Arthur J. Gallagher & Co. (AJG) 2014 Q2 法說會逐字稿

Good morning and welcome to Arthur J. Gallagher and Company's second quarter 2014 earnings conference call.

Participants have been placed on a listen-only mode.

You lines will be live for the 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 and Co.

Mr. Gallagher, you may begin.

Thank you, Christine.

Good morning, everyone, and thank you very much for joining us this morning.

This morning I'm joined, as normal, by Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions.

I'll make some comments on the quarter, add some perspective to our press release, discuss our mergers and acquisitions, discuss the rate environment, and give my thoughts on how I feel about our future.

Then I'll turn it over to Doug to make some comments and we'll go to questions and answers.

I just have to tell you, I could not be more pleased with our second quarter than I am.

It's just unbelievable.

What our team accomplished is just outstanding.

On April 1, we announced our acquisition of Oval in the United Kingdom.

In April, we entered into an agreement to acquire OAMPs and Crombie Lockwood in Australia and New Zealand, and we closed it in June.

We issued a secondary offering and raised just short of $1 billion in April, and we did a $700 million debt offering in June.

And with all that going on, we completed 17 total mergers, including the ones I just mentioned, for almost $500 million in annualized revenue.

We grew our adjusted brokerage revenue 34%, we grew adjusted brokerage EBITDAC 43%, expanded our brokerage margin 190 basis points, grew our risk management revenue 8%, and grew risk management EBITDAC 9%.

Our organic growth in the quarter, all in our operating units, was 4.4%.

Brokerage base commissions and fees were up 3.1%.

Our brokerage supplemental commissions were up organically 9.1%.

Our brokerage contingent commissions, organically up 9.7%, and our list management organic growth was 7.6%.

By all measures, a terrific quarter.

I just could not be prouder of our team.

Let me discuss mergers and acquisitions.

17 mergers completed in the quarter is incredible work by our team.

Remember, in order to get 17 mergers done in a quarter, we have to show these successful entrepreneurs why they'll be more successful after the deal is done with Gallagher than either going it alone or with another strategic partner.

There's competition for these firms, and they chose Gallagher.

I say this every quarter: Welcome to our new partners, and thank you for choosing Arthur J. Gallagher and Company.

Welcome to our growing Gallagher family.

We've been a very active acquirer for 28 years.

We've built our Company by finding compatible firms and proving that one plus one can equal three, four, or even five.

What we have accomplished in the last couple years has truly transformed our Company.

Consider this: We bought Heath to get us started in UK retail.

This lead to Giles, Oval, and other Bolton acquisitions, making us one of the top brokerage firms, with over 70 offices throughout the UK.

We became the largest broker in New Zealand.

We joined the top five in Australia.

We joined the top five in Canada.

We continued our merger and acquisition strategy in the US, maintaining our spot at number three.

And let me say this about the firms that we've acquired: They're all middle-market, niche-focused, producer-centric insurance brokerages right in our sweet spot.

And I'll tell you, once they join our Company, they're like kids in a candy store when they get access to the resources and capabilities that Gallagher brings to them.

We've built a truly global platform with all of our people committed to responding to our clients' and prospects' needs, utilizing our top talent wherever it resides around the world, without any barriers.

Our integration work streams are all on track.

We're winning new accounts, serving our existing client base, and we continue building out our world-class Company.

And the thing that's incredible is that our pipeline for acquisitions remains very, very strong.

Let me move to the property casualty rate environment.

We did a mid-year survey of our property casualty renewals, and you'll read in our release, that it shows about a third are getting increases, about a third are flat in terms of rates, and about a third are getting decreases, but let me peel that back a bit.

First, recognize it's really a tale of two markets, property and casualty, so I'll talk about property first.

20% percent of our clients in the property arena are renewing up, but these are single-digit type increases.

25% are seeing no change in rate, 40% are renewing down, but single-digit type decreases, and about 20% are renewing down with decreases greater than 10%.

And frankly, this is not unreasonable given the fact that we've had no real major catastrophes in the last few years.

As for domestic casualty lines, we're seeing what I consider to be rational count in coverage underwriting.

40% of those clients are renewing up, but these are single-digit type increases.

30% are showing no change in rate, 30% are renewing down, but again, single-digit type increases, and very, very few casualty renewals are getting decreases greater than 10%.

To meet that, we're seeing workers' comp., commercial auto, and professional lines more moving on the upside, general liability and umbrella were flattish to slightly down.

Internationally, as for the UK, we're seeing a similar property rate pressure as in the US, and casualty lines are flat to slightly down.

However, it's important to note that there really wasn't much of a firming market over the last several years in the UK.

So we believe underwriters are beginning to take on a more disciplined underwriting approach, and are asking for some inflation level rate increases.

In Canada, a similar story, but property rates are not as challenged as the US because of a couple of large weather events in the last year.

