Hilb Rogal & Hobbs Q1 2008 Earnings Call Transcript

| About: Hilb Rogal (HRH)

Hilb Rogal & Hobbs (HRH) Q1 2008 Earnings Call April 24, 2008 8:30 AM ET

Executives

Martin L. Vaughan, III - Chairman and Chief Executive Officer

Carolyn Jones - Senior Vice President, Treasurer and Investor Relations

Michael Dinkins - Executive Vice President and Chief Financial Officer

F. Michael Crowley - President

Timothy J. Korman – Executive Vice President, Mergers and Acquisitions

Executives

Mark Hughes - SunTrust

David Small - Bear Stearns

Dan Farrell – FPK

Meyer Shields - Stifel Nicolaus

Nik Fisken - Stephens

Keith Walsh – Citi

Mark Dwelle - Ferris, Baker Watts

Ken Billingsley – Signal Hill

Kyle Kavanaugh - Palisade Capital

Operator

Welcome to the Hilb Rogal & Hobbs conference call. (Operator Instructions) It is my pleasure to introduce Chairman and CEO of HRH, Martin Vaughan.

Martin L. Vaughan, III

Welcome to our first quarter 2008 investor and analyst conference call. I’m here this morning in our headquarters in Richmond, Virginia and at the table with me are Mike Crowley, our President; Michael Dinkins; our Chief Financial Officer; Tim Korman, Executive Vice President and head of Mergers and Acquisitions; and Carolyn Jones, our Treasurer and Director of Investor Relations.

Today, we’ll start by asking Carolyn to present our forward-looking disclosure and risk statement. Then we’ll ask Michael Dinkins to give his financial report followed by my overview and then Mike Crowley’s report on operations. Once that’s done, we’ll open up for questions-and-answers.

Carolyn Jones

Before we begin, please be aware in the course of this call members of HRH management may make statements regarding the company’s future financial conditions, business plan, operations, opportunities and prospects. Including any factors which may affect future earnings that are forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigations Reform Act of 1995.

The company cautions listeners that such forward-looking statements are based upon management’s current knowledge and assumptions about future events and involve risks and uncertainties which may cause actual results to differ materially by those anticipated by the company at this time.

For additional information about the company and the risks and uncertainties we face, we encourage you to consult our annual report on Form 10-K for the year ended December 31, 2007 and other reports from time to time filed with or furnished to the Securities and Exchange Commission. The statements made on this call speak only as of today’s date and the company disclaims any duty to update the information provided.

Michael Dinkins

HRH reported revenues for the first quarter of 2008 were $206.8 million, up $8.6 million or 4.4% over the prior year. Core commissions and fees increased $20.0 million, including $18.4 million from acquisitions net of divestitures. We recorded $3.4 million of supplemental commissions in the first quarter. Contingent commissions decreased $9 million. Investor income increased by $0.4 million due to lower interest rates.

The biggest factor influencing our revenues and earnings for the first quarter of 2008 was a continuation of the unprecedented soft market conditions which existed throughout 2006 and 2007. As reported by the Council of Insurance Agents and Brokers, during the first quarter property and casualty premium rates declined on average 13.5%.

Despite this incredible difficult market, we achieved organic growth of 1.1%, including a cognitive 1.9% in our domestic retail segment reflecting strong new business sales, supplemental commissions, and retention rates which Mike Crowley will discuss later in this call.

There’s a table on the last page of our earnings release that summarizes our organic growth rates by segment. The negative 7.2% organic growth in the excess of surplus lines in brokerage operations reflect the impact of the current property casualty market on our wholesale operations which are experiencing heavy rate declines, compounded by the movement of business normally written in excess of surplus to standard markets.

For the quarter, our reported operating earnings were $0.42, down from $0.65 from the first quarter of 2007. Our operating profit margin for the quarter was 20.3% compared with 26.4% in the first quarter of 2007. In addition to the extremely soft property casualty rates, the financial performance for the quarter was driven by contingents, professional fees and claims, and medical expenses. Lower same-store contingent commissions partially offset by supplemental commissions resulted in the $0.11 per share reduction and reduced operating margin by 2.4 percentage points.

When you combine contingents and supplemental commissions in aggregate, there haven’t been any material changes, just a timing impact. As we look at the balance of 2008 with the representation that we do not have the ability to accurately forecast supplemental commissions or contingents, we can say that a recent analysis of supplemental commissions will put the run rate at $3 to $4 million per quarter. When combined with a reasonable estimate for contingents, the total year forecast is comparable to prior year.

Increased professional fees in claims expense of $2.3 million negatively impacted operating EPS by $0.04 and operating margins by 1.1 percentage points. There are three drivers of this increase. Restricted covenant litigations associated with one office, settlement of the litigation matter, and higher auditing and tax timing fees associated with our forward structure. These items are not expected to have a material impact on future operations.

