your organic growth targets? And then secondly, could you touch a little bit more on the organic growth in National and Western Retail? What are some of the things that you’re doing there to try to improve organic growth there? I realize a lot of that has to do with the pricing environment, but those states have lagged Florida pretty consistently in the past and is there a way to get back organic growth levels up to where Florida is?

Well, first of all, our organic growth is estimated to be between 0–5%. And quite frankly the internal growth of each Profit Center is really dependent upon the leader of the Profit Center. If you have a really good leader, even in bad times, they’re going to grow. If you have not a very good leader, even in good times they don’t grow much.

And so, what we’ve been doing is we are continuing to push to: a) try to implement additional kinds of programs that could help our various offices. Now, for instance, we were able to write an account in the Las Vegas office, which was a large pest control operation because we found our way to a company that had a special program. And it was really because that office and that leader and that marketing major (ph) were able to find their way to that company, and as a result wrote that account.

So, we are trying -- we have a distant early warning system that is on email, which basically is any time that we find a new market or some change in the market, that’s put on the email system, so all the marketing managers and all the offices have knowledge of and access to the information. Now, they may not be able to get to the company, to the risk bearer.

So, in this kind of a marketplace you have good news and bad news. The good news is that you’re going to find all kinds of people willing to write new business. The bad news is you’re going to find all kinds of people willing to compete against you for existing business and new business.

So, we don’t have any particular rate assumptions because we don’t know what the rates are. And each of our offices, the managers of each of our offices, our Profit Center managers, if they do not grow their operating profit by 5%, then their bonus goes down ratably based on less than 5%, 4%, down 3%, so and so forth.

So, each office then would have a goal for the year established by that office and the Regional Executive Vice President responsible. Now, obviously, when you’re looking in November and December to try and estimate what’s going to happen in the first quarter of this year, you can have probably a fairly good idea. Can you estimate what’s going to happen in July back in November and December? No.

So, what we have to do is, whatever it is, what the rates are, we’ve got to get there.

Nick Fisken, Stephens, Inc.

It’s actually Shane sitting in for Nick. Quick question for you, Hyatt, or maybe Jim, on the FIU operations. Can you talk about the turnaround, I guess, that you’re seeing there? I know you had some issues last year I guess with aggressive competition that hit kind of the growth. Can you talk about maybe what you saw in the first quarter from FIU?

Well, we have had some improvement there and frankly we’re back to more of making our budget as opposed to falling quite short of that. And I think there are several factors there. The capacity, the catastrophic Property capacity, and you can think of it even worldwide, that it would be take to write the wind-exposed properties in South Florida, we have in fact our annual treaties are in very good shape and therefore we have been able to move forward and write some new business. And some of our competition has not been able to due to the fact that they do not align new capital to permit that to happen.

So, we feel very fortunate that our program there, that’s been there for many years, and has sustainable capacity, frankly is giving us a nice advantage now to write that business.

I think, Shane, one other thing that you may be aware of, in Florida new condominium projects are sprouting every day. It is unbelievable and it’s not just in the tri-county area. It’s all over Florida, primarily in the coastal area. And so the FIU doesn’t write Builders’ risk, but they’re having new condominiums come on that are completed that have to have to completed value insurance, and that particular area is increased activity. But the number that are just now coming out of the ground, which it takes, let’s say 15–20 months to complete them, when that hits that’s going to be an additional plug.

And so we’re feeling good about that.

And then, looking at the Hull acquisition, I know you guys only had really about a month, or I guess almost 2 months, with them onboard. Can you give us any thoughts on maybe some of the positives and negatives that you’ve seen post-closing that acquisition and maybe any thoughts of, I guess, unexpected cost days or changes, I guess, kind of plan versus actual for those guys?

Are you talking about Hull?

Yes.

No, as a matter of fact Hyatt and I had the pleasure of visiting, I think 14 or 16 of their offices this past month and we would have gotten into Great Falls except that the dust from Mount St. Helens would not permit us to get there, so we got to (Indiscernible). But no, the -- as a matter of fact the depth, strength of that organization as we get in and we get to the second layer inside it’s even better than we thought. Just great people. And we just -- we have a platform there of great people to not only what’s there but to grow it, so we’re just very encouraged by it. So the numbers the first month were right dead on budget, so we can’t be more pleased.

