Brown & Brown Inc (BRO) 2006 Q4 法說會逐字稿

Good day, everyone and welcome to today's Brown & Brown Inc. conference call. As a reminder, today's conference is being recorded. Before we proceed, we would like to inform you that certain of the information that will be discussed during this call, including answers given in response to your questions, may relate to future results and events or otherwise forward-looking in nature and reflect our current views with respect to future events, including financial performance and that such statements are intended to fall within the Safe Harbor provisions of the securities laws.

Actual results or events in the future are subject to a number of risks and uncertainties and may differ materially from those currently anticipated or desired or referenced in any forward-looking statements made as a result of a number of factors, 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 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.

Speaking today will be Mr. Hyatt Brown, Chairman and Chief Executive Officer; Mr. Jim Henderson, Vice Chairman and Chief Operating Officer; Mr. Cory Walker, Chief Financial Officer; Ms. Linda Downs, Executive Vice President and Mr. Powell Brown, President. With that said, Mr. Brown, I'll turn the conference over to you.

Thank you, Amy and good morning, everyone and we will turn the meeting over. The batting order will start off with Cory who will make the financial report.

Thanks a lot. We had a good fourth quarter with the exception of a $5.8 million payment to the state of Florida to end over two years of discussions relative to the [Spencer] raised issues. As a result, our quarterly net income increased only 5.3% to $37.6 million. Excluding the $5.8 million payment, our net income increased 15.3%.

Total revenues for the quarter increased 9% to $214.7 million, up from the $196.9 million recorded in the fourth quarter of 2005. Total commissions and fees for the quarter increased 8.6% or $16.7 million of net new commissions and fees. Core commissions and fees, which exclude the profit-sharing contingent commissions as well as revenue from sold or divested businesses, for 2006, fourth quarter increased $17.3 million over the fourth quarter of last year and of that total, $12.5 million was generated from businesses that we acquired since the third quarter of 2005. The remaining $4.8 million of revenue between the total core commissions and fees and what was acquired was therefore internally generating organic growth, which reflects the 2.5% internal growth rate.

It should also be noted that almost one half of one percentage point of the internal growth rate was lost due to pure accounting adjustments such as our increase in our SAB 101 reserve for future policy cancellations. The specific internal growth rate by business segment is listed in the press release. And Hyatt will discuss those rates and other activities in a minute.

Moving to our investment income. It increased 34.4% in the fourth quarter to $3.1 million due to both higher investment yields and higher investable funds in '06 versus '05. Other income was only$791,000 for this quarter and was comparable to last year's number and most of these gains are primarily from the normal sales of certain books of businesses.

Looking at our expenses for the fourth quarter, while our total revenue grew by 9%, total expenses grew by only 5.3%, excluding the $5.8 million payment. When you exclude that payment, our pretax margin for the fourth quarter of '06 was 31.6%, up from the 29.2% last year. Our single largest line item expense is employee compensation and benefits and as a percentage of total revenue, this line item was 46.7% of revenue, an improvement from the 49.0% of revenue charged in the fourth quarter of '05.

This improvement was spurred by continued improvement in our health insurance cost savings by being part of a national healthcare network, our positive adjustments to our year-end profit sharing accrual and bonus compensation adjustments. Again, excluding the $5.8 million payment, other operating expenses were 14.0% of revenue, up from 13.6% of revenue in the '05 quarter, reflecting a 40 basis point increase in expenses, most of which was the result of higher legal fees.

Amortization and depreciation increased the normal amount due to acquisitions and then interest expense was down slightly due to lower debt balances as a result of normal quarterly principal payments and acquisition notes payments. Our annual income tax rate was approximately 38.5%, which resulted in a fourth-quarter income tax expense rate being at 39.4%.

For the full year of 2006, we had total revenues of $878 million, up 11.7% over '05. Excluding that payment I keep mentioning, our pretax margin, or income before income taxes for the year, were 32.6%, up 150 basis points from the 31.1% margin in '05. The net annual results really are very similar to the quarterly results.

Our net income for the year is up at $172.4 million or 14.5% more than the $150.6 million we earned in '05. Net income for '06 was $1.22 or 13% higher than last year's $1.08 per share. Excluding the one-time $5.8 million payment, our net income for the year was up 16.9%.

From our balance sheet perspective, our financial strength remains strong with over $88 million in unrestricted cash and total assets of $1.8 billion. Our total shareholders' equity increased 21.6% to $929.3 million. With that financial overview, I'll turn it back to Hyatt.

Okay, Cory, a question on the effective tax rate for the last quarter, for the fourth quarter, what was our effective tax rate?

It was 39.4%.

Okay. Looking at the operational part of the Company, looking first at Florida Retail, we have a 15.1% increase in organic growth versus 15.3%, so it has been about 15% for the last three quarters. The big news in Florida of course is that Citizens, the state of Florida, is going to compete and as a result of that, this is primarily focused at personal lines, but it also flops over to some commercial condominium, etc. kind of business.

As a result of that, there is anxiety going around among the private risk bearers. Hartford has announced that they are going to withdraw writing homeowners and Florida personal lines and they are going to withdraw in the small and middle market commercial. The effective date of this looks like it is going to be August of 2008, but I am not sure about that at the moment. It doesn't actually have the kind of impact on Brown & Brown that it does on some of the other agencies for the simple reason that the great majority of our business is outside of Florida and therefore this will not apply to us other than I think in the personal lines area.

Also Auto-Owners, a very large writer of business in Florida, Michigan-based company, is following a little bit saying that they are only going to write -- they are going to write no new business other than in a particular company and very limited at that. So there is some anxiety and of course there is a section that is getting ready to get cranked up that may provide some additional kinds of changes. Not sure about that at the moment.

