Arthur J. Gallagher & Co. (AJG) 2013 Q4 法說會逐字稿

Good morning and welcome to Arthur J. Gallagher & Co.'s fourth-quarter 2013 earnings conference call.

Participants have been placed on a listen-only mode.

Your line will be open for questions following the presentation.

Today's call is being recorded.

If you have any objections, you may disconnect at this time.

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 that will be discussed on this call and which are also 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, Chairman, President and CEO of Arthur J. Gallagher & Co.

Mr. Gallagher, you may begin.

Thank you, Brenda, and good morning, everyone.

Welcome to our fourth-quarter and year-end conference call.

We appreciate your being with us this morning.

Today I'm joined by Doug Howell, our Chief Financial Officer, and the heads of our operating divisions.

Simply said, I could not be any prouder of our team and our results in the fourth quarter and full year of 2013.

We were working toward a strong finish as we entered the fourth quarter, and the team surpassed even my high expectations.

I simply could not have asked for better performance from our team.

Literally every division across the globe contributed to our record results.

Combined Brokerage and Risk Management had adjusted revenue of 18%.

6.2% of that was organic.

22% growth in adjusted EBITDAC.

These are outstanding results.

Brokerage and Risk Management segments combined grew our adjusted revenue in the year $369 million.

This is a real testament to our sales culture.

Every one of us in the Company understands everywhere in the world that we get up every day and we understand that our number one job is to keep the clients we have and to attract new clients.

We all understand that nothing happens until somebody rings the cash register.

We continue to get stronger and stronger every quarter, every year.

Today we've proven that any account of any size anywhere in the world we can serve.

That is exciting.

On the mergers and acquisitions front, 2013 was a banner year.

We completed 31 transactions, two of which were really sizable.

Bollinger in the Northeast and Giles in the UK added significantly to our revenue base in both locations.

Including the other 29 completed acquisitions, we approached $400 million of acquired revenue and $130 million of annualized EBITDAC.

We paid a blended multiple of about 7.6 times, which we believe is a fair and reasonable multiple, and we only had to use about a quarter of the aggregate purchase price in our stock.

All of our partners had choices.

I'm proud they chose to join Gallagher, and I want to welcome them to our growing family.

And our pipeline going into 2014 is very robust.

So we expect 2014 to be another strong merger and acquisition year.

In 2013, our workforce expanded by about 2600 people, almost all of whom joined us through the merger and acquisition process.

We like to say that we added 2600 more brains who working in our culture and our niches and our specialties add incredible firepower.

These new colleagues add tremendously to our capabilities and our opportunity to continue to grow.

Let me add some color now by business line.

I will start with property/casualty retail in the United States.

We had a strong new business year, a great acquisition year and solid retention of accounts in the year.

We saw rate increases throughout the year, and we saw the economy show signs of getting healthier.

Yet think about this, only about 1% -- in fact, less than 1% of our organic growth came from rate and the economy this quarter.

So for 2014, as we look at the rates, we expect the property/casualty market to remain stable with increases on most lines being somewhere on the order of 2% to 3%.

The one exception to that would be larger property schedules in areas that have not experienced severe losses, and frankly, those customers deserve a decrease after number of years of benign weather.

But my continued surveys of our people show underwriters continued to account underwrite, and they understand that there is loss cost inflation.

Managements have shown discipline for three years, and carrier managements continue to tell us to expect the same in the future.

They must maintain their discipline because if they don't, they won't have a return.

Adequate returns can only be driven by underwriting profits.

So if discipline remains and rates are flat to up 2% to 3%, we should see solid organic growth from our new business efforts.

On our wholesale business, we had strong organic growth in 2013, and we see business startups and primary market discipline continuing to present our wholesaler RPS, Risk Replacement Services, with great opportunities.

RPS is the largest MGA operation in the United States, according to Business Insurance Magazine.

Our program business is seeing good growth opportunities, and our open market brokerage is receiving good submission activity.

In our benefits business, 2013 we were lifted by our clients and prospects need for help with the new health care act.

Sorting through new regulations, consulting around exchanges and helping clients decide how all of this fits into their HR strategy will continue to be a boom for us in 2014.

Our international property/casualty business has been our fastest-growing business.

Not only did we do one of our largest acquisitions in 2013 -- that was Giles -- but our organic growth in the international PC world was the highest of the group.

We were strong in the UK, Australia, Canada, Mexico and the Caribbean.

Our opportunities to expand outside the United States are growing because we now have platforms around the world that allow us to pursue bolt-on and folded acquisitions, and we will see more activity in that regard in 2014.

Our Risk Management business had 9.3% organic growth in 2013, and we successfully completed a number of customer-based investments and systems, people and capabilities.

This is leading us to our best new business start in 2014 in seven years.

Plus, we have a carrier outsourcing arrangement that we started January 1 that will be over $12 million in revenue.

We continue to see great opportunities to be an outsourced partner to the underwriting community.

Our investments in Gallagher Bassett are paying off in customer wins in what is a very competitive environment.

And GB was named the best US TPA by the voting readers of Business Insurance Magazine.

And finally, our shareholders had a great win in 2013.

Shareholders received a 40% return, including dividends, for the full year in 2013.

And at our last board meeting, we increased our dividend again.

Okay.

2013 is over, and we are off and running in 2014.

The moves we make -- acquisitions, organic hires, systems investments in 2013 -- should put us in a very good position for continued growth in 2014.

We are bullish.

Most importantly -- this is really critical -- as I traveled throughout our global network, I can tell you that our unique Gallagher culture is thriving.

