Good morning, welcome to Arthur J. Gallagher & Co.'s conference call to review the acquisition of Noraxis Capital Corporation. Participants have been placed on a listen-only mode. Your lines will be open for questions following the presentation. Please limit your questions to the subject matter of today's call, as questions on other subjects will not be addressed. 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. Examples may include statements regarding our plans for future acquisitions and our expected results following the Noraxis acquisition. These forward-looking statements are subject to certain risks and uncertainties described in the company's reports filed with the Securities and Exchange Commission. Actual results may differ materially from those discussed today.
It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President, and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin.
Thank you very much. Welcome, everyone. We appreciate very much your time this morning. Thank you for joining us. I will not read our press release or the deck that we sent out with it. I think that in that release, we laid out our rationale for the Noraxis acquisition very clearly. What I really want to do this morning is briefly add some flavor to what we put out yesterday. First and foremost, we are incredibly proud to be able to welcome Ken Keenan and the Noraxis team to the growing Arthur J. Gallagher family. I want to tip my hat to our people on the international side, who did just a terrific job of working with the Noraxis team to lay out what is going to be, we believe, a very exciting future.
Stephen Hester, the CEO of RSA, and the RSA team has assembled a group of brokers who we believe represent the finest group of professionals in the Canadian market. They know how to sell and grow organically. This is a freestanding organization who are completely compatible with Arthur J. Gallagher & Co. Our DNA is incredibly similar. We are brokers run by brokers, and we believe this is one of those transactions where one plus one can equal five. The culture is a strong fit. They have a very strong sales culture. They are seasoned insurance producers and professionals, and this will be a great merger of teammates who will bolster our global capabilities, adding tremendous firepower to the many specialty niches that the company's building out. This expands a geography we've been prospecting in for years.
As many of you know, we already have eight offices across Canada, and this gives us a much stronger platform. It makes our existing Canadian teammates stronger. This gives us better relationships with our insurance company partners and adds thousands of new clients to the Gallagher client list. We've learned that to be a credible merger partner for the many smaller brokers we like to partner with, we have to have a platform from which to do that, to do the bolt-on acquisitions that we're so good at. This is the platform we needed in Canada. In the last three years, we've expanded in the U.K. and built a platform there. What we believe will be the best platform, we will have the best platform in Australia and New Zealand, and now we have our Canadian platform from which to continue to grow.
Doug will talk about the financial terms, just let me say that for the foreseeable future, we will return to bolting on smaller brokers to the platforms that we've acquired. Doug?
Thanks, Pat, hello, everyone. When we look at this transaction from a financial perspective, it met our criteria on all financial fronts. First, actually this is always our first financial consideration, these are entrepreneurs that know how to sell insurance and make money. They run great businesses and post great margins, and they consistently demonstrate the ability to grow both organically and through mergers. Second, we really like the spread and mix of business. It has good spread across five provinces and 23 locations, a good diversification of clients nicely in the middle market and even the smaller market for that matter. It's spread across many different industries, and production is spread across a large number of producers. There's really good spread and mix of business. Third, we see low integration risk.
This is a business that has operated separately from RSA, yet it has the financial, operational, and compliance discipline that comes with being a subsidiary of a publicly traded company. We will add cost to integrate their back office systems into Gallagher systems. This is work we know very well and is not disruptive to selling insurance. Additionally, RSA is only about 18% of the marketplace, and Noraxis has not been receiving any specialized products or rates. That said, we look forward to continuing to be a great trading partner both in Canada and the U.K. around the world with RSA, we don't see any bumps in that road ahead. Fourth, they have a tremendous deal pipeline. Now they are a broker owned by brokers, we believe more and more Canadian agents and brokers will be receptive to our merger discussions.
Finally, we paid a fair price, and we will pay for it using existing cash, our line of credit, and additional long-term borrowings. It's accretive on all measures. Additionally, as we repatriate earnings into the U.S., that will allow us to use more tax credits, which adds a nice sweetener. We checked all the financial boxes. We are excited to join forces with our new Canadian partners. Back to you, Pat.
Thank you, Doug. Operator, I think we'll go right now to questions and hopefully some answers.