In Australia and New Zealand, properties off single digits, casualties flat to slightly down, and carriers are not really showing any inclination for price increases.

Remember, this is important.

Over the last three to four years, our results have been influenced by rate and exposure growth by less than 1%.

Our professionals help our clients mitigate costs and they're very, very good at it.

We do not need rate increases to grow this Company.

Give us a flat rate environment, and AJG will sell a lot more business than we lose.

We are a sales machine.

Everyone at Gallagher understands nothing happens till somebody rings the cash register.

I believe today's environment shows continuing discipline on the part of our insurance carriers.

All of our major trading partners have been telling us for years, they want to account-by-account underwrite.

In other words, what they're saying is, if the account deserves a rate cut, give it to them.

But if it needs and increase, get it.

And we are seeing that discipline continue in the market.

I do not feel any lessening of that discipline.

I realize there's rate pressure on [lines] that have produced significant returns to carriers, and frankly that's only fair to our clients.

So I believe this is anything but a soft market.

In fact, it's a great environment for us to grow the business going forward.

Let me talk a little bit about our benefits business.

Our employee benefit brokerage business continues to post some of our best organic growth and margins and also has a robust pipeline for acquisitions.

And we are right in the middle of one of the most complex and constantly changing challenges facing American businesses, which is the new health care act.

This presents us with new opportunities to demonstrate our capabilities to existing clients and prospects.

It's also important to note that medical insurance is just one portion of what we provide to our customers.

We offer solutions to the full spectrum of problems around controlling benefits costs, retaining a competitive and productive workforce, and offering a range of retirement alternatives.

It's just a terrific business for us.

Let me move to our property casualty wholesale operation, which we brand as Risk Placement Services.

As a domestic wholesaler, RPS was impacted significantly in the quarter by the rate environment.

However, we continue to grow our business nicely in the programs and MGA arena.

Our underwriting expertise continues to deliver solid revenue growth and contingent increases.

And finally, I want to talk about our risk management business, which is Gallagher Bassett.

We see excellent growth opportunities around the globe.

In the US, we continue to enhance our base workers compensation product with unmatched loss control analytics.

In the UK, we've tailored our systems and processes, allowing us to move from a strong position with governmental customers to commercial customers.

And in Australia, our development of new IT solutions has positioned us to increase our market share with governmental work care covered programs.

So, by and large, a terrific quarter, operations are getting stronger every quarter, and I want to talk just a little bit about the future.

I think that we are positioned for a terrific close to 2015, barring any change in the economic environment or the rate environment, we should have a solid end of this year, and I think we're well set up for 2015.

Doug?

Thanks, Pat, and good morning, everyone.

It's really nice to report a solid quarter and a solid first half, for that matter.

Let's start on the first page with the brokerage segment.

Our top line, $0.66 per share, was aided nicely by the addition of Crombie/OAMPS, which we closed on June 16.

You'll read at the top of page 4 that it added about $0.06 to EPS, and know that they earn about 60% of their second-quarter earnings in the later half of June.

So that was great work by the team to get it closed fast enough to nearly overcome the $0.07 of dilution that arose in the 60 days between the secondary stock offering in April, and the close on June 16.

That's really good work to the team.

Moving down, you'll see the integration line which is in line with our forecast, and you heard Pat say that our efforts are going very well.

Staying with brokerage, but turning to page 2. The organic revenue table at the bottom.

First, while we continue to believe that transparency into the components of brokerage revenue, that's base, supplemental and contingent, we believe that's important and useful.

Please remember that our mission is to work hard on growing all three.

We encourage our team to get appropriate compensation for our services and not to worry at all about where it gets classified on our financial statement.

Second, underneath the organic numbers, our global retail operations grew nearly 4%, yet our global wholesale operations were about flat.

Within retail, benefits was a touch better than the P&C business, and within wholesale, those operations in particular felt pressure from the property market, as Pat said.

Property renewals are seasonally skewed, somewhat, to the second quarter, so we don't see such a level of headwinds coming into the third and fourth quarter, related to property.

Third, let me add a bit more to Pat's statement that historically the firming rate environment wasn't contributing much to organic.

Basically less than 1% of our organic growth.

You read on the first page of the earnings release that the property rates negatively impacted commissions.

But casualty rates had a positive impact.

Numerically, property pulled down our overall organic by about 80 to 90 basis points, and casualty helped our organic by about 20 to 40 basis points.

So you can see the headwinds there on the property side.

Let's move to the brokerage comp, operating, and adjusted EBITDAC margin tables on page 3. You'll see that we've added in the footnote to each table the impact of the four larger mergers we completed since last year, second quarter.

The punch line is that those four deals, in aggregate, bolstered our margins by about 140 basis points, and we got another 50 basis points of margin expansion from the balance of our operation.

We think that's terrific in this environment.

