Good morning, and welcome to Arthur J. Gallagher & Company's fourth quarter 2014 earnings conference call. Participants have been placed on a listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to certain risks and uncertainties that will be discussed on this call 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 Mr. J. Patrick Gallagher, Chairman, President, and Chief Executive Officer of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.
Thank you, Manny. Good morning, everyone. Thank you for joining us this morning. If you hear me raspy a bit through the call this morning, it's because I'm fighting my way through a cold. This morning, I'm joined by Doug Howell, our Chief Financial Officer, as well as some of the heads of our operating divisions. What a great quarter we had. What a great finish to an unbelievable year. As we go into 2015, we remain very bullish. Our team performed exceptionally well everywhere across the globe and in every operating business that we're in. Strategically, I believe 2014 was really a seminal year, a year in which we established a global base that will allow us to continue to grow over the coming decades.
We're done integrating our Bollinger acquisition. Our new operations in Australia, New Zealand, Canada, and the U.K. are all integrating well and delivering results. In 2014, we went from a small retail presence in Australia, Canada, and New Zealand to a top five broker with a real platform for both organic sales and mergers. Our acquisition pipeline is growing there nicely. In the U.K., Oval and Giles are now Arthur J. Gallagher. Across our 70 U.K. offices, we are seeing good sales momentum as well as many acquisition opportunities. I'm very pleased with how the U.K. team is coming together, putting the days of private equity ownership behind them, and selling the Gallagher brand. In addition to our larger deals, we did 57 other acquisitions. That's more than one a week.
These were our classic Gallagher deals, entrepreneurially owned, looking for a home to continue to grow and build their business. In a nutshell, they see how joining Gallagher gives them access to our resources, expertise, and capabilities so they can sell more. I want to welcome all of our new partners. Together, we will continue to grow a great business. I know you all had choices, so thanks for joining Gallagher. Let me go back to the operating results. As we said in the press release, the brokerage and risk management businesses had an outstanding quarter. Good growth, combined revenue up 31% on an adjusted basis. Good organic growth, 5.6% all in. Brokerage basic commissions and fees were up 4.2%. Risk management organic was 12.6%. We had nice margin expansion in both segments.
On top of all that growth, our clean energy investments took another big step up and generated over 50% earnings growth. Well done to all my colleagues and the whole team around the globe. I'm very, very proud of these results. Let me go into a number of our operating businesses for a little bit more color. First, I'll start with U.S. retail property casualty. The Council of Insurance Agents & Brokers rates report is out, and once again, rates are being reported as essentially flat, which we agree with, by the way. Small accounts were up 1.1%, medium accounts were reported about flat, large accounts were reported down about 2.2%. In my opinion, we are in a new era of a prolonged, stable, and rational rate environment. In my meetings with domestic insurance companies, they resolved to continue their four-year market of flattish rates.
Those that need increases are being quoted higher. This really is an excellent market for our brokers and our clients alike. This is a market that will continue to reward expertise, and one thing we're building every day around the world is expertise. Secondly, let me move to employee benefits. In 2014, the employee benefits team was very busy helping our customers manage their benefits and HR needs. This trend will continue nicely in 2015 as the complexity grows along with higher benefits and wage costs. In the U.S., employers continue to deal with the impact of the ACA, the Affordable Care Act. Our team has the tools and resources necessary to assist our clients in compliance with this law. We continue to see solid interest in the Gallagher Marketplace, our private label insurance exchange.
As more employers understand the advantages in offering this to their employees, 2015 will be a very busy year for the exchange. The team continues to invest in tools and resources our clients need to manage their employee benefits and human resource needs. This has helped with strong new business sales, and it continues to drive increased merger and acquisition opportunities in the U.S. and truthfully, globally. Thirdly, when we look at our U.K. and Canada, we're seeing the market there is flattish to a little down. In Australia, New Zealand, it's down maybe mid-single digits. Even in this environment, our existing operations posted 2% in organic growth. Fourth, our wholesale and specialty businesses, both in the United States and London, had a fantastic quarter, solid organic growth of about 5%. Domestically, our wholesalers overcame strong headwinds in the property market.
In international, our London specialty unit grows stronger by the day as we continue to service customers all around the world. Fifth, let me shift to our risk management business, which is Gallagher Bassett. What a strong quarter, what a strong year. 12.6% organic, adjusted EBITDAC margin improved 225 basis points, over 16 points of margin, and a great finish to the year. Revenue growth was fueled by a number of things. First, strong new business domestically and internationally, and across both our large commercial and carrier units. Secondly, client retention at about 95%, and thirdly, mid-single-digit growth in claim counts. Finally, we continue to invest in our managed care offering, our IT systems, and our claims analytics, all with the goal of delivering industry-leading claim outcomes. I want to thank all my colleagues across the globe for pushing through the whole 12 months. What a great finish we had.
For staying focused, for integrating our new partners, selling a lot of new business, and taking good care of our clients and retaining those clients. In 2014, continuing to be recognized as one of the world's most ethical companies. Let me finish by rephrasing why I think 2014 was, in fact, in our history, going to be looked at as a seminal year. We've had aspirations of being a global growth enterprise since my dad opened our offices in London and Bermuda in 1974. We now have 20,000-plus people spread across the globe, bringing the expertise of our organization, no matter where in the world that expertise is located, to our clients. We developed more clients, we developed more mergers, we developed more geographies. We really made some giant strides in our journey in 2014, and I'm very, very pleased. Doug?
