Arthur J. Gallagher & Co. (AJG) 2003 Q4 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the Arthur J. Gallagher & Co. fourth quarter 2003 earnings conference call.

At this time, all participants have been placed on a listen-only mode.

The call will be open for questions following the presentation.

It is important to note that some of the comments made by Arthur J. Gallagher & Co. today may constitute as forward-looking statements within the meaning of the securities laws and are subject to certain factors and risks described in their filings with the Securities and Exchange Commission.

Which may cause actual results to differ materially.

It is now my pleasure to hand the floor over to your host, J. Patrick Gallagher Jr., President and CEO of Arthur J. Gallagher & Co..

Sir, the floor is yours.

Thank you very much, Holly.

Welcome, everyone, to our fourth quarter conference call.

Today I'm joined by Doug Howell, Chief Financial Officer, Rich Cary, our Controller and Chief Accounting Officer, Jack Lazzaro, the Chief Financial Officer of Arthur J.Gallagher Financial Services and our Corporate Treasurer, John Rosengren, our General Counsel, Rich McKenna, the President of Gallagher Bassett Services, Jim Gault, President of our Brokerage Services Retail Division and Dave McGurn, President of our Specialty Marketing operation, which is part of our brokerage segment and handles our wholesaling international and reinsurance division.

As is our custom, I'm not going to read from the press release.

Instead, what I'd like to do is Make some comments on the highlights of 2003, then I'll turn the floor over to Rich McKenna for a few comments on Gallagher Bassett, which is our Property Casualty Third Party Administrative Risk Management Services Operation.

I'll ask Doug Howell to comment on the numbers and we'll move pretty quickly to questions and answers.

Before I touch on 2003, however, I'd like to just mention two items that I hope you all noticed in the last two weeks, our press releases on these items.

First, we've announced an increase in our dividend of 39%, from 18 cents to 25 cents in the first quarter.

The board was very comfortable with this increase in light of the new tax law and of our desire to return more to shareholders.

I want to add, though, this still leaves the company with ample cash to fund internal growth by the brokerage operations we're looking at and to continue our stock buyback activities.

Secondly, in the day and age of corporate governance, the company has moved to an almost entirely outside independent Board of Directors.

At the same time, we announced the formation of our Executive Management Committee, mostly comprised of former board members.

This committee will be very active with the board in continuing to set our strategic direction.

Now on to some highlights from 2003. 2003 was a really exciting year.

The team accomplished an awful lot of the strategies and goals that we set for ourselves and I'll pick a few items that I want to talk about.

First and foremost, the company achieved record new business production in virtually every division.

We continued to be driven by a strong, turned on sales culture.

Everyone at Gallagher realizes that nothing happens until somebody sells something.

In the brokerage segment, we achieved strong operating gains in a moderating rate environment.

Net earnings up 24% for the year is really fantastic.

Rates are moderating, as I said.

Tough lines and tough accounts now may see 1% to 10% increases.

But by and large, the market is quickly moving to flat to down renewals in most lines across most states.

Even with this, if you put our brokerage and risk management segments together, which by the way is how most of our competitors do report, revenues for the year were up 15% and if you look at a two-year period, our pre-tax profits moved up 45%.

During 2003 we completed 14 acquisitions.

I'm very pleased with the people that have joined our company.

What I'm most pleased about is the caliber of the people that are joining.

These people are successful.

We're not doing anything in terms of trying to buy somebody that needs to be fixed up or problem solved.

We don't buy problems.

These folks that join us have choice and they've chosen Gallagher.

Remember, the majority of our due diligence in our acquisition process is on the culture.

We continue to prove that when we get the people fit right, the old adage, one plus one can equal more than two is certainly true.

Our pipeline is full and we'll continue to add new partners to the firm who can add depth and strength to the team.

I'm excited about the acquisition opportunities in '04.

Speaking of culture, I've talked often of the importance of our culture, especially our sales and service culture to the company.

We understand the game is about selling more insurance to more people every day while hanging on to the customers we've got and our culture's a strategic advantage in that effort.

Just in this past week, we got the results of our first ever USA-based employee survey.

The outside consulting firm who helped us with the project was very impressed with the results and I thought I'd go over just some statistics from that survey that might be of interest to all of you.

First and foremost of the people asked to respond, we received a response rate of 78%.

That, our consultants say ask almost double the typical response rate. 92% of the respondents said they agreed or agreed strongly that the customer comes first at Gallagher. 96% of the people who responded said they understand the need for our company to grow and are committed to helping the company grow. 92% of the work force that responded said that they are proud to work at Arthur J. Gallagher & Co.. 90% of the men and women responding, this is important, because two-thirds of our employees are women, said they felt they were dealt with respect in the workplace.