Now, looking over the next couple of quarters, please know that the four larger deals, and now with the Canadian operation closing on July 2, in aggregate, are seasonally smaller in the third quarter, and will actually produce a drag on overall margins of about 40 basis points.

That flips in the fourth quarter and they'll actually bolster overall margins by 1 point to 1.5 points.

Moving to the brokerage segment non-cash line items for the remainder of 2014.

For amortization, assume about $48 million of expense per quarter.

And for acquisition earnout amortization, assume about $4 million of expense per quarter, and depreciation will run about $14 million in expense per quarter.

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

All right, let me shift now to the risk management segment on page 4. Across the board, a great quarter.

Revenues up 8%, margins nicely above our 16% target.

They're doing well integrating the [Carrier book] and we're still making a lot of client-centric investments at the same time.

Looking towards the third and fourth quarter, please know that we'll give back a little of that margin, because as we have said before, we're holding ourselves to a 16% margin target for the year.

After non-cash items, the risk management segment, just assume about $7 million a quarter for depreciation, and about $1 million a quarter of amortization.

Let me shift to page 5 to the corporate segment.

In aggregate, right in line with the midpoint of the range we gave last quarter.

However, when you look at the separate lines, you'll see that there was a strong quarter from our clean energy investments that covered the additional M&A costs that we spent to close the UK, Australia, New Zealand, and Canadian operations.

Looking forward, as you know we are modeling the corporate segment, we encourage you to use the shortcut table format we provide on page 14 of our investment supplement.

Not a lot of movement since the first quarter, in terms of our guidance looking out for the next two quarters, but as I say, when it comes to clean energy, earnings for the year can be difficult to predict so it does have a wide range.

Please make sure you consider that when you're doing your models.

Finally, some comments on capital management.

With our secondary in April and then the debt raise in June behind us, as we look out towards the end of 2015, we would like to have our net debt to EBITDAC ratio back down into the low two exposition.

That said, our free cash flows, the durable [off the shelf] we have, our line of credit, and the ability to use stock and tuck-in acquisitions, we're still well-positioned to continue our smaller tuck-in M&A program for the rest of this year and well into next year.

And, as you heard Pat say, our pipeline's full, so we won't have any problem keeping busy.

So, [when you] step back and take a look at it from the CFO's chair, we're doing really well organically.

Carriers are rationally pricing on an account and line of cover basis.

The economy is moving forward.

We're working hard on integrating the larger M&A operations and having success there.

We're still closing a lot of smaller tuck-in acquisitions, and we have a lot of exciting operational improvement in productivity initiatives going on.

And our culture is thriving.

So, for me, simply put, I think the team is delivering on all fronts.

Back to you, Pat.

Thank you, Doug.

As Doug said, I think we're hitting on all cylinders, and with that, Christine, we'll go to questions and answers.

Thank you.

The call is now open for questions.

(Operator instructions)

Sean Dargan, Macquarie.

Yes thanks.

Doug I guess, first, thanks for breaking out the impact of raising equity early in the quarter and not really layering the earnings until the end.

But I'm just wondering what your thought process was around pulling the trigger at that point on the equity raise?

Simply that we committed to do that with less farmers on the deal.

Since we committed to do an all cash deal with them.

And frankly, we just didn't want to get caught between the boat and the dock, having a large equity rate sitting out there for 60 days waiting to get done.

So we sat down with our advisors and they thought it was a good time to go.

Wasn't the best time in the market, given the financial sector that week, but I was really happy to get it done and get it behind us.

Great, thanks.

And what's your view on using the after market option that you have available to you?

And what factors into using that to, I guess, fund further acquisitions?

Well first of all, as you mentioned, it's not very much.

It's only, what we have left on it, is $196 million, so it's not like it's that big of a shelf sitting there.

Typically, if we have, in the international deals, it's a little bit more difficult to use our stock and acquisitions, if we choose to do that.

So we'd probably use the dribble out, if it comes up, in order to do smaller, tuck-in international deals where they aren't necessarily positioned well to take our stock in the deal.

But it's there just as a liquidity measure.

Thank you very much.

Thanks Sean.

Adam Klauber, William Blair.

Thanks.

Good morning guys, good quarter.

Thanks Adam.

It was a great quarter.

(laughter) Sorry, Pat.

A couple different questions.

How was organic outside of the US?

Internationally, Adam, organic is-- last year at this time, we were running about 10% organic, if you go back and listen to it.

But it's basically running about the same as our domestic operations right now.

And, if I were going to look for any particular soft spot in international, I would say that our very small affinity programs, we had kind of a gang buster quarter last year on it.

It didn't produce quite as much as we retool some product there, but by and large, we're having some nice large account wins there.

But, if I were going to try to break it apart, that's where it would be.

Okay.

And you mentioned that RPS clearly does a lot of property cat.

