Arthur J. Gallagher & Co. (AJG) 2010 Q1 法說會逐字稿

Good morning, and welcome to the Arthur J.

Gallagher and Company's first quarter 2010 earnings conference call.

(Operator Instructions).

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, such as any observations regarding future results.

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 J.

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

Gallagher and Company.

Mr.

Gallagher, you may begin.

Thank you very much, Diego.

Good morning, everyone, and thank you for being with us this morning.

It is an early start.

This morning, I am joined by Doug Howell, our Chief Financial Officer, as well as the heads of our operating units.

I am going to add some color to the quarter.

I thought it would also be a good idea to ask Scott Hudson, our new CEO of Gallagher Bassett, to make a few remarks; and then Doug will make some comments, and we will go to questions and answers pretty quickly.

Given the continuing strength of the headwinds we face, I am pleased with our quarter.

Although organic revenue was constrained in the quarter, our team's efforts to hold the line on expenses and to negotiate supplemental commissions helped us post a 17% growth EBITDAC growth in brokerage and a 6% growth in risk management.

Our adjusted EBITDAC margin in the brokerage segment improved 1.6 points.

You can see the table on page 3 of 8 that shows you where that came from.

These results are in spite of a drop in the property casualty rates of approximately 4% to 6% in the quarter, and also the economy continues to be a drag on us.

We're a lagging indicator of the economic growth, and we saw no exposure growth in the quarter.

Our mantra for 2010 is simply new business, new business, new business; and of course, keeping every single client that we have got.

As you recall, we had a better than average new business quarter in the fourth quarter of '09.

Our first quarter is always our smallest quarter, and I am happy with our new business.

I am also very happy that in the quarter we retained over 92% of our renewals.

Really, really good effort by our folks.

In this competitive market, I am really pleased with that retention.

We're going to keep the focus on this new business, and when the economy finally begins to expand, if we could get a little bit of rate stabilization, we will be back to growing organically.

Arthur J.

Gallagher and Company has a very strong sales culture.

We have a robust and growing new business pipeline, and everybody in the Company realizes that nothing happens until somebody rings the cash register.

We also have strong cross-selling efforts going on across our entire enterprise; that's between property casualty and benefits, between our retail and our wholesale, and between domestic and foreign operations.

These efforts are focused, planned, measured and they are bearing fruit.

Supporting these efforts, we're implementing a salesforce automation program that is in place in our benefits operation and is presently rolling out across our PC retail shops.

We're excited about this because we think with this automation, we will be able to help our producers sell more accounts and help our management team manage our pipeline of prospects.

We continue to recruit teams across all of our business -- our production teams.

Our energy start-up in London is doing very well.

Other recruits in a number of locations are writing new business.

Our Liberty teammates are no longer Liberty folks.

They are fully integrated and validated members of the Gallagher salesforce.

Our niche marketing efforts continue to payoff.

In particular, health care, public entity, construction, real estate, religious and not for profit and higher ed and many others continue to gain a lot of traction in the marketplace.

Health care reform is certainly controversial.

But it is here, and our benefits team has responded extremely well.

Already, our consultants are engaged in many projects helping our clients sort through what all this means to their businesses.

We have put out a comprehensive set of communications to our clients with time lines, frequently asked questions.

We are hosting seminars, webinars and producing a host of web tools that our customers and prospects have access to.

The benefits world is great for us.

It continues to become more and more complex, and the cost of benefit plans continue to grow.

The level of sophistication needed to deal with all the myriad of regulations and various approaches to benefits plays right into our strengths.

Our benefits team had a strong first quarter; and even with cutbacks in in our clients' employee counts, should help us grow in 2010.

In the near future, we're going to need more well-trained young teammates.

I am thrilled that our summer internship program has reached capacity.

A record number of college students -- 170 to 180 -- will join us this summer to learn about this great business.

Let me move to the acquisition front.

I am pleased to see that our activity is picking up.

Including the First City deal in London which was completed in the first week in April, we have done four deals for 36 million in annualized revenue to Gallagher.

I want to stop a minute and welcome all our new partners.

Each of these new partners had a choice, and they chose to join Gallagher, and we're pleased to have you on board.

Thanks for joining us.

Our pipeline of merger and acquisition prospects is very strong.

I feel good about our opportunities for the rest of 2010.

As a final comment on the brokerage segment, I have always been very, very proud of our team and the work that they do for our clients.