That did not break at all by gender lines. 87% of the respondents said they saw themselves working here three years from now.

I'm very proud of those responses.

I think it tells us that even at 7,200 plus employees, the unique Gallagher culture is truly alive and well.

Let me comment on Gallagher Bassett Services.

This company really is one of our crown jewels.

What a year we've had here.

You recall that 2002 was a slower year, the economic slowdown as well as the 9/11 disasters really put a crimp in the business.

Our claim counts dropped precipitously from August '01 to December of '01.

We said last year during our conference calls we felt we could sell our way back to activity levels that were pre-9/11 and we did that and more.

In fact, I'd like Rich McKenna, because the operation did so well, it would be good for Rich McKenna, the President to touch on some of the highlights of the year.

Rich?

Thank you, Pat.

Good morning.

As Pat mentioned, Gallagher Bassett has closed 2003 very strongly.

We have enjoyed excellent new business sales production, which together with the solid client retention has combined to produce our strong results.

Our new business sales for calendar year '02 and calendar year '03 in the North American market alone amounted to $118 million with the $66 million in '03 being our best annual sales performance ever.

All of this growth is internally generated.

We have indeed sold our way out of the 9/11-induced recession.

Our claim counts have fully recovered from the slowdown as Pat mentioned and to illustrate, in all of '01, Gallagher Bassett received and set up 39,000 new claims.

By December of '01 that number had fallen to 27,000.

Today, our monthly average is 45,000 new claims.

In 2003, Gallagher Bassett received and set up over 501,000 new claims which is a 15% increase over '02.

On the technology front, our clients continue to access their claim data through our internet portal, risfacs.com.-ph We have issued nearly 8,000 licenses and our clients initiated over 11 million page viewings last month.

Also, 80% of our clients now receive all of their monthly claims summary reports in non-paper format.

Most take their data either through E-mail or over the internet.

Four years ago in contrast, 100% of those reports were delivered in paper.

On a going forward, we look very strong for January.

New business sales activity continues with robust new commitments.

And we're very positive about our future direction.

Thanks, Rich and congratulations on a great year.

Remember, everyone listening, Gallagher Bassett is not commissioned based but rather activity based and fee driven.

We get some stability in our numbers here with the outstanding organic growth they've had that's not subject to the vagaries of the PC marketplace.

Our benefits and brokerage consulting team, which is part of our brokerage segment, also had a very good year.

Benefits pre-tax was up almost 50% year-over-year.

This was a nice rebound from a slower 2002 which had been influenced by the slower economy.

Health care costs continue to rise.

In fact, personally, I feel that the health care cost issue is one of corporate America's most pressing problems.

Our people consult with and help our clients deal with what is the real issue of those problems.

Let me discuss property and casualty briefly.

I mentioned that rates are moderating in the fourth quarter our organic growth in the brokerage segment was 6%, down from 9% in Q3.

Even with the market changing, retail pre-tax was up 20% for the year.

Our niche strategy has -- we have over 20 identified niche areas that we’re pursuing on a team basis across the entire country.

And our niches are growing much faster than the general book of business.

Our specialty marketing group, again that’s wholesaling, reinsurance and international had a few large reinsurance contracts that simply didn't renew.

We didn't lose the clients, they just didn't buy the cover.

This coupled with the decrease in large catastrophe exposed property rates created some slowing in our specialty market area’s growth.

Even so, year-over-year, the entire brokerage segment was up 24% in earnings.

As you saw from our press release, we adopted the expensing of options in 2003.

Doug will take you through the numbers on that.

I'd like to make a comment on how we use options.

This is the greatest building block in our company.

We give approximately 2.5% of our shares outstanding out every year in options.

The majority of these options do not go to just the top five officers.

They go throughout our entire company.

Giving literally hundreds of our associates the direct benefit of our success.

We feel this directly aligns our people's interests with those of our shareholders.

Remember, also, that generally our options vest over a ten-year period.

We believe this is a very strategic investment for shareholders and well worth the 2 cents a share it cost us in 2003.

I could go on and on and on about what we did in 2003.

I'm real proud of all the things we accomplished.

I feel, we as a company, continue to get stronger and stronger quarter by quarter.

Our operating units are very focused.

They've got good plans, they know how to execute.

Our strategies are in place.

We've got a team that for the most part has been together now for over 25 years with the exception of our new CFO, Doug.

