Hilb Rogal & Hobbs Company (HRH) Q2 2008 Earnings Call Transcript July 31, 2008 9:00 AM ET
Mell Vaughan – Chairman and CEO
Carolyn Jones – SVP, Treasurer and IR
Michael Dinkins – EVP and CFO
Mike Crowley – President and COO
Meyer Shields – Stifel Nicolaus
Good morning and welcome to the Hilb Rogal & Hobbs' second quarter conference call. (Operator instructions) I will now turn the call over to Mr. Mell Vaughan, Chairman and CEO. Sir, you may begin.
Thank you, Laurel. Good morning and welcome to our second quarter call. We appreciate your interest in the company. We are in Richmond, Virginia in our home office. And with me are Mike Crowley, our President and Chief Operating Officer of HRH; Michael Dinkins, our Executive Vice President and Chief Financial Officer; Tim Korman, our Executive Vice President and Head of Mergers and Acquisitions; and Carolyn Jones, the Treasurer and Director of Investor Relations.
We want to start the agenda this morning by asking Carolyn if she will present our forward-looking disclosure and risk statement and then we’ll ask Michael Dinkins to give his financial report. I’ll then give my overview and then we’ll ask Mike Crowley if he will make comments on operations, and we’ll open up for Q&A. Carolyn, over to you.
Thanks, Mell. Before we begin, please be aware that in the course of this call members of HRH management may make statements regarding the company’s future financial conditions, business plans, 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 from 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 the company’s earnings press release issued on July 30, 2008, which is filed with the company’s current report and Form 8-K dated today, July 31, 2008, 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?
Last May, HRH reported financial results for the second quarter of 2008. Reflected in these results is an $18.4 million or $0.51 per share non-tax deductible impairment of intangible assets related to HRH Reinsurance Brokers Limited, a London based reinsurance subsidiary, which was acquired in late 2003 prior to the 2007 acquisition of Glencairn Group Limited.
During the second quarter, prior to the announcement of the Willis transaction, most of the production staff left this small reinsurance unit. Subsequent to the end of the quarter, we entered into a co-broking arrangement with Willis and are optimistic that much of this business can be retained. However, based on the current facts and circumstances, we have recorded the impairment. I do want to emphasize that this was a very small piece of our company contributing less than 0.8% of the revenues, and less than 1.4% of the operating profits during the 12-month period ended June 30, 2008, and with the new agreement, we may be able to retain most of the economic value of the business.
For the quarter, our operating earnings per share, including the impairment charge, was $0.04 compared to $0.60 in the second quarter of 2007. Our operating profit margin for the quarter was 22.7% compared with 24.6% in the second quarter of 2007. In addition to the extremely soft property casualty rates and the intangible impairment charge, the financial performance for the quarter was adversely affected by underperforming acquisition and increased professional fees and claims. The underperforming acquisition as Banc of America Corporation Insurance Agency, BACIA, which was $0.04 dilutive to our operating earnings per share in the quarter and reduced the operating profit margin by 1.3 percentage points.
Mike Crowley will discuss the acquisition performance later in the call, but I will point out that we have aggressively addressed the issues driving their operational shortfall. Increase in professional fees and claims expense of 2.6 million negatively impacted operating EPS by $0.04 and operating margin by 1.2 percentage points. This increase included costs related to a restricted covenant matter, which was settled in the company’s favor for 9.8 million subsequent to the end of the quarter. This settlement will be recorded in our third quarter results.
HRH reported revenues for the second quarter of 2008 were $210.6 million, or $10.5 million or 5.3% over the prior year. Core commissions and fees increased $8.2 million, including $17.6 million from acquisitions net of divestitures and organic growth of negative 5%. Including in the second quarter core commissions and fees are supplement commissions of $3.7 million comparable to the amount included in the second quarter of 2007. Contingent commissions increased $3.6 million in total and $3.2 million on a same-store basis. Investor income decreased by $1.1 million due to lower interest rates.
The biggest factor influencing our revenues for the quarter was a continuation of the unprecedented soft market conditions. As reported by the Council of Insurance Agents and Brokers during the second quarter, property and casualty premium rates declined on average 12.9%. These difficult market conditions continue to put pressure on all of our business segments. We continue to write a lot of new business and our retention rates continue to be strong. Mike Crowley will further discuss these factors later in this call.
For the six months, our operating earnings per share was $0.46, down from $1.25 in the first half of 2007. Our operating profit margin for the period was 21.5% compared with 25.5% the same period of 2007. In addition to extremely soft property and casualty rate and the intangible impairment charge, operating earnings per share was negatively impacted by the following.