Thanks, Pat, and good morning, everyone. What a terrific finish to a game-changing year for Gallagher. All right. Let's please flip to the table on page two. Here are some other items for you to consider as you review our results and work on your models for 2015. Let's start with the brokerage on page two. Brokerage segment adjusted EPS of $0.50, up 22% in the quarter. Foreign currency did not have much impact year-over-year in the quarter, but had the dollar remained at third quarter levels, we would have earned another $0.01. Looking towards 2015, if the dollar stays at current levels, it will cost us about $0.01 in the first quarter and then about $0.02-$0.03 in the second, and $0.02 in the third. Next, integration.
You heard Pat's comments that Bollinger is done and the others are moving along as planned. Looking to 2015, we're seeing integration costs of about $0.07-$0.09 a quarter in the first half and $0.05-$0.06 a quarter in the second half. Again, that's $0.07-$0.09 a quarter in the first half and $0.05-$0.06 a quarter in the second half. Staying with brokerage, but turning to page three, to the organic revenue table at the bottom. Pat gave you some flavor around the world, so let me give you some more detail behind the 4.2% organic growth in base commissions. We saw about a little over 4% came from our domestic retail operations. International was nearly 4%, and domestic wholesale was around 7%. Solid numbers around the globe, no matter how you add them up.
Second, as for supplementals and contingents, together organically about flat in the fourth quarter, which, given we had a gangbuster fourth quarter in 2013, should be viewed as really excellent work by the team. For 2015, we're feeling a little preference from carriers to move from supplementals to contingents, by and large, we are renewing most of our contracts as is, and we see some moderate growth in these lines. Third, rates and exposure together basically had zero impact on our organic growth this quarter. This is consistent with what we've been seeing since mid-2011. Like Pat said, we are in a new rate environment, and still a very healthy one for that matter. Flipping now to page four, to the brokerage segment adjusted EBITDAC margin table near the bottom of the page. Adjusted margins are up over 180 basis points.
About two-thirds of that results from the roll-in impact of the larger deals, and about a third from organic growth and expense controls. Again, that's also great work by the team. Let me give you some thoughts as you prepare your models for 2015 for the brokerage segment. First, we've said this a lot in the past, but I can't emphasize it enough that our brokerage segment has substantial seasonality in our first quarter. You can really see it on page four of our investor supplement. As a result, our first quarter has historically had by far our lowest margins, and we historically post the smallest amount of organic growth in the first quarter versus the latter quarters and full year. I really encourage you to reflect this dramatic first quarter seasonality in your models.
Second, given the sizable amount of M&A we have this year, projecting rollover revenues can be difficult. For your 2015 models, assume rollover revenues about $175 million in the first quarter 2015, $125 million in Q2, $25 million in Q3, and $10 million in Q4. You'll need to add your pick for organic and for 2015 acquisitions. When you make your pick for 2015 acquisitions, please consider that M&A historically in a quarter tends to skew towards the last month, not the first month. That can have an impact in your models if you don't control for that also. Third, also please be careful when you model investment income. Recall that our investment income has revenues from our premium financing businesses. While revenues are somewhat apparent in the investment income line, it isn't easy to see the costs associated with that revenue.
That caused some confusion last quarter. We've added a footnote on page 12 of the release to show the net impact to EBITDAC, which is very small, relatively speaking. Please make sure your models don't have all the investment income hitting the bottom line. Fourth, as for first quarter 2015 margins, we estimate about 80 to 100 basis points of margin expansion from our larger deals as they roll into the numbers. I'm not seeing much more margin expansion from organic in the first quarter, given our seasonality. Fifth, let me give you some non-cash estimates for the first quarter for the brokerage segment. For depreciation, assume about $15 million of expense. For amortization, about $55 million. For acquisition earn-out amortization, assume about $5 million.
As we do more M&A, for every dollar we spend, you need to increase amortization by about 1% of the purchase price per quarter. That will get you close. Let's turn to page four to the Risk Management segment. Really an excellent quarter across the board. Breaking down the organic, our domestic operations grew near 12% and internationally near 17%. Margins were nicely up over last year, and we surpassed our 16% target for the year. I guess that was on page five. Let's turn to page six, to the corporate tables. Overall, we came in slightly above our midpoint guidance, and you'll see the retirement de-risking strategy that we discussed in our last call and in the December 8-K. Remember, the de-risking charge is non-cash, and those payments are made from plan assets, not from our corporate cash. A very nice outcome on all fronts.
Looking forward, when you get ready to model 2015 for our corporate segment, please take a look at our investor supplement, page 15. We've provided a 2014 adjusted view, and we've also provided our estimates for the corporate segment for each quarter of 2015. We've adjusted 2014 on that page 15 for both de-risking and non-cash accounting gains on our clean energy investments, giving you an apples to apples view with our estimates for 2015. A few other thoughts on 2015. First, we're still waiting for some production estimates from our utility partners, so there are still some wide ranges on the clean energy line of the estimates. Second, you'll see that the midpoint of the clean energy estimates is about 10% up over 2014 adjusted.