Recently, Greenwich Associates, a respected consulting firm in the insurance and banking space, evaluated over 300 brokers by surveying over 9,000 businesses and recognized us as a national winner of the Greenwich Excellence Award for quality service in the middle market.

Let me move to the risk management side.

On the risk management side, we also faced stronghead winds.

Our revenue was down 2%, but good expense management by the team produced just over 1 million of EBITDAC growth or 6%.

Claim counts, as you know, have been falling month over month for more than two years.

Two months doesn't make a trend.

Nonetheless, it is good to note that claim counts in February and March of 2010 were flat to the counts in 2009.

Gallagher Basset is very unique in the market place.

We're the largest third party administrator in the commercial PC space, and we were recognized by Business Insurance the last two years as the best third party claims-paying organization.

Very, very proud of that.

We think the future is very bright for GB.

And as you know, in the first quarter Scott Hudson joined us as GB's new CEO.

I thought it would be good for Scott to make a few comments on his first months on the job.

Scott?

Thank you, Pat, and good morning, everyone.

When I arrived in late January, Pat and I agreed that prior to discussing Gallagher Basset strategy, I should spend a significant amount of time meeting with clients, visiting our operations and talking with key business partners.

In the short time I have been here, that is exactly what I have been doing.

To date, I have met with over 40 of our top clients, visited a number of our branches, and my calendar has many more such meetings scheduled in the coming weeks.

I have to say I am very pleased with what I have been hearing from our clients.

Our clients view Gallagher Basset as a very strong, stable business partner -- a partner they can count on for high quality claims handling, loss control, and property appraisals; a partner who is flexible, highly responsive, and has many, many talented, dedicated adjustors and account managers.

I am also very fortunate to have a top-notch leadership team with deep expertise and decades of experience in the industry.

So as I sit here today, I see us in an enviable position relative to our competitors.

I can also tell you that when we do discuss strategy, one thing that that will not change is our focus on being the best possible business partner for our clients.

This means not just doing our best to process claims, but total identification with our clients' risk management goals.

What our clients care about most is driving down the total cost of risk, and we will continue to partner with them to do exactly that.

And on that note, I will turn it back over to you, Pat.

Thank you, Scott.

We're glad to have Scott aboard.

I think it has been a great couple of months, and I will turn it now over now to Doug.

Thanks, Pat, and good morning, everyone.

You heard Pat's comments on how we see the current operating environment.

So like I did last quarter, I am going to give you important detailed information that will help you build your models.

Today, I have three topics.

For my first topic, I want to spend some time on the brokerage segment's revenues.

We're now providing in this press release and in our 21 quarter spread that we post on our website a break out of our commissions, fees, supplementals and contingents.

So in the future, I suggest that you separately model each of those lines as follows.

For commissions and fees, multiply 2009 amounts by your organic percentage pick.

Don't get hung up on the difference between commissions and fees.

I have said before, sometimes our clients want us to work on a commission, sometimes on a fee, and that can flip-flop between years.

In aggregate, you will be close.

Then you need to add about $8 million to $10 million of revenues per quarter for the roll-in effect of acquisitions that we have announced thus far.

Of course, you will also have to make a guess for other M&A deals that we might close over the coming quarters.

To model supplementals, we anticipate reporting revenues of about $9 million to $11 million each quarter over the next seven quarters.

We're just giving you these estimates because the historical lumpy patterns you see in footnote 8 on page 8 will not repeat.

History won't repeat because here in 2010 we have had good success in getting many carriers to provide us information quarterly rather than annually, which should remove most of the lumpy quarter-to-quarter variances.

However, for contingents, they will still be lumpy quarter-to-quarter.

So your models for the next seven quarters should have a similar patter, that you can see on note -- in note 8 on page 8.

In addition, we have said before that in 2011 we might get up to another $10 million of revenue from restoring contingent agreements with other carriers.

My second topic brings us down to the corporate segment, which reports our interest expense, some corporate costs, external costs related to M&A activities and our clean coal project.

It is a bit noisy this quarter, so let me work down the P&L line items so you can build your model.

First, the $60 million revenue and expense lines that you see this quarter will not repeat going forward.

This gross up occurred because we were consolidating those clean energy facilities until we sold down the majority ownership positions in the quarter.

Going forward, we will account for those facilities on an equity accounting basis since we have a minority position.

So really, you can ignore those two $60 million lines going forward.