In the meantime, however, property with wind continues to open up, meaning more capacity and a little bit of reduction, a little bit of reduction, a little bit of reduction in prices and deductibles are coming down. So this is both in the admitted and the non-admitted marketplace. Companies that were shut down in October and November are now writing again. Companies that were not writing in certain areas of Florida in the last quarter are writing a little. So a lot of change of course resulting from the fact that no hurricane last year and hopefully we will have none this year.

The casualty is squirrelly and that means that sometimes it is flat, sometimes it is down 5% to 15%. Umbrellas can be kind of all over the marketplace. Workers' comp is very competitive. Rates are down 10% to 15%. Monoline auto, competitive. More condo business is moving to the Citizens at lower rates. There is in the law a 125% rule and what that means is is that if an admitted market is within 25% of Citizens, meaning not more than 25% higher in terms of the rate premium, then that is not eligible for Citizens.

We do have Regionals that are starting to write new property and that really is all around Florida with wind. The bottom line is is that wind cost is going down and the retail business -- it's coming along pretty good. So I would say that the impact of the new state laws is probably slightly positive for retail.

If you look at National Retail, it's down -1.7% and it was a +0.9 of 1% last quarter. So it is about the same. In the Northeast, New Hampshire and Massachusetts, it is very competitive property and casualty prices, down 10% to 15%. The Regionals do control the middle market in that area. Workers' comp is very competitive. Nationals are starting lower rates to respond and we are seeing that all over the United States.

The Nationals, who have been somewhat holding the line, are starting to get very competitive, particularly in the West. Employee benefits is up 8% to 10% and it varies around the United States with 5% to 10% or 12% is what the employee benefit pricing is going up around the U.S. Varies a little bit by locale. In Pennsylvania and New Jersey, P&C is down 8% to 10%. Workers' comp in most areas is flattish. Contractors in the New York sale area are still fairly firm. Personal lines are very competitive, particularly in New Jersey. Professional liability is down 10%. Employee benefits of course up 8% to 15%.

In Georgia, South Carolina, Virginia, all pricing is very competitive, except coastal property. Dropping down to Texas, property rates are flat on the coast; elsewhere, down 10% to 30%, casualty down 10% to 15%, umbrellas by account, meaning that they will vary based on the account and the account pricing.

The workers' comp, and I think I mentioned this in the last quarter, is getting more competitive and the reason, one of the reasons is that the network filing that was approved, which means that if a company, a risk bearer, has a network of doctors, hospitals, etc. and obviously they are going to get a discount, then if the contractor agrees that that is who his insured employees will use, then it is 10% to 15% down on the workers' comp cost pricing.

The standard GL coverages -- some contractors, some residential contractors are being written with standard GL coverage. That is a little bit of a change. In Louisiana, the Louisiana Citizens, not the Florida Citizens, is and has been writing statewide for property. The casualty rates are very competitive, 10% to 15%, and marine rates are kind of flat.

In Wisconsin and Minnesota, our renewals are down 10% to 15%. Wisconsin is a different market from Minnesota believe it or not. If you are going to write a new account in Wisconsin, take it away from someone else, it is 30% to 35% down. An anomaly is that the workers' comp rates are down 2% to 3%. That's rates. But now, two or three companies are now filed to provide dividends of 40% to 50%. Now we know that dividends aren't guaranteed, but if they don't pay them, they lose the account and it is I'm sure their intent to pay them.

In Minnesota, however, workers' comp is just down -- it is competitive, but it is not as competitive as in Wisconsin. 10% to 12% to 15% umbrellas are also following the underlying. In the Western Retail, that is where -- it's the bloodiest at the moment, down 8.4%. It was -4.5% last quarter. It's still the most competitive part of the country.

The Nationals have now joined the rate cutting and it's gotten a little crazy. Now it varies by location. California is the worst. Washington and -- the state of Washington and in other states, Nevada, Arizona, Colorado, new carriers from the East are coming to town and one of the reasons is is because it is a very profitable business. So in Washington, the renewals are down 5% to 10%, but if you are going to get a new account, it has got to be 20% to 30%. USLH, that's longshoreman and harbor workers, is flat and you know you don't write workers' comp in Washington because it is a monopolistic state. Benefits are a positive up 5% to 10% and our travel business is holding steady in that particular state.

California -- Los Angeles, San Francisco, San Diego -- pricing is very competitive. Even construction ramps are going down in price. There is a lot more competition. In other areas in California, packages are not as competitive, 5% to 10%. Workers' comp, however, 9% to 20% down. Benefits is up 12% to 15% and the quake capacity is shrinking.

In Arizona, again 10% to 15% down on renewals. Contractors, more stable. Workers' comp is off 15% to 20% and we are writing a lot of new workers' comp. As a matter of fact, the thin wall approach that we have had a seminar on is really giving us an opportunity to write a lot of workers' comp where we haven't written a lot. Nor has anyone written a lot of workers' comp since the state fund in Arizona is very competitive. Employee benefits is up 8% to 12% and again new carriers coming to town.

Now one thing I would mention here is when you are listening to all these downdrafts in pricing, you must remember that there is a zone of reasonableness in terms of the amount of dollars that a business is going to spend on property and casualty insurance or employee benefits insurance. That zone of reasonableness is not defined by percentages; it is defined by dollars. So as prices are going down in the last couple of years as opposed to going up in the early 2000s, what is happening is is that umbrella limits are going up. Property limits are expanding. GL limits are expanding. So there is more insurance that is being written. So it is not a straight line kind of deal.

In Nevada, the renewals are down again 10% to 15%. Workers' comp is very competitive. The E&S focus and GL for contractors, those prices are softening. In other words, those prices are going down. Now there's a lot of growth in Las Vegas and again new companies coming in, two to be exact, that we represent that are going to be very competitive. One of the things about Nevada is there are no cats. That is a very positive sort of thing from a risk-bearer standpoint.