And then, just a couple of quick questions for Cory. Any thoughts now that the proposal for stock option expense has been delayed? I know you guys had mentioned in your 10-K that you might look at early adoption. Any change in thoughts there, kind of the plan for you?

Well, yes, I’ll tell you. We were ready to do that and essentially, with the notice from the FDC, it kind of sent shockwaves and everybody was trying to figure out what’s the purpose of that being delayed and were they going to make some changes to it. So, on the advice of our auditors, we did not go on and implement it in the first quarter like we expected to.

So, right now I think we’re going to wait and see until they sort that out and make sure they’ve got the final rules. And so, it will be the first quarter of ’06. But just for informational purposes, we’ve got -- or the big plan that we have is the performance stock plan and that is already being expensed in accordance to 123-R. We’ve got a very small portion of incentive stock options and so right now our best guess is that would be about an additional $200,000 of an expense each quarter relative to that.

Then, the other plan that we have is the broad-based employees’ stock purchase plan and that’s where everybody can buy the stock in the Company at a 15% reduction. Of course, that has to be expensed, so our best guess of that is it’s somewhere around $300–$400,000 of additional expense each quarter for that plan.

So, even though we’re not implementing it, hopefully those numbers give you a little bit of insight as to where we kind of stand right now. But they’re still kind of working on -- nobody is really sure how -- what the best calculation is, so for whatever it’s worth, I throw those numbers out to you.

And then, just one final question for you, Cory. On the kind of D&A levels, I know within the organization we’ve had to true-up and begin in the fourth quarter and then now we have a holding company. Are we at a very good run rate yet in the first quarter, or will those levels, I guess, kind of continue to accelerate? And do you have any parameters you can put on kind of what we expect monthly, absent, obviously, additional acquisitions?

Yes, well, I think we’re pretty close. I would estimate that we’re going to have somewhere around, for the whole year, without any new acquisitions coming in and the change in the accounting estimate, we should have somewhere around $32.5 million of total amortization expense for the whole year is what our best budget projection is. And then, on the depreciation, we should be close to $10 million of depreciation expense.

(OPERATOR INSTRUCTIONS) Charles Gates, CSFB.

I only have one question. If you were to go back in history what period of time from a competitive standpoint would be roughly similar to what you see today?

Charles, actually you don’t have to go back that far, but we’ll go back to the beginning of the last soft market. The hard market started in the third quarter of ’84 and it went through the end of ’86, and then it started getting soft. And so, there were -- there were some ups and downs, but it started -- it was going south 5–10%, maybe a little more, each year. And then in the ‘90s it seemed to accelerate a couple of times and then flattened. But, I think the real 20–30% decrease was somewhere in the ’96, ’97, ’98 timeframe. That’s when we found out -- bear in mind and don’t forget, we’re talking about middle-market business. We’re not talking about the Fortune 1000 companies; we’re talking about middle-market business. This is vanilla kind of stuff.

How roughly do you define the middle market?

Well, good question! We think of it as the -- as commissions that are somewhere in the neighborhood of $2,500 to, let’s say, $300,000, so you’re talking about $10–20,000, $25,000 of premium to, let’s say, $3 million of premium. That’s what the middle market is.

From approximately $10,000 to approximately $3 million.

That’s right.

And basically the answer to my question was ’96–’98 roughly?

Yes, sir.

Charles, (indiscernible), if you go back to the last underwriting profit was made was 1978 by the carriers and there’s a litany of articles saying today that due to technology and to Sarbanes-Oxley and all these good things that the cycle is going to be more narrow and shorter. That’s yet to be seen.

Matthew Roswell, Legg Mason.

Three, hopefully, quick questions. The first one is for the contingent outlook that Cory gave. How much of that is coming from Hull? The second question is the compensation, as a percentage, commission fee improved about 130 basis points year-over-year. How much of that is tied to the increase in contingency year-over-year?