Did that have an impact on organic coming down this year compared to last year?

Absolutely.

In my prepared remarks, that's why I mentioned it.

Our biggest quarter for property placements is the second quarter.

And property is one of our largest lines in the quarter, and it was impacted by probably over 10% reductions.

Yes.

That's the one that caught us just a little bit flat.

If I were going to go back and look at our expectations, just the slide in the property market and how it impacted.

To put our overall down 80 to 90 basis points of organic, I guess looking on the bright side, the casualty rate still being up mitigated some of that overall.

But that's the one that I probably wouldn't have been able to predict that six months ago.

To put this in perspective Adam, we're the largest placer of excess and surplus property risks in the state of Florida.

Right, yes.

RPS is one of the biggest property players out they're very-- extremely good.

And by the way, this is completely appropriate for our clients.

There's no angst about this.

They deserve a decrease.

They paid up big time after the last catastrophe, and this is what the market should do.

Yes, again, it's normal up and down.

What was, looking at Noraxis and Wesfarmers, clearly they're not included in organic, but how are those organizations doing on an organic basis?

New Zealand's is doing terrific, Australia is hanging in there, kind of flattish from what I can tell.

The measurement's a little different, because as we pull those companies out of where they were before.

And Canada's on fire.

We think that there's good results up in Canada.

Great.

And one more question on Wesfarmers Noraxis in particular.

Both good sized organizations out of the US.

How are you changing your management structure?

How are you staying on top of those organizations?

First of all Adam, the detailed level of integration process management that we have is really unbelievable.

It's like being in a construction truck on a job site.

We know every single item that is supposed to occur every single month.

Whether it be a lease renewal or whether it be some account that should be transferred from a different London brokerage into our London operation.

And those work streams are laid out way in advance.

These organizations, remember, they're very similar to what we've been building here in the United States.

We've got terrific leadership that has been doing acquisitions of bolt-on acquisitions over the last decade.

So I said in my prepared remarks, these are niche-focused, producer-centric organizations that look and feel just like us.

And they fold into our organization nicely.

In terms of how we manage them, they report into our structure through our international business that is headed by my brother, Tom Gallagher, and by our CEO in the UK, David Ross, and we fold them in and move on just like we've done for the last [30] years.

Adam, also on the back-office side, as you know, there's strong reporting as we manage that mostly what I would say, the non production layer.

There's strong reporting lines between the CFOs and me, the IT folks and Eric Dean, our global IT leader.

So when you look at it, there's the production side of leadership, and then the local management leadership, they're responsible for everything.

Reporting in, everybody reports into their, kind of, functional leader, also.

So just illustratively, for the first 60 days, I had a call almost every day with the CFO of Australia, highly confident for those that might have met her on that secondary road show.

Just a terrific CFO, illustratively.

Okay that's very helpful thanks.

Thanks Adam.

Sarah DeWitt, Barclays.

Hello good morning.

Good morning.

On the three big deals that you've done this year, could you give us an update on how the integration is going?

Are you on track to achieve the synergies and could there be any upside there?

Well let me hit the integration side of it and I'll use, as an illustration, Bollinger.

We bought Bollinger less than a year ago, they're up completely on our agency management systems.

All of their centralized payables have been moved into our operations already.

All the carrier payables have been moved into our central core.

We've got a ton of their real estate consolidated, the teams are working together.

And the last thing that really needs to go up is just the phone system to go up on our voice-over IP system.

It's pretty well up, but we've some tweaking to do on it.

Clearly, none of these things happen without a lot of hard work and I just want to maybe, with this opportunity to talk, please understand that we've got professionals around the globe that their sole job is to integrate acquisitions.

They've got the integration experience, they're assigned full-time to the process, and also, because we're a company that has done so many acquisitions, almost all of our systems are built-- that's not only systems, but also processes-- are built to plug in new partners and new organizations into our systems.

So it's not like we have, I'm going to use this word, closed architecture, that isn't receptive at all for new partners.

So, basically you can plug and play the new operations.

Bollinger, illustratively, is going very well.

Similar stories with Giles and Oval in the UK.

But remember, in Canada and Australia too, but we're basically using their system.

We don't have overlap really to really any degree in New Zealand, Australia, and Canada.

So we're basically going to be using their system, so there's not a lot of integration that goes along with it.

Let me take the ball on that one a little bit, Sarah, on a different angle.

What I look at is selling and holding onto clients.

Right?

So, what I am really pleased about is with Noraxis in Canada as an example, we've already got people and resources from the US in areas like mining and natural resources, working together with our new offices in places like Nova Scotia, working on clients.

That is exciting.

We're already writing new business throughout Australia, on areas that-- in places that we didn't have an opportunity before, but with our capabilities now, our people are out calling on clients saying this is a whole new world.

That's what is the bellwether to me.

Are we holding onto clients, are we selling more new business?