Special programs is up 14.7%. It was up 9.8% the previous quarter and the leaders in the clubhouse are Proctor Financial, which is our [fourth] space. Then it's FIU and Public Entity. Citizens will affect FIU in terms of pricing, etc. and we're not exactly sure how much at the moment in as much -- there is a positive and there is a negative there. Apparently is the opportunity to buy through the state reinsurance -- top-layer reinsurance -- at substantially reduced prices, which of course will be positive for FIU and then the price reductions on the front side will be negative for FIU and how all that works out, not exactly sure.

Now we move over to brokerage and I am going to ask Powell to talk a little bit about brokerage since that is one of his areas of responsibility.

Thank you very much, Hyatt. In the property area, we have seen changes in the cat-prone areas as you may know. In April, we saw dramatic price increases and shrinkage in capacity and that continued through Q2 and Q3. At the beginning of Q4, we saw really a leveling off of that pricing in the first half of the quarter and then continued pressure or downward pressure on rates at the end of the fourth quarter.

What does that mean? Specifically, more limits on many renewals at the same price or they buy a lower premium on renewal. Some carriers we are seeing, I would call, year-end deals. Those were typically isolated, but there are instances where there were carriers, both standard carriers operating in the E&S environment and E&S carriers, which wanted to try to write an extra $10 million or $15 million of premium and they did special pricing at year-end.

In non-cat property, that continues to be very, very competitive around the country, but in coastal communities, as I said, what we are seeing is typically more limits available for the same price, some changes in terms and conditions. From a liability standpoint, I would say the general rule across the country, we are seeing rates down 10% to 15%. There is a number of accounts, which are -- they kind of vacillate between one, the standard market, and the excess and surplus lines market. Many of those that have been in the E&S market in the recent past are moving back across and the standard market is trying to write those accounts.

Western casualty, as Hyatt alluded to earlier, the E&S market is very, very competitive, specifically residential construction. Several of our facilities out there in December of '05 had their biggest months ever and thus their biggest quarters ever in growth. Right after that in January of '06, we started seeing the slowing down of the number of large residential projects or those projects just going off the table.

In addition, in some of those projects that are coming online now that have been delayed in the smaller projects when there used to be four, five or six carriers that would participate on programs, now there might be 10, 11 or 12. So it is becoming more and more competitive even there.

In Hull and their large personal lines facility and in special risk facility, which are smaller condominium projects, we have seen with the risk bearers' reduced appetite and capacity at the end of the fourth quarter, some of that, we believe, is in anticipation of the changes at Citizens, which we are beginning to see and see how that will operate in the marketplace.

Conversely, we have seen very good growth in the number of our facilities, most noticeably Braishfield in Florida and Halcyon. So as it relates to the Citizens impact directly on the E&S property nonresidential, that is starting to play itself out, but we haven't seen it yet impact that (inaudible).

Thank you. Moving onto professional programs, we have -- professional programs is a positive 0.6 of 1% from a -0.1 of 1%, basically flat. The good news is is that dental was up 8%. Small lawyers, however, were down about 5%. CalSurance was up 1% and it appears that the small lawyers is starting to get to a flattish and maybe can growth this year.

In the TPA Services, we are up 3.6%; was 10.8%. And as sort of the same thing, this operation keeps on chugging and every year, they produce a very nice growth in earnings and our TPA Services is now operating at a real 25%. So that is darn good. We are very, very pleased at that.

Internal growth, you are always asking about that and of course our internal growth projection is 0% to 5%. Now you will say, well, why is that? Well, that is because that's kind of the way it is. If you look back at '03, for all of '03, the internal growth rate was 5.9%. Looking at '04, all of '04, the internal growth rate was 4.3%. All of '05, the internal growth rate was 3.1% and all of '06, it was 4.0%. The average of that is about 4.3%. So therefore our projection for this coming quarter or year is 0% to 5%.

Having said that, then I'm going to turn it over to Jim to talk about M&A and other matters of importance.

Thank you, Hyatt and good morning. First, before getting into acquisitions, I'd like to talk about a couple of very special promotions in this past quarter. The first of which is for Ken Kirk. Ken joined our Company in 1995, part of an acquisition in the Phoenix, Arizona office. Ken, at that time, was the part owner of Insurance West. That office combined with our office about $4 million in revenue in 1995 and Ken has been the major energy and thrust to grow that operation from that $4 million in '06 to a region involving $132 million in revenue spanning states from Colorado west to the Pacific. Ken really embellishes the growth and opportunity for leaders within a company.

Likewise in the quarter, Ken Masters was promoted to a Regional Executive Vice President. Ken joined us in 2002. At the time, he was President of CalSurance, which he continues to serve, at the time of the acquisition in 2002. Ken has led an improvement in operating margin and growth in CalSurance. He also has sourced and led the acquisition of two other very successful programs and going in this year, will be Executive Vice President -- Regional Executive Vice President in Programs.

Ken Masters has a financial and also insurance company underwriting background. Did not mention, but in Ken Kirk, in addition to the insurance background, Ken Kirk had a background in financial and at one time was with one of the big six accounting firms.

So these two individuals send a signal and represent the strong bench that is part of Brown & Brown and also a reflection of the fact that we are in the people recruiting and enhancement business.

Turning now to -- on the acquisition scene, I would like to add a little bit of color to four of the recently announced acquisitions. The first of those, the ALCOS acquisition, about $18 million in revenue in the Detroit area. Gene and John LoVasco who has led the building of an agency there in that community and also in Ann Arbor, Michigan.

It is a very youthful, very talented, very energetic team that -- we had first contact with them maybe about five years ago and kept in contact as they progressed. We kind of shared notes about how they operate and we operate and this culminating in the agreement to merge this past week. We are very pleased about the quality operation there and the future that those leaders hold with respect to growing a larger operation in Michigan and also in the Midwest.