Increase in medical expense of $1 million negatively impacted operating EPS by $0.02, and operating margin by 0.5 percentage points. This increase is due to a planned design change which is expected to drive future savings. This accounted for $0.17 of the $0.23 reduction and an aggregate negative 4.0 percentage points impact. And, as noted, most of these are quarter-specific events. Contingents on timing and the known items that go beside the professional fees and claims should only have a $0.01 to $0.02 negative impact for the second quarter, with the disclaimer that additional unexpected things can happen.

BACIA was negative $0.05 operating EPS and reduced operating margin by 1.1 percentage points. The primary driver was a revenue shortfall. The retention rate met our expectations. However, new business generation was below our expectations, and Mike Crowley will discuss this more in his comments.

Our debt balances remain comparable to those of December 31. As of March 31, we had approximately $60 million of non-fiduciary cash and $244 million available under our credit facility subject to limitations under our debt covenants. During the quarter, we repurchased 482,200 shares of stock for an aggregate purchase price of $15.0 million. Our share repurchase authorization remains at $50 million for the calendar year.

For the balance of 2008, we are planning for continued soft property and casualty rates, a continued low interest rate environment which will impact our investment income level and interest expense on our variable rate debt. At the end of March, 54% of our debt was variable.

Amortization and depreciation for the first quarter are reflected in our expected run rate for the year. Our effective tax rate is currently expected to run between 38% to 40% for 2008. Our non-cash stock-based compensation was $1.6 million in the first quarter as compared to $1.8 million for the prior year first quarter. We expect 2008 annual costs to be comparable to 2007 total of $6.9 million.

We will continue to have some quarter-specific events. In the third quarter of last year, we reduced operating income by $6.4 million for an errors and omissions case dating back to 2001. And in the fourth quarter of last year, we had a 51% tax rate, primarily because of increased reserve from Federal and state compliance.

The quarter-over-quarter comparison will have to take these things into consideration. However, when taking a total year perspective, HRH continues to build the capability to grow market share, provide superior service to our clients, while driving workflow efficiency.

At this time, I will turn the call back over to Mel for further review of our operating results and outlook.

Martin L. Vaughan, III

While we’re not pleased with our first quarter 2008 results, the year is off to a better start than the unfavorable financial comparison implies. Although property casualty rates continue to dramatically decline, we did achieve 1.9% organic growth in our domestic retail operation. This equates to superior new business sales, market share gains, and solid client retention.

As Michael Dinkins described, the quarter was also affected by some quarter-specific items that we expect will not materially affect our full-year performance. The higher-than-normal legal and professional fees in the quarter, a spike in the employee medical cost associated with a change in plan design, and quarterly dilutions from one of our acquisitions, namely the Banc of America acquisition that Michael Crowley will talk more about. In addition, a switch from contingent to supplemental commissions by certain underwriters complicates quarterly comparability, but this should level out over the year.

Our acquisition activity is well below our record pace of last year. However, as a show of confidence in our own prospects, we have purchased over $30 million of our own shares over the past six months. Our focus for the rest of the year will be on achieving positive organic growth, continuing to gain market share and realizing benefits in the form of improved client capabilities and cost savings from our process improvement initiatives.

I want to spend a few minutes adding some detail to my comments regarding the rate environment and acquisitions, and then I’d like to update you on our Glencairn operation in London and comment about our wholesale operations in the U.S. After that I’ll turn the floor over to Mike Crowley to talk more about our retail operations including the Banc of America acquisition.

On the P&C rate side, sharp rate declines continued during the first quarter of 2008 in all the property casualty lines of business. This marked an unprecedented sixth consecutive quarter of double-digit declines. As Michael Dinkins reported, the recent CIAB Lehman survey shows an average decline of 13.5%, up from 12% in the fourth quarter of 2007.

Our experience here at HRH matches well with the CIAB survey and applying the CIAB survey against our own mix of business would generate average declines for commercial property casualty in quarter one of 2008 of 15%. We’re working diligently to capture these premium savings for our clients. However, rate declines of this magnitude have a dramatic effect on our renewal revenues.

Keep in mind that these are averages which vary by line of business and geography, and in assessing HRH or any other brokers’ exposure to declining property casualty rates, the broker’s specific mix of business by line and geography is important as is the mix of fee versus commission business.

HRH is highly leveraged against the market but, in our case, we get some protection from falling property casualty rates from our approximately 15% fee-based property casualty business, our 24% employee benefit revenues, and our 5% to 6% contingent and supplemental commissions.

Last quarter, I mentioned that we expect rate declines to moderate somewhat in 2008 as underwriters feel the compound effect of rate cuts, higher loss cost, and reduced investment income. This didn’t show itself in the first quarter of 2008. It isn’t possible to estimate when the market will head back to normal, but, clearly, there are practical limits to rate cutting that will emerge in time.

In the meantime, we’ll work aggressively to exploit lower rates for our clients. We’ll pursue operational efficiencies that are consistent with our long-term business objectives of superior client service, increased competitiveness, and, of course, gain in market share including our work on process improvements and focusing strongly on underperforming offices.

On the acquisition front, since last year was our biggest single acquisition year ever, of course, we’re focused on successfully integrating those companies. Currently, our pipeline of quality prospects is slightly smaller than it normally is and certainly smaller than it was at the end of last quarter, but it’s still a reasonable pipeline.