Teamwork is everywhere.

Clients are being served exceptionally well.

Our people are turned on, excited by our growing capabilities and really believe we are just getting started.

Doug?

Thanks, Pat, and good morning, everyone.

It's nice to have a great quarter, and I'm encouraged about our prospects in 2014.

We will start on page 2 with the Brokerage segment.

Like Pat said, a terrific quarter and a terrific year.

In the quarter, you'll see the integration costs related to Bollinger and Giles, which were right in line with what we discussed in our last conference call.

You'll also see severance primarily related to management redundancies as we consolidate a number of our similar international operations under common leadership.

That process is going very well, and looking towards 2014, expect to see $0.03 per quarter in total for integration and severance as we continue to bring our various operations together.

Staying with Brokerage and turning to page 3 to the revenue table at the top, some flavor behind the organic 5.8%.

First, you should know that we did have a few nonrecurring wins that fueled organic by about 20 to 30 basis points in the fourth quarter.

Those are great wins to have, but not likely recurring revenues next year in the fourth quarter.

Second, when I look at the organic across our various brokerage units, all performed very close to the mid-5% range in the US.

That's our retail units, our wholesale units and our benefits units.

They were all right near the average.

International, as Pat said, was in the upper single digits.

Third, you heard it from Pat, but it deserves special mention.

I went back and I looked at the last 12 quarters of organic growth.

During that time, there's not been one single quarter where more than 1% of our organic growth came from rate and exposure.

We just sell more than we lose.

We're not only sensitive to slightly up or slightly down rates, and we grew even during a time of a sputtering economy.

It simply shows that we should have continued organic growth, especially if the economy gathers steam, even should rates become a little bit flattish.

Moving to the Brokerage operating tables on page 3 and then to the overall adjusted EBITDAC margin on page 4. Comp is down, operating is flat, which resulted in EBITDAC being up 100 basis points.

That is right in line with what we thought on our last call.

But some comments behind the margin.

First, as we discussed last quarter, Bollinger and now Giles too are seasonally a bit smaller in the fourth quarter.

So to the extent they were a little drag on margins, that was offset by a little bit of margin lift coming from the nonrecurring wins I mentioned just before.

Either way they just offset each other.

Second recall that a year ago, we took the proactive step to reduce our workforce to offset most of the underlying inflation in salaries, benefits and health and welfare.

As we come into 2014, while we do have some operational improvement initiatives and I do feel like we can continue to shift more work to lower-cost labor locations, there is some underlying workforce inflation.

So we are now back to our message track of about 18 months ago.

If we don't have greater than 3% organic growth, don't model much of any margin expansion other than about 80 basis points because of Bollinger and Giles, which run higher margins.

Third, it's time for my annual reminder.

Recall that our Brokerage segment is extremely seasonal with our first quarter by far the smallest.

So please make sure you factor that seasonality into your quarterly spreads.

When you get done, step back and make sure you don't see much of any year-over-year margin expansion in the first quarter.

Moving to the Brokerage segment, non-EBITDAC line items for 2014.

For amortization, assume about $39 million of expense per quarter.

For acquisition earnout amortization expense, assume about $4 million per quarter, and for depreciation, assume about $11 million of expense per quarter.

Then as we do more M&A, for every dollar we spend, you need to increase amortization by about 1% of the purchase price per quarter, and that will get you close.

Okay.

Let's shift to the Risk Management segment back on page 2. As we discussed in our last call, you'll see the ramp-up costs associated with our new insurance carrier relationship.

You'll also see severance as that segment also consolidated some leadership roles.

As we convert IT systems for the carrier runoff block, expect to see about $1 million to $1.5 million a quarter and integration costs running through the third quarter of 2014.

Turning to page 4 to the Risk Management organic table.

It was a strong quarter and a strong year.

And, as Pat mentioned, with the new -- the good new business pipeline and with our new carrier relationship, we should have revenue growth in the upper single digits in 2014.

Let's move to the bottom of page 4 to the compensation table.

You saw it in Pat's comments, and you also see that our comp ratio spiked up in the fourth quarter.

We got hit with a few more really severe medical claims right at the end of the year which cost us nearly $2 million.

It looks like it is just a blip, and it's unfortunate that it hit us late in the year.

Looking at page 5, you'll see that we had nice improvement in our operating expense ratio in the Risk Management segment.

This is even while we invested some of that on client service enhancements.

So nice work by the team on that line.

Moving down to the adjusted EBITDAC margin for Risk Management, we hit that 15.8%, which was very -- for the year, which was very close to our target of 16 points.

Looking forward in 2014, we are, again, targeting 16 points of adjusted margin, which at that level still provides us the opportunity to make further investments into the business.

And finally, on Risk Management, as for the non-cash items, assume about $6 million a quarter of depreciation and about $1 million a quarter amortization expense in 2014, and you'll be close.

Okay.

Let's shift to page 5 to the Corporate segment.

In total, the fourth quarter was right in line with our forecast.

A little better earnings from clean energy was offset by a little bit more acquisition costs related to Giles but right in line.

For the year, our clean energy investment team nearly doubled their earnings from 2012, and they are already hard at work optimizing existing plants and rolling out the remaining plants.

We should better 2013's earnings, and we're still seeing those investments as a nice funding source for our M&A program.

When modeling the Corporate segment, we encourage you to model the segment using the shortcut table format that we provide on page 14 of our investor supplement.

We have now provided our first range of estimates for 2014 for all four components of the Corporate segment.

