Arthur J. Gallagher & Co. (AJG) 2014 Q3 法說會逐字稿

Good morning, and welcome to Arthur J. Gallagher company's third-quarter 2014 earnings conference call. (Operator Instructions).

Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. 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, Robert. Good morning, everyone, and thank you very much for joining us this morning for our conference call. We appreciate you being on the line. This morning I am joined by Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions. This morning, as is our custom, I will add some color to our quarter, discuss our merger activity, discuss each of our operating divisions and then turn the floor over to Doug for some comments. And then we'll get to questions and answers.

It is really unbelievable, another record quarter for Gallagher. Our combined brokerage and risk management businesses, which we look at as our core businesses, our adjusted revenues are up 38%. All in, organic growth was 7.1%, adjusted EBITDAC is up 43%, adjusted margins are up 80 basis points, and our adjusted EPS is up 15%. All in all, just a terrific quarter. I could not be any prouder of our team.

Let me discuss, first of all, mergers and acquisitions. As you know, over the last 18 months we have closed five large acquisitions: Bollinger, Giles, Oval, Wesfarmer's, and Noraxis. These are all onboarding well, with growth opportunities showing themselves almost every single day. But realize our strategy of acquiring our typical entrepreneurial firms continues nicely.

In the quarter, we closed 18 tuck-in mergers, bringing aboard $63 million of annualized revenue, or an average revenue size of $3.5 million per merger. And our pipeline remains incredibly strong.

All of these firms had choices. It is a very competitive merger and acquisition marketplace today. So I want to welcome our new partners and thank them for their vote of confidence. Together, we will continue building our Company.

Let me move to the brokerage segment results and some commentary about the brokerage segment. First of all, the results. Adjusted revenues up 45%. All-in organic, up 5.8%. Adjusted EBITDAC, up 46%. Adjusted margins, up 24 basis points, but remember, and we talked about this last quarter, they were up 90 basis points excluding the seasonal impact of our larger acquisitions. And adjusted EPS is up 18%.

Within the segment, our retail property-casualty business in the United States continues to operate in what I would call flattish environment. Our team is just back from the CIAB meeting in Colorado Springs. That is the Council of Insurance Agents and Brokers, wherein over 20 meetings with markets we continue to hear CEOs talk about disciplined underwriting. As one CEO said, if the account deserves a reduction, I want my team to give it to them. But if the account needs an increase, we better be getting it.

That is exactly what we are seeing on the street. All carriers are keenly aware that with investment yields very low and loss costs inflating, a flat renewal is actually a decrease. This is the fourth year of a market base that is either slightly up or slightly down depending on the account. We're not in a traditional soft market nor are we in a traditional hard market, but rather a stable market. My meetings lead me to believe that the carriers will carry this forward, this discipline into 2015 and possibly even longer. And, frankly, that is a great market for the brokerage industry, and I think it is a great market for our clients.

Our international brokerage business is doing quite well. In the UK, just this week, we rebranded all of our retail offices. No longer are we trading as Gallagher Heath, Giles, or Oval. All our retail branches will trade as Arthur J. Gallagher, a move that I believe will clearly demonstrate that we are come together as one strong Company to better serve our existing clients and to produce strong new business results.

Our benefits brokerage and consulting business in the United States continues to assist our clients with the myriad compliance issues brought about by the new healthcare law. Our private-label exchange, which we call the Gallagher Marketplace, is gaining real traction. I believe we will see significant growth in the exchange in 2015 and beyond. And our merger and acquisition opportunities in the benefits business both in the United States and globally are outstanding.

And finally in this segment, our wholesale brokerage business in the US, Risk Placement Services, had a great quarter. The rate challenges that we faced in second quarter were not as pronounced in the third.

Let me turn to our risk management segment, Gallagher Bassett, which also had an outstanding quarter. Revenue up 12%, all of which is organic. Adjusted EBITDAC is up 19%, and adjusted margins up 96 basis points. GB is seeing strong new business wins domestically and internationally. These are comprised of large self-insured accounts and insurance companies outsourcing their claims work. We continue to make investments in systems around the globe as well as service enhancements with one goal in mind, and that is better claim outcomes for our clients.

So all of our operating divisions contributed to our outstanding quarter. And to top it off, our clean energy investments are on track to top $100 million of earnings this year. All in all, just a fantastic quarter.

All of us get up every day and focus on four things: number one, organic growth; number two, mergers and acquisitions; number three, productivity and enhanced quality for our clients; and number four, maintaining the unique Gallagher culture. I can say in each of these four areas we truly excelled in the third quarter. Doug?

Thanks, Pat, and good morning, everyone. For my comments today, I am not going to repeat each number in the earnings release, but I will say it is very nice to have an outstanding quarter on every single measure. Here are some other items for you to consider as you review our results and work on your models.

All right, on page 1, you heard Pat say integration is going as planned and going well. We had $0.08 of charges this quarter. Looking forward, we expect $0.08 of cost integration costs in the third quarter and then about a nickel in each quarter of 2015.