You can also ignore the other income and loss line, because that $4.8 million is a one-time gain from the sell-down that I just talked about.

Second, the royalty income and income from non-consolidated clean coal facilities, those two lines, should net to about $1 million to $2 million of income, per quarter.

Third, the combined compensation and operating expense lines should total more like $4 million a quarter from now on.

About half relates to corporate and M&A costs and the other half relates to internal costs to conduct our clean coal activities.

Fourth, assume about $8.8 million a quarter of interest expense.

When you add all that together, you will get a pre-tax loss of about $10 million to $12 million a quarter.

Then, apply a tax benefit of about $7 million to $8 million a quarter and you should get a quarterly net loss in the corporate segment of about $3 million to $4 million or about $0.03 to $0.04 per share for the balance of 2010.

My third topic is really just a housekeeping item.

We're going to file our 10-Q early next week, and then we're going to file an F3 registration statement so that we can continue to use stock or other securities in our recurring M&A activity.

I know I have just given you a lot of information and it will take you some time to absorb it.

Take a listen to the replay or print the transcripts, and hopefully my comments should help you with building your model.

As a final comment, when I step back from all the noise and consider the lousy operating environment we're in, I am really pleased that we grew revenues.

We grew our EBITDAC.

We improved our adjusted margins and we continued to make progress on our internal initiatives to build a better Company, all the while giving our clients outstanding service and value.

I really like our position for the future.

Okay, those are my comments.

Back to you, Pat.

Thanks, Doug.

Diego, we can go to questions and answers right now.

(Operator Instructions).

Our first question comes from Adam [Clauber] of MacQuarie.

Please state your question.

Thanks, good morning, guys.

Good morning, Adam.

A couple questions around the supplemental and commissions.

First, could you just talk about, I guess, the mechanism of how the $7 million gets pulled from 2011 to 2010?

Is that from one carrier?

And I guess, could you just explain how that happens?

All right.

Good question, Adam.

Welcome back to the call.

First, the mechanism -- the carriers are now providing us information quarterly so we can book supplemental commissions concurrent with the quarter in which we have performed for those carriers.

Previously, they had reported those annually, and so it effectively pulled the $7 million from the first quarter of 2011 into the first quarter of 2010.

Recall last quarter, if you -- if you recall, Adam --

Right.

We removed -- we had a similar situation where $5.9 million was pulled from the -- was pulled into the fourth quarter from the first quarter of 2010.

So net net, those two items effectively wash out in this quarter and makes about a $1.3 million difference that you will see on page 2 of 8.

Okay.

And then, using your guidance on supplementals going forward, roughly 10 million a quarter, if you use that for 2011, that's roughly $40 million.

But for 2010, if you add the 27 to the 30 million that's roughly $57 million.

So it looks like, even excluding that $7 million from that guidance, that the supplementals would come down a lot.

Am I missing something?

No, you're not missing it.

You're exactly right, and that is what the note on page 2 is trying to tell everyone.

We will -- effectively by going to a quarterly basis -- this is many carriers that are doing this -- with our 2010 contracts, they are now providing us with quarterly information, so that the way you're looking at it is exactly right.

From now on, we will have about $9 million to $11 million per quarter, and the lumpy pattern that you see in the first quarter will not repeat in 2011.

Right.

So they will be lower -- so you think they will be lower in 2011?

Is that because some of that revenue got pulled in 2010?

And I guess inset with that, that is the current state right now.

Is there potential to bring that number in 2011, as you talk to carriers further?

Yes, I think -- here is the question.

You have got to look at it also in tandem with our contingent commission.

We have said before that as a result of restoring our contingent commission contract, we expect do receive an -- up to an additional $10 million of revenue in 2011 as a result of restoring.

So as you look at the hole that the supplementals will produce, we will fill that hole with additional contingents of up to an additional $10 million.

Then we also have the ability to continue negotiating supplementals and contingents as we go along, so the $9 million to $11 million number that I have given you assumes current state today.

Right.

Right.

So the ruling in New York, Illinois, Connecticut, I take it, gives you additional flexibility throughout the year to work with carriers, is that right?

Absolutely right.

As a matter of fact, we want our guys to negotiate the best economic deal that they can do.

We're indifferent to whether it is a supplemental, or a contingent, or base commission.

We have the full gamut that we can negotiate now.

So there will be some movement between those line items.