Interest, M&A and Corporate are relatively straightforward, but -- and you've heard me say this before -- when it comes to the clean energy line item, earnings for the year can be difficult to predict, so we've provided a wide range.

Please make sure your models and note highlight that possibility.

Also, please take a look at the note on page 15 of the supplement.

It explains that because we're so seasonally small in the first quarter, we are likely to warehouse between $0.15 to $0.19 of credits in the first quarter, which then get recognized over the following three quarters.

It all washes out by the end of the year, but it does produce some volatility in our quarterly results.

Finally, some comments on capital management.

Since our last call, we announced that we have closed on a $600 million round of private placements that we will draw down in late February, and we also filed a $200 million asset market or dribble out equity offering.

Between our free cash flow in 2014, the dribble out, our line of credit and the ability to use stock and acquisitions, we are well-positioned to continue our M&A program.

As for shares outstanding, it's looking like the fully diluted weighted shares outstanding for the first quarter will be about 138 million shares.

As for the remaining quarters, that will mostly depend on our M&A levels.

So when I step back and I boil it all down, in 2013 our combined core operations were up double digits on all measures, and we doubled our earnings on clean energy.

Clearly, an outstanding year.

And as we move into 2014, we are in an era of rational rate setting.

It seems the economy is getting better by most all measures, and we have an M&A pipeline that's pages long with fine agencies and brokers that want to join us.

We have a team that's highly experienced and embedded in a rocksolid culture that we think will excel in 2014.

So I like what we did this year, and I think next year holds good things too.

Back to you, Pat.

Thank you, Doug.

Brenda, we are ready for questions and hopefully some answers.

(Operator Instructions).

Sean Dargan, Macquarie.

Thank you.

I was just wondering about the tax rate in Brokerage.

Was there anything unusual there?

No and we did drop-down a percentage, but that's basically because of our -- the weight of our international operations that they are in lower tax locations.

So we hope to see continued downward movement in that, but we dropped a point this year just because of that.

Okay.

Great and thanks.

Just a forward-looking question.

Is there any appetite to increase your leverage to fund future acquisitions, or are you still thinking at kind of 2 times EBITDA?

Yes, I think so.

I think that when we do 2 times EBITDA, it is probably right where we want to be.

There will be sometimes where it rounds up to 2.2, 2.3, and then as the earnings move into the financial statements, it will drop back down around 2. But that still gives us plenty of cushion related to our covenant.

It still keeps us in investment grade level.

So I think that somewhere in that 2 range is right where we want to be.

And what is that cushion at now?

We think that investment grade trips at about 2.75 times EBITDA, but our covenants are at 3.25.

Okay.

Thank you very much.

Gregory Locraft, Morgan Stanley.

Thanks and congrats, guys, on the year and the quarter.

Excellent job.

Thank you, Greg.

Appreciate the comment.

So I feel -- I thought that in the commentary, you were quite bullish on the top line outlook for 2014 and beyond.

So, given where pricing is, I feel very good on top line.

Can you talk a bit about margins because the Corporation is kind of perched at levels that we've never seen before on the margin front.

Really have got to go back to 2004.

So what I'm wondering is, can you compare and contrast Gallagher today versus maybe 2004 when margins last peaked, and how can you kind of run through the previous peaks and keep going higher from here to grow margins specifically?

Because, again, we feel really good on the top line outlook as it seems you do as well.

Great.

Thanks for the comments and just that overarching comment on margins.

That is if you go back in 2004 with the changes in stock-based compensation and when you look at just the differences in accounting, our margins are actually better than ever before in the Brokerage space, so we feel very good about that.

And our Risk Management has always been kind of in this 15% to 17% range when it comes.

That is just the nature of the business.

Which is a leading margin in that industry, by the way.

So we feel good about the margins at that level.

Do we see opportunity for margin expansion going forward?

I've said that if we are not above 3% organic, we probably won't see much other than the impact of acquisitions, which could increase it or decrease it depending on the franchises that we buy.

But by and large, we are in an interesting era right now.

If you look at our operating expenses, we have driven that down to the 16%, 17% range.

We just don't spend money on things that aren't people.

We think that we have opportunities to continue to leverage our offshore centers of excellence that do tremendous work for us, and we think there are some technology opportunities as we roll it in.

You know behind-the-scenes here, the retail businesses converted all of its different agency systems onto one platform here.

I think that only a couple of locations haven't been converted on yet.

So we are making some improvements in technology, but there is underlying inflation.

So where do we see margins going long-term?

Give us 5% organic growth through the next three years, sure you would see some organic expansion.

At 3%, it's going to be tough to have much more, but, again, we think that we are well-positioned.

We've never really cut our 401(k).

We've never cut back on benefits that we provide to our employees.

We've done a good job of keeping our workforce well-paid throughout the entire recession and still today.

So our future when it comes to workforce, we think a 60% comp ratio and about a 16% or 17% operating expense ratio is a good spot for a brokerage like us to be.

Okay.

And any commentary on the other segment, on the risk management?

Yes, you heard in my comments that we got hit with some medical claims right at the end of the year, but we think there's a line of sight in that business to keep 16 points of margin.

If they can grow in the upper single digits, we think that is tremendous.

No margin compression and organic growth that might be approaching double digits.

I don't think it will hit double digit, and we think that's good for that franchise.

This is a labor-intensive business.

There are some really exciting things that are going on inside of Gallagher Bassett right now that really provide some nice value to our clients.