Next in turning to Tallahassee, Howard and Susan Shapiro has built an excellent agency over the last 30 years in Tallahassee. It is both property casualty and benefits serving north Florida, south Georgia, south Alabama, a great team of individuals and that operation will merge with our existing Tallahassee office. This agency also is one that we have had contact with Howard over the last five years or more. We were able to, just matter of fact, to attract his son into the Company, to Brown & Brown, a couple of years ago and he is a great member of our growing youthful team.

Another agency fill-in with the Marcello Agency in Louisiana. Also the Beyer-Beeson agency of Louisiana. This is an operation that Tommy Huval and Mark Romero in our Lafayette office, they have known these agencies for some time and sourced the relationship there and were able to encourage these leaders to join us.

The Marcello Agency gives Brown & Brown additional opportunity to serve the rebuilding and revitalization of the Gulf Coast region. There is a specialty in the marine coverage and the operation will become part of Lafayette retail office.

Another operation to special mention is the ProTexn operation in Dallas, Texas. This was an opportunity that was sourced and led by Linda Downs, who is here with us today. It is now a part of our existing Tampa Lawyer's Program for small firms and is a great addition to that staff. So these are some of the details, just some great businesses that have joined us, very pleased to have them with us.

With respect to general comments on acquisitions, we continue to be pleased with the deal flow, really nothing dramatically different there. We do see continued improvement in the margins of the agencies we talk to that their need to improve and certainly as we come together, we find that there is a very natural fit in terms of growth and the margin expectation of these agencies joining Brown & Brown.

There is venture capital money out there that is looking for opportunities. Perhaps they have replaced banks as the most aggressive buyer of certain agencies, but I would probably comment this is maybe on deals, larger deals or deals probably more than $15 million, $20 million or more than $30 million revenue where there is a bite, a significant bite by the VC money.

And lastly, we continue to expand our capacity to source and integrate an increasing number of deals through internal, both staffing on the legal side, on our due diligence side there, that we expand that as to number of deals. Our average size transaction remains about $4.5 million, $5 million. We don't see that changing, but we certainly anticipate the opportunity to increase the number of deals.

With that, I turn it back over to Hyatt for comments and then we can get into Q&A.

Thanks, Jim, an excellent report. A couple of things I just mention. We continue to be pleased with our growth in our margins. If you exclude the $5.8 million expense, our EBITDA, including the non-cash stock grant compensation, was about 40.1% and that is up about a 0.1 of 1% or something like that. So we continue to, every quarter every year, get just a little better, a little better and of course it is that assiduous attention to detail.

And speaking of assiduous attention to detail, one of the things that I would also like to discuss before we open it up for questions is the succession plan. We have announced Powell -- the Board has announced Powell as the President of the Company and to succeed me in July of '09. Now I will be 72 years of age on the 12th of July of '09 and I will have worked 50 years in the insurance business and I figure that is about enough being on the front line.

I am not going away. The Board has asked me to be the Nonexecutive Chairman. I am going to move down on the third floor and have an office next to Cory Walker and I will be involved in the mergers and acquisitions, recruitment and I even will probably bring in an account or two, which is probably the most fun of all, which I haven't had much chance to do for a long time.

But I think you would like to know a little bit about Powell and since he is here, you can ask questions directly, but the background is is that he started working in the agency in the eighth grade in the accounting department and then worked in collections, which when I was in college, that is what I did, collected money. I can tell you that is one of the reasons why we have a rigid policy of no accounts receivable over 59 days because that is not a very fun kind of business to do, having to go out and collect money from people who either can't pay or won't pay.

So anyway, then college and then three years or two and a half years with Continental as a -- starting out as an underwriter trainee and then moving up into the large casualty underwriting and then to Duke to get an MBA and with a summer internship at a very aggressive, large E&S house in New York City and then back to Brown & Brown in Daytona where he started out as a producer selling insurance just like everybody else that's around here and did well at that and then Jim, he reported to Jim, Jim asked him to head up the marketing department, which he did and grew that department and grew the productivity of the department.

Then Linda asked him to come to Orlando to head up an office that Linda had started in 1980 as a matter of fact and grew that office and then was given retail offices, a number of retail offices, also successful in the oversight and the growth and development there. Then he gave up those offices and was given responsibilities in the brokerage area and then in the Public Entity business and in the now FIU will be reporting to him. So he also has had the services area, that is our TPA that he has been responsible for the last year or so.

So the only piece of the Company that he hasn't had direct involvement with is our program piece, which is about $150 million in revenue and in '09, excuse me '08, at the end of this year going into next year, he will shift around again and have the responsibilities for that area. So that by the time that July of '09 rolls around, he will have had substantial background in every facet of our business.

At that juncture, he will be only 42 or 43 years old and having been in the business at that time about maybe 15 or 14 or 16 years, whatever it is. One of the things that we believe is that we have a very broad base of very talented people. As a matter of fact, our senior leadership, which is 11, met starting Friday afternoon at about six o'clock and we met all the way through Saturday and Sunday afternoon. We quit about 2.30. Reviewing plans, reviewing this past year, reviewing what we are going to do for '07 and beyond. We have -- it will be 40 sitting out there in front of us and then what after and beyond.

So we have a very young, very aggressive group of people. They are totally committed to the Company and the team goes on. And it is going to be fun to be able to be involved, but not have to be on the firing line every day and be in more of a background position.

So that is kind of a potpourri of information that I think would be interesting to you. So having said that, Amy, we will open up the phone for questions now.

(OPERATOR INSTRUCTIONS). David Lewis, SunTrust Robinson Humphrey.

Congratulations on a solid '06.

Great. Thanks, David.

