Arthur J. Gallagher & Co. (AJG) 2009 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Arthur J.

Gallagher & Company first quarter 2009 earnings conference call.

(Operator Instructions).

As a reminder, today's call is being recorded.

Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws.

These forward-looking statements are subject to certain risks and uncertainties described in the Company's reports filed with the Securities and Exchange Commission.

Actual results may differ materially from those discussed today.

It is now my pleasure to introduce your host, J.

Patrick Gallagher Jr., Chairman, President and CEO of Arthur J.

Gallagher & Company.

Thank you.

Mr.

Gallagher, you may begin.

Thank you Rob, and good morning, everybody, and welcome.

Thank you for joining us this morning.

We appreciate your being here.

Today, I'm joined by Doug Howell, our Chief Financial Officer, as well as the operating heads of our businesses.

And as is our custom, I'll make some comments and try to add some color to the quarter.

Doug will make some comments and we'll have questions.

Given the economic times that we're in, which we all know are very tough, we're pleased with our first quarter results.

The results were bolstered by three successful initiatives.

The first was expense control.

The second was our acquisition strategy.

And third, was the negotiation of supplemental commissions.

Led me add some commentary on each of these initiatives.

I'll start with expense control.

In our fourth quarter press release, we listed a number of measures that we had implemented to cut costs in late '08 and into '09.

If you might remember, we focused on six key operating cost containment efforts.

Number one, we eliminated 400 jobs, mostly through attrition, throughout 2008.

Secondly, we implemented a hiring freeze, excepting producers.

We're always looking for good producers.

Number three, we postponed most of our wage reviews to 2010 and that's even after freezing most of our wages in 2008.

Fourth, we curtailed nonclient travel.

Fifth, we consolidated some of our field offices.

And sixth, we shifted additional work to lower cost locations.

Let me just say that our colleagues in the field have done an awful lot of hard work in all these areas.

I want to thank them for executing on these initiatives.

None of this is easy.

Our people are working very hard at this and it shows in the results.

Secondly, acquisitions.

You all know that 2008 was a record year for us in acquisitions.

And that strategy will bring about $100 million of revenue and about $30 million of additional EBITDA into 2009.

Last year's deals definitely helped the quarter.

Third, supplemental commissions.

Our team has worked hard now for over two years, actually three years, with our insurance company partners to negotiate additional commissions.

None of these commissions are contingent and all of them have been disclosed to our clients.

So, as I said, I'm very pleased with our quarter but I will remind all the listeners that we are fighting some very, very strong head winds.

The economy continues to hurt our clients.

Their sales are down, payrolls are down, full-time and equivalent employees are down.

Every one of our businesses is dealing with struggling clients.

And we do think this is going to have an impact on us over the next three quarters.

Let me turn to the property casualty insurance market.

By now, most of you have seen the CIAB, that's the Council of Insurance Agents and Brokers, First Quarter Survey, which that rates are essentially down across all lines across the United States, approximately 5%.

We are seeing efforts in various markets to get increases, especially in some of the cat exposed property areas, but by in large, the market remains competitive.

We would say that the CIAB survey was correct.

I've just returned from the RIMS conference in Orlando and I'd categorize the discussions we had with our major markets as ones where, really, the need to increase rates is being talked about.

What they mentioned, specifically, was that the asset side of their balance sheets are down.

Reinsurance costs are up significantly.

Combined ratios are deteriorating quickly.

New capital is not readily available.

It appears the hedge funds are not ready with their capital.

And reserves have little or no redundancy left.

So to me and to our team, it kind of feels a lot like 2001 before 9/11.

Most carriers are talking about needing increases but I'd say, at present, it's more talk than action but the pain is evident.

However, one thing I think that's different this time around is whether or not our clients could pay higher rates.

I've heard from a number of our people that clients have simply told them they will not pay more premium this year, period.

The quote is, "Help me buy what I can with the dollars I've got.

Those are your instructions." So, even if the market were to tighten a bit, in this economy, I don't know what impact that would have.

Let me discuss the Liberty Wausau acquisition.

As you know, we closed the deal on February 27, so we've now been together for a month.

We've successfully brought aboard approximately 250 new colleagues.

I'm very proud of the PC retail team.

We landed 98% of those people we offered a job to.

We've gotten through the first month's renewals and our new colleagues are truly part of the team.