So we think if we can from that for 16 points at upper single digits organic growth, that's a good spot for us to be.

Okay.

Great.

And then shifting gears, reinsurance brokerage.

Do you guys do anything there, and I thought in the quarter you made a move into that space.

I am just trying to size the move in your appetite for growing reinsurance brokerage.

We have a reinsurance business, and we've done reinsurance forever.

You will recall, Greg, that we sold our Gallagher Re to Aon about six years ago.

That was an effort that we had to flip to try to go after some of the larger treaties that were being placed around the world.

Very exciting.

In the fourth quarter, we were joined in a partnership by Grahame Chilton who comes out of Benfield in the startup of a firm called Capsicum, which is an effort to start a new reinsurance venture that is primarily based on his past relationships.

So that is a -- we've also done a small acquisition in that space in 2013 -- 2012 actually.

So we do see opportunities for growth.

What you're not going to see us do is throw huge expense dollars at that.

We think we've got an opportunity to build something out with Grahame.

We're excited about that.

He's obviously a well-known person in that industry.

He has been very, very successful.

We're pleased to have him as a teammate, and we think we will do great things there.

But it's not going to be something where we spend millions and millions of dollars to find out if we can do it.

Okay.

If I may and I don't know if it's appropriate, but did you take a look at the Towers business when it came up?

We did and we did not bid.

Okay.

Perfect.

Thanks, guy, and, again, great year and great quarter.

Thank you very much, Greg.

Josh Shanker, Deutsche Bank.

I want to talk about a history of selling appetite for smaller potential acquisitions and contrast that with interest rates.

If we think about four years ago versus two years ago versus today, what are sellers interested in receiving for their businesses, and does that have a component in it, and how much are you willing to pay based on the cost of cash basically?

Good question.

I think Pat said in his comments that if you just look at all 31 of our acquisitions this year, we ended up paying a blended multiple on EBITDAC of about 7.6 times between 7.5 and 7.6 times EBITDAC.

So that multiple, frankly, has probably moved up one turn in the last 4 or 5 years.

Is that interest rate correlated, or is it growth correlated?

We see it probably as more growth correlated.

Most of the operations that we're looking at now do have line of sight to some growth that's consistent with our levels.

Do I see it necessarily correlated whether interest rates are at 4% or 5%?

We're just not seeing that.

It doesn't translate quite to that level quite yet.

So, if we're thinking about the 10-year rising, that doesn't put a ceiling on multiples insofar as that money is more expensive.

Or you don't view it that way, or they don't view it that way, or how should I think about the relationship?

I don't think there's been a view right now that the 10 year -- that 1% movement in the 10-year influences that price.

Clearly, if the 10 year goes up 5%, 7%, 10%, then multiples would come down.

But it's just not that tightly correlated.

Okay.

Thanks very much, and congratulations on the year.

Thank you, Josh.

Bob Glasspiegel, Janney Montgomery Scott.

A question on, would the Sedgwick tinkers ever to chance sell in the TPA market.

I was wondering if you could chat a little bit about how that if it all changes the competitive landscape.

The valuations seem to be on the rich side from a pretty savvy buyer.

Does that change the game where prices may be for acquisitions?

But what are the implications of this as you see it?

Well, Bob, first of all, this is Pat.

I think we all know that KKR is very, very smart money, and they've made a very big bet in a business that we believed in without hesitation for 30 plus years.

And there have been times over that 30 plus years, actually 40 plus years that we have been questioned as to whether or not we're going in the right direction, and I think it proves the point that this is a very, very dynamic business and a great business.

We believe that the claims business is an area that we can excel.

It is a competitive landscape.

It doesn't change one wit what our competition is -- or I'm sorry, what our strategy is with regard to that business.

It just, I think, proves up the fact that it's a very valuable business.

If the price got to [13%], [14%], [15%] in EBITDA, is there any price that you would become a seller versus a buyer, or is this just a business you love regardless of where the private market valuations go?

This is a business I love regardless of valuations, and let me tell you why.

If you figure that Robert Hardwick is right at the Insurance Information Institute and that there's something on the order of $1.5 trillion of premium paid in the property/casualty world globally and you realize that some 60% to 65% of that premium turns into a claim every single year, then where is the money in the insurance business?

It's in the claims, and where's the opportunity to help our clients save money?

It's in the outcomes as to how well you do those claims.

And we think we can prove that our outcomes are superior.

When you see major insurance companies outsourcing their business to Gallagher Bassett, essentially saying that their capital would be better served by our handling their claims, the world is coming our way, Bob.

We ain't getting out.

Fair answer.

Less significant question on the supplemental and contingents continue to sort of outperform your guidance going forward.

You know, the business has been profitable.

Perhaps there wasn't a lot of cats.

Underwriters are paying more for good business.

So, as we look into 2014, is there anything we should be thinking about North, South in the trench there and the acquisitions change the sort of run rate materially?

Good question.

First, in the fourth quarter, if you recall, in our third-quarter call, we had a couple of million bucks that was a timing.

They shifted it from the third to the fourth.

So when you look at the fourth quarter, that fueled that a little bit, but we talked about that in the third quarter.

Looking towards 2014, there are a couple of things that are going on.

As we add scale, especially internationally, we see opportunities there to increase our contingents and our supplementals.

We see domestically that we are holding in there on contingents and supplementals domestically.

A flat year would be a good year, we think.

Now if loss ratios continue to improve, maybe there's some upside there.

We are seeing a little bit of a dynamic, and remember, we are doing this right as we speak here.