Hyatt, my understanding is the Florida workers' comp rate reduction will come in at 15.3% on January 1. Can you give us an idea of what percent of Florida Retail came from workers' comp in '06 and what do you think the ultimate impact on your business will be as we look into '07?

Well, first of all, I can't tell you exactly. If we have $185 million or $190 million of retail in Florida, I would say probably 20% maybe is workers' comp. So 1/5 of that is like $35 million maybe, something like that.

Of course, it's rate-sensitive. [In part] is not, David. In the case of the rates going down, you have a lot of business that in fact is under retro type plans that are less impacted by the rate change.

Plus the fact that business in Florida is good. We are growing and people are bringing money to Florida, not just really from the Northeast and the Midwest, but from Europe. So it is hard to say exactly. One of the things, David, and you know this, as prices go down, commission percentages generally go up. So I think -- I wouldn't be too concerned about the workers' comp as regards to any kind of downdraft. It will be a little bit, but not much if any.

And just staying on Florida retail, I understand the Citizens changes will have some impact. We're just not sure exactly what yet. But if you kind of look at the more difficult comps in the second or the last nine months of the year, how do you kind of feel that that plays out? I mean, you benefited I assume pretty substantially from the hardening of the coastal property; that is flattening out a bit. Would you guess maybe Florida retail is probably more up in the 5% to 10% as we look at '07?

You know, that's hard to say. On the one hand, David, the biggest impact that the Citizens change is going to have will be in the personal lines area. So let's say picking the Hartford as an example, the Hartford is going to withdraw over a period of I guess a year, year and a half or two years, something like that, on personal lines. So there will be some replacement. So Citizens will be part of that.

But the situation is that it does cost a little more money to deal with Citizens and it is kind of painful. And there will be -- I assume there will be -- takeout companies that will still want to do business in Florida, although I am not sure about that. So I would say that on the whole and the personal lines area, it is kind of a push for the simple reason that a goodly chunk of our business is the $500,000 to $1 million, $1.5 million, $2 million, $2.5 million homes. And those homes really aren't Citizen type homes because the people want -- they are not looking for just strip-down coverage. They are looking for the all-risk coverage, they are looking for property fine arts floaters. They're looking for excess umbrellas, all that kind of stuff. So I think that is kind of a push.

In the area of condominiums, we have been writing a lot of business with Citizens, and so we will continue to write. Citizens' rates will come down some, so that will have a negative effect. There will be other insurance that we write which may be a positive effect. The JUA, the commercial JUA that was created, has been rolled in -- this is commercial property JUA -- has been rolled into Citizens. And exactly what all that is no one knows for the simple reason that the rules are now being promulgated in Tallahassee as to how all this is going to work. And it just takes a while for it to shift through, but I would imagine that Florida will continue to do well. Now as to whether or not it is going to be 5 or 10 or 12 or 6 or 13 or whatever, I don't really know.

That's helpful. Just finally maybe, Powell, if you could just talk about your outlook for wholesale brokerage; had a little bit slower growth and down growth here more recently with capacity improving. Would you anticipate that to see some more robust trends as we go into '07?

Yes. What I think is going to happen, I just came back from London last week, and there is a lot of syndicates over there trying to figure out how to deploy their capacity. And the discussion over there was it may not be in the reinsurance area; it will be in the insurance area. So as this thing with Citizens plays out, that may impact how they deploy their cat capacity in Florida or redeploy it in other coastal communities.

Areas like Texas and the Gulf Coast and up along the Atlantic states continues to be very -- it is all E&S in the coastal areas. So I think that we will see -- as Hyatt alluded to earlier, if you can buy 10% or 15% or 20% more limit in property in those coastal communities, some of those areas people were buying very low limits because the price was just so cost prohibitive. So I think we are going to see some trade-off there where people buy more limit for a similar price or maybe a slightly lower price, number one.

Number two, on casualty, particularly as I alluded to earlier, western casualty and residential construction, part of that growth -- it too goes as the economy goes and as some of those projects have been delayed or put on a shelf, that slowed down a segment of that and as that heats up in certain areas, that may lead to more growth.

Also Hyatt alluded to the fact that there are certain markets, typically regional carriers, regional standard carriers, that are writing some of the habitational or residential construction business. That is on a very limited scale and usually what we have seen all along is the issues with construction defects, which started on the West Coast, have slowly, slowly kind of migrated across the country and so now today in areas in Florida with commercial residential, that would be the building of condominiums, the building of certain apartments and things like that, that is in the E&S market more than the standard market.

So like I said, I think there is a lot of opportunity for growth and part of it will be when some of the markets figure out how they want to redeploy their capacity in the E&S facilities. So that is my thought.

That's helpful. Thank you.

Nik Fisken, Stephens Inc.

Cory, what is our outlook for a contingence in Q1?

You know what? We really don't have an idea yet. It is going to take until March to really start seeing it. But given the fact that we have had a very good loss year in terms of catastrophe, we wouldn't be surprised if it is at least equal to what we got last year.

Okay. And Hyatt, are we going to hit $1 billion of revenue in '07?

Good question. We are going to do it sometime. Is it going to be on 12/31 at 11.59? I am not sure, but we are going to push hard for it.

15% gets us there.

I think a little bit over 14% does.

Yes. Something like that.

And Cory, can you give me the details on the 1.5% hit to internal growth again in the fourth quarter?

No, no, no. It was one half of 1%.

Okay, okay.

Normally -- it was really closer to 3%, but part of -- SAB 101 is where you have to provide an accrual for future policy cancellations that you don't know of. So every quarter, we have to look at that and we run what our historical cancellations have been on a rolling four-quarter basis. At the year-end, we had to make a fairly sizable upward adjustment to it, which comes right out of revenues. So that's what that was.

