Brown & Brown Inc (BRO) 2010 Q2 法說會逐字稿

Good morning and welcome to the Brown & Brown, Inc. earnings conference call. Today's call is being recorded. Please note that certain information discussed during this call, including answers given in response to your questions, may relate to future results and events or otherwise be forward looking in nature and reflect our current views with respect to future events, including financial performance. 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 and other factors effecting the Company's business and prospects are contained in the Company's filings with the Securities and Exchange Commission. With that said I will now turn the call over to Mr. Powell Brown, our President and Chief Executive Officer.

Thank you, Cecelia. Good morning, everybody. I am here with Cory and Tom Riley. We are in Florham Park, New Jersey for our quarterly board meeting. I'd open by saying that no carrier wants to lose a renewal. They're very aggressive on new business pricing and there still exists a gap between new business and renewal business pricing. Regional carriers are very aggressive. With that I will now turn it over to Cory for the financial report.

Thanks, Powell. Our net income for the second quarter of 2010 was $41.2 million and that was slightly up from last year's second quarter net income of $40.7 million. Our earnings per share for both quarters was $0.29. From a revenue standpoint, commissions and fees for the quarter decreased 1.4% or $3.5 million to $241.1 million from the $244.6 million in last year's second quarter. As always included in our press release is the table that summarizes our total growth rate and the internal growth rates from our core commissions and fees. And that core commission and fees excludes profit sharing contingencies and any books of business sales that we sold that was there last year. From a profit sharing contingency commission point of view we received $6.4 million this quarter and that's about $400,000 less than the $6.8 million that we received in the second quarter of last year. Looking forward into the third quarter of 2010 we currently expect between $6 million to $8 million of profit sharing contingencies.

For the fourth quarter, we will receive whatever FIU receives, which right now is expected to be around $4 million to $5 million if the wind does not blow in southeast Florida. Now looking at the internal growth rate schedule. We had a negative internal growth rate of 4%, but excluding the negative impact this quarter of Proctor Financial, which we discussed in the first quarter conference call, our negative internal growth rate was only 3%, which is an improvement from the fourth quarter of 2009 negative internal growth rate of 8.3% and the negative internal growth rate in the first quarter of 2010 of 5.6%. Both of those numbers are without Proctor, also. Our total core commissions and fees for the quarter decreased 1.1% or $2.7 million of net total commissions and fees. However, within that net number was $6.7 million of acquired revenue. That means that we had $9.4 million less commissions and fees on the same-store sales basis and hence the 4% negative internal growth.

As the internal growth schedule indicates the vast majority of the negative growth really came from our retail operations and Proctor Financial. Powell will talk about the activities in each of these business segments in a minute. Our investment income decreased around $100,000 and that's just due to lower interest rates on our short-term money market accounts. Our other income increased $1 million, which is primarily due to a legal judgment that was ruled in our favor. Our pretax margin for the second quarter of 2010 was 27.9% compared with the prior year margins of 27.2%. That's an improvement of 70 basis points. The improvement is still 50 basis points even when we exclude the $533,000 credit resulting from the change in our estimated acquisition earn-out liability, which came to us because of FASB 141R.

If you look at employee compensation and benefits as a percentage of total revenues, that stayed at 49.8% of total revenues, similar to the same as last year's second quarter. The total dollar decrease, however, on a net basis in employee compensation benefits was approximately $1.3 million. However, $1.7 million of this net total was attributable just to the new standalone acquisitions that we completed since last year. Therefore excluding the impact of these standalone acquisitions, we actually had $2.9 million in less compensation and benefits and that is primarily relating to a reduction in salaries and bonuses. However, around $300,000 came from a positive adjustment in our self-funded medical fund. Our non-cash stock-based compensation cost was $1.8 million in the second quarter of 2010 and that is consistent with the estimated cost over the last few quarters.

In the current quarter, other operating expenses decreased as a percentage of total revenues 70 basis points to 13.8% of total revenue. The total dollar decrease in the other operating expenses was $2 million. However, $300,000 of this aggregate total was attributable to those standalone acquisitions, so therefore, excluding the standalone acquisitions we had an aggregate reduction of total operating expense of around $2.3 million. These decreases were really kind of broad-based, but the largest changes in decreases were in occupancy costs, supplies, insurance expense and bad debt write-offs. Looking at amortization and depreciation expense on a combined basis is very comparable to the second quarter of 2009. Our interest expense is tracking on line to what we expect, about $3.6 million a quarter.