On page 2, to the organic revenue table at the bottom. I have four comments on that. First, you'll see that we had an excellent quarter on all three components: base, supplementals, and contingents. Please understand that we coach our field to understand the importance of getting appropriate compensation for our services, and to us it doesn't matter where it gets classified in the financial statements.

Second, you will see that we have added a footnote explaining that we had a great quarter in terms of net, larger account wins. But note, even without this perfect storm, or maybe what I should say a perfect sunshine, our base organic growth would be about 4%, and overall brokerage organic would be about 5%. Either way, an awesome job by the team this quarter.

Third, the impact of rate was slightly negative but less than a percentage point this quarter, which is very similar to the last two quarters. So like Pat said, we are in a stable, rational rate environment which is very healthy for our customers, the carriers and the brokers.

And finally, breaking down the 5.8% brokerage organic growth, domestic was just shy of 5% and international was a bit above 8%.

Now let's look to page 3 to the brokerage adjusted EBITDAC margin near the bottom of the page. Adjusted margins are up 24 basis points on the face, but really we are up about 90 basis points when adjusting for the margin compression due to the seasonality inherent in our larger mergers and that we had forecasted in last quarter's conference call. So being up 90 basis points without the seasonality is really excellent work by the team.

Looking towards the fourth quarter, it looks the other way. The larger merger's seasonality bolsters overall margins by about 102 to 150 basis points. Also, let me give you some non-cash estimates for the fourth quarter for the brokerage segment.

In your models for amortization, assume about $55 million a quarter; for acquisition earn-out amortization, assume about $5 million; and for depreciation, assume about $15 million. Then you will also need to adjust your models as we do more M&A. A good rule of thumb is for every dollar we spend, you will need to increase the amortization expense by about 1% of the purchase price per quarter, and that should get you pretty close.

Before we leave brokerage, let me hit one other item that is causing some questions. Please turn to page 9 of the earnings release. This quarter, you will see $19.1 million in the revenue line called investment income and gains realized on book sales. Let me break that line down for you.

In there, there is $900,000, which is true book gains from sales of books of business. And you can see that when you adjust that out on page 1, like we always do. Next, there's $5 million in that line from investment income on our premium float. It is up about $2.5 million from third-quarter 2013, mainly due to the float we now have in Australia and New Zealand, which have much higher short-term investment yields. And finally, there's about $13 million from investment in -- from interest income and fees where laid to the premium financing business that is part of the Crombie/OAMPS brokerage operations.

What you can't see is about $10 million of costs classified in compensation and operating expense lines down below, which is what we spend to operate the premium financing business. So on a net basis, the premium financing business makes about $3 million a quarter.

As you look forward, the book gains are not really recurring, and that is why we adjust for those. But interest income on the premium float and the net earnings from the premium financing operations is part and parcel to our brokerage business in Australia and New Zealand.

All right, let's turn back to page 4 of the earnings release to the risk management segment. Really, an excellent quarter across the board. Breaking down the organic, our domestic operations grew near 10% and internationally near 20%. So good performance in both areas.

Looking at the fourth quarter, we don't see an organic quarter quite as strong as the third quarter, more in the 5% to 8% range. And we intend on making some more client-centric investments, so we are targeting a fourth-quarter margin of about 16% for the risk management segment in the fourth quarter.

Let's shift to page 5 to the corporate segment. In aggregate, you will see us right in line with the midpoint of the range we gave last quarter, with a slightly stronger quarter from our clean energy investments, more than covering a touch more M&A costs.

Looking forward, please spend some time on page 15 of our investment supplement. We have added a couple of footnotes in there to help you with your models.

First, you will read in footnote 3 on page 15 of our investment supplement that we are in the process of making an early payout offer to former employers -- employees that are still in our frozen pension plan. This de-risking exercise will happen in the fourth quarter, and payments will come from plan assets, not from our corporate cash. The related fourth-quarter non-cash P&L charge is not reflected in the estimates for the fourth quarter that we show on page 14 of the supplement. In mid-December when we know the amount of the charge, we will likely file an 8-K with the numbers.

Second, footnote 2 on page 15 of the supplement provides our first guess at the corporate segment first-quarter 2015 earnings. We are waiting on longer-term production forecasts from the utilities, and we might be able to provide -- and when we get those, we might be able to provide a better guess at the remainder of 2015 also when we thought the 8-K in December.

Finally, a comment on foreign currency. There wasn't much impact this quarter when we boiled it all down, and we estimate at current exchange rates it will cost us about a penny per quarter going forward if the exchange rates stay where they are today.

So those are my comments. And then as a wrap-up, like I said at the start, it is a terrific quarter on all measures. Back to you, Pat.

Thank you, Doug. And, Robert, we are ready to go to questions and answers.

(Operator Instructions). Michael Nannizzi, Goldman Sachs.

Thanks. I have one question about integration of these large acquisitions. Can you talk about operationally how that process is going? What are -- do you see opportunities for additional synergies from any or all of these acquisitions? And do you have capacity to continue to think about new candidates should opportunities arise? Thanks.

Thanks for the question, Mike. This is Pat. First of all, the integration across the board -- that is in New Zealand, Australia, Canada, and the UK -- is going extremely well. We are seeing exactly what we had hoped for. When it comes to expanding the business, we needed a platform in those locations to continue to do the bolt-on acquisitions that we do so well here in the United States and that we have been doing in the UK. And we are seeing that activity percolating along very nicely.