If I look at the $1.22 just reported and I add back $0.03 from the Florida resolution, are we comfortable in saying we are going to hit our 15% earnings growth on the 125 in '07?

We haven't changed our policy on that.

No. What you're saying is are we going hit 15 over 125 as opposed to 15 over 122 and the goal is 124. So if you are going to be apples and apples, it would be 15 over 124.

And then last thing, if I look at the last eight quarters, Western has been positive in one of those eight quarters and I am just trying to isolate how much of it is rate driven versus how much of it is issues with the operations.

Well, it is obviously a little bit of both. We have had several changes of heads of offices and one of the things that is abundantly apparent in that kind of rate environment, the head of office has to be a salesperson who is out bringing in business and helping to get the ox out of the ditch when the ox is in the ditch and when someone is not that person -- in other words, they don't have those characteristics, that they are more of an administrator -- then that doesn't work. So we have made several changes and they've worked out very well and so we go forward. But I would say this. The downdraft out there, I haven't seen quite that kind of competitive ferocity anyplace in a while. So it has been different, Nik.

So it's too tough to call because the price issue on whether or not we can post a positive top growth for this year?

Well, the goal is to get to breakeven in the West and so that is the goal. I think there is a reasonable shot at doing that, but until we get there, we don't know. Here is the other thing about the West that is a little bit of concern. It is and it isn't. We have got all these new companies coming to the West. These are eastern companies who are hopscotching across to Colorado, to Arizona, to Nevada, to California and they are in the middle market and this is more vanilla kind of stuff. This is not high-risk stuff. So it is going to continue to be very competitive.

So one of the things that has occurred though is and this is positive is that, as for instance, workers' comp rates have come down in California, now the state fund, which is one of the large writers, the commissions have gone from 5% up to 10% and 11% in order for them to remain competitive. So it is not all negative, but it is kind of a bloody battleground for us.

Doug Mewhirter, Ferris, Baker Watts.

I just had to talk about continued commissions again briefly. I am sure you saw the recent I guess goodbye kiss from Eliot Spitzer before he went to the governor's office where he sent the letter out to some of the major carriers saying you hit my mandatory ceiling on contingent commissions, so you need to stop paying them. Do you see that causing any more widespread effects as far as the treatment of contingent commissions or have you seen any reductions in certain lines parallel with that?

No, actually, as you know, when he sent that goodbye kiss, he also sent the way to handle it and the way to handle it is is that, and this is what the Travelers and others are doing, is that let's assume that the amount of profit-sharing commission that agency A is going to get in February or March of '06 for '05. Let's say it is $100,000. So Travelers comes along and says, okay, what we will do is we are going to pay you $100,000 in February or March of '08 for '07. It is not contingent upon anything. It is known.

So then in '08, we will sit down and figure out again what we are going to pay you in '09. So now what is happening is is the Regionals are all smacking their lips because they are sending around the signal that this is a way that the Nationals are going to take advantage of the agents by not paying them as much profit-sharing commission as they would have otherwise. Therefore, we, these Regionals who are a little more profitable anyway, have contingent profit-sharing that if you make money you will earn more. So this is not all done down in a vacuum.

Matthew Heimermann, JPMorgan.

I had a couple of questions. The first question was you made a comment specifically with regards to Florida with where commission rates may change to offset some of the rate pressure. Can you just talk nationally what you're seeing in terms of commission movement?

Well, this is sort of standard. When prices go down, commission percentages have a tendency to go up and it is generally -- the first place is in workers' compensation and in states where maybe they have gone down to as low as 4% or 5%, now they are up 7%, 8%, 9%. Some states that -- where you do not have a competitive environment, commission percentages are A) lower and B) pretty much flat, meaning they don't change much from year to year. Where you have a competitive environment where there is money being made in that line, it is more price sensitive. Then you are going to have -- as prices go down, commission rates go up. So we are seeing a little of it across the United States. It has been more prevalent in those states where you have workers' comp is a big line, but it is also in other lines too.

And then with respect to the question on the supplemental commission side, do you think it is a fair characterization that the Regionals are making that the agent comes out less ahead with supplemental versus the old way?

Well, it doesn't matter what the reality of life is; it is what the agent perceives. And one of the disadvantages that the Nationals have is is that the Regionals have a tendency to be closer to some of those agents and so they are whispering in their ears. So my sense is is that this is America. It's a competitive society. So it will all work out.

The last thing was with respect to the number of companies or carriers you are doing business with as you see some of these companies expanding westward, are those companies you do business with -- so I guess is the roster of companies expanding in any way, shape or form or is this, for you, not the same folks at the party?

What it is is -- it is companies that have moved from -- have opened up places in the West where they are eastern companies. An example, the very first one to do this was an Ohio-based company that is a mutual company and they decided to open up in Arizona. So they came to us and said we would like to open up. So we did that and now they are I think either our first or second largest carrier in Arizona. They came early and have been I think quite successful. So that is occurring across the board and most of the companies, almost all of the companies that I know of that are opening up are the Regionals because they are looking to put production underwriters in place in certain states and write the vanilla middle-market business.

Thank you. Greatly appreciate it. Have a good day.

Meyer Shields, Stifel Nicolaus.

If I can put one more question with regard to the western region. Hyatt, you talked about how you need to have the right leadership in place in a dramatically softening environment. Right now, do you have all the right leadership in place or are there more changes that need to be made?

No, I think we are in pretty good shape. Might be a change or two, but nothing -- there's no burning buildings out there. There may be some people who are getting to an age where they want to retire or step aside and be a producer, but there is no burning buildings.

Okay. That's good news. With regard to pricing, there is a lot of talk out there about how this cycle was different from previous soft markets. The description you said today, it sounds pretty aggressive and I was hoping you could sort of compare what you see now with what you saw when softening started getting traction the last few soft markets.