Our effective tax rate currently is running about 39.45% and should be a good number to use for the final two quarters of the year. So that really wraps up the quarterly review. The year-to-date number in trends are very similar to the second quarter and the earnings per share just for the six month year-to-date was $0.59, which is 6.3% decrease from the $0.63 we earned in the last six months of the or the first six months of 2009. And really, when you look at that the main difference is, is really due to Proctor in terms of their commissions and fees down $11 million for the entire six month period and that really makes up the vast majority of that decrease. So with that financial overview, I will turn it back to Powell.

Thank you, Cory, good report. Florida retail was down 3.7 versus 6.8 in Q1. Rates in Florida on property, general liability and automobile are down 5% to 10% on average. Some times down 10, 15% to 20% on rare instances. Citizens rate increases on commercial residential properties are bringing the E&S market back into play. Exposure units are typically flat to down 10%, except in the construction area where rates are down 5% to 15% and exposures are typically down 10% or more and many times much more. I would like to recognize West Palm Beach for a great quarter in Florida retail of Q2. National retail was down 2.1% versus down 2.2%. Rates on property, general liability and auto are flat to down 10%, while exposure units are flat to down 5%. Work comp in the northeast is flat to up several percent depending on the state. Upstate New York rates are the firmest, while New Jersey and around New York City the rates are under the most pressure.

The construction business is holding up from an exposure standpoint better in New York than in New Jersey or Connecticut. In the south, GL auto and property rates are flat to down 10, with exposure units down flat to down 10. In the construction area rates are flat to down 15 and exposures are down 5 to 15. In the Gulf Coast region, Louisiana to Texas, property GL and auto rates are flat to down 10% and exposure units are flat. The oil spill impact in the short-term is neutral because of the hiring of contractors to do work on the cleanup efforts. Long-term outlook at present seems to be negative, obviously due to the drilling moratorium through November 30th. More to come as that plays out. In the Midwest rates are down 5% to 15% and exposure units are flat to down 15%. In the Midwest regional companies are very, very aggressive. In the west down 8.7% versus down 16.1%. Property GL and auto rates are flat to down 10. Work comp rates in the west are up 5 to down 15.

The two most competitive places in the west from a rate standpoint seem to be Denver, Colorado and Portland, Oregon. Work comp is very aggressive in Arizona and to a slightly lesser degree in California. In May there was a house bill 1394 that was passed in Colorado that confirms that faulty workmanship can constitute an occurrence and thus a construction defect claim could be covered. So several carriers are vacating the Colorado construction market. Exposures in the construction area are down 5% to 20%. In the employee benefits arena, small rates, small groups, I'm sorry, that is under 50 insured lives, rates are typically up 5% to 15% on average. Large groups, which are individually rated, are up 5% to 20% depending on their individual experience. The exposure units or total insured lives on health plans are flat to down. In the wholesale brokerage arena we were down 1.1% versus 3.1% in Q1.

In the brokerage segment of the wholesale area, general liability is easily the softest of all markets. Standard markets, especially regional carriers, continue to stretch and write classes of business that are outside their normal appetite. Apartments and condos are targets. Rates can be down as much as 20% to 30%. Exposure units are flat to down 10, except in the construction area where it can be down much more. Professional liability and D&O rates are down 5% to 7% on everything but financial institutions and real estate-related accounts. Financial institution market is tightening up with only four to six carriers willing to write primary coverage. Many carriers that work or write small community banks are reducing their limits or getting off the account.

Exposure units are typically flat to down slightly except those involved in technology and financial services, which can be up. In the property arena CAT prone rates are down 5% to 10%, but accounts over $1 million of premium can see rates down over 20%. In non-CAT areas rates are down 5% to 20%. The standard market continues to expand our appetite in the property area as well. In binding authority rates are flat to down 10% and exposures are flat to down 10% as well. In Florida we continue to see small admitted unrated carriers on some classes of business, i.e. condos, and in Colorado, as I said earlier, house bill 1394 has created limited availability to write contractors with certain binding authority markets. In the programs arena professional programs are down 4 versus down 8.4. Lawyers remain very competitive with rates down 5% to 25%.

Title agent businesses are down substantially, which most of us would expect, and dental continues to be the winner in the club house growing organically, but rates and exposures are down slightly. And special programs down 10.4 versus down 25.9 at Q1. Proctor we expected to be down $6 million to $8 million in Q2 on their core revenue and we were actually down $2.6 million due to an extension of runoff, of the runoff of a large account. Their new business is very good, but I would like to point out that we do expect Q3 and Q4 to be down $2 million to $3 million in their core business as that account runs off now. So it is really an extension of what we said for Q2 that didn't all materialize in Q2. It is going to hit more in Q3 and Q4. FIU is seeing increased competition in both wind and excellent accounts in Q2.