And then, a final question, I guess more for Hyatt, as to whether the -- it looks like the rate decreases are accelerating or not?

I think you mentioned in case of the profit sharing going forward (indiscernible) from Hull and our budget and the answer is zero from that in terms of any play with that. And I’m sorry, I missed the second piece of the profit sharing.

Second piece was the compensation, as a percentage, commission fee improved nicely year-over-year. It was up about 130 basis points. Any idea how much of that was coming from the increase in profit sharing?

No, I think that that change has perhaps even more to do with some of our mix of business. In fact, if we -- on the program side of our operation the compensation would be a lesser component than would be in Retail and also in Brokerage, so I think there was some degree of movement there. If you look at each component there, they’re relatively the same. Some degree of improvement in that if you take out profit sharing, which we look at really excluding profit sharing. Otherwise, it somewhat taints your results.

You asked a question about do I think that rates are going to continue to sort of go south.

Right.

And the answer is, yes.

At an increasing rate?

Well, I don’t know about that. It’s going to be -- it’s going to be different in different states, but you can tell from my comments in certain areas, 20–30%; other areas, that’s not true. So will the entire area and all the states in the United States become the same? No. But I would say that over this next 9 months that rates generally are going to go south from where they are.

Now, kind of alluding to what Jim’s comment was a little earlier, Matt, is that with Sarbanes-Oxley there’s one good thing that really came out of that is I think that it tightened up the requirements to be more consistent with probably loss reserving, and so I think there will be less of a tendency to be able to do cash flow underwriting thinking your reserves are a little bit heavy. And so, that’s where Jim was saying is there a possibility that rate cycles will be shorter and shallower than they have in the past and only time will really tell if that proves out. But that is an interesting thesis.

That will be interesting to see what happens.

Haney Sebas, Viking Global.

Just a few questions. Hyatt, you mentioned the different kinds of business in Florida and I think (indiscernible) put them all together, Florida is getting worse and we should (indiscernible) negative this year. I was just wondering what are your comments on that.

Second, just following on from a previous question, the market improvement that we saw in the first quarter on the compensation side, now you said (indiscernible) business mix (indiscernible) for the full year and coincident with that you said that the higher expenses were because of higher Professional fees. Again (indiscernible) that’s the full year and what Professional fees are those?

And then finally, on your debt-to-capital ratio you mentioned that the (indiscernible). I guess what level would you be comfortable with?

The first question, I need to ask you a question. You said it looks like Florida is deteriorating and therefore what?

We should probably see negative numbers organically, I guess is what I’m saying.

Oh, no. I think you’ve got it backasswards. As things get more tight here in terms of the market prices go up, therefore, that’s positive. You’re thinking about it from an underwriting standpoint. We’re thinking about it from a Brokerage or an agent.

I guess I mean -- you mentioned Worker’s Comp soft, (indiscernible) soft, (indiscernible) soft. (indiscernible) more soft than (indiscernible).

Oh, yes, well, the answer is (indiscernible). That’s just the marketplace. We’ll be writing more business; we’ll be growing, so Florida is going to continue to do well. Now, are they going to grow 6% or 9% or 3%? I don’t know. But I wouldn’t be at all negative on Florida.

Now, the second question on the compensation, keep in mind, the first quarter as a percentage of total revenue, that 44.7% was employee compensation benefits, that is a quarterly low historically always in the first quarter because of the impact of contingencies. On a go-forward basis I think you’ve got to look at probably closer to a 49–49.5% in terms of total compensation is what we’ll probably end up with.

That’s our revenues. I haven’t included contingencies.

Well, that would be including contingencies on a -- on an annualized basis. Now, on the Professional fees they did increase in the first quarter and we would kind of expect that to be somewhat the same, maybe starting to tailor off, obviously, hopefully later in the year. And the sooner it can tailor off the better it is in my view.

And what was the third question again?

Your debt-to-capital ratio, I guess, what’s the maximum you’d be happy with.

Well, we don’t know. That’s a good question. We are not very overly aggressive on that, meaning that we’re not going to borrow more money than we think we can absolutely handle. So, as we go down the road and opportunities present themselves we’ll make that decision. But, I think the average for the -- for our peer group is somewhere in the 45% area, but I’m not -- I don’t -- 45–50, but if you look at the interest coverage ratio, (indiscernible) ratios much higher.