So the fact that we are now one of the largest brokers in Australia, we are we believe the largest in New Zealand, is giving us opportunities there to continue to bolt acquisitions on, and the same is true in Canada and the UK.

So the work streams that are involved in bringing these people aboard, minor things like, just as I mentioned in my comments, the rebranding in the UK are going extremely well. And I think that what we are hoping for in the long run is to continue to be able to build those businesses out.

You asked the question as to whether we have capacity to continue to do acquisitions. I think the leadership in each of those locations is excited. They are turned on and they are telling our story to smaller business owners that I believe will want to join us. So we have plenty of capacity. Our pipeline is very strong both domestically and globally, and I think it bodes well for future acquisitions.

And are there costs associated with the rebranding effort, for example, or just certain steps during the integration process that you incur? Or are those all contemplated when you think about and talk about the impact on margins from those acquisitions?

Mike, it Doug. A couple of comments that amplify what Pat said. In answer -- direct answer to your question is those costs that we incur for this rebranding exercise and to do the system conversions and everything, we classified those in the integration cost line. So we break those out for you there. But our adjusted operating margins would exclude the integration costs associated with those deals.

I think also, just important, it is not really a broad-brush approach. Each acquisition has a different integration exercise. For instance, Bollinger that we bought a little over a year ago is just a part -- it has been fully integrated into our Northeast region operations, and so that is pretty well done at this point. And that was a series of inner -- merging in 12 different branch locations and merging our New York office and our Philadelphia office and a couple in New Jersey. So that is done.

So that is a different exercise than what you see in Canada, Australia, and New Zealand, where there really isn't a lot of integration associated with those. Because we don't have substantial -- didn't have substantial operations in Canada, New Zealand or Australia, so it is really more of them becoming part of us. So that is different.

And then in the UK, when you have got organizations like Oval and Giles coming together, there are a series of branches that are merging together. There are leadership changes that are going on with that. So each one, it is not a broad-brush approach to how we integrate, but each one has their own separate plan on how they become part of Gallagher.

So -- and that is all being done as we work. And it takes about a year to 15 months to really make all that happen. But like I said on Bollinger, we did that merger in August of last year, and here in October we are pretty well done with that.

Got it. Great. Thank you.

Sure. Thanks, Mike.

Kai Pan, Morgan Stanley.

First, the question on the acquisition for loss on Mike's question. Basically, what underlying growth rate I believe is not in organic growth at these five large acquisitions that you recently acquired?

Kai, good question. On the Bollinger acquisition, it is pretty tough for us to track that at this point. At this point, they are merged into our operations, and so we are not seeing -- I don't see a lot, a big difference between Bollinger and what our Northeast region offices are performing at this point.

When you look at Australia, New Zealand and Canada, the growth rate there in the low single digits similar to our operations. In the UK, as we put the Oval and Giles acquisition, I would say their growth rates are more flat.

There is also an exercise that we go through, and we do cull out some clients as a result of suitability, capability, et cetera. And sometimes they are just costly to operate. So we spend a year culling through the book of business. We are not making money on the account, we need to go through a repricing exercise on that. If the service load is too heavy, we may need to just sit down and say that we can't afford to service your business, so maybe you need to find another broker. By and large, we work through those over a year to 18 months on the deal.

So there's also a difference in the accounting basis. You do have some -- in some of the acquisitions, they pre-recognize monthly bill. In our situation, we don't, so we have to levelize that out. So there's a whole exercise going through on the organic. But by and large, it is not all that different than what you are seeing across Gallagher globally.

And actually -- Kai, this is Pat -- it takes six to 12 months for our new partners in those parts of the world to really understand the power of the organization and to tap into things like salesforce.com and the niches that we have got. And once that gets some traction, we do quite well. So it is a year of basically getting to know each other.

Okay, that's great. Then on the organic growth is a very nice rebound from the last two quarters; but underlying is 4%, also nice growth there. But I just wonder if you can give a little more on the large account activities. I believe that wasn't an issue in the past. Just why this quarter?

As a confluence of events, but our teams did some great jobs on a couple of big wins that came through in the quarter. That is just a little out of pattern for us. We don't see that happening quite as much. But our guys, they are good at large accounts, and it just came together in this quarter. So 5.8% overall with those in, about 5% without them overall. That is a pretty good quarter.

That's great. Lastly, on reinsurance, I believe you don't have a large reinsurance brokerage operation, but you just have some investment -- minority investment in a new start-up. I just wonder, given what is happening in the reinsurance marketplace, what is your thought about getting into that business?

Well, we are extremely excited about our partnership with Grahame Chilton and Capsicum Re, and it is kind of an interesting play there. The traditional view of the marketplace in terms of reinsurance is that you have to have incredible amounts of analytics to be able to compete.

And one of the things that [Chile] has kind of brought to the table is that with all of the capacity that is in the reinsurance market, there is a premium now on execution, on actual placement. So it is -- in essence, it is almost kind of a return to the past. And that business is going extremely well for us. Obviously, we are not the majority owner of Capsicum Re, but we are a good partner, and we see really great traction there.