I can tell you right now, one carrier is deeply considering moving from a supplemental back to a contingent and we have got a couple other smaller carriers that are looking at moving from a contingent to a supplemental.

Okay, and just one question on acquisitions.

You have had a pretty good flow recently with the last couple of deals.

Looking at the pipeline going forward, do you think that you can repeat the flow we have seen in the last three or four months?

Adam, this is Pat.

I think you know very well that acquisitions are lumpy.

You can never really predict or plan when certain things are going to hit.

I will tell you that I think activity is more robust in 2010 than it was in 2009 and our pipeline is outstanding.

Great, thank you very much, Pat.

Thanks Adam.

Our next question comes from Bob Glasspiegel with Langen McAlenney.

Please state your question.

How are you doing, guys?

Morning, Bob.

(Inaudible), I just want to make sure I understand, A., how it flowed through in Q1, and just what are the drivers that would change it from the sort of $2 million to $3 million for the quarters going forward.

In the first quarter, you had the $4.8 million gain, and then you -- so will tax effect that at what rate?

40% tax against that gain.

Okay, and it looks like your tax rate was low, so if I use like a normal 40% credit, looks like you picked up another $2 million or $3 million.

So it was like about $5 million this quarter?

Yes.

Ballparkish?

How much -- yes, about $5 million this quarter was contributed as a result of that.

Now there are some one-time costs in there, too.

We provide that detail on page 4, too.

.We put up -- there is some incentive compensation as a result of completing some of those projects that went up.

There were some professional fees associated with that.

So the gain of 4.8 million, probably by the time you offset the costs associated with producing that gain in other activities, it is probably down to more like 2.5 million of pretax gain.

Plus, had you the tax credits --

Then you get tax credits through the benefit line.

Of $2 million to $3 million.

So this was an above trend sort of quarter because of that gain?

Right.

And we think we will make about $2 million net-net per quarter going forward for the next three quarters.

Now, but some of that is taxable.

I mean, the stuff that you get royalties -- I mean, and the tax credits are clearly in that number so --

Yes, I have given you the net EPS -- or the net earnings number, and the composition between tax credits or pretax income or loss, all nets down to about a $2 million --

That is an after-tax number you're giving us?

Correct.

And then the $10 million next year is an after-tax number also?

Yes.

Okay.

What would drive it positively or negatively -- I mean, what are the sort of two or three macro or operational things that will get you on or off that track.

First of all, in order for us to move from making $6 million to $10 million a year to making closer to -- up to $40 million a year, we have to move from operating under temporary permits to operating under permanent permits, and that usually takes six months to nine months to get that down.

So we figure that for 2010, we will be working hard to get our permanent regulatory permits.

That is one thing.

When does the clock start on that six to nine months?

Started basically the first of the year.

Okay.

But it also depends on when -- you can go back in and ask for an extension, too.

So --

So after 9/30, if you haven't gone to permanent, something has delayed you a little bit?

Yes, and it can be anything from regulatory -- just bottlenecks, to that they have asked for slight modifications to something we're doing.

There are equipment issues.

In one plant, we had to put a small piece of tin over the operating conveyer belt in order to push the rain off.

There's lots of things as we try to get these plants operating efficiently that will take -- it just takes awhile to do it.

We had that same situation under our Section 29 plant 15 years ago.

And -- okay.

Is there anything else -- macro, Obama, proposals or one way or another that --

No, not that we're seeing.

You always have the issue that utilities are not -- may use coal to fire their spike load needs.

So a lot of these plants are in the South, and so they will run primarily in the summer when the -- during the air conditioning season.

But right now, you have got low natural gas prices, so these plants can run natural gas rather than coal.

So in addition to just getting them to work, right -- getting the regulatory permits, you will have the seasonality in what the utilities are doing to burn coal.

And if natural gas prices remain low, they may not burn as much coal, and they will use natural gas.

So there is just the decision the utilities have to make on what fuel they are going to use.

That's bad or that's good?

That's bad if they do more gas?

Well, I think that we would always like to have our plants running full-out, but we don't plan for that.

And the $40 million estimate we have, that is not a full-out running estimate.

We do plan for displacement.

Okay.

And just to make Pat do a little bit of work, and to hear from my old friend -- so basically, no change in the market?

Rates are down as much as they have been going down, so operationally, 2010 is going to be same sort of environment as 2009?

That's the message?

Yes, Bob, we're at that place in the market.