And one final question. What’s the interest rate on your line of credit that’s under $5 million?

It’s running roughly 3.5% right now. It’s tied to prime.

Ron Bobman, Capital Returns.

I have 2 quick questions. One was, Hyatt, what’s the current thinking on the change in the attachment (indiscernible) in Florida for the hurricane CAT Fund? I think it’s sort of still pending or in the legislature. Could you update what you’re hearing in that front, please?

Ron, I think the legislature and the Chief Financial Officer was trying to look at the capability of the CAT Fund as a way to help attract really third-party capital to Florida to write more business to help, if you will, reduce business in Citizens. And who knows exactly where they end up on that.

Now, the CAT Fund, mentioning that, was designed to be an event coverage, meaning there were 4 deductibles in ’04 and therefore, there was not much payout in the CAT Fund to the carriers as would have been anticipated probably in a design of the CAT Fund and they’re going back and re-assessing that. It would appear that it’s going to go into some type of a modified deductible that would be more generous the carriers in ’05 and beyond than ’04. So, this will help attract capital to provide markets to help us. So, I serve on the Advisory Board of the CAT Fund. Frankly, the state has done a great job of protecting that money and then designing a way to use it to help attract capital to Florida.

Are there specific numbers as far as what’s on the table for a first event, a second event, a combined third or fourth, something to that effect?

Well, there is, but I think the technical interpretation and implementation of that is far beyond the impact on us because what rates reside in the CAT Fund are not necessarily passed on to the public.

OK, I’ll move on to my second question. How concentrated are your contingent payments by carrier? Could you share some sort of metrics?

They’re extremely dispersed. As I told you, we have 141 different carriers that paid us profit sharing. Our largest carrier, this organization represents approximately 6% of our premium volume and relatively the same with respect to the profit sharing with that, so it’s extremely dispersed. And as I mentioned to you, 111 different offices received payments directly from those carriers.

If you talk about Regional companies, Ron, as a class (indiscernible), that really represents a larger part of our market as a company than in fact the National organizations.

Matthew Minot with (Indiscernible).

I wanted to ask you all, yesterday in Philadelphia Ellen Vink (ph) of Rims (ph) called for abolishing contingent commissions and sort of going for a unified front by the Risk Insurance Managers Society. I was wondering if you all could comment on that and to what extent that Society covers or doesn’t cover the types of clients that you all have. Thanks very much.

Well, obviously, those are the Fortune 1000 risk managers and I don’t quite understand what they’re saying because, you see, if a broker has a fee on an account and they agree that the fee is all that they can take on that account, then what the risk managers are saying is they’re asking them to reaffirm that that’s all they’re going to take on the account. And if they take something other than that, then they’re violating that contract. So, I’m a little confused about that.

Now, relatively speaking though, the risk manager of the business, which is the largest business in the United States and I think there’s maybe $10 billion of revenue (indiscernible) is not where we are. And the large, maybe $30–$35 billion of revenue that’s not represented in the Fortune 1000 is what we call the middle market, the vanilla and sometimes not-so-vanilla middle market.

So what we feel is that contingent commissions based on a profit sharing hurdle, which is what the huge majority of ours are, are actually beneficial to the consumer and also beneficial to the long-term health of the business itself. And I’ll give you a very perfect example.

When I started in the insurance agency business in 1956, when I was working part-time out of college, I asked my Father, “What is this $2,800 contingent commission based on profits?” with this big long sheet that showed all the losses and et cetera. And he said, “Well, it’s come about as a result of the fact that as the companies were expanding in the United States they were trying to place some underwriting responsibility on the shoulders of the agent.”

And of course it’s hard to find an agent who doesn’t think that every risk is a good risk, but when all of a sudden they start realizing that some aren’t so good, then -- and if they get some compensation for writing good risks and doing front-line underwriting, then that’s beneficial to the client.