One new development that we’ve seen is several quality shops exit the market because they didn’t believe they could maximize value in this rate environment. And also with HRH shares available and attractive for re-purchase, we’re being a bit more selective about acquisitions.

All that said, we expect to do fewer deals this year than last year, but quality acquisitions remain a key growth strategy at HRH and we have available capital to take advantage of any opportunities that come our way. Tim Korman, our acquisition chief, is here, as I said and he’ll be available for questions and answers.

Last quarter, we talked a lot about Glencairn in London and I want to report that Glencairn has made solid improvement in the first quarter of 2008. On an operating basis, they grew revenues modestly and exceeded bottom-line budget due primarily to the cost actions that were taken in the fourth quarter of ‘07. I visited the office several times in the past few months and I’ll report that spirits are good in spite of the cost cuts.

All of our London operations are under one roof now, and operational integration is progressing nicely. Our London operations continue to receive high marks from their U.S. peers at HRH for their ability to serve our clients and we have jointly written a number of new key accounts. Bottom line, although one quarter doesn’t make a year, we’re on track for significant improvement at Glencairn.

Our domestic wholesale business is the last thing where I’d like to touch. The excess and surplus lines of business and our managing underwriter business again posted negative organic growth in the first quarter, although both of those operations as far as organic growth is concerned improved from the fourth quarter of 2007.

These are great businesses, but they continue to be affected by lower property casualty rates, but they’re also affected by the diversion of business from excess and surplus lines markets and wholesale markets to standard markets as a result of the increased risk tolerance on the part of primary underwriters. Our strategy for U.S. wholesale is to compete aggressively for new business and renewals, pursue efficiencies and control cost, and position ourselves for superior profitability as the P&C cycle turns.

To close, I want to say that even though the current market is extremely soft, HRH brings a remarkably stronger resource base to the marketplace than in past soft markets. We have a broader customer base by size, geography, line of business, and specialty. We have competitive and proven operating models for sales, client service, risk management, and administration.

We have pervasive sales culture based on effective team selling and accountability and we have superior talent throughout the organization particularly our client-facing folks, our producers, our account managers, and our technical talent. We have a critical mass of productivity-enhancing technical applications and a large and growing employee benefit practice.

Fundamentally, we are positioned stronger than ever to provide national shared talent and resources with local touch sales and service to serve clients with consistently superior service while others cut corners and, finally, to consistently gain market share even in a tough market like today.

We’ll now ask Mike Crowley to give you his report.

F. Michael Crowley

As we previously mentioned, there were a number of factors affecting the results, including longer than revenue timing issues, increased legal expenses, the performance of the Banc of America Insurance Agency acquisition, and continuing softness in the property casualty market. Let me take these issues one at a time.

First, we identified larger than usual revenue timing issues. This is revenue that we expected in the first quarter that will be booked in the remaining three quarters of the year. Second, we experienced a significant increase in legal expenses resulting from litigation to protect employment covenants at one of our branches.

With regard to the Banc of America Corporate Insurance Agency, the primary focus of the sales professional at our direction at BACIA has been to secure the relationships with the current clients following the acquisition by HRH last fall. This required a significant time away from new business efforts, but I’m pleased to say it resulted in a retention rate consistent with our expectations. The new business pipeline is being rebuilt and we expect new business sales for this group to get back on track quickly.

Results were also affected by severance cost which will not recur related to the right-sizing of the organization. They were also affected by nonrecurring revenues, a slowdown in their mortgage consulting business, and as mentioned earlier, a shortfall in their new business.

On a positive note, the new business for the quarter in the domestic retail segment remains strong with a slight increase in the number of new clients and total new business dollars produced. This led, as mentioned earlier, to a 1.9% organic growth in the domestic retail sector. HRH continues to gain market share while battling the continuing decline in property casualty rates. We have experienced three consecutive years of record new business and a positive beginning for new business in 2008.

Our sales professionals continue to bring more clients to the firm than ever. We clearly need to recognize the need to control costs and are looking at every aspect of the business. Same-store operating expenses increased less than 2% in the first quarter. Our retention rates remain steady and our commitment to quality, service, and a broad range of capabilities is the key factor in our ability to keep clients and gain new business.

In the first quarter, we continue to add great new production talent to the organization. Let me give you a few examples. John Wilson joined our Colorado operation as a producer and, prior to joining HRH, he has been a successful producer at a regional firm but moved to HRH because of our resource capability. He’s a graduate of the University of Kansas and the University of Kansas School of Law and he’s currently a member of the Colorado Bar Association.

Joe Ford recently joined our Dallas operations as an employee benefits producer. Joe most recently served as National Sales Director for Cigna and has nine plus years of experience and is a graduate of Arizona State and Boston College Graduate School of Management.

Joe Garcia joined our Miami office as President of that operation. Joe most recently served as President of ExecuSure risk management in New Jersey. His experience includes five years with a top ten broker where he managed their Arkansas operations and he has been a senior auditor for Arthur Andersen. He’s a graduate of the University of Central Florida and holds the CBA, CIC and AAI credentials.