We're still in the middle of negotiating some of our relationships.

We are seeing a little bit of a dynamic of some carriers pushing to move from a supplemental back into a contingent.

If that would happen, you'd have a little bit of timing where instead of recognizing supplementals in 2014, you'd get it is as a contingent in 2015.

But overall we think that the carriers are seeing the value of what we're providing.

We think that the volume and the loss ratio outcomes that are coming with it.

I think that we're in a stable position to a slightly better position in 2014.

And the carriers are having great years, Bob, so that helps us.

It just seems like we are at the point in the cycle where historically given the profitability is higher, and it's tougher to grow.

They are usually in a position where they are willing to pay a little bit more to get this profitable business.

So I think for giving a combined ratio, contingents and supplementals might be rising for the brokers.

Would you argue with that, or is that a fair point?

I think it's fair point.

Okay.

Thank you.

Thanks, Bob.

Sarah DeWitt, Barclays.

Given your comments that less than 1% of the brokerage organic growth came from pricing and exposure, is there any reason why you shouldn't exceed that 3% hurdle organic growth rate, even if P&C prices flatten or turn slightly negative?

No.

No, no.

I think the question was is we actually sell about 5% more than we lose.

Would we see margin expansion below 3%?

I'm sorry.

There's two questions in there.

We said that we wouldn't see margin expansion below 3%, but can we see organic growth above 3% with flat rate?

The answer is yes.

Yes.

Right, yes.

I was just focusing on the organic.

Okay.

Great.

And what's more important, the economy or P&C pricing for your organic growth?

The economy.

Actually if you go back and look at it, I mean in some of our investor presentations, we plot out what rate increases are versus our organic.

And even in tandem when the rates were dropping 10% to 15%, we were showing organic growth plus or minus breakeven.

So you can see there that the economy does have the ability -- if you go back from, let's say, 2003, 2004 through 2007, even with rate decreases, substantial rate decreases going on in the insurance pricing, we had a robust economy, and we were still growing gangbusters back then.

Okay.

Great.

And then finally, could you elaborate a little more on the carrier outsourcing deal that you won at Gallagher Bassett, and what sort of opportunity do you see that as longer-term?

Well, it's a great arrangement wherein we've essentially taken over a claims organization for an insurance company.

Those people rolled into our employment, and we going forward will be their outsource claim provider, and they will be the capital provider and the underwriter.

I see huge opportunity in this regard.

If you take all the startup capital that has moved itself to Bermuda then wants to come on shore, one of the last things these carriers want to do is build infrastructure.

Right?

So they want to come onboard, and here's the analogy I use.

If you want to get in the trucking business and you're an offshore capital provider, you can do that by coming onshore, getting the licensing you need, etc.

making sure that you've got all the licenses and the rates and what have you, and you can hire an underwriting team and you are in the business.

You don't want to have a bunch of adjusters sitting across 40 states waiting for accidents to happen.

So what we can do is say, look, when you have the accident, dial this 800 number.

Our people are on site as fast as can be.

You have got a very professional adjudication team.

We are all over this thing.

We can manage every component of the claim from the early-onset through the litigation, and you don't have to have infrastructure.

And by the way, we will do it better than you do it if you hire your own claim people, and we'll show you that and prove that with our outcomes.

What's the opportunity there?

Limitless.

Great.

Thanks for the answer.

Arash Soleimani, KBW.

Just had a couple of quick follow-ups.

I know you had mentioned before the joint venture with the reinsurance brokers.

I was just curious what drove the decision to get in at this particular point in time?

It's very simple.

The individual became available.

Yes, that is very simple.

(laughter) And the other question just in terms of the margins, I know we said there was kind of a one-off within the Risk Management.

So just kind of looking forward to the fourth quarter of 2014, is it fair to kind of assume that roughly that 15.8% guidance that was originally in place for the fourth quarter of 2013 should materialize then?

We actually are targeting 16 points for the year.

There might be a little tick up, a little tick below that on a quarter by quarter basis.

But we think we have good line of sight, that our Risk Management segment can post 16 points of adjusted EBITDAC margin for all of 2014, and there might be slight little variances on a quarter by quarter basis.

But I hope we don't have another handful of claims like we have next year.

Oh definitely.

And then finally, in terms of the -- you mentioned in the past that most of the competitors within Brokerage tend to be smaller players.

I guess going forward, you'd mentioned on the conference today again that Gallagher can service clients of any size.

Is there any shift in strategy looking forward the next couple of years to sort of compete more in the larger client space or --?

Well, Arash, let me answer that.

We compete across the full spectrum.

If you look at the insurance industry as a pyramid and at the top of the pyramid is the Fortune 1000, we are represented in that Fortune 1000.

We do a very good job on a number of large accounts that would be brand names that I won't mention on a conference call that we are very proud to have as customers.

As you go down that pyramid to the very bottom with your small personal lines accounts, we play very well in the affinity space, which is very small accounts that are done electronically or by call center or what have you.

So the full spectrum we compete.

There is no shift in strategy.

We want to get stronger in every sector we play in.

If you look at the acquisition activity, to be a business insurance in the United States top 100 broker, number 100 last year did like $22 million in total revenue.

So we believe there's about 18,000 agencies in America.

Some say there is as many as 30,000, but we believe there is about 18,000.

That means there's 17,900 smaller than $20 million in revenue.

We know this because we measure it.

85% of the time when we go out into competition in the field, we are competing with somebody who is smaller than we are.

So we compete 15% of the time with our larger competitors.