42 of our branches participated.

So, if you think about it, while it's a large deal, it fits right in with our tuck-in strategy.

This is a tuck-in acquisition in 42 locations.

I've been to a number of these branches and I have to tell you this deal has put a shot of adrenaline into our brokerage segment.

People are really excited.

With the exception of the Liberty Wausau deal, however, the additional acquisition activity has slowed somewhat in 2009.

We're seeing pricing come down.

This has some sellers sitting on the sidelines.

We're being cautious, as well, because of the economy.

And having said that, we did close three deals in the quarter and I want to welcome our new partners and thank them for joining Gallagher.

Good firms always have choice and I'm proud they chose Gallagher.

Well, let me move to the risk management segment.

Here, too, efforts to watch costs were the key to success in the quarter.

Head count is being controlled, compensation expense is actually down and a 1% margin expansion is really coming from these expense controls.

Our businesses in Canada, Australia and the UK continue to perform well.

And our 1% organic growth, even overcoming a decline in claim counts in the US, shows that new business sales remain strong.

So, let me just comment on the rest of 2009.

Our strategy remains unchanged.

There's going to be a strong focus on cost management.

Again I want to commend our field force for just doing a phenomenal job there.

A focus on mergers and acquisitions, tuck-in growth.

Continuing to support our niche marketing efforts.

Focusing on helping our clients in these difficult times.

And frankly, selling, selling and more selling.

Doug.

Thanks, Pat and good morning, everyone.

Today, I have five comments.

First, a housekeeping comment.

We intend on filing our 10-Q later this week.

And don't forget we use -- don't forget to use the quarterly spread on our Website that shows trends and seasonality as you build your models.

Second, as you can see on page two of our earnings release, we had an outstanding first quarter in terms of contingent and supplemental commissions.

But as we look out over the next three quarters, we don't anticipate similar improvement but we do believe we will match what we got in the last three quarters of 2008.

Third, a three part comment on acquisitions.

Part one, in our January call, we indicated that 2009 would be favorably aided by the rollover impact of acquisitions.

We said that for those 2008 acquisitions, we anticipated realizing an additional $25 million to $30 million of EBITDA in 2009.

We still feel comfortable with that estimated range.

Part two, some comments on the Liberty and Wausau deal, like Pat said, that we closed on February 27.

Earlier this year, we stated that we anticipated the deal would about break even in 2009 and that it might contribute about $25 million to $30 million of EBITDA in 2010.

At this time, we still feel comfortable with our 2010 estimate.

And we are now hopeful that we might see some slight EBITDA contribution from the deal, here in 2009.

Part three, related acquisitions.

Excluding the Liberty and Wausau deal, we don't anticipate as big an M&A year in 2009 as we had in 2008.

We continue to use a mix of 25% cash and 75% stock.

And we are tightening terms and conditions, as we partner with those rational sellers that understand, in today's world, EBITDA multiples are falling.

Sellers, if they choose, can hold our stock and reap the benefits when multiples improve.

My fourth point relates to expense savings.

In our last earnings release, we stated that we are entering into the harvest phase of many of our cost containment initiatives and we anticipated saving $25 million to $30 million in 2009.

We still feel comfortable with that estimate as we work hard on controlling head count, shifting work to lower cost labor locations and reducing operating expenses, yet all the while still improving our sales and service quality.

Fifth, I'm still getting a few questions on how to model the additional cash flow Gallagher gets from the run down of our deferred tax asset.

The short cap answer I've given before is as follows.

Just compute what you think we'll pay in taxes, then reduce your estimate by about $30 million to $40 million for each of the next four to five years.

So, as a wrap up comment, despite a falling economy and a very soft market, we are pleased with our first quarter and we're working our business hard to deliver a respectable financial performance in 2009.

Okay, Pat, those are my comments.

Back to you.

Well, Rob, I think it's time to open it up for questions and answers, please.

Thank you.

(Operator Instructions).

Thank you.

Our first question is coming from David Lewis of Raymond James.

Please go ahead with your question, sir.

Thank you, and good morning.

Good morning, David.

Congratulations on a fine quarter.

Thank you very much.

My first question relates to the consolidated operating expense ratio.

Over the last several years, it's kind of run in the range of 22% to 23% and I know you've worked hard to get that down.

By my calculation, it was 19.3% for the quarter.