E&S carriers can compete if the condo is willing to accept a 5% wind deductible versus a 3% wind deductible. On smaller accounts FIU regularly sees companies with minimal policy surplus. Excellent business is very competitive and I would like to acknowledge Acumen Re in Ephrata, Washington, a public entity operation, for both having a great quarter and special programs. In services we are up 30 basis points in Q1, in Q2 as we were in Q1. Sam Boone and his team continue to do a great job in the Medicare set aside businesses and TPA areas. Now I would like to turn it over to Tom Riley for an acquisition report.

Thanks, Powell. In the second quarter we completed two transactions totaling $7.6 million, the biggest of which was the Stone Agency near Hartford, Connecticut, which was approximately $7 million. As you have seen we have completed three more transactions in the third quarter, which totaled $5.1 million, the biggest of which is the Common Wealth Agency in Charleston, South Carolina. We have been very busy in past quarter and few months as we have quite a lot of inventory in the pipeline. The potential tax change does seem to be driving more acquisition candidates to look at possible transactions. I would anticipate a very busy next few months as our acquisition teams are evaluating several opportunities currently. We really have not seen any new competitors in the current quarter and pricing remains consistent with what we have seen in the prior few quarters. So with that I will turn it back to Powell.

Thank you, Tom, for a good report. In conclusion, I would like to say that rates remain soft even in CAT prone areas, as you have heard. All carriers are under great pressure to grow premiums and thus don't want to lose even one renewal. New business pricing seems to be the most agressive and regional carriers are leading the way from a competitive standpoint. So with that, I will turn it back to you, Cecelia, to open it up for questions.

(Operator Instructions). Our first question today comes from Keith Walsh of Citi.

Good morning, gentlemen. First question for Powell. When I think about the retail business and I look at all the small business metrics out there, whether it is lending, new start ups, business optimism, they all look pretty bleak and I wanted to -- so how do I reconcile that, those indicators with the improving organic numbers that you guys are showing and maybe if you could speak specifically to your new business, what you are writing right now? Thanks.

All right. Well, good morning, Keith. I would tell you that I think it is probably a matter of perspective and your question comes at a time where we sort of have felt that although some of the leading economic indicators in small businesses may not have totally reflected that in the past. So remember, we are still, in terms of retail business, still shrinking, as you know. So that's number one. Number two, we continue to write a lot of new business, whether it is prior to or during this period of economic slowdown. And I wouldn't say that we are writing more new business now than we have historically. I would say that we are writing in a historical normal amount of new business, but the accounts that are existing clients are not shrinking as much, if you want to make a very broad statement.

And so come carriers -- some clients or prospects have shrunk to a level that they're either going to stop and they are going to continue at that level and go back up, hopefully in the future, or they're not going to exist. And so that is what we have seen. So in extreme scenarios where you have places like Las Vegas is a great example, southern California, Arizona, to a certain extent in Florida, where you see more bankruptcies than we have ever seen in terms of businesses, particularly small businesses, but I think that what you are seeing is a reflection of what we felt throughout this period, which is our client, middle market clients, have been and will continue to be for the near-term under incredible pressure. Their businesses have been shrinking and it seems as though they may not be shrinking as much, although they're still shrinking particularly in certain areas of the country, but we continue to write a lot of new business in our system. So in a historical norm in terms of new business.

That's great. And then second question for Cory or Tom. When I look at your cash balance, I think the first time in over a decade that your cash is higher than your debt on your balance sheet. It seems like even with the acquisition pipeline being as strong as it is you can't deploy this cash fast enough at this point. Any other thoughts for what you would do with the excess cash? Thanks.

We think the acquisition opportunities are very plentiful and we will be deploying that in that mode. And until it proves that, that is not the case, we really have no other plans for it.

And just to follow up there on the M&A front, you're out there buying agencies right now. I'm assuming they're feeling the same pressure that you are feeling in your core business. I mean from a return on invested capital standpoint wouldn't it be better to buyback stock right now than to buy an agency that's actually shrinking.

I would like to answer that. This is Powell, Keith. We believe that there's somewhere between 20,000 and 24,000 independent agencies across the country and although every single one of those would not fit culturally or they may have a little different business philosophy than we do, we think there are a lot of very high quality acquisitions across the country and in places, for example, I was in Charleston, South Carolina in a new acquisition yesterday and they have a bunch of very high quality people in that operation. And that's what we are focused on.