The sales culture, we've tested that.

We now know for sure it continues very strong.

Things look pretty good for 2004, given the rate environment is probably the only thing that takes us down.

One accomplishment, though, in 2003 that I'd like to mention was recruiting Doug Howell to the team.

As our new CFO, I can tell you he's been accepted by the group.

As he approaches his first anniversary, we're very, very glad to have him aboard.

Doug, why don’t you talk to the group about the numbers.

Good morning, everyone.

Thanks, Pat, it's great to be on such a winning team.

I'd like to provide commentary on items that may help answer questions that typically arise in these calls.

My first comment relates to our cash.

In addition to using $62 million to pay dividends and $81 million to buy back stock during the year, we used $25 million for capital expenditures, $25 million to pay off all corporate debt and $29 million in acquisitions.

That's net of the cash acquired.

Also I think it's important to highlight that in 2003 our brokerage and risk management segments generated $2 of cash earnings per share as compared to GAAP EPS of $1.75.

That's 25 cents of additional cash EPS.

Compared to prior years, cash earnings are up 27%.

Finally on cash and liquidity, we have no debt outstanding for general corporate purposes and recall that in late July, we consummated a new $250 million line of credit.

On my second point I'd like to offer some numbers for those of you that track contingent commissions and their impact on the brokerage growth.

Fourth quarter 2003 contingents were 7.9 million versus 7.1 million in the fourth quarter '02.

So with or without contingents, our brokerage growth was slightly over 10%.

For the year, contingents were 33 million versus 23 million in '02.

So without contingents, our growth rate is about 14% for the year.

Third I'd like to draw your attention to the substantial reduction in investment concentrations.

Both those investments we have on the books and those guarantees, letters of credit and commitments that were off balance sheet.

In total, we've reduced investment exposures by $122 million by December 31st, 2002.

For my third comment I'd like to make some comments on our sin–fuel-ph tax credits.

On the morning of our last conference call in October, we received word that the IRS would not take action against Progress Energy, which is very good news for the industry at that time.

Since then, the IRS has resumed issuing private letter rulings which is also good news.

As we previously discussed and disclosed in our 10-Q, Gallagher has an interest in the synthetic coal partnership that's been under IRS examination.

In the last few days, the IRS advised Gallagher that their examination will be closed without any changes being proposed.

This is more good news and we remain confident in all of our synthetic coal tax positions.

While it's never business with usual as the IRS, we continue our efforts to optimize our existing coal projects.

During the fourth quarter of 2003, we finalized another project and we’re beginning to see more activity as investors return to the marketplace.

If during 2004 we can sell portions of our projects for an economic gain we will.

If not, we'll use the credits for our own account.

If we use them for our own account, this means for the entire year 2004 our Financial Services segment should break even and our overall tax rate will be in the mid-to-lower 20s.

However I caution that we are still working with our partners on quarterly reduction Schedules, which will show us how the pre-tax production will play oput on a quarter by quarter basis Generally, we try to match our expenses with our credit, however, there are enough vagaries in the weather and the sourcing and delivery of raw coal that there might be a slight mismatch in some quarters that produce small operating gains or losses I'm going to repeat what I just said.

If you assume for 2004, that will have a mid-to-lower 20s effective tax rate because we're producing coal for our own account, you should assume that the Financial Services segment will break even on a pre-tax basis for the year.

My fifth comment relates to our decision to early adopt expensing stock-based compensation.

In Pat's comments he gave you a rundown of why stock ownership by hundreds of our employees is an important element of our compensation program so I won’t repeat those positives now.

Rather I want to peel back some of the numbers and help you understand the future impact of those new accounting [indiscernible].

First we stated in our press release that adopting this new accounting process cost us $1.4 million after tax or 2 cents per share.

Actually, if you peel back the rounding, the number is slightly over 1.5 cents.

Note that one penny relates to employee stock options and the half relates to our employee stock purchase plan that was implemented in mid-2003.

Second, as a reminder, the entire impact of the -- hit the fourth quarter and we did not restate prior quarters, because it just wasn't material.

Next year, these costs will be spread across several quarters.

When we implemented the new accounting in the fourth quarter it increased our compensation ratio by about 0.6% and reduced our pre-tax margin by about 0.6% in the brokerage segment.

It didn't really move the ratios that much for the risk management segment.

Here's some help as you build your models.

Hang in there with me and I'll try to make this as clear as possible.

There's two pieces.

Here's the first piece.

Because we use the perspective method under financial accounting standard 123 and because our options generally vest over ten years, you need the latter end impact of this new accounting pronouncement.