You and I have seen this many times before, where the existing book of business that a Company is renewing, they are doing everything they can to hold rate.

But new business is being put on the books at substantial discounts.

So what you have got is a situation where, if an account -- if it is a good account, it goes out to competition.

You're 10% to 12% to 15% off in a competitive environment.

If they renew with the existing carrier -- and what a lot of our guys are doing is just basically going and saying, "Look, let's see if we can renew this thing months early at three to five off." Many times carriers are saying, "No, don't want to do that.

We're not giving rate right now." If that thing goes out to bid, it is going to come down 10% to 12%.

Someone else can going to write it and be very happy about it.

But one guy was actually pretty funny.

I was in a production meeting last week, and one of our guys said that he had two carriers, and he said you're not really happy with the book you're on, but you really want this company's book.

They aren't happy with the book they are on, but they want your book.

Why don't we swap them?

So it is very much sort of the same situation.

If there is competition, rates are coming down.

Got you.

Thank you.

Thanks, Bob.

Our next question comes from Jay Gelb of Barclays Capital.

Thanks.

First I just wanted to --

Good morning, Jay.

Good morning.

How are you, Pat?

I'm great, thanks.

Hey, Doug.

On the organic growth, it looks like there was $7 million or so pulled forward in supplementals.

So the minus 2.8% organic growth, that includes that benefit, right?

So it seems like organic growth would have been less excluding that one-timer.

So I am trying to get a sense of --

Jay, that is actually not right.

You have to -- I mean, the 7.2 got pulled forward, but don't forget the 5.9 that got pulled out also.

So on the table on page 2 of 8, we have levelized for the two timing items in terms of computing organic growth compared to 2009.

So the 7.9, is mostly offset by the 5.9.

So the 2.8 that you looked there puts the two years on an apples to apples basis for purposes of computing the organic growth computation.

Okay.

That is helpful.

Yes.

And then next, can you talk about the ability to improve the stated pretax margins and brokerage going forward?

EBITDAC was up a little year-over-year, but stated appears to be down somewhat.

Yes, we think that like we talked about on the January call, because of the 4% workforce reduction, that should pick us up $20 million net-net after escalation of benefits and medical costs, et cetera.

That might offset the continued declining organic growth, so we're hoping to hold margins compared to prior year.

I wouldn't expect a substantial increase in our margins going forward.

Okay.

For 2010.

Right.

And then for the RIMS feedback on some of the larger brokers accepting contingent commissions, it seems like they have pulled back from prior stances.

Does that change Gallagher's view at all in terms of accepting contingents?

No, Jay, I think that we have been very clear -- this is Pat.

I think we have been very, very clear on our position on this from the outset.

I think the (Inaudible) era was a very painful era.

But one thing that came out of that pain, which was probably good for our industry, is transparency.

And we have stated all along that we are willing to -- not only willing -- we do, in fact, disclose every single item of compensation to every single client that we have.

And if a client chooses not to participate in either a contingent commission or supplemental and commission, we pull them out of those calculations.

And that has been our stand from the beginning.

Transparency is good.

Supplemental commissions are good.

Contingent commissions are not evil, and they are disclosed and agreed by our clients.

All right, great, thank you.

Thanks, Jay.

Our next question comes from Meyer Shields of Stifel Nicolaus.

Please state your question.

Thanks.

Good morning, everyone.

Good morning, Meyer.

Doug, let me start with one question for you.

When we look at the cost for -- the compensation cost per average SPE, it is up a little bit more than 4% in both brokerage and risk management.

Is that impacted at all by the fact that headcounts are changing significantly over the past couple of quarters?

I think that that number is being influenced by the Liberty transaction where we brought in a predominant number, mostly producers, and that is what skewed that number up.

Okay, so we shouldn't use that as a compensation inflation run rate?

Here's the thing is, I think it is a good number to use.

Internally if we tried for administrative and mid-office and back office, that is a good metric.

The problem that you have there is that because our producers are on a formula, it distorts that calculation.

So I wouldn't use that as a metric for your purpose.

Okay.

Thank you.

Can you give any guidance in terms of the combined ratio range that underlies your estimate of supplemental commissions flow?

No, this is important to understand, Meyer.

Supplemental commissions are -- pardon me -- they are set and fixed for the year.

The carriers, when they settled with the AGs, agreed that those commissions would be set and disclosable in the year that they were being that they were being paid and given to the -- to us as brokers.