We see 2015 as a stairstep year to 2016, where there could then be another move up in earnings as we put a few more plants back into service this year. Third, you'll see that our first quarter clean energy estimates are also seasonally smallest, which results from the accounting rules, not from production. Effectively, the accounting rules require recognition of tax credits somewhat in proportion to our pre-tax earnings, not as such credits are generated. In our case, we produce more credits in the first quarter than we can recognize in earnings, but then catch up over the following quarters. Footnote one on page 16 shows this effect. Finally, some comments on our M&A program. Excluding the large deals, we did 57 mergers in 2014 at an average multiple of EBITDAC of 5.9 times and a weighted average multiple of 6.7 times.
Average pro forma margins were in the very high 20s. Second, looking towards 2015 M&A, we can spend about $400 million on nice tuck-in and bolt-on mergers in 2014 without having to issue any stock. That said, there will be tax structure deals and mergers where the seller wishes to take our shares, so of course we would do that. Based on our pipeline, we see opportunities that might push us over $400 million in purchase price. If we did another $150 million-$200 million of purchase price, we might need to use about 3 million-4 million shares in 2015. Our pipeline is terrific at this point. All right. Those are my comments, and like I said at the start, what a great way to finish a game-changing year. Thanks, Pat. Thanks, Doug. Manny, you want to open the lines up?
Thank you. The call is now open for questions. If you have a question, please pick up your handset and press star one on your telephone at this time. If you're on a speakerphone, please disable that function prior to pressing star one to ensure optimum sound quality. You may remove yourself from the queue at any point by pressing star two. Again, that's star one for questions. And our first question is coming from Michael Nannizzi of Goldman Sachs. Please go ahead.
Sure. Thank you. One question I had was in risk management. There's been a lot of growth there. I know you talk about the 16% margin as kind of a target. Is there operating leverage in that model that could allow you, if you continue to see the kind of growth that you've seen, to kind of reset that to 17% this year or maybe higher? Just trying to get an understanding of kind of the levers of that business and where the leverage might be. Thanks.
Yeah, I think we're targeting about 16.5% of margin, so there's some opportunity to improve in the Risk Management segment. Got it. Then, just in terms of what's driving that, is it
Is there a relationship between top line and margin, or is that just kind of that mid to high teen margin business no matter how big you are?
Yeah. Well, listen, no matter how big we are, that could change the answer. I think in the size that Gallagher Bassett is right now, with the investments that we want to make for improving our customers' claim outcomes, we think 16.5% is pretty healthy and industry leading at this point.
I was going to say the same thing, Mike, this is Pat. We believe we have the industry leading margin. I'll tell you, it's not the same as the brokerage business. When you write new claims business, claims show up, you better have somebody there to adjust them.
Got it. Okay, great. Just trying to get an understanding also of the comp ratios in the brokerage business. Obviously, there's a lot going into what those numbers were this year and also other operating expense. Is there a way that we should be thinking about those pieces separately, or is there just too much noise to be thinking about extracting or extrapolating a trend line?
Listen, I think that our investor supplement on pages four and five of the investor supplement provide a good historical trend on that. We see a comp ratio in the high 50s, and we see a operating expense ratio in that 17%-18% range as probably a good go forward ratio.
Got it. Great.
You've got to look at that for the entire year. Remember, that can cause issues in our first quarter because our comp ratio is, because of our seasonality, when I'm saying that in the high 50s, that's for the year. 17%-18% for operating, that's for the year too. Again, our first quarter is so seasonal, you'll see those numbers higher than that.
Got it. Just one quick news point. I saw that the CFO of international had left. Can you kind of talk about what's happening in Europe, maybe an update on the integration, and any sort of update on management out there would be helpful. Thank you.
Sure. I was just there last week and had some very good sessions with the leadership team there. We have a CFO that was offered another opportunity to work someplace else that we're sorry to lose him, he's a good guy, and he's taking an opportunity in private equity that he thinks will be better for him. The team remains very solid, very pleased with the integration that I'm seeing. As I mentioned in my prepared remarks, we're now trading as Arthur J. Gallagher everywhere. We are seeing organic growth. We're selling more than we're losing. That's good. I think the troops and the leadership team over the last six months really come together nicely.
Great. Thank you.
Thanks, Mike.
Thank you. The next question is from Adam Klauber of William Blair & Company. Please go ahead.
Thanks. Good morning, guys. Couple different questions.
Good morning, Adam.
How are Noraxis and Wesfarmers doing on an organic basis? It's not included in organic, but how are they looking so far?
Together, just slightly between 0%-1% organically between them. Maybe a little softer in Australia and New Zealand and a little better than that in Canada. With that caveat, there is some differences in accounting. We've tried to levelize for that as best we can as I give you that answer. We're nice flat, a point or two between those two units.
Okay, thanks. I think you mentioned there's going to be some more integration cost in 2015. Could you give us an idea, I guess, just more what that's about and what should be the ultimate impact of that integration cost?
Yeah. I said the opening part of my comments that we see $0.07-$0.09 a quarter in the first quarter and second quarter and $0.05-$0.06 a quarter in the third and fourth quarters. Most of that has to do with system integration, real estate consolidations, and moves. We have incentive compensation for some of the teams that are working on that. There are some employee change costs that are in that number. There's, of course, a lot of excess travel that goes on with it, lease abandonment charges. It's the common things that you would see similar to what we did with Bollinger. We brought in 12 different units there. We moved some folks around. We rebranded, there's cost in that. It's just the standard integration cost that you would see, just like Bollinger.