And if in fact their business feels a little pressure in the near-term, we believe that good people grow and create good businesses and we know that Charleston, South Carolina, as an example, is a good place to do business. That's not saying that there aren't tons of other good places around the country. I just happened to be there yesterday on the way to New Jersey. And so I would tell you that we think our returns on invested capital, even if some of those assets shrink slightly in the near-term, will rebound as the economy improves and we are very comfortable with doing not only investment opportunities, but our balance sheet to be able to capitalize on any opportunity that presents itself now or in the near, in the future, actually.

Great. Thank you very much.

And our next question comes from Jack Sherck with SunTrust.

Thank you very much. Powell, going back to your opening comments about the regional carriers being very aggressive on pricing, has that competition intensified this quarter versus 1Q or is that kind of just more of the same?

No, I think it -- Jack, good morning, I think it is more of the same. Regional carriers, particularly in the Midwest and in non-CAT prone areas, are historically always very competitive. And I don't think there's anything new about that today. The thing that I do believe, though, is you start to hear more carriers, including regional carriers, talk about the pressure they're feeling to grow their premiums. And in doing so, they are considering how do they get more opportunities to write new business. Does that mean they appoint new agents, do they focus more energy on their most productive agents? Every carrier has a little different strategy, but we don't think that's a negative, that's just a statement and a potential positive to us because we do a lot of business with regional carriers and think they're great, great companies to do business with.

Right. And then just a couple of quick housekeeping questions for Cory. Cory, did you say the organic growth rate in 4Q was down 8.3 ex-Proctor, than 5.6, down 5.6 in 1Q?

Yes, I mean -- .

I think I heard those numbers.

In the fourth quarter it was 8.3 without Proctor and 5.6 the first quarter, right.

Okay. And then just moving on to other operating expenses. There was about $34 million this quarter versus $36 million kind of a run rate in the prior quarters. Can we now look at, since it seems that none of those savings were really one-time in nature more of a $34 million run rate there?

That is true. There's probably a little bit in there that, like legal costs, those kind of things that are, can fluctuate from quarter to quarter, not necessarily onetime, but when you get into the occupancy costs and general supplies, those are savings that basically are being created at our decentralized office locations and so those are kind of what the normal levels would be right now.

Okay. And then just my final question on the acquisition front. It sounds, I mean we have all talked about the change in tax law and how that would help the acquisition front, but it seems that this quarter, at least so far into 3Q, things have intensified a little bit. Am I kind of hearing that correctly from your language.

They have. It is -- I would like to have put more on the books in the second quarter than we did, but I kind of put in an analogy as the world cup soccer games, we have been running and running and running and running and running for hours and we haven't scored yet, but I feel like there's some goals out there that are coming and there is a lot of, I hate to use the pipeline is full because I don't know what that really means, but there are a lot of potential transactions out there for the last few months.

Great. Thank you very much. Congratulations on the good quarter.

Thank you.

We will go next to Adam Klauber of Macquarie.

Thanks. Good morning. A couple of questions. The improvement in organic from year-end to current going from roughly negative 8 to negative 3, is that 5 point differential mainly exposure units?

We have -- Adam, good morning. We have said that exposure unit have and continue to make up the vast majority of the impact on our negative organic growth. So the answer is yes.

Okay. Okay. So they still make up the negative, but that negative, as you said earlier, has become less. Is that correct?

Yes. What we have said, Adam, is that we believe somewhere between one-third and 25% of the negative downdraft pressure is rate. So the resulting two-thirds to three-quarters would actually be exposure unit shrinkage.

Okay. And have you noticed any change in audit premiums over the last three months or so?

The short answer, and this is anecdotal evidence, is not dramatic. But once again, there are places around the country where you get the feeling that people feel more positive about their businesses, but until you see the audit come in you don't know. We have always said that as the economy goes down slightly you are going to have more return premiums and APs and as the economy improves you are going to start to have more APs than RPs. So we aren't seeing that in aggregate yet because we haven't seen an uptick, as you haven't, in the overall broad market middle market economy.

Great. The wholesale business seemed like it had a pretty good quarter, particularly as you mentioned, you still have risks going to the standard market. Do you think this quarter is sort of, is, could be potentially blimp or can it continue to stay relatively stable in this tough, tough market?