Well, thank you so much for all the answers.

Thanks, Kai.

Charles Sebaski, BMO Capital Markets.

Wanted to get a little bit additional color on the organic growth. I guess from whether it is outside of the new account, the large accounts, because those are wins -- the more traditional business. Are you seeing that from current account base expansion or net new clients to the business? Where is any additional on where that is really stemming from?

Sure. Let me break that down for you, Charles. This is Pat. First of all, when the market over the last four years has either been firming a bit -- and, again, the CIAB numbers are not out yet, but in the past we have seen as much as 4%, maybe 5% rate increases. Now we are seeing flattish to down a bit. Our people have mitigated those impacts. And the marketplace itself has contributed less than 1% either up or down to our organic growth.

Our organic growth comes from one thing: we sell more than we lose. We get up every morning, and we knock on doors and we tell people we ought to handle their insurance. And the data that we are able to accumulate today, which is far better than anything we have seen in the past, tells us that we know that 90% of the time, when we go out in the marketplace to compete, we compete with a player that is smaller than we are. Now, for people like myself that came aboard in 1976 when nobody even knew who we were in Chicago, that is a whole different position to be in. So our organic growth is coming from market share increase, period.

One thing, Chuck, to amplify on that. We just don't lose accounts that much anymore. When it really comes right down to it, on our bread-and-butter accounts, our service quality that we measure every day is better than ever before. And so we just don't have service -- we just don't drop the ball on renewals.

Our -- in this low rate-change environment, our customers get to see the capability. They are not just constantly looking at rate increase or rate decrease. So they are actually being able to look through and see the differences you get with Gallagher: our niche expertise; our service quality that is higher than most of our competitors. So they get to see the differentiation that you get with Gallagher, and we think that is leading too good organic growth.

By the way, as far as the size of the firm today, I believe we are probably the only firm of our size that pays our people for what they basically write.

No, I -- and I wasn't trying to get to whether the organic had do with pricing increases. I guess the question, and maybe I am thinking about it wrong, is on your traditional mid-market business, whether you have accounts where somebody is not buying cyber liability, and this year they are versus picking up an account that was a client of [hub] group. You know the --

Both of those.

That's -- I was wondering if there was one that was leading to more of the organic growth than the other.

So, I tell you, you raise a really good point. One of the things that we are focusing on very heavily is exactly your point on lines of business that we are not presently writing. So we are looking at every single account as it comes up for renewal. And if we are writing the property and the auto, but we don't have the general liability in the umbrella, we are going at it at adding those lines. At the same time, it is straight-up competition on new pieces of business. So it is really accommodation of both.

Okay. And then a follow-up on the margin, kind of two parts. One, in the release it talked about some -- you talked on the brokerage about some salary and compensation expense reductions in the quarter. And I am wondering if that is to continue or what really drove that. And additionally, Doug, you said the brokerage margin should expand 100 to 150 basis points on the seasonality reversal. But if you also have organic growth over three, there's more margin expansion. So I am guessing should adjusted EBITDA margin in the fourth quarter be in excess of 24%?

Well, I'll answer -- I am not going -- to an absolute number, I would have to check last quarter, last year, our fourth quarter last year. But let me hit it in reverse. The larger deals will contribute 100 to 150 basis points of margin expansion. Our normal organic growth, our normal acquisition activity, will have an impact on margin also.

So the back part of your question there is that in a -- if we said in a perfect world that we have zero margin change at 3% organic growth, then you would see 100 to 150 basis points due to reversal of the seasonality on the larger deals. Greater than 3%; there could be some more margin expansion less than 3%. You might -- it might be tough to hold in there where we are. So that is the first.

And the first part of the question was on the -- we provide some -- on pages 3 of 11 of our press release some explanation with respect to changes that impact comparability of our comp and operating expense ratio. It is just lower level. When we say salary decreases and a reduction in incentive compensation, there is no current, large-scale change in headcount or anything like that. That is just a natural change as we become more productive. We just don't hire quite as many people as maybe terminate. But there is no big riff in there that is causing that adjustment.

Okay. And there is no -- there hasn't been a change that might up-end the employee base of, hey, we are doing a comp review and adjusting our comp strategy?

No.

No. Our people deserve to get paid, and they are getting paid.

Excellent. Thank you very much.

Arash Soleimani, Keefe, Bruyette & Woods.

In terms of the growth you mentioned in 2015 for Gallagher Marketplace, is there anything we should think about in terms of margins on that end? And will that be new-client wins, or is that existing clients? Wanted to get some more color on that, please.

Well, I think the marketplace is going to get a lot of traction both from new-client wins as well as existing accounts that are presently in a more traditional arrangement, either moving to defined contribution or just liking the ability to give their employees more choice. So I think you'll see a greater movement, especially as we get around to the fall of next year when open enrollment is once again on us.

Right now, I think people are still learning about the exchanges and they are interested in them. But I think because open enrollment is already going on, most people are stuck with renewing the kind of process and program that they have in place. They also are concerned about not losing any grandfathering as we go into more compliance rules in 2015. And so I think it is going to take time through the spring and the summer of next year for the cease week to really understand the opportunities the exchange provides. And I think you'll see a nice blip in 2016 and 2017.