It takes us, Adam, a year to 15 months to integrate a larger deal. Maybe that'll stretch to 18 months on some of them. Really, each one of them is different. In Canada, Australia, New Zealand, it's more extracting them from their former parent, those costs. When you get into the U.K., it's a little bit more intricate as you put together Oval, Giles, the old Heath Lambert, and the old Arthur J. Gallagher. It depends on the country. If you look at the past, Bollinger's done, and the costs were very similar when it came to that one, too.
Okay. Do you think 2015 will be for-- I imagine these are mainly Noraxis with Wesfarmers. Do you think 2015 will be mainly the end in 2016, we shouldn't have too much, or should these be ongoing through 2016?
No, I think we're pretty well done by the end of 2015. There'll be some drifts. One of the issues when it comes to real estate abandonment costs is you don't take the charge on an abandonment until your last folks are out of the building. We would never do this, but if you had a 300-person office and two people were left, technically, you can't take the charge until the two people move out of the building. We would obviously not do that. We'd get it done faster. There might be a little bit of that that creeps into 2016, but by and large, we'll be done.
Okay. That'll be great. Then switching to the wholesale MGA segment. Clearly there's been some pricing pressure in property. I know through most of the year you've had pretty good flow still coming from the standard market to the E&S market that helps submissions. I'm hearing some inklings that that flow is slowing down a little. I guess, what are you guys seeing in the market?
We had a great fourth quarter. We killed it in the fourth quarter. We had a lot of activity. I'd say the property rate decreases really did affect us in the first and seriously in the second quarter, July 1, September, those tend to be big months. As we came into the fourth quarter and some of that property was behind us, we killed it. It was fantastic. Submission flows were up. Our hit ratios were up. Remember, we're the largest MGA in the U.S., and so those are many times small startup businesses around the country that are coming in. That's kind of a good sign for the economy. We are seeing small startup businesses that need cover. I'm very bullish, and we're excited about the acquisition pipeline in those businesses as well.
Okay. Thanks. That's helpful. Doug, on net cash provided by operations, could you give us some idea? We have it around $350 million in 2013. Is that going to be up materially in 2014?
I'd say at above $400 million in 2015. We can do $400 million worth of deals, mostly from our free cash flow. If we have to use a little stock, if we can go to $600 million of deals, we'll do that. By and large, we see our cash flows being pretty strong. The nice opportunities are that we're seeing global opportunities to use our cash in acquisitions. We're seeing nice opportunities in Australia, Canada, and New Zealand. Also too, on that point, one of the things we've talked about in the past, if you look at us from a global basis on our cash taxes paid, we're down to basically about 10% of our EBITDA overall. You can't use exactly the 10-Q or 10-K numbers because they had to have some estimated taxes.
We've done a really good job between our tax credits and our structure internationally. We're paying only about 10% in actual cash taxes paid as a percentage of our EBITDA. Cash flows are pretty good.
Okay. One thing. If dividends are running in the $200 million plus range, you have $400 million of cash flow, how do you have $400 million for acquisitions?
Well, I took the dividends out when I got to the $200 million. If you want to start with an EBITDAC number, 10% goes to taxes, about 10% goes to CapEx, about 5% goes to the cost of reducing our taxes, 25% goes to dividends, so to speak. You get down to about a 40% number of our EBITDAC number that's available for acquisitions.
Okay. Maybe we can talk more detail on that. I don't want to take up too much time, but that's helpful. Thanks.
Okay. Thanks, Adam.
Yep, bye.
Thank you. The next question is from John Campbell of Stephens. Please go ahead.
Hey, guys. Congrats on a good quarter and a good year.
Thank you, John. Appreciate it.
Absolutely. It looks like you guys used some of that at the market stock plan in the quarter. I think you've got about 166 or so remaining, in the balance of the, I guess, the next year or two. Just trying to get your thoughts on the program for the remainder of the year. Then Doug, is that going to be tied to the kind of north of $400 million acquired rev without using stock comment you just made?
A couple different answers to the question is that when we talk about using stock for acquisitions, we can either use the dribble out to bring the cash in and then push that out in an acquisition, or we can use stock directly to the sellers, depending on the structure. My commentary about maybe using 3 million-4 million shares in 2015 would include, we could choose to use the dribble out to do that, or we could choose to do it directly to sellers. They're inclusive of one another.
Okay. That makes sense. Doug, just two housekeeping items here. What was CapEx in the quarter? Maybe if you can give us a sense for what you guys are budgeting out for the year. Is a 35% tax rate a good starting point for brokerage for the year?
Yes to the last question. I think that in terms of CapEx, the general rule of thumb is whatever we depreciate, we probably spend in CapEx plus maybe 10% or 15% more of that number. That's kind of the way we budget our CapEx. I think that was your two pieces of the question, right?
CapEx in the quarter.
CapEx in the quarter. Hold on a second. Let's see if I can get that. Maybe $22 million? Yeah, $22 million.
Got it. Okay, thanks, guys.
Thanks, John.
Thank you. The next question is from Dan Farrell of Sterne Agee. Please go ahead.
Hi. Good morning.
Go ahead, Dan.