I think that it is -- one quarter doesn't make a trend, in our opinion, and so we don't know yet. And part of that is we believe there's really three types of risks. There are risks that are clearly excess and surplus lines accounts and will stay there. Conversely, there are accounts that are clearly standard market accounts and they will always probably be in the standard market. And then there are accounts that look and feel and smell like an E&S risk and yet in times like today, they can convert into standard market risks and as the economy improves and the market kind of normalizes, those accounts will kind of vacillate or move back towards the E&S market.

We are still in an environment, as I said in my prepared comments, that there are risks that are E&S looking and in nature that are gravitating towards the standard market and many of those are written by regional carriers. So they're going to continue to see that. As I also said, there are certain accounts that are flowing back into the E&S market in areas like a Florida where the Citizens Property Insurance Company is raising their rates. So, with a little bit of a negative there's a little bit of a positive there, but it is too early to tell, Adam, on that.

Okay. Thank you. Finally on the acquisitions, the deals you are looking at, is there a set of companies that are on the $10 million range and above that are in that mix or is it mainly $10 million and below at this point?

No doubt the -- there are some above that, but no doubt the majority of them are below $10 million, obviously. But we have a few in the pipeline that we have got that are above that market.

Okay. Great. Thank you for the answers.

And we will go next to Keith Alexander of JPMorgan.

Hi, good morning, guys. Good morning. Most of my questions have already been answered, but I was wondering, it seemed that contingents were slightly higher than expected in the quarter. Was there anything unusual there this quarter.

No. I think it was kind of right in the range that we were thinking. I think we said it was -- I think in the first quarter, if I recall, we said maybe 4 to 6. So maybe it got to 6.4. So a little bit extra there, but not significant.

Okay. There wasn't any benefit from deferred FIU contingents from last year.

No, no, nothing from FIU.

Okay.

I take that back. There was about 900,000 at FIU and if there was a little bit of difference that probably was, we were thinking maybe 750 and I think it came in at 900. So you are right, Keith, on that.

Okay. All right, thank you.

And we will go next to Sarah DeWitt of Barclays Capital.

Hi, good morning. I wanted to follow-up about your organic growth in the quarter. Do you expect the trend of improving organic growth to continue and when do you think you could turn the corner into positive territory?

Good morning, Sarah. I would tell you that, and this not meant to sound flippant as a response, but when somebody could tell us when exposure units are going to flatten and uptick, we would have a better feeling on when we think we could start to move towards positive organic growth. So, we believe that in the current rate environment, rates on average are down 4% to 7% across the country. If exposure units are up slightly to up substantially, but up slightly we believe we'd grow organically in that environment. Unfortunately, I don't -- I wish we had it, but we don't have a crystal ball that would be able to tell us when that's going to occur. So, it would be just speculative on our part.

Okay, great. Thanks. And then secondly, you have been able to expand the margin in the quarter despite negative organic growth and I think you have said in the past that you really need positive organic growth to have positive operate leverage. So do you think that this trend could continue or what do you have in terms of opportunity to reduce expenses further?

Yes. No, what, Sarah, what we have said historically is when we have slightly negative organic growth we can have potentially, not all the time, we could potentially have operating improvement. When we have negative organic growth we have margin pressure. Coming from an area where we were, i.e. 8.3, 5.6, down we were not in that environment. And we believe that as we continue to improve in terms of as the economy improves, that we will have better operating leverage. That said, we also think that no one shrunk their way to greatness as a Company, so untill we grow organically we at our local operating office level are trying to manage the expenses the best we can, but knowing that it is all about people do business with people and we need to write more new business and do everything we can to retain our existing clients. So we don't have another lever to pull per se, as some people have asked us before, that are additional expenses as we are in this negative environment. We are pulling ever lever we know which to pull.

Okay, great. Thanks for the answers.

Thank you, Sarah.

And we will go next to Brett Huff of Stephens.

Powell and Cory and Tom, good morning.

Good morning, Brett.

Thanks for taking my call. A few of my questions have been answered. Just a quick follow-up on the last on and then another organic growth related. Powell, I forget the word you used last time, but I think you said pockets of optimism or something similar, it sounded sort of sporadic or distributed around the country. Were those, is my, is the right way to think about your, the exposure units getting less bad. Were the exposure units in those areas you had kind of referenced last quarter, were those the drivers of that or is that not a connection that we should make?