It is not going to have any impact on our margin one way or another.

Correct.

Okay, great. Thank you. And I know in terms of the large account sales, you have mentioned in the past, perhaps I think it was maybe at your last investor day that you were trying to penetrate a bit more into the large account space. With that said, should we expect more of these sort of organic growth boosts from large sales to continue here and there over the next couple of years or so? Or is it truly one-time in nature?

Well, I think, Arash, our people get up every day and go out and compete head to head with everybody that is in the marketplace. As I said earlier, 90% of the time when we compete, we are competing with a smaller, probably more localized competitor. But we are very good at large accounts. We -- large accounts are what created Gallagher Bassett four years ago, 50 years ago, and it's -- but they are lumpy. And one of the things we want to do is be as transparent with you as shareholders as we can possibly be.

Okay, no, that is very much appreciated. And lastly, just to confirm, did you mention the risk management margin -- I mean, not margin, organic growth would go to the 5% to 8% range next quarter?

Yes, we see that as a more reasonable range than nearly 12%.

Okay, perfect. Thanks so much.

Mark Hughes, SunTrust.

For the strength you did see in 3Q and risk management, you had mentioned more self-insured, more outsourcing by insurance companies. Could you give some more detail on that? Are you seeing a greater flow of opportunities? Your hit rate is up. What is driving that?

Actually, this year, I would say it is both. We have had a very good year on the large account front. Written business is up substantially from prior year. I think that the product offering that we are getting, the people that we are recruiting are getting some traction in the self-insured market. Large accounts are looking at us as a very viable choice for doing their claims work.

But, also, very excitingly to me, and I think this is true shift in the business, is insurance companies that are willing to outsource claims work. It starts off in times with them taking a look at locations maybe where they don't have infrastructure where they would like us to do some support work. And then ultimately over time, oftentimes, it leads to true partnerships. I won't mention names because I don't think that would be appropriate on the call, but I will give you one example.

There is one large insurer that basically outsources the entire construction book of business they have to Gallagher Bassett. I was able to go to the partnership meeting where we were working together on how do we want to adjust those claims and what differences do we want to see. There were over 150 people in the room. That is people working together from the insurer and from Gallagher Bassett making sure that the product offering they have in the construction world in the United States is differentiated by virtue of the fact that the claims outcomes, they believe, will be superior. That is exciting stuff.

Yes, it really -- it really comes down, Mark, to demonstrating claims outcomes that are better. The audience will listen to that whether it is a commercial customer, a public entity, a carrier. When we are paying $9 billion a year of claims, maybe we are touching on 800,000 claims a year that we're paying. Our outcomes, we can prove, are better. And when we get in front of any customer on that, they see the advantage that it brings to their business.

And let me go back to Doug's comment. This is Pat. When you think about the fact that we will pay out billions and billions of dollars in claims, most of the insurance companies you follow don't pay as many dollars out in claims as we do.

Right. And then a final question. How would the wholesale business do in the quarter?

It was outstanding. We had a great quarter. If you think about the second quarter, we had an awful lot of catastrophe property renewals in the second quarter, and those were down substantially. And as we commented in our second-quarter results, I think that is appropriate for those accounts because they paid dearly for property cover that has really not had many cat losses. But that, we didn't have a big property renewal quarter in the third quarter. Our MGA and MGU business did extremely well, and our open-market broking did extremely well. So organic growth was very strong there in the quarter.

Better than average?

Yes.

Yes.

Better than the segment as a whole, Mark.

Understood. Thank you.

(Operator Instructions). Adam Klauber, William Blair.

A couple of different questions. In the US retail business, how is net new? And I guess want I'm looking for -- the market is just is a little bit more stagnant, not a lot of rate increase, not a lot of rate decreases. How does that translate into the level of opportunities compared to maybe a year ago?

Well, given one-year difference, I would not say that there is much change there, Adam. But here's the thing. Doug mentioned in his comments, you give us a flat market up 2, down 2, sideways 3, whatever. And our expertise and our capabilities are what we are selling against the relationship that exists. So 90% of the time, we are competing with somebody that is smaller than we are, and 90% of the time, I believe, we can prove that we have expertise that exceeds that local broker's capabilities. Now, I think we should win 100% of the time and unfortunately we don't.

When we do win, though, and you step back, you are familiar with the fact that we are very niche focused in what we do in retail P&C in particular. 85% of the business that we write that is new falls in one of those 33 categories that we think we are stronger than anybody. So expertise is truly selling in the marketplace. Not just size; we don't win accounts because we are big. We win accounts because we are really good at their business, and that means market share is coming our way.

Okay, that's helpful. As far as RPS, again, good to see it popped up this quarter. Fourth quarter, is it another larger cat catastrophe-warranted renewal season?

No, not really, Adam.

Okay, it is mainly the second quarter. Is the second quarter the largest, then?

Yes, it is.

Okay. That's helpful. Doug, as far as -- obviously pretty strong in supplementals and contingents. Part of that is fair amount of acquisitions. Can you give us an idea, what is the impact on the brokerage margin for that, for increasing supplementals and contingents?