For the 2003 options, you should show a 1 cent drag each year through 2012 as the options vest.

Then, ,if you assume we issue about the same number of options in 2004, that will add another penny of expense for each year from 2004 through 2013 as they vest.

In other words, if you assume we continue our historical pattern of granting options, the impact on EPS from options in 2004 will be 2 cents, 3 cents in '05, 4 cents in '06 and so on and so forth.

That's the first piece.

Here's the second piece.

Because we didn't implement our employee stock purchase plan until mid-2003, the annual impact is more like a full penny but there's not a laddering effect.

When you build in your model, just assume that this plan will cause a penny drag in '04, a penny drag in '05 and a penny drag in '06.

In the end it's not a huge deal but I wanted to make sure that everybody had it right in the models.

For my sixth point, I want to talk a little bit about the impact of foreign currency translation because I get some questions on that from time to time.

Recent deterioration of the dollar had an adverse impact on the brokerage segment's 2003 results.

The impact on EPS and the margin is as follows -- had the exchange rates in 2003 been the same as in 2002, brokerage segment fourth quarter 2003 earnings would have been about a penny higher and pre-tax margin would have been about 0.5% higher.

For the full year 2003, brokerage segment earnings would have been about 3 cents higher and pre-tax margin would have been about 0.5% higher.

In both cases, nearly all the margin impact relates to the compensation line.

A sound bite on FIN 46.

Recall that we implemented that in the third quarter.

Although the FAS are still tweaking the rules based on the most recent guidance available, nothing has really change for us and FIN 46 has not had an impact on Galyer’s net income or stockholder's equity.

Another sound bite on our acquisition strategy.

Our team is maintaining its discipline to avoid deals that are too big, too expensive or worse yet, the wrong culture fit.

We're in this business for the long haul and we'll pay a fair price for merger partners that we see as a win/win for both parties.

The pipeline is full and we will continue to be active acquirers.

My ninth and final comment is going to sound a little bit like a broken record.

I said this in the last three or four calls.

Please remember our brokerage segment has significant seasonality.

Accordingly, when you build your models for brokerage, we strongly encourage you to do it by quarters.

For assistance, please refer to the 12 quarter sequential view that we post on our website.

It should come as no surprise to anyone that historically our margins have been lower in the first and second quarter than in the third and fourth quarters.

Those are my comments.

Back to you, Pat.

Thank you, Doug.

Holly, I'd like to open the floor for questions and hopefully some answers now.

The floor is now open for questions.

If you have a question, press the numbers one followed by four our your touch tone phone at this time.

When you pose your question, please pick up the hand set to provide optimum sound quality.

Once again, ladies and gentlemen that is one followed by four on your touch tone phone at this time.

Please hold while we poll for questions.

Thank you.

Our first question is from Jeff Thompson of KBW Incorporated.

How are you?

Good morning, Jeff.

I wanted to focus in on your comment on property casualty premium rates.

Give a little more color -- I think you're saying you're seeing rates overall go down.

Is that a first quarter kind of outlook or is this something your gonna see for the year?

And secondly, maybe talk about your own brokerage line.

Do you think margins are peaking as a result?

How are you going to deal with this operationally?

Well, let me do this.

I'll make a brief comment and I'd like Jim Gault, whose heading our retail brokerage operation to field the question.

To your point, I think as we go into the first quarter and then through '04, we're going to see flattish renewals to down with the exception of some of the tougher placements, medical malpractice is going no place but up, some of the high, tough, access liability is continuing up.

In general, just as you look at the whole book of business, I think the field now as we're looking at more of a flattish environment by the mid-to-end of '04.

We're still seeing some upward motion in the first probably two quarters.

I do want Jim Gault to touch on the rate environment.

Jeff, this is Jim.

Just a couple comments.

Just yesterday I met with a manager of a very well known stock carrier we do a lot of business with.

She told me that they're hoping to get 10% overall, but she says that she doesn't believe that will happen throughout the year.

I spoke to another market last week who said sort of the same thing.

The reality is, what Pat said, which is what's really going on in the street is something more competitive than that.

I think the answer for us, for this year, for brokerage services, is pretty simple.

We've already shifted into a softening or more moderating market approach and plan, which requires a couple things.

One, it requires selling more new business which Pat has already emphasized that we are a new business company.

And also emphasizing more in client retention.

We've got a bunch of initiatives under way to emphasize that.

So we can retain our clients and grow the top line just by our own sales efforts and if the market's there, it's great.

If not, we believe we'll sell a lot of insurance.