Here’s one of the things that I found was that in those companies where we had good underwriting loss ratios, and this was back when I was writing accounts and it applies today equally as well even though I do not write accounts, I found that in a case that where I represented, or we here represented Company A and agent X down the street also represented Company A, and we have a good loss ratio and we’re getting contingent commissions and they weren’t, that we could be more competitive, price and coverage, on new and renewal accounts and that gave us a leg up.

So, the situation in the risk management account is that the risk managers themselves ultimately are going to determine whether or not a risk bearer can make money on their account. And so, if they can or can’t, then that’s up to the risk bearer to make the decision.

When you look at the broad base of sort of the vanilla-ish kinds of accounts, the middle market, if accounts are not interested in loss control, if they hire poor drivers who have accidents and kill people, if they ignore safety rules and have injured or maimed employees as a result of their not being able to see the advantages of having a safe workplace, then those people ought to pay more and maybe go broke. Those people who do though adhere ought to pay less and ought to be more competitive and therefore, would be able to grow their businesses.

So, we think that contingent commissions, based on profit sharing, based on an underwriting hurdle, are in the best interests of everyone and that when the folks in the risk management business are talking about contingent commissions, they’re talking about something different. They’re talking about contingent commissions that aren’t based on profits. They’re contingent commissions based on, as I understand it, volume and that’s really not what we’re talking about.

Does that answer your question?

It does indeed. Thank you very much.

Probably more than you wanted to hear.

It was more than I bargained for.

David Lewis, Suntrust, Robinson Humphreys.

A quick follow-up. Hyatt, obviously you talked about the softening market, but one thing we haven’t really talked about is changes and exposures and coverage levels. Obviously, in the hard market the risk managers pull that back a little bit to keep the effect of the rate change. Can you talk about what you’re seeing out there now that the prices are softening?

Well, one thing that is nice, David, is that generally speaking business is pretty doggone good around the United States and that means that (Indiscernible) interests are going up. And we’re seeing some additional premiums on Audit, so that’s a little bit of an underpinning. Back in 2000, as rates were rising, we were also seeing a reduction in the number of (indiscernible). So we have a little bit of help from the standpoint there’s a business cycle to it.

Is that the question you were asking?

Yes, but even if the cycle is flat, don’t risk managers typically say, “I’ve got a million dollars to spend. I want to reduce my risks.” versus the hard market where you had to take on a little more risk?

Well, that’s true, but you’re talking about risk managers and we’re talking about the owner of a business or the accountant of a business and what they’re saying is the same thing, “We don’t want to spend more than X for our insurance.” And so, therefore, when you get to X, then tell me what I can buy for that or tell me how to reconfigure. So, yes, as prices go down, then there are additional lines of insurance that are written because maybe they had been written before and the decision made to drop the coverage during the early part of 2001-2-3.

And one of the areas would be, David, additional limits on umbrellas where someone had $10 million and they dropped it to $5 or $2 and now they can go back to $10.

Right.

And I’ll tell you, the other thing is when you have a catastrophe like we had 4 hurricanes in Florida and where you have so many counties in Florida that got hit by one or more of them, I do think you get people who tend to think more long term and say, “I really probably ought to increase the value on the -- that I’ve got my building reported at or my inventory.” and that kind of thing. So, you do have a tendency to have a little bit of increase in coverage, just on the natural basis in areas that you have catastrophes.

And that doesn’t just mean Florida either, David. It means from Brownsville all around the Gulf and around Florida all the way to New York City.

Nick Fisken, Stephen Inc.

I just wanted to clarify, I think it was Jim’s comment earlier on the contingents from Hull, did you say those were not in the budget or you weren’t forecasting growth? I just wanted to be clear on exactly what you said.

Well, Shane, I think the question was, did you -- if you look at the balance for the year you have numbers in there for Hull, and the answer is, No, they’re not in there. First of all, we never budget the profit sharing commissions to begin with. And then, Cory’s comment with respect to being in the range of roughly last year by the end of ’05, in that projection our thought is there is nothing coming in from Hull & Company.

And there are no further questions.

Thank you very much, Ladies and Gentlemen, and we’ll see you in July. Be here before you know it.

And that will conclude today’s conference call. Thank you for your participation.