And if that's the case, that generates excitement, and in all three cases, the UK, Canada, Australia, New Zealand, very, very good energy.

And financially, there's nothing that makes me think that we won't see our expectations be realized on these, financially.

I think they're delivering to our earlier measures, there's still lots of synergies, and frankly, as we start working more and more with them, we see tremendous opportunities.

If you look in the press release to the operating expense table, actually we put a footnote in there.

The fact that these larger deals run kind of higher operating expenses than what we do.

That's a great opportunity for us, to go in there.

Doesn't really impact the people that are doing the business, we'll just be able to procure goods and services better, we'll be able to use our offshore centers of excellence better.

We'll be able to-- our volume purchasing will help.

So, I see it as a great opportunity to realize our synergies.

Great, that's a great answer.

And then secondly, on the insurance brokerage organic growth, I know you said if prices were flat you could still grow organically.

But if we were to look out a year and prices were down mid-single digits, is that still an environment where you think you can grow organically and expand margins?

Absolutely.

Again, in my prepared remarks and Doug's remarks, we mention the fact that even with rate increases, in some instances, up 5% or 6% over the last three years, the impact on our results has been less than 1%.

So our people do a good job of helping our clients renew coverages at costs that are less than what's being requested.

And that's by changing deductibles, changing structure, et cetera.

So, if the market is flattish to down single-digits, we'll do great.

Remember, some of our clients are still not buying to a recommended level of exposure cover.

There's a lot of them that, during the great recession, opted out of coverage that they're going to take the risk on.

We still see lots of opportunity for our clients to-- If there's a slight rate decrease, let's reduce the deductible a little bit, let's increase the top end.

Maybe you think about buying another line or two that you opted out on.

So that's what our guys are doing everyday.

Is your insurance program matching to your risk appetite and in decreasing prices, people tend to buy a little bit more insurance.

Which kind of knocks the downside off of that a little bit.

So, we see good opportunity for it in this up two, down two, up three, down three type environment.

Okay, great.

Thanks for the answers.

Thanks Sarah.

Mark Hughes, SunTrust.

Thank you.

Pat, that was a fabulous quarter.

Congratulations.

Mark, good start.

(laughter)

Would it be possible to share the rough percentages of property, the revenue from property, in 2Q versus what you would see on a full-year basis, just so we get a better sense of that seasonality?

Yes I think that property, if I looked at it in our brokerage business, let me get my sheet here.

We'll stick with wholesaling, that in the second quarter, wholesaling really, [50%] of their property placement, as a percentage of the revenue coming in the second quarter and you are down into the 30% or 40% range in terms of their mix.

When you look at overall, you're seeing kind of 30% to 35% as a mix of business in the second quarter, but the rest of the year, property comprises maybe 20%.

So, depending on which business, but overall for us, the mix of business is maybe 30% of our business in the second quarter, and then 20% for the remainder or for the other quarters during the year.

And then, revenue seasonality within the acquired businesses, I'll ask that question and then I'll also ask, under the circumstances, any just general commentary about the 3Q EPS?

If you did roughly $0.80 this quarter, how should we think about the Q3?

You've given us some ideas on the margins, and that's appreciated, but just given the magnitude of the movement in the business this quarter, how should we think about the Q3 relative to the number that you just put up?

Well listen, we've always shied away from providing any EPS discussion with respect to our brokerage and risk management segment.

So, I hate to say to you Mark, I'd would rather not do that.

In terms of how we see seasonality with respect to the bigger deals, like I said in my comments, we see maybe a 40 basis point drag on margins in the third quarter, because of the lower seasonality of the big four, actually the five acquisitions that will be in our numbers in the third quarter this year.

Then in the fourth quarter, we see that to be 1 point to 1.5 points up.

And then when you get out to next first-quarter, they have an impact of greater than 150 basis points margin expansion.

So, I'd rather not comment on EPS, but there is seasonality in those larger deals and I think if you run it through your models, I think you will get to a pretty close answer.

Okay, thank you.

Thanks Mark.

John Campbell, Stephens.

Hey Pat and Doug, good morning.

Good morning Jeff.

Great quarter.

Thank you.

So, good risk management results, I'd say particularly in the margin line.

So, first, what's driving that near 17% EBITDAC margin?

And then Doug, I know you guys said you're still targeting the 16% for the year, the which does imply a little bit of fading over the back half of the year.

So just fill us in on some of the investment opportunities and risk and then, maybe, just assuming greater scale, and maybe even tapering investments, what you guys see as peak margins longer-term?

I think that business longer term, we like 16 points to 17 points of margin in the near term.

So we think we are at kind of full margin on that business.

Again, to expand margin in that business, you really need at least 5% to 6% organic growth to expand.

It's not quite as leveraged as it is on the brokerage side, where we say you need 3% or more in order to expand margin.