No change in strategy.

We continue to focus on each layer of that pyramid, and we want to get bigger and stronger in every category.

And the important thing about that is it matters out in the marketplace.

The bigger we get, as I said in my prepared remarks, we add brainpower to the organization.

That improves our niche capability.

It improves our specialties.

It helps us in the risk management world, and it helps us in the small account world.

And when, again, you go to a business that's as vast as the insurance business is, our growth opportunities in virtually every category are almost limitless.

So, yes, we will continue to compete hard in that upper middle market and into the larger accounts where we see great opportunities to expand through the whole spectrum.

Okay.

Thank you for that answer.

That was very thorough.

Michael Nannizzi, Goldman Sachs.

Thanks.

So I have a couple of questions.

I think you've touched on the benefits business in the past.

I mean could you give us a little bit more color on kind of what's happening there?

Maybe break out a bit more, if you could, on the organic growth, the competitive environment, M&A and kind of how you are building out your strategy in that area?

Thanks.

Sure.

I'd love to tackle that, and if you've got any further questions, I'm happy to have Jim Durkin chime in.

The benefits business, I think we've been fortunate that a number of years ago, we organized ourselves into separating the benefits from the property/casualty arena.

So we've been building a benefits business as a separate organization called Gallagher Benefit Services for the last 20 plus years.

We believed 20 years ago that that was a separate expertise, and I think we've been proved right in that regard.

So today what we find ourselves as is more of a consultant than a broker in that business.

The insurance companies have consolidated down to very few players, and it's not really about going out and getting a cheap price for a client on their benefits business.

It really is about stepping back and looking at what their HR strategy is, what their total pay strategy is, and seeing if we can't help them both design that strategy, as well as implement how benefits fit in that business.

Now that's become extremely complicated.

15 years ago we didn't have a compliance person on staff.

Today we have 25 compliance people.

17 of them are lawyers.

We're not running a law firm.

These are helping our clients with the compliance obligations they have under the law, and that goes all the way back to Orissa and comes through to the pack.

So, it's a very complicated business once you get 200 lives or more in your group, and we're very, very good at that.

Now what that is fueling is heavy acquisition opportunity.

Because if you're smaller broker with a bunch of 200 to 300 to 1000 to 5000 life cases, you can deal with the new law.

It is just that simple.

You think you can.

You start down that road, but you can't.

And so what's happening is that the smarter entrepreneurs that have got great client relationships are joining Gallagher Benefit Services so they can go out to their clients, which is exactly what they should be doing and saying, we really do have the capability to handle all this complicated stuff that you're facing as it relates to benefits.

The organic growth there is about in line to a little bit better than our PC growth, but I think that that will increase as the mandates and as the big complications of the new law become more apparent to our clients.

I think we have a position now in a competitive state where many of our smaller competitors are telling their clients not to worry, we are on top of it.

But when they begin to find out how really complicated this act is, we think that there could be thousands of pages of regs coming out.

I think our organic growth will continue to surpass what we are seeing in other lines.

It's a very exciting time for us.

Our people are working incredibly hard.

Every small accountant is trying to figure out what to do.

Every client is trying to figure out whether they want to use an exchange?

Do they want to go to defined contribution?

Are they going to stay with defined benefits?

Are they going to be self-insured?

Are they going to be fully insured?

What are they going to do?

They can't sort that out themselves.

They need help, and that's a real boon for us.

And would you at some point consider breaking that out so we can see that?

It's obviously a very different business from this year.

If it's more of a consultative capacity, it is certainly a very different business than the brokerage business.

Well, it's really not.

I say that we are more consultative in that, but in all fairness, our property/casualty business is very consultative as well.

You get down into the affinity, and it's a straight price play.

But when you look at what we're doing as a property/casualty broker, it's the same.

So we really do think of them as very similar businesses and spend an awful lot of time trying to make sure we cross-sell those businesses.

I see.

And have you spoken about kind of what the margins, like how big that business is as a percentage of the total and what the sort of margin profile of that business is?

Have you given that information?

Yes, we have.

We're between $500 million and $600 million in revenue.

The margins in that are in the mid- to upper [20s] margin too.

So it performs in line with the broader brokerage business depending on where you measure it.

So we have (inaudible).

Great.

Thanks.

One question I have is on the supplementals and contingents.

What is the margin on those relative to your traditional commissions?

Well, it depends.

We don't actually have it set.

But generally the supplementals and contingents fund a lot of our management, our field management bonus pools and everything.

That's really where they pay.

We don't -- supplementals and contingents are not subject -- in most cases, subject to formulas for the field production tasks.

So it's a higher margin clearly, but most of it -- we've always said 75% -- 70% to 75% of it hits the bottom line, something like that.

Got it.

Okay.

And then lastly, you mentioned talking about a prior comment.

Was it partnering with alternative capital and reinsurance, or was it partnering with new startups on the insurance side of it?

I wasn't totally clear.

No, we started a partnership with Grahame Chilton in the UK, and we're calling the business Capsicum Re.

And it's a reinsurance brokerage operation.

And do you view that as a prototype for potentially doing similar transactions in the US or with Bermudians or potentially?

No, we don't really see that as something we would probably be doing in the United States, but we've done partnership arrangements around the globe before.

We started in Perth, Australia with an equity investment that then went to 100% majority.

We started -- we have a good partnership in the Caribbean with what we think is the strongest broker down there, which we own 80%.

And you might recall a year ago we took a position in our Mexican partner.

So we like that approach around the globe.

Got it.