The other thing is, we're in a softer and moderating market.

We emphasize very tight expense controls and number one on that list is head count and we're -- we've got controls in place for that.

And in addition to that, we still expect to have our productivity increased throughout the year and in years to come.

We've got a bunch of initiatives to better use technology and using professional standards as a way to deliver better product to our client at lesser cost.

So it's a two-pronged approach.

Keep your clients and write a lot of new business and control the expense side and do what's right to increase productivity.

We're confident that we'll be able to do that.

Jeff, to your margin question one of the things I want to remind everybody, please, we've worked over the last year or so to improve margins because we've had such heavy hiring in '01 and '02.

Margin is not what we drive in the company.

Every time we do an acquisition, it's margin dilutive.

Everyone needs to remember that.

Do I think we can expand productivity?

We've increased our productivity in terms of revenue per employee every single year over the past ten years and we'll continue to that effort.

The actual end of the day margin will be influenced by other things as well, including acquisitions.

Did I answer your question, Jeff.

That means it could potentially be lower, not necessarily due to the market, could be acquisitions as well?

That's correct.

Maybe just as a follow-up to understand a little better, do you have any comment in what the rate increases were in the fourth quarter?

And maybe break it out by property and casualty as some way to understand it a little better for us?

I think if you look at -- across our whole book, it probably was in that area of around 6%.

Okay.

You were talking about levers on margins, is it possible that you could sort of trim head count more in the future?

You might find a need to do that or am I --

Absolutely not.

We've had -- I think that Jim and Dave and the other operating guys have done a fantastic job this past year.

As I said in our conference calls, a number of quarters ago, we felt the nets were full.

We wanted to take the new hires to shore and we've done that.

In fact, without acquisition, head count is essentially flat in our brokerage operation year-over-year, which has been a great effort.

We're not trimming bodies.

In fact, if you think about it, in a sales company, you've got to be putting more people on the street every opportunity you get.

We do that by recruiting people organically and by acquiring people.

I don't foresee any trimming of the head couldn't at all.

I'll get off and let someone else ask a question.

Our next question is from Hugh Warns of JP Morgan.

Good morning, Hugh.

Good morning, everybody.

Good morning, Hugh.

A quick couple questions.

First I'd like to hit on outlook for the benefits world for the fourth quarter and second question I want to hit on is just kind of outlook on the M & A side.

We’ve seen a lot of the companies over the last 6 months trying to get multiples on peak earnings.

Just like to see if we could get some update on your thoughts there, Pat?

Let's start with the benefits question, Hugh.

Great.

I think that benefits will recover in -- did have some recovery in the fourth and will recover more in '04 because the economy is improving.

Right.

Did you have positive growth in the benefits in the fourth quarter?

Yes, we did.

Good.

We did get positive growth.

It wasn't double digit top line, but it was good midrange single digit and I have to tell you, that's a dog fight, because our clients are facing, in many instances, embedded increase, inflationary increase of their benefits program as much as 14%.

They are pushing back in every place they can.

As you know, while we charge commissions there, those commissions are always disclosed and people know exactly what our compensation is.

It's a point of negotiation.

So in a tough economy, when you've got most benefits are also driven by head count.

It's a tough economy.

When you have head count decreasing and people have their rates going up through the roof, it's really tough.

I'm proud of what the team did there.

I think the outlook is continued modest growth in '04.

The second part of your question?

Acquisitions.

Yes.

And what the private world is looking like right now.

The banks haven't helped us in any respects as we’ve said over and over.

They tend to buy at multiples that often we won't pay.

Sure.

I don't think we’re gonna1 see a slowdown in bank-driven activity.

That means we have to be careful at making sure we pick our partners -- as Doug said in his comments, we'll definitely pay a fair price.

Do I think pricing may have peaked at a time when earnings growth might have peaked?

There is likelihood that that's the case.

Okay.

The other follow-up question that I had was, just some clarification, Doug, on the Financial Services business.

I know it's hard for us to do the FIN 46 side, but it looks like it washes out.

If we're thinking break even for Fin Services, then we’re thinking of a corporate tax rate of around 24-25%?

Mid-to-lower 20s.

I can try to pin you down.

It all depends how you ask the naive question.

That's right.

Thanks a lot, guys.

Thanks.

Thank you.

Our next question is coming from Bob Glasspiegel of Langen McAlenney.

Good morning, Bob.

Good morning to Pat and Doug and all.

I'd like to flush through the financial services in the quarter and the outlook going forward.

I think we had said break even and we had a modest gain there.

Were there any partnerships that strung there?