At the end of the year, they are allowed -- so it will be fourth quarter to first quarter of this year and next -- they are allowed to look back and to reset that supplemental commission.

If company "x" is paying us a 2% supplemental commission, and during the year for whatever reason, our relationship with them does not perform well, they are very capable of looking into 2011, and saying, "You made 2% last year.

I am paying you 1% this year, going forward into 2011.?

These are not actually the -- it is not something that you calculate off the loss ratio.

They are allowed to look back and basically determine, based on their view of the relationship, what the go-forward commission is going to be.

And one of the reasons that we're disclosing this is, in fact, these things can be all over the board next year.

Okay.

So what would have been on 2011 would have been based on 2010, in any event?

Exactly right.

Okay.

I'm sorry, I had that confused.

And last question, I guess also with Doug, in your revenue guidance you talked about $8 million to $10 million of acquired revenues.

Correct.

That's only based on revenues -- I'm sorry, on acquisitions on to date, is that right?

Correct.

Okay --

It does include the First City deal that we announced the first week of April.

But through what we have announced thus far today, it is another $8 million to $10 million per quarter going forward.

Great.

Okay, thanks so much.

Thanks Meyer.

Thanks, Meyer.

Our next question comes from Mike Grasher of Piper Jaffray.

Please state your question.

Thank you.

Good morning, everyone.

Hi, Mike.

Congratulations on your quarter.

Thank you.

Pat, early on your comments, you had mentioned growing pipeline.

Was that specific to M&A, or new business in general?

Mike, that is both, actually.

I think -- I am really, really pleased with the pipeline in terms of emerging acquisitions; but I am also excited about our salesforce management tool that we are putting in which is going to let us manage and measure our pipeline for prospects literally by branch, by producer.

Okay, and I guess I'm just trying to square that with some of your other comments in terms of the economy and how it impacts your business, no exposure growth in that.

I guess, can you share with us a little bit more insight into how you see through that, and perhaps part of that is the tool that you're utilizing?

No, I think there are a couple of separate things here.

Everybody is talking about green shoots in the economy.

We're seeing different economic measures showing that maybe we're coming out of this recession, and that's all good news for us.

Having said that, in the first quarter we saw no real economic positive impact on our clients' exposure units.

We're not seeing payrolls increase.

We're not seeing sales jump.

We are hearing from our production force that it looks like things have bottomed out.

But the accounts that we're renewing right now are not renewing saying, "Take my sales up 15%." They are no longer saying "Take my sales down 25%," and literally a year ago right now, we were hearing from many clients, "Take my sales" or "Take my construction revenues down 50%." That seems to have abated.

So that is positive for us, but we're not seeing the growth from that which -- we will get healthy when our clients get healthy.

Okay, fair enough, that is helpful.

And then regarding M&A, there has been some conversation around [MarshMac] sort of maybe, maybe not, having some impact on pricing.

Your thoughts or comments around that?

And does it fit -- do they fit your sort of, I guess, knitting in terms of the types of entities that you would be looking at?

Well, I mean, they are a new and positive entrant into the M&A space that we have been in for the last 10, 15 years.

They -- our typical deal is probably smaller than they would be looking at.

They have done a couple of very nice deals in the last quarter or so.

And you're still looking at a space in the United States alone with something on the order of 18,000 agents and brokers out there.

That's not people, that's firms.

And we -- frankly, we don't bump into each other that often.

Fair enough.

Thank you very much.

Thanks, Mike.

Our next question comes from Brian [DiRubbio] of Yield Capital.

Please state your question.

Good morning, guys.

Good morning, Brian.

Two questions, both relating to M&A.

First, we have had two acquisitions since the beginning of the year that have been international -- the Brazilian brokerage firm and again in London.

Is this the start of a change in focus away from just buying US-based brokers and looking more abroad?

Well, Brian, I would say it is fair to say that literally for the last 20 years we have done acquisitions internationally, so it is not a change in focus whatsoever.

But I think we're more active internationally than we have been, which is clearly a very thought-out strategy.

We are -- the Brazilian deal, by the way, was a very small deal.

It is a great toehold for us in an emerging market.

You will recall that two years ago we did a similar type of thing in the Caribbean.

Yes.

A year-ago we did a deal that was similar in Perth, Australia.

So we have been active internationally.

And yes, it is a focus for us.

Okay.