The back half of the year, purely it's the amount of investment that we want to make in modernizing our product offering, enhancing our quality, improving our productivity, and then adding product lines and services to customers.

So the reason why we're above 16 points this margin is the team held off a little bit in making those investments until we see the organic showing up and it did at 7.6%.

So the rest of the year we'd like them to get back into continuing to make some product enhancements.

We're getting ready to roll out a new analytics workbench here, the version 3 of that, here in the third quarter.

So this is just product enhancement, product improvement.

Client service enhancement.

And we see ourselves in that mode into 2014 and 2015.

A little too early to talk about 2016, but that's where we see ourselves.

And John, let me comment.

These are world-class margins in that business.

And there's heavy investments in IT and people.

When you bring on a client, a large commercial client or a large insurance company, you better have the people at the desk because the claims are coming, trust me.

Got it.

Thanks for that color, guys.

And then just from a housekeeping item, it looks like that international acquired route, the flow-through is driving the brokerage tax rate down.

And I might have missed this from earlier from you Doug, but, just curious about how to think about that brokerage tax rate, going forward, after we assume the annualized impact from the recent international deals?

By the time you roll on the lower tax jurisdictions of Canada, get the full impact of the UK with Oval, and the lower tax rate, again, with Australia, you could see that move another point lower in the near-term.

Got it.

Thanks guys.

Thanks.

Dan Farrell, Sterne Agee.

Hello, good morning.

Good morning.

There's been a lot of focus on the large deals, but while you've done these, you've also been very active in the smaller transactions and I was wondering if you could just talk about the current environment and pricing that you're seeing on those smaller deals.

Look me talk about the environment and then I'll let Doug talk about the pricing.

The environment for doing acquisitions just continues to be incredibly strong.

We see globally is, there are literally thousands and thousands of smaller agents and brokers around the world.

Most of these agencies and brokerage's are run by baby-boomers.

It's clearly their largest asset.

And at some point in time, they've got to monetize their life's work.

And so the pipeline just regenerates itself, literally, month after month with people that are considering -- and some of these things take years to get done.

I mean, some will move in a couple months.

But others will be sort of kicking the tires, looking at whether they want to do it, discussing it with you for, literally, years.

And we just are constantly going through the process of looking for, number one, people that know how to run a good business.

We constantly say, if you don't make money for yourself and your family, you won't make money for us.

But if you run a good business, if you are really good at clients and have a culture that fits-- Another thing people say is, how can you put on 17 acquisitions in a quarter and change their cultures?

We don't.

If the culture doesn't fit us-- 99% of our due diligence, once we get over the fact that they make money, is all about whether the culture mach is going to be right.

And once we get that set, we can literally show how one plus one can equal a lot more than two.

So I think it's an interesting business situation right now on a global basis.

Our opportunities are literally, just every single month, the list just gets longer and longer of people we're talking to.

I'll let Doug talk about the pricing.

Dan, I think that's a good question, we did 14 deals in the quarter for $55 million of revenue, that stacks up to about $4 million of revenue per shop.

Just terrific sales folks that joined us.

We're paying about seven times for that, in terms of the pricing.

Do I see that moving higher?

Not on the smaller deals.

I think that's a pretty fair price for what we're paying right now.

Over the longer time, we've kind of always been in the 6 to 7 times EBITDA range, so we see that holding in there.

Some of the larger platforms, if they're large geographical folks, maybe we'll pay a little bit more than that.

But right in line with what our expectation, nice asset deals where we get to amortize the purchase price that brings our tax rate down on those.

So I don't see much of a different environment.

I look at the deal sheet, there's hundreds and hundreds of those folks on there.

So I see lots of opportunity to continue to do that.

And, the teams are working on it every day.

Okay, thank you very much.

Thanks Dan.

(Operator instructions)

Meyer Shields, KBW.

Thanks, good morning guys.

Good morning.

When you talked in the past about how 2% organic growth is generally enough to produce margin expansion.

Is that the right sort of threshold for the international deals as well?

Great question.

I think so.

I think that in most of the environments in which we're operating there, if you take out, perhaps, Toronto and Sydney, the operating areas, I think, have enough low cost environment, that I think growth of 3% or more shows some margin expansion opportunities.

That said, please realize that New Zealand runs terrific margins, Canada already runs terrific margins, Australia, there's opportunity there, that's where we see the opportunity to grow margin there.

And then, most of the place that we see margin opportunity is because of having more volume, so more premiums that we're writing that we can negotiate better compensation arrangements.

Then also on the operating side, I think there's opportunities in real estate consumables, and co-sharing of IT systems, et cetera.

So that's really where we see the margin opportunities, in the operating expense line more than in the compensation line.

Okay fantastic.

When you look at the major deals you have done over the last year, year and a bit, are you keeping all of the people that you want?

Absolutely.