Just a question on your smaller M&A, the sort of 57 other deals that you do. How do we think about the margin of those deals coming on? I know you've talked about the larger ones having a higher margin, but when we think about smaller M&A, does that generally come on at the same margin? Is it a lower margin? As you bring it onto the platform, you can lift those margins up?
No, typically they pro forma maybe a couple margin points better than, let's say, our overall brokerage margin segment. By the time we put our employee benefit plans, on the smaller deals, there's not a lot of synergy opportunities, Dan, on the tuck-ins. The place where we get opportunities on the smaller deals is in our capabilities and resources that allows them to go out and sell more insurance.
Right.
Okay.
I'd say, in general, margins pretty similar to what we've got.
Okay.
Pro forma.
Yeah, they're in the high 20s, just like ours. We're in the 25, 20-something.
Unrestricted cash of $314 million at the end of the quarter, how much would you characterize as usable cash within that number?
I think it's about $200 million.
Okay.
Most of that's offshore at this point, as our acquisition opportunities internationally, there's $200 million there.
Okay, great.
Also in our balance sheet, since we're talking about it, is we do have credit carryovers of almost $250 million. Those are warehouse credits that we'll be able to use to reduce our tax rate going forward, too.
Does that factor into your previous comment that you're sort of, in reality, a 10% tax rate on the EBITDA? Do you factor that in when you think about it?
Right now, we're actually producing more credits than we're using, so we're actually warehousing some of the credits. The reason why is through 2015, a lot of those credits have a special feature with them that allows us to reduce our AMT down to about 8% or 8.5%. Those are special credits that it's okay to have in the warehouse, so to speak, but that will help us reduce our cash taxes paid going forward substantially.
Okay, great. Thank you very much.
Thanks, Dan.
Thank you. The next question is from Mark Hughes of SunTrust. Please go ahead.
Yeah, thank you. In the corporate segment, you described or suggested there'd be a step-up in 2016 in the contribution from the clean coal. Would it be similar to what we're seeing from 2014 to 2015?
Oh, I'd hoped to better that. I think it's a little early at this point to say, but we'd hope to see a betterment to what we're doing this year. If you really look at it, if you look at how these things work, we get plants up and running, we put them in service, and then we move them to different locations during the year. This is a year there'll be a lot of further work by the team, and we hope to get more of those plants online towards the end of 2015. You'll see the hard work that's going on right now will start paying in 2016.
To be clear, the clean energy-related contribution of $90 million stepping up to, say, $100 million at the midpoint for 2015, it ought to step up even faster in 2016?
Based on what we're seeing now, yes. That can change, but yes.
Then the 1Q guidance you give for Corporate, does that include some de-risking, which I presume would be non-operational, and you'd segregate that out when you report operating earnings? This does not include the de-risking?
There's no de-risking charge in the first quarter of 2015. There were non-cash gains in the clean energy line in the first quarter of 2014. We'll treat that as an adjusted item when we report our 2015 results. You should be able to see that on page 15 of the investor supplement where we take reported Corporate, we adjust for the de-risking, and for the non-cash clean energy step-up in basis gains, and then we give you 2015 on a comparative basis. We don't see step-up in basis gains in 2015, nor do we see a de-risking charge in 2015.
That rollover guidance you gave for the organic growth or to help us calculate revenue, does that include all of the deals you did through the end of 2014?
Yes.
Okay.
That is not just big deals, that's all deals through the end of 2014. Does not include any organic, nor does it include any 2015 mergers that we haven't closed by 12/31/2014.
Final question, did you give the organic growth in the benefits business?
The benefits business was north of 4% in the fourth quarter.
Thank you very much.
Mm-hmm. Thanks, Mark.
Thank you. The next question is from Bob Glasspiegel of Janney Capital. Please go ahead.
Good morning, Gallagher.
Good morning, Bob.
Question on currency. The numbers you gave us on the impacts for Q1 through Q4, those will be adjusted out. Those are not going to be in the adjusted earnings?
What we'll do, Bob, is typically when we present current year information, in order to make it comparable, we will make an adjustment to the prior year. When we get to 2015, we'll basically adjust 2014 to remove the currency impact as an adjusted item.
Well, I guess I'm not sure I followed the answer. Sorry. Is this going to be something we should factor in as a headwind in our adjusted operating earnings, or is it going to be neutralized?
Well, it depends on what you start. What I would do is I would take down the prior year 2014 by a few pennies and then project off of that. I said $0.01 in the first quarter, $0.02-$0.03 in the second, and $0.02 in the third. I'd drop down 2014 and project off of that because that'll be a new baseline for 2014.
Okay, I got to hit you offline on that. Are you factoring in both income statement and balance sheet? When you're given those numbers?
It's just the income statement effect. We don't have balance sheet changes that go through the P&L.
No assets overseas that get marked?
No, that goes through OCI.
Okay. Your severance charges and lease were heavy in the quarter. Anything specifically that was driving the $0.12?
No. Listen, if you look at the integration efforts that we've had. Are you talking about in the integration line, or are you talking about the severance and lease abandonment line?
The $0.12 for workforce and lease termination, $26 million, you said.
Well, actually, the $0.12 was in the acquisition integration line. We didn't have much in workforce and lease termination, $1.8 million.
Okay.
of course, it's the $0.12.