Harry Dinger joined our Northeast region as Head of Surety Operations in New Jersey. Harry brings 24-plus years of surety experience to HRH. Previously he had worked for EMAR Group at Marsh USA where he was Senior Vice President and Construction Practice Leader and Surety Manager for the Northeast.

Partho Gosh joined HRH in New York City as a property casualty producer focusing his financial products expertise in the power and energy sector. Prior to joining us, Partho was Senior Vice President and the Global Practice Leader for weather and energy special products for Marsh in New York.

These talented sales professionals add considerable revenue generation capability to HRH and we are delighted that they chose our firm to continue their careers. The challenges we face in 2008 present a considerable headwind to our efforts to grow earnings.

We’re pleased with our ability to show organic growth in such a difficult property and casualty rate environment. We are focused on maintaining the balance between our cost reduction efforts and our ability to consistently create value by growing market share. We are sticking by our strategy of talent, expertise, and specialization in both the property and casualty and employee benefit sectors.

We will continue to drive process improvement and efficiencies through our new regional operations managers as mentioned in the fourth quarter who, under the leadership of Chris Purvis who is working along with Michael Dinkins; Viren Kapadia, our Head of our IT; and me in that effort.

In closing, we have a great team at HRH and all of us are striving to continually raise the level of expertise and service that we deliver to our clients. In the end, it is the quality of those services and capabilities that will determine our success or failure.

Martin L. Vaughan, III

That concludes our report. Michelle, please open for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Hughes - SunTrust.

Mark Hughes - SunTrust

What confidence do you have that the supplemental commissions will come later in the year? Have you gotten assurances from the carriers? How should we look at that?

Martin L. Vaughan, III

But the nature of supplemental commissions is the fact that you are provided information by the carrier at the beginning of the year regarding the rate of those commissions against your volume. So the volumes are pretty steady, and we know what the rates will be as opposed to normal contingents which are paid at the end of the year. So we have pretty good confidence that we know what we’ll receive from those carriers that have instituted supplemental commissions.

Mark Hughes - SunTrust

Now that we look at the contingent commissions for last year, what should we think in terms of the magnitude of the change year-over-year as we think about 2Q? You did $8.5 million in 2Q ’07, any general thoughts about 2Q ‘08?

Michael Dinkins

We did $3.9 million in Q2 ‘07, $8.8 million total for the total year. And as we indicated in my comments as we look at supplemental commission, the $3 or $4 million run rate that we’re at right now looks like something fairly reasonable. Again, that could vary because you don’t know who you’re going to renew your business with what carrier, but somewhere in that range.

Mark Hughes - SunTrust

What’s your strategy in terms of cost structure? Do you plan to keep the current cost structure for the foreseeable future? The rate environment has been pretty tough. But in the domestic market, are you just going to keep the core that you’ve got and ride it out here?

Martin L. Vaughan, III

At the end of conference call last quarter, we talked about some initiatives that we have to reduce costs and we identified those at around $16 million. We made some progress on those in first quarter, not to the full extent that we would like. But we’re still planning on some cost savings throughout the year with the initiatives that we’ve talked about in the past.

Operator

Your next question comes from David Small - Bear Stearns.

David Small - Bear Stearns

Two of your last acquisitions we’ve seen have been dilutive when they’ve come out of the gate on a quarterly basis or even Glencairn, I believe, was dilutive till last year. Could you maybe just tell us if you’re doing anything to change your integration process? Or has your thoughts around how much you’re willing to pay for an acquisition changed?

Martin L. Vaughan, III

The right answer would be that when we buy something, we’re buying it for a very long term and so we’re not buying it for one year or for one quarter and a lot of times, which we’ve said in the past that we’ll buy a company that doesn’t have results that match ours understanding that over a couple years we can make progress and get their operations up to our standards.

So in the case as we said at the end of last quarter in the case of Banc of America, they had reasonable margins although not up to our standards. They performed well for us in the two months that we owned them in the fourth quarter and, this quarter, they were down some because of the things Mike Crowley discussed. So, we have high hopes for BACIA. There’s a lot of great people there and Mike Crowley will continue to work with Stan Jablonowski to make sure that investment pays off for us.

F. Michael Crowley

David, we’re aware of the issues. As I said in my comments, they had a mortgage consulting business where they consult with banks on their real estate portfolios making sure that they have appropriate insurance. That market really dried up and we’re redirecting a couple of producers in that business. We also had a vacancy in the surety operation for a couple months.

And, as I said in my comments, we hired a very senior person from Marsh to fill that vacancy. We expect those revenues to pick back up, and they had a couple of nonrecurring revenue issues that popped out in the first quarter, but we feel good about those segments.

And also, keep in mind that two-thirds of Banc of America’s business was employee benefit consulting business and health and welfare business. So it’s not as central to the property casualty market rate declines as some of our other operations are. So we feel, as Mel said, real good about the talent, real good about the sales talent, and again, we’re just looking at one quarter here.

David Small - Bear Stearns

You had mentioned, Mike, in your prepared remarks around litigation efforts to retain employees. Could you just give us some more color on that?