Well, this is not quite as soft as the market of '82, '83, '84. I'm sure all of you on the call remember that one, but it is similar, very similar to some of -- when we started -- when prices started to recede previously, it started around '87 and it would go down a little bit and flat and go down a little bit and flat and then there were some more aggressive years. But pretty much the pricing went down pretty much all the way to the year 2000. So really that is 13 years give or take.

Now in that price reduction, don't forget it varies by state, it varies by line and in some places workers' compensation was going up, etc., etc. And in Florida in 1992 you had Hurricane Andrew and so prices went up there for a while and you had some Gulf Coast stuff, etc. I wouldn't characterize this as being any worse than some of the other years, but I would say that it is a very competitive time. It is as competitive as the most competitive years that we saw in that last 13-year down swoop cycle.

Okay. That's very helpful. One last question if I can. You mentioned how the national carriers are starting to cut rates. Is that a fourth-quarter issue where premium goals were a factor or has that continued so far in the first quarter?

Well, it did start in the fourth quarter and so I think -- it seems to be, and again it varies a little bit by state -- it seems to be more prevalent now though than certainly in October of the fourth quarter.

Dan Farrell, FPK.

Let's talk a little bit about business that is placed through Citizens and maybe you can talk a little bit about the commission structure at Citizens versus auto carriers and just the overall process and differences in place in business through them versus other auto carriers. Then also how much more of your business in Florida do you think Citizens is going to represent? If you can even answer that at this stage.

First of all, relative to personal lines with Citizens, it is kind of hard to explain. But in the personal lines, if you -- there are certain pieces of the personal lines on which there is no commission paid and certain pieces on which commission is paid and so if you look at an average -- the commission on the Citizens is around 8% maybe 9% on personal lines and that is less than the commission that we would normally get on our homeowners, which is 15%. By the same token, there is a lot more work, effort, etc., etc.

In the case of the condominium business, I think the commission there is 12%, but again it doesn't get paid on all of the premium. So I can't exactly tell you what it would be in terms of the overall premium, but again it is very difficult to do business with. The other thing is is that it is hard to get binding done. If you send in an application, it may or may not be bound. So it is a real -- and of course the Citizens is not supposed to be an easy market. The Citizens is supposed to be the market of last resort. That has changed a little bit as a result of this legislation. So it is a large piece of our business now. I don't know -- is it the largest? I don't think so, but it is going to grow this year.

Now hopefully we will not have hurricanes this summer and the market will start to come back and as the market as it is in commercial and in some homeowners, it is coming back, the larger ones, but there will be certain homes and certain structures that in Florida that will not ever really be standard again and the reason is because of construction, the age and the lack of construction regulations, the codes, meaning they were not built to code or the code was nonexistent. Some of this is west Florida as an example. In west Florida, the codes are much more lenient than they are in southeast Florida.

So we don't view this -- this is just another part of being an intermediary. We have to provide coverage through whatever the best market is for our customers and that is what we will do and Citizens is a market and we have been working with them now pretty closely for a year. We understand them pretty well, but it still makes it very difficult.

That's helpful. And then just generally looking at '07 versus '06, I know you have maintained a 0% to 5% organic target, but it seems the pricing environment seems like it is going to be a lot more challenging relative to '06 and there also seems to be some tough comps. To put up an organic number in that 35% range, do you feel like there is more pressure for you guys to execute on the other levers besides pricing to try to write more business, more exposure, units, maybe some more kicker from higher commissions, things like that?

All of the above. But if you go back through our history and you look at the -- we have had many more years of downpricing than we have uppricing. And when you have downpricing, it is very challenging. But we write more insurance when there is downpricing. We also write more new business when there is downpricing. So it is a stressful time. But when you put it all together, we still -- that's why we say 0% to 5% because this market is a little more volatile, particularly Florida and the Gulf Coast, then it has been in the past. So we are not feeling any more or any less bullish about '07 than we did about '06 and '05, etc. We just know that some way or other, we are going to bust a gut to get our earnings and our growth up and we sort of seem to always do it.

John Fox, Fenimore Asset Management.

Hyatt, you have given us a lot of detail. I was just wondering on the new Florida legislation if you could maybe summarize -- you said that you thought overall it would be positive.

Sort of, John. I think -- here is -- it's very difficult to assess it at this moment because there are positives and there are negatives, but then there is rulemaking and the rulemaking is starting to go on and that is also another piece of the puzzle. So I guess your question would be is it going to be -- when you put it all together, is it going to be a positive or is it going to be a negative. Is that the question?

Yes, I guess maybe list the two biggest positives and the two biggest negatives at this point.

Well, the two biggest positives probably would be the reinsurance, the very competitive reinsurance at the top layers for FIU. That is a big positive. The fact that we will be writing some condominium coverages, frame and [joisted] masonry, at prices that are a little more reasonable. That is a positive.

Negatives would be that it is going to cost more money, meaning it is more -- it is less efficient to do business with Citizens than it is with a regular company. So that is a cost. And then we are going to have more competition on price at FIU and some of our whole operations, like whole personal lines and maybe special risk. So we are just all working our way through that.

And what do you mean by the rulemaking?

When statutes are written in the legislature, they are then given -- the responsibilities are focused on the Department of Insurance or Office of Insurance Regulation, etc., etc. So then they take the statute and in order to implement the statute, rules have to be written by the submitted, by the Department and there is a review, the administratives procedures, the Administrative Procedures Act of, I don't know, 1980 or '72 or whenever it was. So there is a hearing process.

So the Department of Insurance Regulation -- Office of Insurance Regulation will say, okay, here is how we are going to administer this based on what the statute said and what we think the intent of the statute was. And so there is a great deal of latitude in some of that. So we have got to be watching that rulemaking carefully.