Is the rough run rate on the revenue side where you'll be going into '04 if you're running these things yourself?

Thanks, Bob.

Two questions there.

Nothing significant in the gain or loss activity in the fourth quarter.

As you know, we wrote off a substantial number of our investments over the last year or so.

We continue to peel some of those off, even though we wrote them down for book purposes, we'll still managing them out of our company.

We had gains on some and some had small losses.

But they're all on a thimble, Bob, nothing big.

With respect to outlook for Financial Services next year, I think the run rates that you're seeing here are probably pretty close to the run rates you'll see next year in terms of top line and expenses.

So I would say that you've got the information that you have.

Just make sure that you consider the impact of FIN 46.

Because we only had that for the last two quarters.

Right.

But the million seven of earnings, you would say is just round off noise or it wasn't any sort of unusual gains?

Bob, we have enough investments in here.

Some of them are in asset management, some are in real estate.

Then you've got the coal production.

It's going to bounce around a couple million bucks one way or another on a quarter, but it won't move past that, hopefully.

Finally on buy back, you're saying we'll continue at the same rate despite the dividend increase, we shouldn't look for any change?

I think roughly to offset to some extent the acquisition and option grants.

Is that your goal on buy back?

We don't believe that this change in dividend will have an impact on our cash significantly.

I think -- our buyback program will still be done with the same method we've done in the past.

That doesn't necessarily revolve around acquisition or options.

It doesn't necessarily revolve around market timing either.

We'll use the available cash we have to buy back stock when we can.

Thank you.

Thanks, Bob.

Our next question is from Alfred Lockwood of Roxbury Capital.

Good morning.

You covered most of the main points, just one more thing on the dividend.

Is there any change in the long-term thinking on the dividend payout ratio?

Well, thanks for the question.

No, there is not.

In fact, our historical ratio has been to be somewhere below 50% or around 50% of GAAP earnings.

In the discussion with the board we were focused on cash earnings and felt we had plenty of room to do a one-time reset and just go back to what we historically do, look at the dividend after the close of business in any given year and see if there's room for an increase.

Okay.

So when you're looking at, you know, up to 50%, you're looking up to 50% of the GAAP earnings?

Cash earnings.

Up to 50% of the cash earnings.

Historically it's been closer to 30%, 35%.

Probably closer to 40%.

Good.

Thanks.

Thanks, Al.

Our next question is from Nick Siskin of Stevens Incorporated.

Doug, can you give us more specific, you said in fourth quarter '03 you finalized another section 29 project.

Yes.

If you go back and look in the history, we've had -- or we have several projects we've been working on for a number of years let's say.

And with the IRS' actions during the summer, some of those activities we slowed down a little bit.

And so as a result of the change in the IRS position, we went ahead and restarted our working on a couple of these other projects and we just got one up and running by the end of the year that's been in process for quite a long time.

And so as a result of that, it gives us more capacity to burn coal or produce coal.

And we'll have the opportunity to either try to decide whether we're going to monetize that or burn it for our own account.

We have several other ones in the pipeline, too.

If we can get them up and running and working, we will.

But in this case, we got one done here in December.

So your guidance of the earnings and tax, that division, it's just assuming that one facility is up and running and not the others that you could do?

Correct.

Okay.

Great.

Are you guys seeing the number of exposure units increase because of the economy?

I'll let Jim handle that question.

Nick, I would say that it appears that it's beginning to come back.

But I haven't studied.

I don't have anything that I can firmly tell you that we know for sure.

But, yes, there's a feeling that it is coming back and that exposure units will start to increase, yes, are increasing.

Is the feel less than 5% or greater than 5%.

As I said, I haven't measured it, Nick.

I can't tell you.

I'm sorry.

Okay.

On the -- last question.

On the 6% internal growth for brokerage, is the outlook for that to continue to climb just a general observation on your commentary about rates?

Is that -- is that the guidance you're trying to give us?

You know, I don't have any firm guidance for you, Nick.

I think that if you take a look at the quarterly spreads that we put at the website, you'll see that we have a change in that organic growth rate over the last eight quarters that is trending down.

And I don't know how far down it's going to go.

I think the trend in the first and second quarter next year will still be up, positive.

I don't know if it will be 6.

I don't think it will be 9.

That's about as good as I can do.

It has an awful lot to do with the mix of business.

Depending on how much directors and officers and medical malpractice and California work comp are doing, that can offset some of the stuff that is large property schedules, which are still coming down.

I don't really have a guidance number for you, other than I think it will continue to be a decreasing number.