F. Michael Crowley

We had one office where, quite frankly, we were raided and we are aggressively defending our employment agreements and restrictive covenants in that office. So that situation was isolated to one event in one office.

David Small - Bear Stearns

Given the margin volatility we’ve seen over the last few quarters, could you just remind us about where your long-term margin expectations are for HRH?

Martin L. Vaughan, III

What we call our strategic margins which we would expect to achieve in a more normal market would be between 27% and 28% and we feel like that the economic model and the mix of business that we currently enjoy will generate those types of margins. It’s very difficult to hold those when rates are going down 15%.

David Small - Bear Stearns

And just to clarify, that’s operating margin.

Martin L. Vaughan, III

Yes.

Operator

Your next question comes from Dan Farrell - FPK.

Dan Farrell - FPK

I was wondering if you could talk a little bit about your budgeting process and how you were looking at 2008 at the beginning of the year. And then just maybe talk a little bit about where the quarter came in versus what you originally expected and maybe some of the things that you thought would happen versus some of the things that may have surprised you that was seen in the quarter.

F. Michael Crowley

In our budgeting process, the best way I can describe it is grueling and bottom up. We literally go through three to four passes of the budget. Let me just give you an example of a specific office. That office presents its budget to a regional director. The regional director analyzes and determines what needs to be changed. It goes back to them. By the time that budget gets to me, it’s seen a couple of passes. But when it gets to me, Michael Dinkins and I literally sit down with the regional director and, in many cases, the branch manager if there are issues in an office, and we go through that budget line by line.

We look at a five-year historical performance of the office. We look at five-year historical performance by producer and their book of business, new business and renewal. We look at the staff, the compensation, every expense line for every single office, and build that budget from the ground up.

Our assumptions for the 2008 budget included an average 7% decline in property casualty rates across the year. Back in October and in the fall when we were doing the budgets, we expected the first quarter to be down again. We expected things to mitigate somewhat in the last couple of quarters of the year. Clearly, the first quarter has been much more aggressive with regards to rate declines than we had anticipated. So that has an impact.

We know that when we build a budget that not every office is going to perform exactly like the budget. So we take that into consideration as well and the budget was an attractive budget. With regards to the first quarter and the company, we are slightly off of plan and some of that has to do, if not all of it, with timing issues.

Dan Farrell - FPK

Can you put a number around it at all? As you look, what’s the difference between what the actual reported number was versus what you thought it might be?

F. Michael Crowley

No. We don’t give that guidance.

Dan Farrell - FPK

On the acquisition revenue that came through the quarter, the $18.4, it’s a lot lower than what I would have thought it may have been and, obviously, some of it is from Banc of America shortfall. But can you give us a little more detail there? What were the Banc of America revenues in the quarter and was there any other shortfall in any other smaller deals that took place last year that should be flowing through? And then maybe can you give just some expectation of what you think Banc of America trends at for the rest of the year?

Martin L. Vaughan, III

First of all, understand that the $18 million number is net of divestitures. And so, there were slightly less than $3 million in divestitures so the new acquisitions would have added something over $21 million even with the shortfall.

Our records, one of the things we do religiously every quarter is to measure same-store performance and acquisition performance. And I can tell you that with the exception of Banc of America acquisition, the other class of acquisitions were either neutral or accretive and performed either better or pretty much at expected. So we’re pretty happy with how that went. Unfortunately, Banc of America is much larger, so it has greater impact.

Dan Farrell - FPK

It would be great to just get a little more clarity on the actual numbers for Banc of America. If it’s $66 million of annual revenue on a quarterly basis, I would have thought roughly $16 million. Are we talking $10 million came through on Banc of America, $12? Is there any way we can give us some more clarity on specific numbers?

Michael Dinkins

As a general rule we don’t disclose below segment level information so we don’t have to give every one of our operations details. And once we do it once, we’d have to continue it. I think Mel’s point is that I think with Banc of America, like with many of our businesses, you’ll note that the commissions and fees are slightly less in the first quarter than other quarters.

So dividing it by four is not the way that you should look at it relative to Banc of America. And, as Mike indicated, the business focused on retention of clients during the turnover and has now rebuilt their pipeline and we felt pretty good about the business going forward.

Operator

Your next question comes from Meyer Shields - Stifel Nicolaus.

Meyer Shields - Stifel Nicolaus

The supplementals that are recorded as revenue in the first quarter of 2008 are those the supplemental component of contingents paid in 2008 or is that an accrual for the stuff that will be paid next year?

Michael Dinkins

Accrual for stuff that will be the combination of both, we received some cash this quarter for prior quarters that we recognized when we got it and then most of it is setting it up for next year, but it doesn’t change the timing of the cash. The cash generally comes in March. It’s just that we’re now able to accrue some of that this year.

So let me start over and then clarify. For those who switched over, we got the cash that we accrued last year in this quarter, but we recognized the revenue last quarter. And we’re starting to accrue it on a go-forward basis for this year.

F. Michael Crowley

Meyer, generally, we’re not waiting a full year to receive those monies. We generally are accruing, but we’re receiving the monies throughout the year.