Great.

Thank you.

Mark Hughes, SunTrust.

Yes, I think you mentioned that this is the best new business start in seven years?

Could you expand on that?

Are you talking about the business in its entirety, and are you taking into account the growth through acquisitions?

No, I was talking about Gallagher Bassett, in particular, Mark.

We just had a really good start to the year.

We haven't put any numbers out there that are not publishing any numbers.

But that's a business that can be lumpy because they are oftentimes dealing with large accounts, and we just -- you typically win less than 50% of what you're working on.

And for January 1, we won a lot more than 50%.

It was a very good start.

Yes, we are seeing -- Mark, we are seeing some really nice receptivity by prospects for some of the enhancements that we're making in our systems and our capabilities.

And I think that there's a good message that's going out that we're outcome based on what they should be.

The outcomes that we produce are better than what they were doing before whether they were the carrier of a different TPA.

And we are being able to demonstrate that better.

So that has translated into some nice new sales for us.

Right.

The underlying claims frequency in the Risk Management business, any change in trend there?

It's up about 1.5% to 2%, Mark.

It's about the same?

Yeah, about the same.

That is an interesting proxy for the economy, by the way.

Right.

And then in the wholesale business, I think you'd said -- you mentioned startups.

Are startups accelerating, and are you seeing any distinction?

Are you seeing small businesses perhaps?

It's all -- what I am talking about, when I make those comments, I am speaking all about small businesses.

Our MGAs in particular do well when strip malls are filling up.

Taverns are starting.

Stuff that the regular market is not going to participate in.

And we need that economic activity to fuel those MGAs, and we're seeing good activity there.

Is it getting better?

Is it accelerating?

Yes, I would say it is accelerating.

Yes.

Okay.

Thank you very much.

Dan Farrell, Sterne Agee.

Just a question on Brokerage margin again.

Once you get past the 3% sort of inflationary pressure on expense that you talked about it, can you remind us how you think about the mix of fixed and variable costs?

I'm just trying to think about in excess of 3%, how much could potentially fall to the bottom line?

Well, listen, it's a complicated question and answer, but here we go.

First and foremost, if you assume same wage workforce inflation that we've had for the last five years, it has basically been not that much.

If you assume that, when you get over 3% organic growth, 60% of that growth should contribute to margin because we paid the producer about 30% of it and we have field management.

Then you get into the volume issues is, is that growth coming because we are just changing the zeros on a policy?

Clearly that's more margin accretive than it is if we are having to go out and compete for new business while we are providing substantial quotes, lots of proposals, and if it's a heavy service load, new client, where there's lots of certificates of insurance, a lot of auto ID cards, then that's not as margin accretive.

So it depends on the nature of that.

If it's just zeros on the policy, assume 60% of that should contribute to the bottom line.

If it's just having -- giving more bid bonds, giving more -- if our construction practice goes on and they are proposing on 1000 projects and we're having to provide the insurance quotes on each of those and only one of them closes, that's not as profitable as it is if we got a contractor that just continues to grow as an existing customer.

So a complicated answer, but by and large, when you get over 3%, this a little bit that can hit the bottom line in total and in this wage environment and this workforce environment at this point.

Okay.

Thanks.

And then on the clean energy, your guidance, I think, range is $63 million to $80 million.

If I was to compare that to your ultimate targets, which combined with royalty income, it looks like it will be more like $110 million annually, how much potential is there going forward to close that gap further, what needs to be done.

And then also can you update us on any update with regard to maybe monetizing your ownership with (inaudible).

All right.

First, as you know, let's work backwards.

Our monetizing (inaudible) we are going through a strategic alternatives process with that.

We put that on hold a little bit towards the end of 2013, but we will pick that up again here in 2014.

In terms of the opportunity to further expand more production out of existing plants, we see that we are constantly trying to optimize the use of existing plants.

We still have six plants that haven't been moved to their final resting places yet.

That activity, there's a good pipeline for that.

We're proposing on it at a lot of locations.

Where would I like to be by the end of 2014?

I would like to have all plants at least permanent installation construction by that time.

I think that's a realistic goal.

So do we have a line of sight of getting to improving off of 2014's range?

Yes, we do.

We think that there is still further opportunity for that.

Remember our objective, however, is to get these all in and then monetize down so that we own between 20% and 40% of the plants.

So we have a portfolio of 34 plants so that vagaries in any one plant, whether it's running today or not running, whether it's down for service or not, it kind of washes out in the diversification across the portfolio of plants.

We do have good line of sight to that.

There is good positive momentum on construction, chemistry, tax accounting.

All of these things, we see there is good momentum in this space.

So 2014 should be another year of ramping up to better position us for 2015.

Great.

Thank you very much.

(Operator Instructions).

John Campbell, Stephens.

Pat, you mentioned in last year's 4Q call that you guys were just seeing some positive momentum just building through, I guess, just increasingly positive audits.

If you can just talk a little bit about how you're seeing that this year versus just last year?

Sure.

I mean I think the financial yin and yang in the businesses that as you are approaching your renewal, carriers want to make sure that their exposure units are quoted appropriately.

And clients want to make sure that they lowball it.

So between the lowball and the end audit, you get back to what's the right number.

So we have seen -- we are in positive audit territory.

We have been for a number of years.

I think we are probably approaching what is more like parity, though, where the actual exposure units that are being placed on the policy at renewal are kind of closer to what they actually should be.

So we are in positive territory, and this is not 20%, 30%.

These are small incremental audits that do give us line of sight into what we've been saying for a number of quarters.