The dilutive impact of the BACIA acquisition $0.09; increased professional and claims expense $0.08, in part related to the aforementioned settlement, which will be recorded in the third quarter; the timing related to the shift from contingent to supplemental commissions $0.05; and increased cost associated with the employee benefit program in the first quarter $0.02. These four items reduced our operating profit margin by 3.2 percentage points.
As indicated during our first quarter call, we expect combined supplemental and contingent commissions for the full 2008 year to approximate the combined 2007 amount. For the six months, revenues were $417.5, up $19.2 million or 4.8% over the prior year. Core commissions and fees increased $28.3 million, including $36 million from acquisitions net of divestitures and organic growth of negative 2.2%.
Supplemental commissions were $17.1 million compared to $3.8 million deferred tax of 2007. Contingent commissions declined by 5.4 million in total and 6.6 million on a same-store basis. Investment income decreased by $1.5 million due to lower interest rates.
During the quarter, we’ve repaid $10 million under our revolving credit facility. As of June 30, we had approximately $65 million of non-fiduciary cash. During the quarter, we repurchased approximately 174,000 shares of our common stock for an aggregate purchase price of $5.3 million, bringing the year-to-date repurchases to 656,000 shares at a total purchase price of $20.3 million.
At this time, I would turn the call back over to Mell for a further review of our operating results.
Thank you, Michael. Obviously, the big news for the quarter is the agreement to coming HRH with the North American operations of Willis Group Holdings. And since that announcement in early June, I’ll tell you that the reaction by HRH associates and our clients and the investors that I’ve talked to has been overwhelmingly positive. And the HRH and the Willis associates have invested countless hours planning for our future together. And I think this probably stunted our results a little in June. Obviously, folks walked in to their office on Monday morning, early in June to find out that the company had been sold and we’ve been on the road show talking to people, getting people enthused, and there’s a great feeling about the future I know in both companies.
And as we went along and through the road show and having meeting with producers and leadership in 20 different cities, and as presented the logic and the value of the transaction to over 3,000 HRH and Willis employees, you could see and feel the enthusiasm for the combination grow. So I think that at this point, on that front, things are as positive as they can be. Obviously we are looking forward to the future and want to get on with that as quickly as we can, but run our business effectively in the meantime.
The combination of the two companies is compelling and a strategic fit, expanded resources, and gains in market strength in many of the primary markets in the U.S. And together our competitiveness and ability to serve clients in North America is significantly enhanced and, in my opinion, will be unparallel. Operationally, HRH had a solid quarter with new business and retention rates steady with those of a year ago, indicative of productive selling and market share gains.
Financial results, however, reflected continuing commercial property and casualty rate declines, and to a minor degree, the softening U.S. economy. Organic growth and profitability were reduced primarily by a handful of offices missing plan, and Mike Crowley may add some comments to that. Profitability was also affected by dilution from one acquisition, which Mike will talk about, and higher year-over-year legal and claims cost that Michael Dinkins mentioned and that I’ll talk a little bit more about in a few minutes.
As far as the rate environment goes, the market settings for commercial property casualty business continues to be extremely soft. There is no relief. There was no relief in the second quarter. And the business – most of the business we have in that segment, in the middle market and large accounts, declined by more than 14%. And according to the best source on that, which is the CIAB and Lehman Brothers reports. That means that rates have now declined on a double-digit basis for seven consecutive quarters, and I can’t remember that in the U.S. and I can’t remember that occurring before in my career.
The rate environment, coupled with the softening economy and the credit crunch, and the housing slump make for strong winds in our face. But I’ve said before that our favorable spread of business, both by line of business and geographically and by customer mix, it makes us – positions us very well. And our ability to win new business, of course, helps us to weather those conditions.
I want to talk a little bit about the litigation front. During the second quarter, we had opportunities to settle or close non-compete, non-piracy and other cases and we took advantage of those opportunities. This resulted in higher year-over-year legal claims and expenses. And as Michael Dinkins said in his report, it’s about $2.6 million or $0.04 a share. In last quarter, in the first quarter of the year, we also had the same situations with heavier than normal cost in this area as we defended our non-competes and non-piracies.
The piracy, last quarter we talked about one major case involving a single office, and the piracy of those people in that business has affected our organic growth. But I’m happy to report that things are settled in that office. The associates are doing great and the office was profitable in the quarter. And as Michael Dinkins has reported, we settled that case shortly after the end of the quarter and received an award of $9.8 million, which will go a long way towards offsetting those additional costs that we had in the first and second quarter.