The other thing, too, this is Doug.

The other thing, too, we hear the carrier saying they'll want 10% and they’re gonna hold to their guns on that.

If they follow through with that That then I will have one answer, but if they soften, that will be an issue for us.

It depends on how convinced they are that they can get the rate increase.

I'd like to make a point about this, though.

To me it's kind of interesting.

Most of the carriers and we'll be seeing two of our carrier partners today, realize that the rates right now are probably at levels that they haven't seen for quite a while.

They're feeling really robust about last year, in particular on a calendar year basis.

That's the general driver in my opinion of a market going to go the other way.

But, this is not new stuff to us.

You're talking to a group of people who have been together for 25 years.

We've been through hard and soft markets.

We understand the drill.

You are looking at, frankly, a team that knows how to put the operation -- we know the playbook.

That's the playbook we're getting out.

Great.

Thank you.

Once again, ladies and gentlemen, to ask a question please press the numbers one, followed by four on your touch tone phone at this time.

Our next question is coming from Jeff Tremblay.

Good morning.

Can we discuss a bit more about commissions.

Are you seeing pressure there on the part of carriers?

No.

So it's holding up pretty well?

Yes.

Okay.

And then in terms of organic growth, that was a relatively good number.

Were there areas of specific strength?

And can you comment a bit about your newer hires, whether they're performing in line with expectations or is there anything worth mentioning there?

Yeah, I think there is worth mentioning.

I hope it's the last time I have to mention it.

These new hires are no longer new hires.

Many of these people joined us in '01, some others in '00 and '02.

They are performing absolutely in line with expectations.

If you take a look at the trend line and what have you and our compensation expense, it's coming down exactly the way we hoped it would, which means basically these people's books of business are ramping up.

This next year will probably be, they'll be at full compliment by the end of '04.

We think it was a strategy that we executed well at a time that it was available.

Again, if you go to that 12-quarter spread at the website what you'll see that as the market was firming, we had opportunities to recruit people that we had tried to recruit for years and people that were just outstanding professionals for many reasons in the marketplace.

They were just available at that time.

We hit the timing of that absolutely perfectly.

At the very hardest part of the market, these people were coming aboard and selling.

And I really think that is part of why our 6% growth compares favorably to some other competitors.

And I hope that they'll continue to outperform for us.

Thank you.

I have a question about your investment strategy.

Has there been any news regarding the Beacon Hill and Asset Alliance information?

No, This is Doug. we have no new news on that.

Thank you.

Thank you.

Our next question is coming from Nick Pursos of Sandler O'Neill.

Good morning, I had a couple of questions.

With regard to pricing sensitivity, are you seeing any difference in trends between middle market accounts and larger accounts, Pat?

Jim, do you want to try to address that?

I would say that there really is not that much of a difference.

We track it as much across the board in terms of the lines of cover and the middle market accounts still have lots of property and so they're affected by the same retail and re-insurance that the big guys are to a large degree.

So, no, I don't think there's much of a change there.

This is Dave McGurn.

I would just add on the property side, you're seeing a lot more rate sensitivity on the catastrophic large property portfolios than you are in the middle market accounts.

That's obviously because the cat premiums were extremely high a year an a half ago and are starting to come back into the normal fold, if you will.

Yeah.

That pressure on the large property schedule is definitely downward pressure.

The thing I'd like to mention, though, I’ve mentioned this in previous calls, this is not necessarily across the board, everybody's getting a decrease.

What we're seeing is that underwriters still have discipline.

As I said in my comments, tough lines, tough accounts.

By tough, I mean accounts that have bad loss ratios are not getting decreases.

They are in fact getting increases because there is still underwriting discipline.

Okay, great.

Maybe I can turn to Doug's comments earlier with regard to foreign currency.

Why would the -- why would there be a foreign currency drag?

That's implying it's hitting the compensation line and not the revenue line.

Am I missing something.

Most of our international business, the revenue is denominated in dollars but our expenses are in sterling.

You did seven deals in the quarter, do you have a number for what the revenues represent for those seven acquisitions in the quarter on an annualized run rate?

I don't have that off the top of my head.

For the year, we believe we purchased about $35 million to $40 million worth of annualized revenues on our deals.

And for the quarter, I think it's somewhere around half, maybe less than half.

Great.

Thank you.

Thank you.

Thank you.

Our next question is a follow-up coming from Jeff Thompson of KBW Incorporated.

Hey, Pat, now that we're sort of getting through the pricing cycle, what's your view on captive formation?

Has it been what you expected, how does it compare with previous cycles?