Meyer Shields - Stifel Nicolaus

I’m trying to understand the level of certainty in the supplemental revenues for the quarter.

Michael Dinkins

I think for the quarters going forward what we saw in the first quarter of ‘08 at blueprint from what we recognized, we’ve met all the criteria for revenue recognition. So we know the amount, etc. So there’s no doubt about what we’ve recorded as supplemental commission. When we record them, they’re certain.

Meyer Shields - Stifel Nicolaus

Are the accruals for future quarters in this year based on the agreements you’ve made with the carriers for 2008 or are they estimates for what you’ll be getting in 2009?

F. Michael Crowley

They’re based on the agreements we have and specific increase supplemental commissions from the carriers based on our book of business for 2008.

Meyer Shields - Stifel Nicolaus

I just want to dig a little bit more into the supplemental contingent issue. With the $3 to $4 million run rate that we expect in 2008, was that also the case in the first quarter?

Michael Dinkins

Yes. We recorded $3.4 million in the first quarter, and that was in line with what we think the run rate will be for the balance of the year.

Meyer Shields - Stifel Nicolaus

And that’s a component to the organic growth rate in the domestic retail.

Michael Dinkins

That is correct.

Meyer Shields - Stifel Nicolaus

The acquisitions that closed in 2007, were all of those represented in contingents collected in the first quarter of this year also?

F. Michael Crowley

No, they were not, because Banc of America, as policy before we acquired them, had declined to take contingent commissions. So we have notified their clients that we will be taking contingent commissions going forward on non-fee business where we don’t negotiate our compensation with the client, just like our own. And so we’re in the process of dealing with that issue now. There were no contingents in the first quarter for Banc of America.

Martin L. Vaughan, III

Meyer, there were $800,000 in contingents for the class of acquisitions.

Operator

Your next question comes from Nik Fisken - Stephens.

Nik Fisken - Stephens

You are talking about acquisitions, internal growth, servicing clients, market share gains, and that first quarter was only slightly off plan with earnings down 35%. And if I look at ‘03 to ‘07 operating earnings per share, if you take out legal settlements and whatnot, your earnings are basically flat. And now it looks like ‘08 is going to be down versus ‘07. So what I’d like to get a better idea is when should we see some earnings growth and what’s the goal?

Martin L. Vaughan, III

Nik, first of all, we’re not expecting ‘08 to be down from ‘07. We’re not expecting that at all, and the message that we were trying to deliver is that there’s significant amount of timing, particularly relating to contingents and supplementals and also in other forms of revenue. And that there are some quarter-specific charges that even though we don’t like the fact that they’re there, they will not have a significant impact for the total year. So, I don’t for a minute think that and don’t plan for the earnings to be less than ‘07.

Nik Fisken - Stephens

So what’s our earnings per share goal? I’m not saying for ‘08. I’m just asking ultimately, if pricing returns to normal conditions, are we targeting 15% earnings growth like we were in the past?

Martin L. Vaughan, III

Why certainly if rates were flat right now given our retention rate and the new business we’re selling, we would far outstrip 15% earnings growth now. And so absolutely, we would plan to grow earnings. It’s very difficult to do when the rates are going down 13% and 15% without short-cutting or trimming muscle, the things that we don’t want to do is to step back on client service and step back on talent. And it could be that ultimately that we’re faced with that but, at the moment, we think that we’re better off to continue to strongly gain market share.

And given our view, our view may not agree with some of the views about what’s going to happen in the underwriting marketplace. But, at the moment, we think we’re better off to continue to gain the market share and control our cost and serve our clients and that we’ll reap the benefits when the market turns.

Operator

Your next question comes from Keith Walsh - Citi.

Keith Walsh - Citi

Under your watch, the track record on M&A it’s been mixed at best, with Hobbs, Spillman, Glencairn, and now B of A having some issues. What’s to give us comfort that this management team can effectively integrate the acquisition class of ‘07 which is your largest ever?

Martin L. Vaughan, III

I don’t want to disclaim responsibility for anything, but I would correct you and tell you that Hobbs was not under my watch, that was the former CEO and I did deal with it a lot. And, not to try to sidestep responsibility for that but we’ve done hundreds of acquisitions, and it’s not just about me. And there’s hundreds of successes to point to as we take a look back at acquisitions.

In spite of a handful that may have taken longer, including Hobbs, which took longer but turned out to be fine, the track record is that most of the value that’s been built here over the years, both before I arrived and after I arrived, is from acquisitions. And so, I’m disappointed in some ways with it, but I don’t view one year of performance at Glencairn or one quarter or one year of performance at BACIA or what we went through with Hobbs, I don’t view any of that as long-term failure because I think ultimately all of those acquisitions have built and will build value.

Keith Walsh - Citi

With your stock at basically five-year low right now, are we at a point where the Board is considering strategic options here and, if not, why?

Martin L. Vaughan, III

Yes, I obviously can’t answer that question.

Operator

Your next question comes from Mark Dwelle - Ferris, Baker Watts.