And as always, we will continue to vigorously defend our rights under all of our non-compete and non-piracy agreements. It's just what we do. As we head towards our expected fourth quarter close of the Willis transaction, we are going to continue the rapid and precise planning for our integration and the associated benefits of the Willis and HRH combination. We are going to stay focused on client service and new business production, and finally, we will continue to aggressively manage our costs in this ultra soft insurance market.
I'm going to ask Michael Crowley if he will now give you his report on operations. Michael?
Thanks, Mell. As Mell has said, our second quarter results were affected by the same factors that impacted the first quarter results. Continued softness in the property casualty rates, increased legal expenses, the performance of the Banc of America Insurance Agency acquisition, and revenue timing issues adversely affected our results.
The good news is that the majority of the HRH offices performed very well under difficult market and economic conditions. Results were impacted by the performance of six operations. And the performance of these operations accounted for negative 3.6% organic growth. We are taking or have taken steps to improve performance of those offices, including right-sizing, including dealing with pipelines for new business. We continue to believe in the Banc of America Insurance Agency team and our reasoning for this acquisition, including the addition of significant talent to HRH and the ability to grow our employee benefits business.
Timing accounted for $3 million of revenue expected in the second quarter that will now shift to the third and fourth quarters. We remain very pleased with our retention of our clients, which has held steady despite enhanced competition. We are also pleased with our new business sales. Reported new business was consistent with the same period of 2007, despite the fact that rates have dropped significantly.
In summary, we are retaining our clients and our talent. We are writing significant new business and we are continuing our efforts to improve the quality of our service to all HRH clients. We remain focused on expense control and continuing our efforts to related efficiency and process improvement.
I want to second what Mell said regarding the pending combination between Willis and HRH and travel around the country, our people are very excited about this opportunity. The ability to add additional capabilities for our producers, to drive new business, the opportunities for our people in various offices around the country, and the overall combined strength of the two organizations I think bodes extremely well for the future for both Willis and HRS. And we’re all excited looking forward to capitalizing on those capabilities. Mell?
Thanks, Mike. That concludes our report. Laurel, would you please open up for questions.
Thank you. (Operator instructions) Our first question comes from Meyer Shields. Your line is open and please state your company name.
Meyer Shields – Stifel Nicolaus
Thanks. Hi, Stifel Nicolaus. Good morning all.
Meyer Shields – Stifel Nicolaus
I guess two questions. One, how does the pending HRH – how does the pending Willis acquisition impact the efforts you are making to get higher commission rates to partially offset declining insurance rates?
Meyer, this is Mell. We have not been trying up until this point to get higher commission rates. And as you know, we have commissions and contingents. And even though our income obviously goes up or down with rates, because we are 85% commissioned, we do not have an activity program – have not had an active program in place to go out and try to convert contingents to any other forms of income or to lobby for higher income from carriers. I'm not saying that we shouldn’t do that, we just haven’t done.
Meyer, this is Mike. What we have done on an individual account basis is, if we have an account where we are providing significant service and if our income either through reduced commissions because of the great work we've done for our client reducing their costs, put us in a position to where we do not feel that we can achieve our profit margins on that account. We are discussing on an individual basis our income with clients to make sure that we are not handling business on an unprofitable basis.
Meyer, this is Mell again. That situation will change with the combination of the two companies because we will be committed in helping – in working, you know, we’ll be one company and we’ll be all working together to increase commissions and to be paid because we have a goal over the three-year period together of making up for any down – any of this $50 million in contingents that we may have to give up.
Meyer Shields – Stifel Nicolaus
Okay. That’s very helpful. And a second question if I can. Whenever you have a transaction like this, obviously there are going to be some just affected employees that leave for whatever reason. Can you give us any help in terms of understanding what your expectations are for that?
Meyers, this is Mike. Today we have not lost one producer due to the Willis acquisition.
Meyer Shields – Stifel Nicolaus
Meyer, this is Mell. That’s true in the U.S. We have lost two – I want to make sure we have full disclosure. We’ve lost two producers in the UK although that was a very – for good reason, although it was a very small part of the business, unrelated to what’s in the press release, which talked about producers that left prior to the Willis announcement.
Meyer Shields – Stifel Nicolaus
Okay. Did that–?
But that’s out of 602 producers. So –
Meyer Shields – Stifel Nicolaus
Okay. That’s fine. Thank you very much.
Operator, that’s very good.
Okay. We have no further questions sir.
All right, great. We want to thank everyone for your time and your interest this morning. And we particularly want to thank the HRH associates for your hard work and dedication and support. And everybody have a good day. Thank you.
That does conclude today’s conference. Thank you all.
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