It is an improving economy.

It's not an economy that we see going robust.

We're not seeing, for instance, on the benefits side, any kind of real addition of headcount to our clients employment.

People are doing everything they can to hold back on that, which does translate, however, to a very successful growth with our temporary health firms.

But we are in positive territory.

It's not huge, but the clients' businesses are doing better.

Let me just put it in perspective financially for you.

We're talking in all of 2012, I think our net positive audits were $1 million, and in 2013 it was a similar number.

And then in the depths of the recession, we might have had just net negative audits of $0.5 million to $1 million, something like that.

So it just doesn't swing that much for us as a broker.

Okay.

Great.

And then, Doug, just on new debt, all-in interest expense around $17 million or so a quarter, is that pretty fair?

The blended rate on that $600 million was 4.7% on $600 million, so 4.7% times $600 million is about $14 million a quarter.

On the new debt.

On the new debt, right.

Okay.

Great.

Thanks, guys.

Alex Lopez (multiple speakers).

Oh, no.

I misspoke.

It's $7 million a quarter.

Sorry, guys.

Alex Lopez, Portales Partners.

Just following up on the notion of cross-selling.

What kind of topline opportunities do you see moving forward?

I.e.

how much can this add to your top line?

Well, you know, cross-selling is one of those things that's the Holy Grail, right?

We've studied our books of business across our divisions.

Where we've been exceptionally good is making sure that our wholesaling operation garners the opportunities that our property/casualty division has in the E&S market.

We have now captured 50% of our E&S placements into our own wholesale and risk placement services.

We've probably captured 85% to 90% of the placements that the organization makes in London into our London specialty group.

Where we have great opportunity and we have not had the depth of penetration that I'd like to see is between our property/casualty operation and our employee benefits operation.

We think there's great, great opportunity there.

All-in cross-selling, though, I would say for 2013 between benefits and PC probably contributed about $9 million of total revenue to the Company.

Great.

Thanks.

Congrats on the year.

Thank you very much.

I appreciate the comment.

[Chris Leggett], William Blair.

Just a quick one on acquisition activity.

It seems like it's picking up a little bit in the UK and Europe.

Are you guys seeing anything attractive going on there in the underlying environment or just opportunistic buying for the pipeline?

Well, I think it's two things.

First, on the economy, the UK economy is actually doing pretty well right now.

There's been some nice recovery there on the fundamentals, and so we're seeing that as a nice opportunity.

I also think, though, it's more that the aspect of when we bought Heath Lambert a couple of years ago, it really made a statement that we have a serious interest in the retail presence across the UK.

Before we have been primarily a wholesaler and the London market broker.

So I think it's just we are getting presented with more opportunities.

We think that there's a view now with the Giles acquisition that we have a focus on the retail space that the brokers over there are very keenly aware of what we do here in the United States.

They like our niches, they like our resources, and I think they see there's an opportunity for them moving from a small independent.

Teaming up with Gallagher, it's a great opportunity for it to grow.

So I think we're just getting presented with more opportunities also.

Also, I'd say, Chris, the UK market in the Brokerage space got very overheated a number of years ago.

There were a number of these opportunities that we looked at, and the multiples were off the Richter scale.

And you now have private equity firms that are having to bite the bullet and realize that they've got to exit.

And expectations and pricing has come much more into line with what we're comfortable paying.

And so it's been a great opportunity as one of the people that kept their powder dry to be able to move into that market and actually get reasonable multiples to bring these teams aboard, as Doug said, who are excited to be part of what we're building as a team.

Great.

Are there multiples similar over there to what you sort of quoted for the full year?

Yes.

Okay.

And then just a quick follow-up on the benefits conversation.

Any thoughts from you guys and on the liaison acquisition by Towers Watson?

And are you rethinking your strategic approach to exchanges, and sort of how are you looking at the selling season going into 2014?

No, the liaison acquisition by Towers, we've been very pleased with how Towers has reacted and their commitments to us.

Towers spent a very significant amount of money for that acquisition.

They're not going to buy that business to wreck it.

In fact, we've had very good discussions with them on the fact that they want Gallagher Benefit Services to continue to be clearly one of their strongest partners.

We've had good success with that platform.

We've have about 32,000 employees that are presently signed up to be on that platform.

We see line of sight to probably over 100,000 employees going onto the platform sometime during 2014, and we think it will be a good partnership.

But we've also been very clear, Chris, that this is not our only exchange.

We view the exchanges as platforms and markets.

And our job is to consult with clients as to where the best place for them to place their employees will be, and if that is a state exchange for one client and a liaison for another, that's how we're going to play it.

We are a pure consultant.

Okay.

Great.

That's really helpful.

Thanks a lot.

Thank you, Chris.

Thank you and it appears we have no further questions at this time.

I'd like to turn the floor back over for closing comments.

Great.

Thank you, Brenda.

Again, everyone, thank you for being with us this morning.

We are really pleased with our 2013 results, and you can probably tell by the tenor in the room here we're pretty darn excited about 2014 opportunities.

I think we're building an exceptional franchise that has phenomenal prospects for continued growth.

Consider this one little factoid.

We did our first $400 million of total revenue in 1995, and we grew the enterprise by that much in 2013.

And, as I said earlier, we really believe we're just getting started.

So thanks for being with us this morning.

We appreciate it, and we look forward to talking with you at the end of the first quarter.

Thank you.

This does conclude today's teleconference.

You may disconnect your lines at this time, and thank you for your participation.