Is a 19% to 20% kind of operating expense ratio sustainable or were there more restrictive travel criteria in place during the first quarter that may loosen up a little bit for the balance of the year?

I don't think that you'll see us loosen up anything for the balance of this year.

Having said that, I think as you build models out into the future, there will be a time when we have to travel, non client travel.

And right now, we've curtailed 90% of that, if not more.

Okay.

And of the $25 million to $30 million of expense saves, how much of that flows through the compensation line versus the operating expense line?

Is it 2/3 compensation maybe?

No, I think it's probably the other way around.

I think there's probably 25% that goes through the comp line and then, the rest of it goes through the operating expense line.

Okay.

And just lastly, regarding the risk management division, what were the claim count trends in the quarter?

And have you been able to reduce any excess claims processing capacity in that area?

Well, the claims counts themselves in the United States are down about 5% for the quarter.

And we've absorbed that capacity by virtually hiring nobody in the quarter.

That's helpful, thank you.

Thanks, David.

Thank you.

Our next question is coming from the line of Dan Farrell of FPK.

Please proceed with your question, sir.

Good morning.

Morning, Dan.

Just a question on the supplemental revenues in the quarter.

Can you tell us what the total amount of supplementals were or give us a base, relative to last year?

Can you also talk about some of the factors that drove the growth in the first quarter?

And then also, in terms of thinking about it going forward, I think you said, it wouldn't match first quarter.

But can you talk about trend for the rest of the year and compare that to the year ago periods for the last three quarters?

I'm just trying to think if this can be a similar type of growth rate.

No, here's just to clarify my comments.

For the next three quarters, we anticipate getting supplemental and contingent commissions equal to what we got last year.

So while we had $6 million worth of growth in the first quarter of this year, we don't expect similar growth in the next three quarters.

So, as you build your models, just assume that we're going to get, for the next three quarters, what we got in the last three quarters last year.

As for supplementals, we typically have not given the amount of supplementals out, for a variety of reasons.

And I think we're sticking with that at this point.

Okay.

And then, can you just comment on the growth?

It seems like we haven't heard much about supplementals recently, but now it seems like there's a larger amount of growth.

Is that a fair statement and what's maybe driving that?

It's simply that we're getting our supplemental contracts in place over the last two years, is what's fueled the growth.

Okay, great.

Thank you very much.

Thank you.

(Operator Instructions).

Thank you.

Our next question is coming from Meyer Shields of Stifel Nicolaus.

Please go ahead with your question.

Thanks.

Good morning, everybody.

Morning, Meyer.

Can you talk about, relatively speaking, whether organic growth is holding up better in the commission or fee side of your brokerage revenues?

I would say it's holding up better on the fee side.

And that's as expected?

Yes.

And is there any change in employee benefit rate trends on year-over-year basis?

No.

So we're still seeing a mid-single digit increase?

Yes.

And last, I think Pat, you mentioned reinsurance rate increases.

Are you seeing that outside of property cat?

I know that it's not a business you're in anymore.

It's primarily property cat, Meyer, is what I've been told.

Okay.

And you're right, we're not in that business all day, every day.

So, it's probably not -- we're not dealing with that on the large treaty side ourselves anymore.

Right.

I'm just taking of advantage of just the information floating --.

And I was just -- those were comments that were told to me by the CEOs of the insurance companies we met with at RIMS.

And I do believe they meant that they were seeing rates go up in the cat area, primarily, but also in other lines as well.

I think the financial lines is going to be a real difficult one for them.

Okay.

Are you seeing any increased concern over the capital strength of the insurers?

In other words, are your clients sensitive to that?

Yes, they are very sensitive to it.

Are they paying for it?

That's a good question.

I think that's spotty.

I'd say in the middle market, no.

I think at the risk management level, yes.

Okay.

Thank you very much.

Thank you.

Our next question is coming from the line of Mike Grasher of Piper Jaffray.

Please go ahead with your question, sir.

Thank you.

And also, congratulations on the quarter.

Thank you, Mike.

It looks like a lot of hard work has paid off.

It's a lot of hard work, you bet.

The supplemental contracts, I just want to go back to that for a second.

How much is the environment driving that?

Where the clients maybe can't afford as much premium but the risk metrics certainly change or maybe the rate goes higher and driving the risk metrics higher, as well?