No I don't think that is the connection that you should make, Brett. What I would say is this. The comment last quarter about pockets of optimism or things, if you -- I think what I said is I gave an example of an area like, not a state, an area like San Antonio, Texas or Seattle, Washington. San Antonio, Texas the unemployment rate is under 7%. Their economy is based on two big things that drive it, healthcare spending and defense spending. And so that is a different environment, obviously, as opposed to Arizona or California or Florida with much higher double digit unemployment rates. In Seattle, Washington those businesses were going full steam until the end of 2008. 2009 those businesses out there went down.

And if you walked along the street in Seattle, Washington today and you asked a business owner how they felt about their business, I think there's a certain level of optimism that they have that they haven't had there in a while, but we may not have seen that come through in terms of their exposure units being up yet, meaning from an insurable standpoint. So to answer, that's kind of long winded, but saying that I think the performance of our Company this quarter was broad based in nature in all of our divisions and so it is not, it was not focused specifically in something that I implied or I stated as a pocket of optimism. I actually tried to make sure that everybody didn't misinterpret that comment last time because, as Sarah asked earlier and you are asking, we are still shrinking organically. And until we grow organically, we are not going be happy about it.

Thanks. That's helpful. And then one last question, have you guys thought about the PSP and if that will change or stay the same, just as the stock price has been sort of flattish lately, have you guys considered how that might be altered over time or address that particular issue?

Yes, we have. I am not trying to be funny, Brett, the answer is yes, we have. The answer is we are committed to creating a wealth-building system that will reward performers in our Company. And coincidentally, we have been talking about it just recently. And so I think that we will modify that slightly in the future to the benefit of our team members and so I think that will be something that will come out in the future.

Great. I appreciate your comments. Thanks, guys.

Thank you.

Our next question comes from Meyer Shields of Stifel Nicolaus.

Thanks. Good morning, all.

Morning.

I'm sorry. Powell, can you talk -- I guess the most impressive sequential organic improvement was in western retail. Is there anything unusual going on there relative to --

Well, I don't think -- if you remember, Meyer, what we did is Roy Bridges moved or took, went from Florida out to the west coast as has been actively involved with those teams now for now over a quarter. But, I think it is an involvement. We have a lot of good people in the west and they have bumped through some unique economic times, but I think it is a combination of a bunch of things. I think Roy is helping out. I think the team is doing a great job that is out there. And there's a lot of improvement yet to go until we grow organically. Obviously, we won't be as pleased as we would be if we were growing in a positive fashion, but we will ultimately, but there is no secret sauce if you are looking for that.

No, I just really wanted to understand what was going on.

Yes.

With regard to the wholesale segment, there have been some news reports suggesting that AON is going to stop sending wholesale business outside of the AON family. Would that have a dramatic impact on Brown & Brown wholesale revenues.

No, we don't do a lot of business with them in our wholesale operations and we have heard that. And with all the changes in the not only the things with the attorney generals, it would not surprise me or us if Marsh, AON or Willis got back into the wholesale business, but I don't know what ultimately that will look like in the general landscape, but no, if they decided to force everything in house that would have a very minor, if any, impact on us.

Okay. And last question, if I can, just for Tom. Should we anticipate a slow down in M&A if and when the capital gains tax rate goes back up?

That is a good question. I hope not because we were obviously doing acquisitions before when the tax rate was different. I think you might have two different things moving in different directions. One, when the tax rates go up, which we are assuming they will, you are also going to have, we would think we were getting, heading toward an improvement in the economy, which would end potentially less soft pricing on the PNP pricing. So one would also think that that would give them, a lifting of that would help give them incentives for the transactions that have not closed over the last couple of years to get back in play. So, to answer your question, I would, there are some people that clearly are going to try to sell in the next five months, but some other people have been sitting on the sideline until their business could grow, I would think they might come in play as soon as things start looking better.

Okay, great. Thanks, all.

We will go next to Dan Farrell of Sterne Agee.

Good morning.

Morning.

Can you just give us a little more detail on some of the reduction in comp expense and what's driving that. Is it headcount reduction. Is it more just lower profit center bonuses. Just a little more detail there. And then secondly, more broadly on the expenses, you guys have done a great job on both comp and other expenses in offsetting some of the negative organic growth. My question would be when we do start to get the flat to slightly positive organic, do you think there's a need to then go back and reinvest a little bit into the business because you're obviously probably running pretty thin right now?