Got it.
of acquisition. Yeah, that's up a little bit from the guidance I gave in October by a few pennies. Largely, had an opportunity to push forward on a couple contract terminations, and we did have a nice move that we got taken care of, that allowed us to take a charge in the fourth quarter.
Okay, last question. Your dividend increase is a lot slower than your EBITDA per share growth, and you're issuing stock, so the shareholders are sort of getting less of the increase in earnings, understandably, because you're using the money for deals. Is that something we should sort of expect, or does the dividends and capital management start to march in line with the EBITDA growth at some point?
I think we'll probably keep that growth in dividend at a slower rate than EBITDA growth, depending on the deal pipeline.
The thought process behind that, Pat?
We took our dividends up substantially a number of years ago, Bob, you remember that?
Yep.
Got to a point where we kind of constrained cash with dividends. Still have the best yield in the business, have shared, I think, nicely with our shareholders our growth. When we had a slowdown in the Great Recession, we did not deduct any of that from dividend payment. I think as we build our capital plan going forward, we see ourselves being modest in dividend increase and continuing to be very acquisitive.
There's just a terrific opportunity for M&A activity right now, Bob. I think that as the baby boomers are getting closer to retirement, there's really a nice number of family-owned entrepreneurial franchises out there. We see lots of M&A activity that can be a good use of our cash.
Got you. Thank you.
Thanks, Bob.
Thanks, Bob.
Thank you. The next question is from Arash Soleimani of KBW. Please go ahead.
Thanks, good morning, everyone.
Good morning.
I just wanted to follow up again on the FX question. Just kind of making up a number here, if we were expecting, let's say, again, making up a number, $1 for 2015, does it make sense to take that down a few pennies for the FX and the adjusted EPS?
I think so. For the whole year, maybe $0.02 or $0.03, you're going to have the impact of last year. The real issue is the pound spiked up during the middle of the year, then fell off. The Canadian Aussie dollar just kind of had a trickle-down effect throughout the year, then kind of fell off a little bit as the Canadian dollar did in the fourth quarter. You get a little bit of this spike up and spike down during the year. I think that's probably a good way to look at it.
Okay. Yeah, in the press release, I think it says FX is excluded from adjusted, it sounds like the adjustment is made to the prior year numbers from what you're saying.
Correct.
Okay.
Yeah. We represent prior year to show the impact of FX it's comparable without currency movement.
Okay. That makes sense. Thanks. I know you talked about some of the rollover numbers from acquisitions. Can you just talk about the seasonality of revenues in those acquired companies and how that seasonality compares to Gallagher's historical seasonality?
Well, listen, if you roll them all up and you put them all together, actually, it accentuates our seasonality a little bit more. We were always a small first quarter company, and a lot of these transactions we've done have not, I would say, changed that much.
Okay. The first quarter of 2014 adjustment that you guys made, this might be, again, a better question for offline, but if I get to the net adjusted of $16.5 million that you have for the first quarter, on a per share basis, I can't get to that $0.06. Is there something else in there that could be impacting that?
All right. Help me, where are you?
I guess it's the corporate as adjusted page of the supplement.
Okay.
You start with $4.6 million as your net earnings for corporate in the first quarter. With the adjustment, it goes to negative $16.5 million. You have negative $0.06 as the EPS for that quarter in corporate adjusted. I guess that's page 15 of the supplement. Basically just on a per share basis.
Yeah, let me look at that offline.
Okay. That's fair. It's probably a better offline question.
Thanks, Arash.
Yeah, I appreciate the answers.
Thank you.
Thank you. The next question is from Kai Pan of Morgan Stanley. Please go ahead.
Good morning. Thank you for taking my call.
Good morning, Kai.
First question on the organic growth in U.K. and in Australia, New Zealand, Canada. Looks like overseas organics slower than you had in the U.S. Just wondering, is it just market environment over there, or if there anything in your control you can improve that organic growth going forward?
Well, I'll touch on some operating aspects and let Doug give you the numbers. I think what we're finding is when we put on a nice tuck-in acquisition anywhere in the world, that thing is integrated in nine months. They're hitting the ground running. Gallagher's helping them. Our resources are working, and they're selling more business. We do these larger ones like Heath, Bollinger. It probably takes 18 months till the troops have found the restroom. They know what they're doing. They know how to get to the resources. The resources are engaged, and organic growth is influenced by the fact that they join Gallagher. I think you have to expect that to occur in Australia, New Zealand, Canada a bit, and the U.K.
Also, to your point, the market is softer in Australia and New Zealand, a bit softer in Canada, a bit softer in the U.K. than it is in the United States. As Doug said in his prepared remarks, we're seeing almost no impact from market advances or declines in the U.S. domestic business. That's not true in these other countries. Doug can talk about the specific numbers. Yes, I do think that over time, as we have with our acquisitions in the United States, once they're integrated into Gallagher, organic growth does improve. You want to talk about the specific numbers? Yeah, look, I think that when you look at of the ones overseas right now, we're seeing nice net unit sales growth in Canada. We're having nice net unit sales growth in New Zealand.
Australia is a place where bringing our sales culture there will help us do that. Still they're selling some nice business there. In the U.K., we had really nice results out of the Oval acquisition. Giles was steady. I'm not seeing any particular weakness as I go around the globe on that.