Well, I'm not exactly sure how to approach your question.

Let me see if I can -- you started by asking about how this works with supplemental commissions?

Yes.

What you've really got there --.

Or the contracts, in general, and if you've got a surge in the number of contracts, is the environment driving any of that?

Yes, I think the environment is driving it, certainly.

What we're talking about with our insurance companies is, they've had some of the most successful years since the 50s.

And this is going to be a tougher year but '06, '07 and '08 were record years.

And we're operating as their distribution system in a declining economy now and also declining rate environment.

And so, having not been able to take contingent commissions, which virtually was almost every market's way of sharing the wealth with their distribution system.

we've sat down with them and said, "Look, additional income is warranted.

It's something we will disclose." And at the beginning of our negotiations in 2005, 2006, I would say there was push back.

The industry, by and large, liked the fact that contingents are by their nature contingent.

And we've had more success over the past few years negotiating more contracts with more carriers, as they've begun to realize that we are, in fact, an important part of their distribution network.

That is not reflected in individual rates quoted on individual accounts at the underwriting desk.

Okay.

That's helpful.

Thank you.

Our next question is coming from the line of Paul Howard with Langen McAlenney.

Please go ahead with your question, sir.

Hi, good morning everyone.

Great quarter.

Thank you, Paul.

Just one question on your noninterest bearing accounts where you moved all your cash balances, where you're not getting any interest.

Just wondering, do you have a timeline on when you might get into or going back into interest bearing accounts?

What needs to happen, in terms of the world financial markets, where you might do that?

Well, first of all, let's dimension what it would mean.

We'd probably make anywhere from $0.5 million to $1 million more a quarter right now if we shifted from risk free accounts into risk bearing accounts.

So, the amount of gain that we're going to get is pretty small when we do it.

Because of that, I'm probably not in a big hurry to jump back into more risk for the sake of getting a little bit more return.

Now, if interest rates were to go up dramatically, we'll have to weigh that.

In the meantime, I'm seeing another six months or so, at least, as we let the banking sector shake out.

Let the stress test really be understood by everybody and what does that mean.

See how the banks do in raising additional capital.

But I don't see us doing it in the second quarter, certainly.

Especially, to get just a small smidge of additional income.

Okay, thanks.

Thank you.

Our next question is a follow up question from David Lewis of Raymond James.

Please go ahead with your question, sir.

Thanks.

Pat or Doug, is there going to be any financial impact from Liberty Mutual?

As we kind of look through the coming quarters, are there any upfront expenses that you have to cover that will get expense in a period and then, you get reimbursed later?

Or is there any timing differences?

I know you look for it to be a breakeven to modest accretion on an EBITDA basis.

Yes, here's the answer to your question.

In the first quarter, buried down in the numbers, is probably a $0.25 million net-net loss in the first quarter related to Liberty, as we paid for all of our transaction costs and our startup costs on it.

I expect for the rest of the year, that we might show some EBITDA this year and then, you'll see the full impact of that in 2010.

So, it would be pretty neutral to positive on the balance of the year?

Yes, that's correct.

Okay.

And was there any change in the reimbursement reserves or trends during the first quarter?

No, there was not a significant change in that.

Great, thanks very much.

Thanks Dave.

Thank you.

There are no further questions at this time.

I would like to turn the floor back over to Mr.

Gallagher for any concluding comments.

Yes, I do have a few comments, Rob.

Thank you.

Thanks again, everybody, for being with us this morning.

Again, I think, given the economic conditions, we're very, very pleased with the quarter.

A 7% EBITDA margin improvement in our brokerage segment, a 1% EBITDA margin expansion in our risk management segment, brokerage and risk management EBITDA for the quarter, up 50%, earnings per share, up 55% -- I think that this does affirm the strategies that we've put in place.

And I'd remind everybody that this is coming from our colleagues' unbelievable hard work in the field.

I want to give credit to all of our colleagues who are diligently watching costs.

It is tough out there.

Now, having said that, I'm very optimistic about our industry and our Company.

People need insurance and certainly, in this risky world, they need advice.

So, if we focus on that and continue to recruit the very best people, when the economy turns around, we and our shareholders will be well rewarded.

Thank you very much, everyone, for being with us today.

Thank you for your participation, ladies and gentlemen.

This does conclude today's conference call.

You may disconnect your lines at this time.