You know, supplemental is pretty close to our -- the impact on margins. Supplementals are pretty close to base commissions apiece. So that impact is more in line with the base fees.

The contingents, 75% of that hits the bottom line typically on a contingent. The important takeaway on this is it is getting harder and harder. And while we believe the transparency into those three components is important for you as analysts and shareholders alike to understand, the lines are getting a little blurred on that. It used to be that some -- the contingents went directly to the house 100%. There are situations where contingents, we do share with the field to a certain extent. Supplementals, some get shared with the field, some don't. But we provide all three there.

But like I said in my opening remarks, we think it is important to get it however the carrier believes it is best that they would like to make a payment to us in recognition for our services. We'll take it any way we can get. But the margin on the contingent is better than the other deal.

Right. And any visibility into 2015 that -- I know there's a lot of factors that can go into both of those categories. Will the strong growth continue, or do you think this just represents a pretty good year?

Yes, Adam, we usually typically have better insight in that in our January call than we do here in October. We are still getting to the point. But if the carriers are healthy and they recognize the value of our distribution, we think that supplementals and contingents will remain an important component of our story next year, too.

Okay.

But January is a better time to ask us when we get through a lot of the conversations with the carriers over the next coming months.

Right. And then looking at the corporate segment, not surprisingly interests and banking costs and you do a good job of disclosing it. Interest and banking costs and acquisition costs are up a fair amount this year compared to last year. Is that mainly related to the brokerage acquisitions?

Yes, it is the new debt that we put on from the last two private placements that we have done compared to last year at this time. But it is the debt funding that we are using to do the brokerage deals.

Right. And the acquisition costs are mainly the brokerage deals, right?

Yes, right. And just so everybody understands what we do with acquisition costs, these are the pre-deal costs where we don't have internal resources to do the deals, or we require one-time, non-recurring expertise. In the past, those were all capitalized as part of deal price. But under GAAP, you'd need to expense them, so we track them in a separate bucket and we report them here.

And, clearly, again, you did some very large deals this year, so it makes sense that you are going to incur materially bigger acquisition costs. Is it that can be sort of the rule of thumb if you do some bigger deals next year, you can see those more similar to what we saw this year? But if you don't do bigger deals, we can see those come down? Just looking for a way to think about it.

I think that that number on a recurring basis -- and the disadvantage on some of these costs is internationally you don't get to deduct them for tax purposes. (Multiple Speakers) so you will see the reason why there is very low tax benefit associated with those items in the financial sense.

Yes, a run rate of maybe $3 million a quarter after tax might be a typical run rate. By us still doing nice tuck-in deals in the UK, Canada, Australia, and New Zealand, that is where it will come from.

Right. Okay.

But I wouldn't say if there is a large deal that happens sometime in 2015, that would probably spike that number up a little bit.

Okay. And then finally, when we look at the brokerage margin clearly on an EBITDAC basis, it has come up nicely. If we look year to date on a pre-tax basis, it's more even. And then [faring out] against some of those costs we're talking about, and I know that is how you have always reported it, but those are more related to the brokerage segment. So it almost seems like the margin on a year-to-date basis pre-tax has really come down, not gone up. One, am I off base? And maybe I am off base; that has happened before. And two, I guess, how should we think about that?

Well, I think that because of the large amortization that goes along with our acquisitions, that can influence the pre-tax margins dramatically. So on a -- and the brokerage (inaudible). So typically, I hate to say, we spend very little time on the pre-tax number because of the amortization. Out of fairness, if you were going to do that, you probably should then put in the after-tax benefits that we are getting from clean energy against that also, because those are funding deals (inaudible).

So we typically focus on EBITDA. If you really look at it on an EBITDA per-share basis, this year there has been -- there was nice 15% growth in the quarter. If you wanted to assign the interest expense to that, we are still well into the double digits of growth. If you took all of the interest and you assigned it 100% to the brokerage segment, we are still above I think it is 12% or 13%, maybe 14% growth in that number. So typically, EBITDA per share is the way we look at it. And then pre-tax is pretty much still a function of how much you allocate to amortizable intangibles the acquisitions.

Right. Okay.

It is a tough metric to track, especially comparatively.

Right. That makes sense. And then as far as (inaudible) EBITDA, what was operating cash flow for year to date compared to year to date last year, if you have that? And if [still have it] for the quarter?

Well, as you know, using the GAAP cash flow statement that is provided is very difficult to use because of the changes in the premium accounts that we -- the premium levels that we hold for our customers. So that is a tough (inaudible). But, generally, our cash flow tracks very close to EBITDA times about 75%. And that gets you pretty close. So I would have to go through it to look at it, but that's kind of a nice metric to look at.

Right.

But then that is assuming you are paying tax on those items. Now obviously, then you would add in the tax. If you wanted to put clean energy up in that, that changes the number. Then you basically can just take EBITDA. Not too far off.

Okay. So when we see the cash flow statements, again, some of those balances can move back and forth --

Yes. The indirect method on a GAAP basis for a broker is a very difficult thing to use.