Okay, that's great. There's a distressed situation, Towergate in the U.K. You said in the past you're not interested in it. I just wonder, given the situation over there, do you see organic opportunity from the competitors, such as hiring brokers or getting new business?
Well, Kai, we're always looking to hire good people into the organization, I would not say that that provides us any astronomical opportunity.
Okay, that's great. A number question for Doug. You just want to clarify, you said margin expansion from these large deals last year going to help you about 80 to 100 basis point. Is that for the full year or just for the first quarter?
That's first quarter.
Will that help the subsequent quarter as well?
Well, remember, by the time we get to the second quarter, every deal really will have been in our second quarter numbers of last year, except for Noraxis, which is the Canadian acquisition. Remember, we bought Oval on April 1st, so that was in our second quarter 2014 numbers. We bought Wesfarmers effective mid-June, but they have a strong June, so we picked up some of their numbers. Really, Noraxis, we closed on July 1st. The impact of the roll-in of the larger deals will pretty well be in our numbers. There might be a little bit of an impact in the second quarter, but I don't have that number in front of me.
Okay. Organically, you said that you expect no expansion in the first quarter. Is that right?
I think it's very hard for us to show organic growth, organic expansion, in the first quarter, given our seasonality.
Okay, you do expect some margin expansion in the latter half of the year?
Well, listen, I think that, depending on what organic is, we've said that anything above 3%, we might have a chance at it. Anything below 3%, it's hard work to remain flat. If you get negative, of course, that's hard to hold margins. We'll see where organic comes in, and we'll have a better feel for that at the end of the first quarter.
Great. Lastly, if I may, you have a terrific year in terms of number acquisition done. It seems like people are waiting to join the Gallagher family. I just wonder, do you see any increase in competition in terms of getting deals, in terms of just valuation? Because you're paying still, I think, pretty reasonable at six or seven times the EBITDA. I just wonder, is there increasing competition in terms of valuation for deals?
If you take a look at the size of those deals in the 57, I will tell you that there's competition for every single one of them, but it's not as fierce as it is when you get bigger.
Okay, great. Well, thank you so much for all the answers.
Thank you, Kai.
Thanks, Kai.
Thank you. The next question is from Scott Heleniak of RBC Capital Markets. Please go ahead.
Hi, good morning. Thanks.
Good morning, Scott.
I just want to touch on a couple questions first on risk management. The organic growth rate was higher than the overall growth rate for that segment. Just wonder if you could refresh me on the difference. Is that just currency then?
Say your question again, the organic growth was?
Was higher in risk management. It was 12.5%, but the overall revenue growth rate, I think, was 11.5% for that unit. The difference, is that currency then?
Yes, it is.
Yeah. Okay. I figured it was, just clarifying. Wanted to clarify on the risk management margins, the target you gave, the 16.5%, is that for this coming year, or is that just over time you're targeting that?
That's 2015 target.
Okay. The client retention, you mentioned 95% of risk management, which is very good. Can you compare that historically? Is that an all-time high, or how does that compare to previous years?
I'd say it's pretty similar.
Okay.
Over the last couple of years, it's probably up a point or two.
All right. Just a question on the recent move in commodity oil prices. Does that have any impact on your ability to utilize any of the tax credits you have? Is there any impact on that at all?
No, there's no phase-out based on oil prices.
Okay.
There is a phase-out based on coal prices. As oil comes down in price, so does coal. That actually helps us, we're a long way away from a phase-out in coal prices.
Okay. All right. Thanks a lot.
All right, thanks.
Thank you. The next question is from Paul Newsome of Sandler O'Neill. Please go ahead.
Good morning, congratulations on the quarter.
Thank you, Paul.
The first question, are you seeing claim count increases in your risk management business on a same store basis or account by account basis, or just?
Yes, we're seeing same stores or account by account up about 5%.
Given that it's mostly workers' comp, if I recall, that suggests that we've got a little bit increase in frequency of workers' comp.
I think we're seeing frequency and more employment. It's not that our customers are less safe, it's that they have more employees.
Excellent. I wanted to ask a little bit of a devil's advocate question. If we are indeed going into an environment where rate is pretty flat, why is that necessarily a good thing for a brokerage operation, which obviously all of them make a lot of high margins, when you could argue that much of what you provide is dealing with the volatility, the inherent volatility in insurance prices, which historically have been pretty volatile, and you need a lot of help to make sure you are on top of what was happening in the market?
First of all, Paul, our clients need a lot of help no matter what the rate environment. What you had in the past, historically, you get these hard markets where all hell breaks loose. You can't get the insurance. It becomes a seller's market. You basically make every single one of your clients unbelievably angry. When the rates start to settle down, your loss business goes up. When you're in a flat rate environment, you're not ticking off every single client because prices go crazy. You've got a reasonable request for increases if, in fact, their losses have not been good. You can help them cope with their loss situation and improve their pricing by reducing loss, and you don't have somebody show up who's a one-off broker with a 25% decrease in the cost of the program. Now we're all on a level playing field.
Base costs are about the same. That's why my comments are, now it becomes an expertise game. Who do you want to hire? You want to hire the Jones agency down the street that has a really nice guy that plays golf with you on Saturdays but really doesn't have any expertise, or you want Arthur J. Gallagher that has literally hundreds of capabilities behind us to help that client regardless of what their business is and regardless of where they want to play in the world. Give me that opportunity without having rate declines of any substance, I will outsell my loss business, and I will not have to factor in rate decreases, and we will do extremely well.