What's your outlook there?

I'll let Jim touch on that.

It's been an exciting area for us.

It's been terrific.

Our Gallagher captive services and our facilities are having unprecedented growth now and their plates are full going forward.

What you'll see, because we've been in the alternative market as long, if not longer, than anybody.

There's a tail on hard markets where clients finally get it, they understand that if they really want to control their costs long term, they need to get into a risk management program where they can either assume a lot more risk or share risk with others.

So what we believe will happen at least in those parts of our companies, they'll have very strong growth, because people will say, I'm going to get out of this cycle and I need to control my own destiny.

So I think it's very, very bullish for what we think is going to happen in the future.

There's another positive about that, Jeff.

And that is that this is very complimentary on a cross-sale base is with our brokerage operation and Gallagher Bassett.

Gallagher Bassett's growth from captive formations in the last two years has been one of their fastest growing areas.

We don't see that dying off in the next few months at all.

Jeff, this is Dave McGurn.

Just as a point of reference, many of these people that are going to captives are middle market clients.

Even though the market in the softening, these people are still paying 100%, 150% more in premiums than they paid three years ago.

They're continuing to look, as Jim said, to the alternative marketplace.

Can you give us a sense how many new captives do you have in '03 versus '02.

I don't have that number.

Okay.

All right.

Good.

Thank you.

I can tell you we started -- last year was probably a record year.

We started more last year than any other year in the past.

Thanks.

Thank you.

Our final question is a follow-up coming from Bob Glasspiegel of Langen McAlenney.

I’m probably micro scoping much more deeply, Pat, than you intended with some of the comments I'm trying to tie together.

But I think the last conference call you gave an outlook for 9% organic growth.

I'm not sure whether you were talking brokerage or commissions and fees in response to an answer.

Now I think you're saying it's not going to be 9.

It looks like this last quarter organic growth of 6 was in line with what you characterized pricing has having been in the quarter, which suggests there wasn't a whole lot of unit growth outside of pricing going on.

Am I tying things together incorrectly or does it sound like there's been a little delta in the last quarter in your fortune telling?

You correctly categorized it as fortune telling.

And in the third quarter conference call I said it felt 9-ish going forward.

And, you know, I think there has definitely been a little bit less than 9-ish in the fourth quarter.

Right.

Somewhere between the 5% and 6%.

So I really -- I mean, I can't borough in many deeper for you than that.

I think going into the first quarter it still feels around 6-ish, but I'm fortune telling again.

Right.

It sounds like your text is the market is slipping a little faster you thought, rather than the new hires not generating unit growth that you were thinking, right in the shortfall is in the market relative -- not the maturation of new hires.

Right.

That's a fair characterization?

Yes.

Therefore, you're moving faster on expense controls than maybe you might have been a quarter ago?

I don't know if I'd say that's accurate.

You know, Bob, one of the hallmarks of the company, we like to say we throw dollars here around like manhole covers.

George, right?

You heard that before.

Right.

We're very cost conscious in everything we do.

That's part of our culture that we're not going to lose.

Right.

I would not drive you to looking at your models to saying we're going to start reducing expenses in some fashion that's at a level any greater than what we've done in the past.

Thank you very much.

That's helpful.

Thank you.

I think that's all the questions is it, Holly?

Yes, sir.

I'd like to make a final few comments in closing here.

First and foremost, I am absolutely thrilled with our results in 2003.

I think we just had a terrific year.

And I want to thank and acknowledge the 7,000 plus men and women who work here who made that happen.

We simply wouldn't be where we are today without the dedication of our people.

Our survey shows that our people understand our mission, they're very engaged in what we're trying to do in terms of growth.

They're committed to growth.

They understand our client comes first and they're proud to work at our company.

What more could a CEO ask than that?

I'd also like to thank the shareholders that are listening who had faith in the strategies of the management team.

I know 2003 was a little bit of a roller coaster ride with regard to our stock price.

Our price moved from 29 to 23 to 32 over a one year period and I realize you people get measured quarter by quarter as well.

I'm glad many of you stayed the course.

I appreciate those who rode along with us.

I can assure you that the team is working very hard to make 2004 another record year.

The thing that's exciting about our place, the new sales, all the rest, it's fun, but the thing that's exciting to us around this table is that we really know we're just getting started.

Stay tuned.

I think the story will continue to be a good one.

Thanks, everybody, for listening this morning.

Holly, that's it.

Thank you, ladies and gentlemen, for your participation.

This does conclude today's teleconference.

You may disconnect your lines at this time and have a wonderful day.