Yes. Okay. And then as we think about cash usage for next year, again, cash flow is -- it looks like it should be growing a fair amount. Do you think as we look at acquisitions in 2015, will you have a -- use a higher component of cash compared to 2014?

Absolutely. I think that next year we have the capacity to do $500 million to $700 million worth of deals and not use any extra debt or stock.

Okay. Thanks a lot, guys.

Sean Dargan, Macquarie.

Your brokerage margins were still pretty healthy despite the 70 basis points of headwinds identified in the press release. I am just wondering what the difference between the 70 basis points and the 50 basis points you are talking about earlier were attributable to and if they will be recurring in future third quarters.

I think your question was, is last quarter we had provided guidance with respect to -- or some thoughts on what the seasonality of the larger deals might produce in the fourth -- or in the third quarter. And we guessed 40 or 50 basis points of compression. They ended up being about 70 basis points, and the seasonality ended up being about 70 basis points. Is that the crux of your question?

Yes.

The difference is this, is my guess was wrong probably by about 10 to 15 basis points. And on $175 million, I just probably undershot a little bit. The other piece of it is the accounting review recognition, when we pulled the historical basis statement, there are some accounts where on a historical basis, before we bought them, where they recognized monthly bill on -- in advance. We recognize monthly bill on a monthly basis. So that caused a little bit, about another 10 basis points difference in my guess. But there was nothing substantially different.

There's also a mathematical anomaly in the 70 basis points versus 50, but we won't get into that on the call here. But it is basically the same number, but I probably undershot a little bit last year. That said, we still grew over the top of it, and we improved 90 basis points. So I probably underguessed last quarter.

Great. Thanks. And I'm wondering if you have thought about what impact, if any, an Ebola pandemic would have on your business and to the P&C industry as a whole?

Well, I will comment on that. This is Pat. I think that those that are underwriters have some concerns. Spending some time again at the CIAB just a couple weeks ago, when you think about -- just for one example, worker's compensation for hospitals. It is an issue. The good news is that we are brokers. We don't take that risk.

The other thing, too, is what is really interesting is that this is where our niche expertise. If you go back to the bird flu a number of years ago, we actually sponsored a lot of forums in our higher ed practice to discuss how the university risk managers came together. We organized that; we discussed what the universities would do in a situation of this.

So underlying this in our niche businesses, our niche practice leaders are thinking about this every day. They are talking to our clients. And this is exactly what Pat was saying earlier about when people recognize the capabilities of Gallagher that you get with this, you are not going to have a smaller broker that is convening the heads of the risk management departments from 60 different universities around the country having this kind of dialogue about how they protect their students and their faculty. So your question actually is exactly the difference between using our capabilities versus a smaller guy.

Thank you.

(Operator Instructions). Josh Shanker, Deutsche Bank.

So, in looking at the US market, I follow the US stocks; I tend to understand it pretty well. In thinking about the UK S&E market, where is Gallagher positioned now? Where is Gallagher positioned in five years? Is this a market, the defragmenting market the same way the US market is? And what is the scalability and outlook for Gallagher's UK business overall?

Well, I couldn't be more excited about it. And to your point, yes. The lion's share of the business that we have across the UK -- we have 70 offices across the UK -- is SME business. And it gives us tremendous opportunities. We are very -- by the way, we are very good at that business, and we really like that business. And we know how to make a lot of money at it, whether it is by breaking it down into affinity plays or whether it is just simply handling it in a very efficient manner. We are very good at that business.

So what we are going to see, I think, is assimilation of the two, actually three, firms -- Heath, Oval, and Giles -- which will take us the better part of another year or so to get everybody grounded in the same spot. We will then be able to look at that SME business and see how a firm that has got that much of it should handle it. And as I said, we are very good at it right now. So we know how to improve the handling and structure of that business.

And then we are going to focus very heavily on growing it. And we are going to grow it about two different ways. One is we are going to be out in the street marketing every single day, telling people whether they are large or small that we ought to handle their brokerage. And secondly, we are going to buy firms that have good, solid SME business and fold them into our platform.

So we are good at that in the United states. We are very good at that in Australia, New Zealand, the UK, and Canada. And we see great opportunities to grow small and personal lines business globally.

So how does the market share stack up, the level of fragmentation compared to the US marketplace in that line of business?

Well, I will give you an example. So in Australia now, I think we are probably the fourth largest player in Australia, and we don't have a 10% market share. We think our market share is something like 5% to 7%. In the UK, we are probably the third largest player in that market, and we probably don't have a 25% market share. So the ability to do that business better than your smaller competitors, who are handling it in a more traditional manner, gives you great opportunities to expand market share and to build efficiencies in the system.

And with that volume, too, it also allows us to build a better product. So that will differentiate us at the point of sale also.

Yes, Josh, let's put this in perspective. I will be giving a presentation at SNL, the conference next week in New York. If you go to the Insurance Information Institute, Robert Hartwig's operation, the estimation is that there is something like $4 trillion of premium. That is all life, health, property casualty, personalized, commercial globally. We don't touch $50 billion of premium as an organization. We are third or fourth largest in the world, and we don't touch, literally, 10% -- not 2% market share. So what is our opportunity to expand? It is limitless.