Well, Dan, let me answer that first. As I mentioned, the majority of it does come from salaries and bonuses. So first of all, as the internal growth occurs, a negative internal growth occurs, we have offices are less profitable so that does impact the bonuses. So that's probably 30%, 40% of that number. The rest of it is salaries and where that occurs is on a decentralized basis, every profit center leader knows what his team members need to do and a lot of times if somebody retires or leaves, they kind of hold off in replacing that position and get the team members to figure out how they can handle it and that's the way occurs, because you will never see us say, well, we are going to reduce headcount by 100 people.

We don't know how that happens, because one office may not be able to reduce anybody. They may need to hire people and another office could get rid of two based on their own circumstances. And that's the strength of a decentralized environment. But keep in mind, one thing I want you to remember is that the one area that is actually have an increase, which did have an additional increase, is on new producers is continued to go up because we do reserve 1% of our revenue base for what we call people category and that's where we take profit center leaders who have demonstrated a real ability to hire high quality people and we tell them to go out and hire a new producer or a marking manager and the half of their salary for the next two years will come out of this people category. And so essentially that's about $9 million a year, over $9 million a year that we take in from the offices that we then spit back out to people that technically we don't really need right now, but we are training them.

And so we have been doing that since the '80s and that continues. So I think the main thing to realize is that these are decentralized decisions and so it is a very thoughtful for each office in terms of what they can do and what they can not do. I hope that gives you an idea, but the idea is yes, we are more efficient today than we were three years ago going into this head storm and that really is the silver lining around this entire Company, because when we do get a dollar's worth of increased revenue just because exposure units went up, we are not going to have to necessarily to hire new people right off the bat. Over time they will, but it will be done more along the lines as the economy starts to come back and that's why we do say that when we do get back to positive growth we think our margins will come back stronger than they were three years ago. So hopefully that answers it.

That's helpful. Thank you very much.

Our next question comes from Dean Evans of KBW.

Yes, thanks. At this point most of my questions have been answered. I was just hoping we could touch back on M&A for a quick second. Are you seeing any increased competition from some newer competitors, such as Pat Ryan or someone like that?

Well, obviously, Pat Ryan is in the E&S space now, but we have not seen anything from him and no I don't think so. We have not run across anybody that we haven't seen before. So I am sure Pat's out there and is going to be looking at some potential acquisitions, but so far, the answer to that question is no, nobody that we haven't seen in the past.

Okay and are there any -- with regards to M&A, are there any -- I know historically you have kind of just looked for the right fit, but is there anything right now that kind of stands out to you as a good opportunity. I mean it sounds like employee benefits is running along pretty strong for you guys. Is that maybe an area of focus.

Well, you obviously there's two sides to every transaction, so they have to be interested in doing something, but we are -- obviously, we are a little more careful, I guess I would say, and last year on employee benefit acquisitions and we are back looking at them. Obviously, we are still careful with that space, but there -- no, to answer to your question, there is not any specific areas. If it is a cultural fit and they can run at the kind of operating margins that we want them to run at, then and it seems to be a fit then we are definitely interested.

Great. And I guess my last question, I was just kind of hoping to touch on sort of what your current thinking is on the healthcare reform and how that can impact that employee benefits business?

Sure, Dean, it is Powell. I would tell you that there's still yet a lot to be resolved in healthcare reform. As you probably know, in the bill that was passed and signed into law, it says that the Secretary of Health and Human Services will dot dot dot, meaning she will have the latitude to interpret as she sees fit 1,045 times. And so there are a lot of things that are yet to be sorted out. My personal opinion is that there will be a lot of change in the midterm elections this fall. And there are certain people that ask us do you think that healthcare reform could be repealed and I categorically do not think that could be repealed. However, I do think there could be modifications and clarity in the current bill.

For example, there are unintended consequences like certain employers could choose to pay a penalty and force their employees into some sort of exchange program. I don't think that was the intent of the law, although that is how the law is currently written. Some of those things I do believe will be resolved or clarified going forward, probably need to be clarified with the changes, whatever those are, after this fall. But there's still a lot of uncertainty which creates opportunities, we believe, for us, but it is just a little unclear right now what those are going to look like.

Okay, helpful. Thank you.

We will go next to Keith Walsh with Citi.

Hi, guys, just a follow-up for Powell here. With respect to the oil spill in the Gulf Coast region, just want to know are you seeing customers that are filing claims and if they are, are they engaging you to help them or are they going direct to BP? Thanks.