Thanks for the answers, guys, and congratulations on the quarter.
Thank you, Paul.
Thank you. The next question is from Joshua Shanker of Deutsche Bank. Please go ahead.
Yeah, Hank, I apologize. Joining a little late, given my notoriously byzantine questions, I can't imagine anyone's asked them yet. The first question is to think about acquisition pipeline for 2015 and your debt to capital ratio. Is there any difference in how you think about paying for deals with cash, whether cash on hand versus cash with debt issuance or paying with equity?
Yeah, of course, we always think about that. I think this year is that we're kind of targeting a debt to EBITDAC ratio of 2.5x by the end of the year. Our free cash flows, it does leave us some more borrowing capacity towards the end of the year, too. We're issuing a lot of debt this year, I don't see us using a lot of stock this year. Our pipeline is good right now. The multiples are reasonable out there's just lots of nice franchises that are coming up. For us to do 50, 60 deals again in 2015 at a nice revenue multiple, like this year was $4 million, I think, on a size deal.
It looks like that we can buy $200 million-$300 million of revenue with cash and maybe just a smidge more debt by the end of the year. Obviously, if the appetite's bigger than that, we can use some of our shares. Right now, when you can pick up nice franchises in the 6 to 7 multiple range, I think that's a good opportunity for us.
Like Pat said, it brings some terrific resources to us, some great niche players that have some great niche. It will fit well in our niches, fit well with our product set that we have, some nice programs. There's some really nice opportunities out there right now.
Okay. Switching gears a little bit, looking at the investment income and book gains line, do you happen to know the number for book gains?
Yeah, it's on page two. The book gains were 4.7 in the quarter.
That's kind of what I guessed.
Yeah.
If I look at that and I look at last quarter, the yield on fiduciary assets seems to be close to 2%. Am I crazy or I mean, that seems fantastic.
Well, I can't speak to whether you're crazy or not, but I could probably do some math here while we're on the phone. Let me work on that and see if I can get back to you. I think that we are seeing We do make some nice money on our fiduciary funds in Australia and New Zealand, where yields are a little bit higher there. That could be influencing a little bit, but let me see if I can do the math and get back to it. You did see the premium finance note on page 12. If you take out, maybe that's what you're looking at. If you take out the investment income on our premium finance business, maybe that'll produce a different math for you.
I think we did it, but we can continue to play around with it.
All right. Let me just look at it here while we're talking.
That's it.
Great. Thanks, Josh.
Thanks, Josh.
Thank you. As a reminder, ladies and gentlemen, it is star one if you would like to ask a question. The next question is from Ken Billingsley of Compass Point. Please go ahead.
Good morning. I just wanted to follow up on adding more plants in 2015. Can you talk about how the impact of regulatory changes and I guess, until the last few weeks, a more milder weather, the impact that it's going to have on maybe the projections that you had initially set out for plant expansion and maybe what would create a slowdown in those expansion plans?
All right. First of all, regulatory changes on the appetite for coal in the U.S. There's no new news in this. The fact is that most of these plants run till 2021. It takes a long time to take a plant offline, should a utility decide to do that. I just don't see a major disruption by utility because of regulatory changes taking any of our clean energy plants offline. If they were to do that and shut down a utility, those plants are portable, and they can be moved to another utility that hasn't shut themselves down on that. Moving the plants around is an option. I don't see threats by displacement of substantial amounts for natural gas in a lot of our plants that we use.
Frankly, when we sit there and pick plants, we're talking about 33 machines, with an opportunity of thousands of boilers at plants around the country. Most of the places that we put them in, that we have a long-term view of the utility's appetite to continue to run the plants through 2021. That said, we will get a plant from time to time that decides to shift to natural gas, and we'll take it down and we'll move it. That's why we'd rather own a portfolio of 33 of them than own maybe 40% or 50% of those versus own 100% of 15. There's some nice diversification aspects of that. I don't really see the risk that you highlighted there as being a reason why we wouldn't get more plants up and running in 2016.
Okay. Regarding the natural gas, are these alternatives that are in place using natural gas, or is this infrastructure that they have to build out?
Most of them would have to build out substantial infrastructure, and then also just getting the gas to the plant in such volumes. There are some plants there that you'd have to have some pretty big pipes going across a long range in order to get natural gas into these plants. The rail lines are there. The coal's been coming in for decades. Moving that's a big move by the utility plant. They would have to do it. A smaller plant that's not running that many tons, they might be able to pump enough gas into it, but then they got to retrofit their burners. It's not an easy thing for them to convert to gas, and it takes a long time. We have proactive conversations with the utility managers on this.
We have insights into what they're going to be doing with their plant, and we don't see big threats from that right now.
As in most of your plants, the 33 that are in place, coal is the primary. There's not another alternative already in place there now.
That's correct.
Okay. Thank you.
Thank you, Ken. Thanks everybody for being with us this morning. Appreciate you being on the call and thanks for your questions. I think that it's fair to say that we just finished with an incredible year, and I couldn't be any prouder of the team and what we accomplished. We just accomplished an awful lot in 2014, and I'm looking forward to continuing our growth journey in 2015. Thanks for all of you being with us today and have a good rest of the day.
Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.