So, then, taking that together, do you think that the growth rate of Gallagher's business organically or even inorganically in the UK is better, equal to, or less than what it is in the United States?

Well, I think it will be about the same, frankly. We are very active. The United States has a leg up in the fact that since 1986, we have probably done 400 acquisitions, and those people for the most part are still with us. And so our acquisition pipeline and our acquisition opportunities in the United States, where we believe there's something on the order of 30,000 brokers, most of them run by baby boomers, is probably a little greater than what we have got in terms of experience, spread and headcount in the UK.

So I would say probably we got better opportunities to grow in the US through the acquisition process. But if you look at the flip side of that is we are not as big in the UK. So as a percentage basis, we should be able to continue to keep it going.

I just look at this whole thing and say go back to the United States comment. If there are 30,000 agents and brokers in the US, and there are people that estimate there's 18,000, some estimate 30,000, I don't know what the right number is. To be number 100 on Business Insurance's list this past summer, you did $22 million in total revenue. So there's something like 17,900 agents and brokers in America that are smaller than $22 million. I think we have got lots of room to expand.

Yes, and we click on, we have done 42 acquisitions year to date. We have done -- in the quarter, we did 18 smaller tuck-ins for $60 million of revenue and $3.5 million of shop. Those are terrific shops. They have got great, great sales leadership in those operations. And by joining us they get our capabilities, get access to our niches, get access to our technology, get access to our industry and functional experts in it.

It is a great combination. If you are a guy that is running a $4 million shop in Peoria, Illinois, you can get all of the global resources that Gallagher has. That is a nice merger, and that is a win-win for us both.

Well, Josh, you raised a good point, because I think this is important. We don't talk about it much. Every time we get on these calls, everybody wants to focus on one number, that is organic, organic, organic. We are up 45% this quarter because we did a lot of great acquisitions with people who are staying with us. That is not easy. You can get 10 to 15 proposals to sell a $10 million business. We are fighting every day. That is real growth. That is real growth. And when Doug says we did 18 tuck-in acquisitions in the quarter, we didn't have one closing that went awry. We didn't have one time a check didn't show up. We didn't have one group of people that didn't get set up on Oracle. We didn't have anybody whose results we were not able to consolidate in the quarter. The back-room capabilities that we bring to this should not be underestimated. This isn't an easy thing for people to do. I am incredibly proud of our acquisition engine that we have built here at Gallagher.

Thank you very much for detailed answer.

Dan Farrell, Sterne, Agee.

You mentioned your increasing efforts to try and get better compensation for what you do and not really -- and being indifferent if it is in standard commissions or contingents, et cetera. I was wondering if you could expand on that old bit more and talk about what you're doing today that is different. And then also are things like your global scale now and global platform and also systems and technology helping you do things that you maybe couldn't have done before in that area?

Great question, Dan, and the answer to that is yes. There's all kinds of capabilities. They are coming from two things. One is size and scale. We are recognized now, clearly, by our larger trading partners as very large global players. And so it is kind of funny. I mentioned the CIAB conference. I have been going for 28 years. 28 years ago, if we asked for meetings with the larger trading partners, we didn't get them. They didn't have the time for us. Today, with over 21 meetings schedule, we had to turn away probably 20 opportunities to have additional meetings. We just didn't have room on our dance card.

Secondly, the information in our capability of using SharePoint and data warehouses are just making us stronger and stronger in terms of knowing our book of business and looking at that book of business in different ways and doing things that are beneficial to our clients.

So, for instance, based on the information that we have got, we have been able to create a better umbrella program for middle-market clients. And we have basically said to a small handful of companies, if you will write a stronger form for our clients, we think what we can do is then point you in the direction of the place in our network where those clients are, and you will have a better opportunity to write them because you give a better coverage product to our clients. Those are things we couldn't have done even five years ago.

So scale, information, those are all playing to our benefit. And the fact that we are where we are globally is creating a lot of excitement by our insurance company partners.

That's great. And then a question on the smaller M&A activity in the quarter. What was the average multiple paid for those 18 deals? And then also, how would the average margin for all of those compare with your overall brokerage margins?

Two answers to that. And I will give it to you for the nine months of the year on the 42 deals is that the simple average of the multiple is 5.81%. The weighted average multiple is 6.81%. We are not seeing a substantial number that multiple differences and substantially different. The margin on it for the deals that we did is 30.4% on the ones that we did this quarter.

Okay, great. Thank you very much.

Robert, any other questions?

There are no other questions, Mr. Gallagher. I will turn the floor back to you.

Great. I will just make a very brief closing comment. What can I say about a quarter that has adjusted revenues up 38%? All-in organic growth is 7.1%. Adjusted EBITDAC up 43%, adjusted margins up 80 basis points and EPS up 15%. A terrific quarter. Our team knocked the ball out of the park.

I just want to thank all of you for being with us this morning. Thank you for your questions. Our team is turned on. We are helping clients. We are bringing in new accounts every day. And quite frankly, it is fun to be us right now. Thanks, Robert.

Thank you. This does conclude today's conference call. You may disconnect your lines at this time. Thank you for your participation.