Greg Lapin, Tribeca Global.

Hi, it's Greg Lapin. Just wanted to ask when you met with senior management in the weekend and other times and you are looking over the budget and as you examine the comp ratio, it looks like you are on track to reach the 45% level near term, but in the future over the next several years, is there an ability to even get lower on -- get to a lower level? I know it is better than the 45% level in various segments, but also some of the lines of business that you are in are not as profitable. So I just wanted to get any feel you have on the comp ratio looking out?

Well, Greg, you are right on target. We obviously are all over the way we do business all the time and in as much as our compensation program is geared to rising profit margins, meaning if you are a leader and as the profit margin increases, then you get more bonus, etc. So everybody is looking to do that. We feel and of course there's always been this thing about, well, when you get to be 40, 40%, is there anything beyond that? The answer is yes, we think so.

Now how are we exactly going to get there? We don't know. But it is done just like eating an elephant, a bite at a time. So one of the things that we are very sensitive to is the slices of business that are the most profitable and as a matter of fact in our last meeting this last weekend, we surfaced an idea that has been sort of around for a while that is probably going to be implemented over the next year or so, which is a very positive idea, a little different. So if you ask me what that is, I can't tell you because it is secret. But all of those things we have to go forward and do and it is a little bit here and a little bit there.

Don't forget, Greg, if you look at the margins in the home state and you then look at the margins everyplace else and if one were to say can you get to those Florida margins over the next five years elsewhere and the if the answer to that is yes, realizing the Florida margins aren't going to be static, they are going to continue to go up, then the potential for increased profitability is very -- we are very optimistic about it.

Now it takes -- you know what our strategic plan is. Number one, we are in the money making business. Number two, we are in the people recruiting and enhancing business. So what it takes is it takes that number two cog in the wheel, the people recruiting and enhancing, it takes the right leadership with the right background and training in order to accomplish this and it is three yards and a cloud of dust every day and every week and every month and every quarter and every year, etc., etc. So we continue to go forward.

Now as we grow, the M&A is never as profitable as the fully integrated offices and so you know that we have substantial resources to effectuate the right M&A pieces and as that occurs, if it continues to be in the $2 million to $10 million kind of deals, that is one thing. But if there is a large one that comes along then that is probably going to flat us from the standpoint of operating margins for a bit.

But again, the beat goes on. The way we look at it is that we don't count on anything that is big. We count on sort of the same way that we got here, which is small and middle stuff and the M&A business and every year trying to make sure that each office increases their margin. So it is just a very, very long term outlook, but we feel that there is altitude above 40%.

Thanks for that comprehensive answer. I was cut off the call, but it sounded like, when I got back on, you were talking about some of the benefits and disadvantages of the regulatory changes. What about from unrated carriers getting their ratings back, how fast can that take and are those markets that could move the needle?

Well, are you talking about unrated or are you talking about a company like [Iron Shore]? Is that what he's talking about?

Right.

Well, I guess they are supposed to be rated come March or April or May. I don't know. Is that right, Powell?

Yes, mid-March.

And they have got $1 billion and of course what they have done is they have gone out and got all their investors expecting to get entrepreneurial pricing and then Governor Crist sort of knocked a hole in that in Florida, which is the biggest market. So I would imagine they are thinking something about that at Iron Shore, but they are focused on doing middle-market stuff and so that will be a welcome additional market for us. And it is not just Florida; of course it is all over the coastal areas. So that would be good.

David Lewis.

Cory, three quick questions for you. One, can you talk about expectation for 2007 amortization and depreciation as it might compare to what you reported for '06?

Our amortization next year given the current status should be somewhere close to $38 million.

Plus new acquisitions.

Well, any new acquisition that comes along. But right now, it would be -- depreciation should be around close to the $13 million mark and our interest expense should be around the $13.4 million mark without -- unless there's additional borrowing for acquisitions in the year.

And what was amortization appreciation again for '06?

For '06, we were about 36.5 and depreciation --.

11.3.

That's helpful. Your expected tax rate for '07 be in that 39.5 area?

No, no, no. That 39 was just the fourth quarter. We are still sticking to, at the end of the year, at 38.5, just shy of that and so that should be a fairly good number unless we grow in some states that have a higher state tax rate. That's what impacts the most.

Okay. And any thoughts on kind of free cash flow in 2007 range as it compares to '06?

All those numbers you can figure out yourself.

All right. And just lastly, Cory, you talked about a positive fourth-quarter incentive comp adjustment. What did you mean specifically?

No, no, no. There were normal adjustments to the [Proctor] and [bonus] buy. Certain offices that don't hit their targets. If they don't hit their targets, there are adjustments to that.

Right. The normal pluses and minuses.

That's exactly right. That's all that was.

Meyer Shields.

Just really quickly. You talked a couple of times about how reinsurance is purchasing at the upper levels under the new Florida legislation is good for FIU. Can you take me through the details of that?

Jim, do you want to do that?

Meyer, currently FIU buys reinsurance from the cat fund, plus they go out in the open market to buy reinsurance to protect their PML above the cat fund. So the cat fund is saying we will now provide that to you at a much less rate than you are buying in the open market. So that would enable us to be equally competitive on the pricing at FIU at the lower end because it is an admitted company and we have the advantage of using the cat fund for our reinsurance program.

Okay. Won't those savings have to be passed along to policyholders?

Yes, and that's part of what we are meeting with the department and our rates right now to do that. So there will be some -- as Hyatt mentioned in his overview, there are two sides to that. Number one is we would wind up probably with additional capacity. But secondly, that capacity would be at a lower premium because we do have to reduce the rates to reflect the savings from that reinsurance.

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

I think that is all and good luck, everybody and we will talk to you in April.

Thank you. That does conclude today's conference. Thank you for your participation and have a great day.