So can we then -- I know it is always hard to say, but more of a balance or more of a -- where 90% of your acquisitions may have been US-based, you could probably see that decline in the next couple of years?

Absolutely.

Okay.

And second question, again on acquisitions, as I am thinking about the potential change in cap gains rates for the end of this year, can you sort of give us a sense of the capacity that you guys have both in terms of the number and the dollar amount of brokerage you could potentially buy if you sort of get a rush to beat the increased tax rate before the end of the year?

Yes, Brian, that is a very good question, and I predict that we're going to have that opportunity.

I also predict it is not going to be just this year.

Remember, the nice thing about what we're doing is that we're buying in three separate divisions.

So you ever our property casualty retail operation, you have our benefits operation, and then you have what we call our specialty marketing in the international.

And so the capacity-- if we were to wrap up and do eight deals in a quarter, people might go, "Oh my gosh that's a real ramp up." When you realize you split that by three operations, there is a lot of capacity for us to be able to bring new deals into the Company.

So if we get a rush by the end of the year, we will be able to handle that.

I will let Doug talk about capacity, dollar amounts and that type of thing.

But you're on to something here which I think is very important.

I believe there will be both a rush to quality -- and that is a cultural quality as well as an organizational quality.

I do believe that the cap rates -- the capital rates -- gains rates are going to be a big influence, and I do believe that the complexity in particular of what is going on in the benefits area is going to drive more people to seek housing inside an organization like ours.

So I'm very excited about our merger and acquisition opportunities.

And Doug, you can talk about the -- what kind of volume we can handle in terms of financial.

Yes, I think that we can probably do $300 million worth of deals this year just on our current capacity.

So -- that is purchase price going out.

So if you pay 6.5 times EBITDAC for it, maybe you can get somewhere around $40 million to $50 million worth EBITDAC.

That is on an annualized basis.

We have that kind of capacity.

That is using a mix of cash and stock.

No, understood; and still do about the 50/50?

Yes, I think that probably the rest of of the year we can do 50/50.

We can go up to to 75/25 stock -- that's what we have been doing in the past a little bit, but we have good cash flows that could handle that.

Okay, and actually just the final question.

The purchase lease said you had 5.6 million of revenues.

I think Pat mentioned a $36 million annualized -- Pat, did you include the --

I included First City in that.

That was closed in April.

Okay, so that's 36 including the First City?

Correct.

Perfect, thanks a lot, guys.

Thanks, Brian.

Thanks, Brian.

Our next question comes from Keith Walsh of Citigroup.

Please state your question.

Hey, good morning, gentlemen.

How are you?

Good morning, Keith.

Couple of questions.

First, go back to Jay's question earlier.

I am kind of confused about this -- the way you're reporting organic here with all these moving parts.

I appreciate you trying to split this out for us, but I think it is more confusing than anything.

When I look at the minus 2.8%, I'm getting a lower number the way I'm looking at it -- I guess commissions plus fees and the kind of n taking out the $17.2 million, and why are you overstating organic this quarter, relative to the way I should think about your business on an apples to apples basis, is sort of the question?

Now the answer to that I would say is no, absolutely not.

The industry has included supplementals and commissions and fees and a calculation of organic and has excluded contingent commission.

We lay it all out for here.

You can compute it how you want to, but we lay it out.

Putting us on an apples-to-apples with the industry, we get 2.8%.

But remember, that number is the delta over 2009.

So in the timing items line, if you see there it says, "Timing Items, Net" and then "Footnote 1" we had two timing items that impact the first quarter 2010 compared to 2009.

We lost $5.9 million to the fourth quarter.

We picked up $7.2 million from the first quarter of 2011.

They net to 1.3.

So in fact, what we have done is we have levelized for the computation of the 2.8% the impact of these two-timing items.

So I don't know what the other company's commissions and fees organic number is, if you just compute it on that.

Maybe you can get that from them.

But in terms of how we see this being done, we put ourselves consistent with the industry and we have computed the delta between 10 and 9 on a apples to apples basis, and that's how we get 2.8%.

Fair enough.

I mean, we have got all the pieces here, so we can do it whatever way we want then.

But -- The second --

That is the whole purpose of table 2 is to try to make sure that we're giving you an apples to apples comparison and trying to put it consistent with the industry.

Then the second question, just looking at the chart you lay out below that with the contingents.

When I look at that 14.2 million in 1Q, 2010 -- or $15.5 million, let me say -- that is embedded within your 204.2 commissions number?