Yes we have only had good retention there.

I have to tell Meyer, when we've been able to buy people from a private equity concern, five years ago I would have said we didn't really want to do that.

I was wrong.

When they get aboard a brokerage run by brokers, they like it.

Okay fantastic.

Glad to hear it

Kai Pan, Morgan Stanley.

Good morning.

Good morning.

Just for the underlying margin expansion for the quarter, you said about 40 basis points?

50 basis points from the-- 190 in total, 50 that came from the underlying business, 140 from the four big deals.

Okay.

So just on the sort of 50 basis points underlying margin expansion, given that you-- sort of, that was produced by only 3.4% organic growth.

So just wonder, if you maintain 3% or 4% organic growth, do expect to see 50 basis margin expansion going forward?

Maybe.

But I think that what fueled some of our margin expansion this quarter was increased contingents and supplement's that have a little bit better impact to the bottom lines.

But the big question is what's happening with inflation, so I'm not dodging the question, I just don't know.

Right now wage inflation seems to be under control.

We still have productivity opportunities that we can use productivity lifts to pay for raises that our folks deserve.

We still have opportunities on real estate and consumables.

IT systems are getting-- there's more demand for IT systems.

So I can't guarantee if it's not above 3% that we're going to have margin expansion.

Great.

Then, on the acquisition front, you did like four big deals in a very short amount time.

Is it time to take a pause, step back, and to focus on integration and running your core business?

Or are you still constantly on the lookout, I mean, for the larger deals?

Secondly, it looks like you have [planting your flags] around all of the major English-speaking markets.

So I just wonder, do have any appetite outside, the-- in other markets as well?

Let me answer that, Kai, first of all, yes.

It's time for us to digest and focus on integration.

We're doing that every single day.

So when I talked in my prepared remarks about work streams, we're on top of what's going on in every office, 70 offices around the UK, 50 offices in Australia and New Zealand.

A bunch of new offices in Canada.

We're looking at that every single day, and yes, it's time to digest a bit and we're not looking at any substantial new large deals as we speak.

Having said that, we open to doing acquisitions?

Absolutely.

Especially our bolt-on acquisitions around the world.

One of the reasons we're excited about what we did in Australia is even with the size that we've accomplished in Australia, we'll have less than 5% market share.

Terrific opportunity to do bolt-on acquisitions and we'll continue to do that in Australia, UK, America, and Canada.

Those bolt-ons will be, as Doug said, on the smaller side.

As it relates to non-English speaking territories, you'll recall we took a 21% interest in our Mexican trading partner, Grupo CP, we've opened a small operation in Chile, we'll continue to invest in Latin America and we look to continue to expand our global footprint.

We're a global company, over 27% of our revenue and 27% of our people are now outside the United States, and we see that as a great expansion opportunity.

Yes I think to dimension it size-wise, too, just so that we're saying, we think it's really important to put our toe in the water in some of these other countries.

We did that in the Caribbean initially, with a small deal.

We did it in Perth, Australia with a small deal.

That leads to other opportunities.

Plunging into non-English speaking countries in a large way right now is not in our strategic plan.

Putting our toe in there with a nice $4 million to $5 million agency there, so we can learn the country, learn the business, get some smarts on the ground there.

I think that's a nice step over the next couple of years.

In the US, when we talk about smaller deals, remember, there are some nice $75 million to $100 million transactions or brokers out there that we think might be coming to market.

We would definitely take a look at those.

We don't see $500 million deals out there or $1 billion deals out there that are really percolating around.

So when we look at this, you have to think of us not doing something greater than $100 million in purchase price.

But there's a lot of really $50 million, $60 million shops out there that are looking to join Gallagher's, so we'll continue to look at those.

Remember though, if you take a look at this month's business insurance, if you look at the US top 100, to be number 100, in terms of an agency in the United States, you've got to be $23 million in revenue.

So, couple that with the fact that we believe there's something like 20,000 agencies in America.

So that is consistent around the globe as well.

Thank you so much and good luck.

Thank you, Kai.

We make our luck.

Charles Sebaski, BMO capital markets.

Good morning.

Things for getting me in.

Thanks Charles.

Wanted to know, just a follow-up there on the acquisitions.

On the benefits side versus the broker side.

And how you see that queuing up.

That's a great question.

Thank you for asking that.

The benefits business right now.

Let me speak to first, domestically in the United States.

The new PPACA law, basically in my opinion, puts small benefits brokers out of businesses.

We have 26 people in our compliance department here in Itasca supporting our US business, and 20 of them are attorneys.

If you think about the compliance issues for anyone with 100 employees or more, and that's huge number of employers in the United States, they cannot contend with this law.

And their brokers and agents can't help them.

And they're figuring that out.

So our pipeline as it relates to smart consulting and broking firms in the United states that realize they need our capabilities is extensive.