Mark Dwelle - Ferris, Baker Watts

There seems to be an undertone to a lot of the questions that a lot of us have asked and I’m going to say it fairly bluntly. There’s obviously been a pretty big disconnect over the last eight or nine quarters between how we’ve been forecasting earnings and how the company has been delivering them. And a lot of those differences aren’t small. They’re substantial differences.

Is there something in terms of the way you’re integrating acquisitions, the soft market, the change in contingent commissions, is there anything that you can point to that we’re collectively getting wrong?

Because there’s got to be something that we’re collectively not getting because all of us have been around here for a long time and I don’t see what it is that we keep consistently getting wrong.

Martin L. Vaughan, III

The biggest change is that we’ve stopped giving guidance and the other big change is that the regulations don’t limit us in so much about what we can say. And we’re talking about that now, again, and we’re going to talk with our Board about it because we are concerned with what you have described as the disconnect. And we think we have to re-examine it and see if there’s a better way. And we’d love suggestions. If you have suggestions for us, we’d love to have separate conversation to see what we can do.

Mark Dwelle - Ferris, Baker Watts

I’d definitely like to take a constructive view towards all of this. And I agree with your general sentiments that a lot of the business seems to be getting better, but it hasn’t definitely been showing up in the results.

Martin L. Vaughan, III

I’ll give you one example. We talked last quarter about the fact that our contingents were going to fall $6 million short and yet, as I viewed the reports, there was only about $0.02 reduction, so we’re not communicating effectively or enough or we’ve got to figure out a better way to do it. I agree with you.

Operator

Your next question comes from Ken Billingsley – Signal Hill.

Ken Billingsley – Signal Hill

Mel, did you say that you expect to do fewer deals in 2008?

Martin L. Vaughan, III

Yes, I did say that we expect to do fewer, but when I say fewer, we deal more in revenue than we do in number of deals because you can do a lot of small deals and not have much revenue. Last year was the largest acquisition year in the history of the company. We had over $150 million in annualized revenue.

And so, even if we thought we were going to have a normal year, a normal year for us would probably if you go back five or six years, average would probably be $65 to $70 million in annualized revenues. And so, just by the nature of that, of what’s normal, we would expect to do less than last year.

But, on top of that, the pipeline’s a little smaller and we have to make decisions about the use of our cash. And, right now, our company’s own shares are awfully attractive to us. And so you could make a case to say why would you buy companies you don’t know when you can buy a company you do know in the same ballpark.

So we’re going to stay in the acquisition game and we have plenty of dry powder to do that. And Tim Korman and the team will be looking for good prospects and we’ll be moving quickly on them. But we’ll probably be a little more conservative because last year was so big and because we like our own stocks a lot right now.

Ken Billingsley – Signal Hill

Does that mean you’re looking to have a normal year or that you may actually be below the normal?

Martin L. Vaughan, III

I can’t really tell. It’s still early and we have enough in the pipeline to have a normal year if the cards fall right. But given the timing, you just can’t really predict that. We’ve had years where we only did $10 million and we’ve had years where we did over $150 million. And you just can’t predict when they’re going to fall and, of course, we’re not going to make them happen. We’re going to make sure that strategically the properties fit and that we don’t stretch and overpay.

Ken Billingsley – Signal Hill

And you had made a comment that from a opportunity that it may not be as robust as what you’ve seen. I believe I’ve heard the comments to the contrary that with tax changes at the end of this year potentially good and the fact that pricing is down that there may be more opportunity to keep pipeline improving.

Martin L. Vaughan, III

I made two comments. I made a comment that the pipeline wasn’t as full as it was at the end of the year and the fact of the matter is that, part of last year, the pipeline was double and triple normal. So the pipeline is back more to normal now. That’s the message that I was really trying to deliver, slightly below historic norm. And so we still think there are deals to be done.

The other comment I made is that we’ve seen something new in that we’ve had several quality prospects that we really liked, talk to a number of people, and then take themselves off the market because they didn’t think they could maximize value in this premium environment either because they didn’t think they could make their earn-outs or they didn’t think that the prices were, not just for us, we had competition from the normal group of buyers. And these were quality shops that just backed completely off the market and we really haven’t seen that before. It’s not pervasive, but it happened four times, and we haven’t that seen that in the past.

Ken Billingsley – Signal Hill

Are you seeing underwriters beginning to pay excess commissions on particular lines of businesses or in certain regions trying to stimulate growth?

F. Michael Crowley

We have not seen that to any great degree. We are pleased with the calculations on the supplemental commissions that we’re getting. We think they’ve been fair on that when they’re transitioning from contingents to supplementals, but I have not seen them do anything nor am I aware of them doing anything on a large scale to increase commissions to drive business.

Operator

Your next question comes from Kyle Kavanaugh - Palisade Capital.

Kyle Kavanaugh - Palisade Capital

I had a question related to some of the things you’re saying your goal for 2008 is to have an increase in year-over-year earnings. But, however, if you look at the first quarter, it’s down so much. It would imply dramatic growth for the remaining three quarters. So I was just trying to figure out what the thinking is to make a statement like that.