Well, let's talk about the oil spill 'cause we believe the oil spill can be a game changer politically in the Gulf Coast regions as it relates to, and I will come back to that, as it relates to claims, we have not seen that many claims yet and I don't know if we will. What we are seeing, though, in places like the panhandle of Florida, is clients that are talking about their businesses are down, meaning Memorial Day weekend, Fourth of July weekend in the summer where people that live in Atlanta and live in the northeast and the Midwest that were coming to the panhandle of Florida have canceled their reservations and that doesn't just impact the hotel or the motel or the condo that they're renting, it impacts the local economy with the restaurants and the put-putt golf and all the other things that are going on in those communities. Fortunately, what we are hearing though is that those people are still coming to Florida, they're just going to the east coast. So they're coming from Jacksonville, [Amelia Island down to maybe the West Palm Beach area and everything in between.

So, that is sort of -- yes, Vero, as Cory said. That would be the economic environment. We also do not believe that the insured losses from the oil spill, which are estimated to be somewhere between $1.3 billion and $1.5 billion, to have a material impact on rates on a broad market basis. That's number two. Number three, as it relates to the political impact, as you know or probably know the State of Louisiana $65 billion of their economy annually is related to the oil and gas business, that's on shore and offshore. And in the State of Florida, interestingly enough, $60 billion of our economy annually is related directly to tourism dollars. And so if in fact you have an individual candidate in the State of Florida that is running in a highly contested gubernatorial race or in a US senatorial race and they have been very pro-drilling and they have footage of that individual and then commenting as such and then all of a sudden you have a picture of a small bird covered in oil dying on the beach. That doesn't go over real well with the electorate.

And so I can't tell you exactly who that helps and hurts yet, but it definitely is a game changer from a political standpoint. And so I think that what you are going to find is you are going to have people that own properties in the Gulf Coast region, this is not just Florida it can be anywhere along the Gulf Coast, that their businesses will be impacted and the question is where will those vacationers or tourists go instead of going to where they are. Are they going to go to another place in the state or are they going to go to just another place in the country all together?

Okay. Thanks.

And we will go next to Mike Grasher of Piper Jaffray.

Thank you very much. Good morning, everyone. A couple of quick question. Can you update us on sort of the percentage of your book that is in the southeast corridor?

Okay. Well, good morning, Mike. I would tell you that about 30% of our total revenue is in Florida and so is southeast corridor in your definition Florida, Georgia, Alabama-- .

South Carolina, Mississippi, Alabama.

I would tell you that it is just slightly over 30%.

Okay, so not much above the Florida.

No.

Okay. And then, the other question, Powell, when you are talking about workers comp rates, be it up or down, what classes of risk are you speaking to, all classes across the board or can you speak any more specifically to a particular high risks versus more mundane risk.

No, those are, Mike, to answer your question, those are broader statements across all classes of business. As you know there are some states that are NCCI states that promulgate rates and help experience mods there and there are other states do those on their own. There are also states that allow carriers to deviate from where they file and then deviate from their own rates versus using a filed rate exclusively from NCCI, i.e. Florida example, as an example, everybody uses the same rates. And so the carriers have to develop programs which are usually dividend programs or retros, which allow exposure, really insureds that have good loss experience to pay a reduced amount of money over the annual term. In other states, that could be a California, that could be many other states, they actually file their own rates and then have the ability to deviate off that rate up front. So every state usually comes to their ultimate cost of doing business for Workers' Compensation a little differently, but my comments were broad market, all classes of business, high risk, low risk and everything in between.

Within that state or that region.

Correct. That's correct.

Okay. Appreciate it. Thanks very much. Thank you.

Our next question comes from Meyer Shields from Stifel Nicolaus.

Yes, I just wanted to follow-up on the M&A again. With regard, we have had a couple of quarters where you have reduced the earnout payables and I am wondering whether you are actually changing the provision as an initial contract for current deals?

No, Meyer, we are not. I mean, that FASB 141 it just puts a -- it is kind of a ridiculous statement, as you have heard me say before, but you have got to project out three years what the exact earnout you expect. And anything changes from that you have got to run through P&L. And so the only reason why these things are really changing is that you will never ever hit it right on the head and every acquisition is a little bit different. They kind of plus and minus. So you are going to see every quarter numbers flow in and out of that account and I know that most of you, including me, I just ignore it and that's why you kind of have to look at the operating profit excluding that. But the bottom-line is the way the contract that we use doesn't change at all.

Okay, perfect. Thanks so much.

And at this time we have no further questions in queue.

Well, thank you very much, Cecelia, and thank you all very much for attending the conference call and we will look forward to talking to you all next quarter. Have a great day.

That does conclude today's conference. Ladies and gentlemen, again we appreciate everyone's participation today.