No, it is separate from that.

Okay.

Okay -- then third question, just for Pat, you're just talking about unit growth, and then you're still saying you're not seeing it yet.

Is it likely that the customers are just still cautious and they are waiting until next year renewal before they start to sort of ramp up insurance buying again?

Yes, I think so.

I think that is a fair comment.

When I talk to to insurance companies we work with, they feel that they are probably about, when you finish the second quarter, almost through the wave of return audits.

So some will say through the second quarter, some will say they predict through the third quarter.

I talked to one yesterday that says through the fourth quarter.

But small accounts, in particular, I think are finally at a base point where you're not going to see any kind of of return audits.

You are going to start to see some additional premium audits, and larger accounts are probably a quarter or two away from that.

Great, thank you very much.

Thanks, Keith.

Our next question comes from Alison Jacobowitz of Bank of America Merrill Lynch.

State your question.

Hi.

Pretty much most of my questions have been answered.

I'm just wondering if you could talk some -- I don't think I heard you say about the pricing of acquisitions what you're seeing happening with the price you're paying these days.

Sure.

Yes, I think, Alison -- I think acquisition multiples have been coming down over the last couple of years.

I think that anywhere between five and seven is kind of where the deals have been going out at.

We will probably get a little bit more aggressive on that toward the end of the year.

Not substantially so, but a little bit more.

Thanks.

Thanks, Alison.

Thanks, Alison.

(Operator Instructions).

Our next question comes from Mark Hughes of Suntrust.

Please state your question.

Thank you very much, good morning.

Good morning, Mark.

On the risk management side, sounds like some stability in the last couple of months.

You don't want to read too much into it, but anything you can attribute that to?

Payrolls stabilizing, claims frequency up?

What -- any more thoughts there?

I think that the recession, Mark, has really put a damper on the claim counts over the last two years for two reasons.

Economic activity -- so if you're not running three shifts, you're running two shifts, you are going to have fewer claims.

And also, I believe employees -- in particular those employees who have minor injuries -- just aren't reporting them.

We have seen our medical-only losses drop substantially in 2009, which was an interesting phenomenon.

And what that tells me is that the guy that has got a minor injury, he's just going to go home and take care of it.

He's really not wanting to set himself up to be noticed.

Do you think that has run its course and we have lapped that effect and thus, the stability?

I would like to answer that at the next quarter.

Two months, as I said, doesn't make a trend, I think, but possibly yes.

I think we're at a point where, if economic activity picks up and people start to hire more people, if people feel a little more secure in their job, then yes, I think that claims accounts could start to creep up again,.

Historically -- this last couple of years has been a really interesting anomaly.

It has been good for our clients.

I mean, we're all in the business of trying to help them reduce costs.

It is good to see claim counts go down.

But when economic activity picks up, I mean, unfortunately there are more injuries, and that looks like that might be coming around right now.

Great, thank you.

Thanks.

Our next question comes from Meyer Shields of Stifel Nicolaus.

Please state your question.

Thanks.

Doug or Pat, I guess I'm not sure who to ask this to.

When we look at the supplementals and contingents, should we assume there is a rule of thumb in terms of what percentage of that will actually go out as compensation?

Actually, our supplemental commission, by and large, most of it hits the bottom line.

But there is an element of that that we use in order to compensate some of our field management level.

maybe 10% of it, 15% of it, we will set aside as a way to compensate field management.

But it is not a direct apples to apples allocation, but we use that as a way to fund the bonus pool to a certain extent.

But it is important to note that supplementals and contingents do not question run through producer formulas.

That's right.

Okay, great, thank you.

Ladies and gentlemen, there are no further questions at this time.

I will turn the conference back over to J.

Patrick Gallagher, Jr., for closing remarks.

Yes, thank you very much, Diego.

I've just got one quick thing to say.

I mentioned in the fourth quarter call that conditions that we face, I think, are as tough as I have seen in my 36 year career, and we continue to face those conditions.

We face declining rates, a very soft economy and aggressive competition.

But I'm proud of the fact that this quarter, the Gallagher team proved ourselves up to these challenges.

We grew our Company, and as I said, I'm proud of that.

Thank you for being with us this morning.

We appreciate your being on the call.

I know it is an early call, and we appreciate you being here.

Thank you, Diego.

That's the end.

Thank you.

This does conclude today's conference call.

You may disconnect your lines at this time