Martin L. Vaughan, III

Well, most of the thinking is that the greatest part of the earnings decline is timing and a large part of the difference is timing. And we have the advantage of knowing the detail of that, knowing of where those dollars are on the contingents and how they’re going to come. And so that’s a large part of it.

We also have the advantage of knowing when some of the cost savings will come through and specifics about some of the nonrecurring costs. Keep in mind also that there was an $0.11 in I think it was in the third quarter, there was a $6.4 million expense on an E&O claim that occurred prior to us buying a firm back to 2001 that will not recur.

Kyle Kavanaugh - Palisade Capital

I was also just letting you know some of the things that have been mentioned, we have one of the toughest P&C rate environments in quite some long time. And, clearly, it’s having a major effect on volumes of business and margins. So that’s a headwind you’re facing and I don’t expect that to change any time soon.

So I was just thinking maybe it would be better to be on a more conservative, you probably run several cases and maybe you’re presenting to us a baseline case or something or a better than average or like a growth case. But, considering how the trends have been for a couple of quarters, it might be more realistic to look at probably the tougher case scenario.

Martin L. Vaughan, III

Kyle, that’s one of the reasons that we’ve been careful not to give guidance and we’ve been careful, I agree with you. And we’ve been careful to not to give the guidance and we’ve been careful to talk about how severe the headwind is. However, we’re selling enough new business to overcome the headwind to a degree and we do have a very deep, significant budgeting process and a lot of sensitivity analysis in there.

And Mike Crowley said earlier that our budget called for 7% reductions in rates for the year. We have budgets that call for sensitivity down to where we are now, where we would have 12% and 14% reduction, but we’re selling enough new business to overcome that.

So I understand what you’re saying and I’m certainly in no way are we trying to give guidance or paint a some rosy picture because this is the toughest market that I’ve seen in my 40 years. And if you look at where we are, people talk about the rates going up at the end of 2001, after 9/11. Well, overall, commercial rates are back to what they were then and so it is strong headwind. However, even with the sensitivity analysis given the entire set of circumstances, we’re trying like the devil to grow some earnings.

Kyle Kavanaugh - Palisade Capital

Do you face any impairment tests? Have you done any recently? When is the next one? How is that accounting?

Michael Dinkins

We test our goodwill annually, first of every October. However, if anything materially happens, any time during the year that would raise a question relative to that, we would do a test at that particular point in time. But we just recently went through that testing last October and it’s scheduled to happen again this coming October.

Kyle Kavanaugh - Palisade Capital

Mel, you mentioned your stock is attractive. Did you already indicate that you have a buyback or you’re going to?

Martin L. Vaughan, III

We have acquired about $30 million of our shares in the last six months and, Michael how many shares did you say we bought.

Michael Dinkins

482,200, $15 million in the first quarter.

Kyle Kavanaugh - Palisade Capital

What is the remaining authorization?

Michael Dinkins

The remaining authorization is $50 million on the calendar year. So $35 million for the balance of the year.

Kyle Kavanaugh - Palisade Capital

You mentioned the pipeline for acquisitions is not as full as at the end of the year. Now is that pipeline definition the pipeline for the industry? Or is it the pipeline for what your team is working on? Maybe your team brought down the pipeline.

Timothy J. Korman

We have an internal pipeline that we track weekly of all the deal flow that we see and opportunities that we have. And we’ve been tracking it for years and, as Mel said, it’s probably down to more normal levels right now, down from probably historically high levels last year.

Operator

Your final question comes from Meyer Shields - Stifel Nicolaus.

Meyer Shields - Stifel Nicolaus

I was wondering if you could take us or explain why there was a need to focus so much on client retention at the BACIA. That seems unusual for acquisitions.

F. Michael Crowley

I think there is a very valid explanation. For BACIA, if you go back and look at the history of that company, it was built by acquisition, by the banks acquiring insurance agencies and then the banks acquiring banks and they had a couple false starts. And then they were put up for sale, taken off for sale, and then they were put up for sale and put out for an auction process.

So during a long period of time for the last year, they didn’t know who was going to own them. They had a real challenge making sure that their people stayed on board. We were aware of all of that when we got involved with Banc of America.

And frankly, as we said, I think last year, we were the white knight. We provided the culture and the capabilities that really fit with their sales staff and we’re very pleased not only with the retention of the clients but with the retention of the sales staff since we bought Banc of America. But they went through a lot of change and a number of their divisions. There’s one senior person there who never left his job and has had nine different business cards.

So they had a lot of turmoil in the history of that company and we feel like that we’ve stabilized that. But we wanted to make sure that, because of that turmoil that they’ve been through, that we did retain what we bought.

Meyer Shields - Stifel Nicolaus

So you wouldn’t expect that for other acquisitions.

F. Michael Crowley

No. I think that is specific to their history. But it’s a good firm with good people and we’re expecting good things from them.

Martin L. Vaughan, III

In closing, I want to thank our analysts and investors for your interest in HRH and, of course, we want to thank all of the HRH associates for your hard work and dedication to serving our clients. Good day, everybody.

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