And we are clicking off literally an acquisition almost per week when it comes to benefits.

And these are great firms with great clients who know that they need the capabilities that we have to be able to serve those clients.

Those that aren't recognizing that will die.

They'll be done in the next decade.

So what an opportunity for us.

Internationally, the opportunity to expand our consulting as it relates to benefits in the UK, in Canada, in Australia, New Zealand, those are territories for us that are just wide open and I think we offer a great complement to people who would consider joining us in those regions.

And we've been very successful.

We had a very nice acquisition closed in the UK this quarter and we're very excited about that.

Those are capabilities that will actually help us in the US.

It's a great business for us.

It's our next multi billion dollar business, in my opinion, and we provide a great home for those professionals that want to join us.

Do those international consultant benefits businesses have a similar margin profile to your current business?

Or is it different in any way?

It's very similar.

Okay.

And I wonder if you have any color in how the cross-selling has been working between, I would especially say in the US as you talked about, these 100 person firms and getting benefits leading to brokerage or vice versa.

Any additional insight on that?

Another good question Charles.

That's an area that we focus on intensely and it's significantly improving quarter by quarter.

And the opportunity is unbelievable.

If you take a look at our property casualty brokerage operation in the US, and our benefits operation, about 90% of those businesses are not cross sold.

And both operations are up on salesforce.com and we are looking at that every single week and the opportunities are huge.

I appreciate the answers.

Thanks Charles.

Mike Nannizzi, Goldman Sachs.

Hello, thanks.

Most of my question was answered, but I've one question, just in thinking about M&A, can you talk about how your tax credit factors into M&A decisions?

And sort of, how scalable those benefits are, to the extent that you are able to grow EBITDA through acquisitions?

Thanks.

Yes, I think that the ability to repatriate money from overseas in order to bring it into the US and then not pay the US tax on it, there's opportunity there.

We did that with the Canadian deal and we did it with the Australian deal and it brings our multiple down on what we pay by about one turn.

So we think there opportunities.

In the US, obviously generating more US taxable income, there's opportunities to use more of our tax credits to do that.

We're running up towards $100 million of earnings a year off of that business right now.

We think there's still some more opportunities to move that higher.

But you know, I think after about 2015 or 2016, it will kind of be at terminal velocity there.

So we see it as an opportunity, but would we still have done the Australian and Canadian deals with out them?

Absolutely.

The multiple we paid still was a fair multiple.

This was a little bit icing on the cake.

We try not to ever do a deal-- would never do a deal just because we can use more tax credits.

You've got to get the right deal.

But frankly, the ability to grow our US taxable income and use more of our tax credits is an opportunity for us over the next seven years.

Remember, these programs run out in 2021, and we can produce enough credits maybe to get us to 2023 or 2024.

But by and large, it's a nice cash generator to fund these acquisitions for this next six or seven years.

But we don't do a deal just because of the credits.

That's fair.

Great thank you.

Thanks Mike.

Mark Hughes, SunTrust.

Yes, thank you.

Any updated thoughts on the exchange opportunity?

Is any business changing hands because of the exchanges, either for you or competitors?

Mark that's a great question.

Let me handle that.

We take a very strong position on this which is, A: We do have a private insurance exchange that we've helped start in partnership with Liazon, and we offer that as one of the many things that we'll do for clients.

But we look at exchanges as just more of the same, frankly.

Our entire history is going into clients' offices and helping them sort through what they should do with their risk and what they should do with their benefits.

And these are new opportunities to move to-- new contribution approaches, as opposed to defined benefits of defined contribution approach.

And there are lots of different exchanges.

So really what it does, is it provides some confusion to our clients.

It's difficult for our clients to sort through all these options on their own.

And so it's just more of the same when it comes to sitting down with clients and helping them sort through what should they do with their benefits.

Remember, it's not just the health insurance spend that clients are dealing with.

Probably in most businesses, compensation and benefits is one of their leading largest expenses, right?

And benefits is part of that.

So what we're helping our clients sort through is what they do about their workforce.

What's the strategic approach to keeping their people and making sure that they're giving them the benefits package that's competitive.

That includes health insurance and may include an exchange and it may not.

And that just makes for more work for us.

Thank you.

Mr. Gallagher we have no further questions at this time.

I would now like to turn the floor back over to you for closing comments.

Thank you Christine.

I just have one very brief thing to say, and that is, thank you again everyone for joining us this morning.

I already said this, but I think it bears repeating.

I could not be prouder of what our team continues to deliver, first to our clients and then secondly to our shareholders.

The thing that's kind of fun about being in my seat is that, while I'm pleased with the quarter, I'm incredibly confident that this franchise is just getting started.

So thank you for being with us this morning.

We look forward to talking to in a quarter.

This concludes today's conference call.

You may disconnect your lines at this time.

Thank you for your participation and have a wonderful day.