Thank you. The call is now open for questions. If you have a question, please pick up your handset and press star 1 on your telephone at this time. If you are on a speakerphone, please disable that function prior to pressing star 1 to ensure optimum sound quality. You may remove yourself from the queue at any point by pressing star 2. Again, that's star 1 for questions. Please hold while we poll for questions.
Our first question today is coming from Charles Sebaski from BMO Capital Markets. Please proceed with your question.
Good morning, and thanks for taking my call.
Sure. Thanks, Charles.
Just a question on the margins and, in the makeup of the business, where are they coming from, in the commercial versus the personal lines and the persistency? It's just, the margins seem incredibly high on an EBITDA basis, which is great, but just some more color would be appreciated.
Yeah. Thanks, Charles. Their margins are strong across all of their businesses, and we see that as very typical in the Canadian marketplace. There's not one particular area necessarily that stands out in terms of margin. I think the opportunities up there for us to really, if you look at the synergies we're proposing, there are not that many synergies that we're proposing, or not that much in terms of additional EBITDA from that, relatively speaking. It shows you they're well-run, very well cost-controlled, and it's just the nature of the Canadian marketplace. We're seeing that across other opportunities we're looking at there also on smaller deals.
Just on organic basis, how does this business look on an organic perspective? I guess, when I saw the 2015 revenue projections versus the 2013 actual, it seemed relatively even. Maybe I missed that, but it didn't seem that there was a lot of growth projection in the '13 to '15 numbers.
Organic has been running very similar in Canada as it has in the U.S. We're seeing that in the low single digits, mid-single digits level. In terms of the expectation for 2015, I think we've been a little conservative in that. We think it's got growth opportunities very similar to what's in the U.S.
I appreciate it, and I'll turn it over for the other folks.
Thanks, Charles.
Thanks, Charles.
Thank you.
Thank you. Our next question today is coming from Dan Farrell from Sterne Agee. Please proceed with your question.
Hi, good morning.
Good morning, Dan.
Good morning. Just a couple things. Is there any meaningful seasonality to think about as we think about modeling this? Also, can you give us a rough sense of what amortization and depreciation from this would turn out?
Yeah, Dan. Actually, this business is interestingly, if you really look at all the deals we've done lately, they're strongest in the second quarter, and then weakest in the first quarter, and then the third and fourth quarters are not too terribly different. In terms of the amortization and depreciation with respect to this deal, maybe what I should do is just give it to you for the second quarter. Assuming we don't close Noraxis until, let's say, July 1st, and let's say we don't close Wesfarmers until June 30th or July 1st, we're looking at depreciation for all of Gallagher of about $11 million in the second quarter and amortization about $41 million per quarter.
In terms of the actual Noraxis, again, you're seeing if you just assume about 1% of the purchase price per quarter, that's a fairly conservative estimate, and we see that coming true with Noraxis also.
Okay.
It'd add $3 million to $4 million of amortization alone. Basically, for all of Gallagher, it'd be $11 million of depreciation in the brokerage segment, I'm sorry, and $41 million of amortization in the second quarter.
That's very helpful. I had a question regarding Noraxis employee benefits business. That's their smallest piece, and I think you guys highlight that that was concentrated sort of in one area. I'm wondering how you think about the growth opportunity in the Canadian market for that business. You highlighted being able to expand into other geographies. I'm just wondering also, is some of your knowledge and capability in your employee benefits business, which you've invested in quite a bit, is some of that transferable up there as well in helping to expand that?
Dan, this is Pat. We're very excited about this. We've been building out in Canada with smaller acquisitions in the benefits space now for about the last three to four years, this is going to give us another nice shot in the arm. Yes, some of the capabilities that we've both acquired and built out organically across the United States will be applicable in Canada, we think there'll be some great cross-selling opportunities.
Okay. All right, great. Thank you very much.
Thanks, Dan.
Hey, Dan, just since I'm there, as you roll forward, you're looking at about $14 million of depreciation in the third quarter and about $47 million of amortization at third quarter, too, if you're looking for third quarter numbers.
Thank you. Our next question today is coming from Jay Cohen from Bank of America. Please proceed with your question.
Yes, thank you. I guess thinking geographically, you've now built a pretty big platform, and you will be building a bigger platform in the U.K., Australia, New Zealand, Canada. When you think out, not this year, but in the future years, where geographically do you need to now make the next investment or build the next platform?
First of all, I think from a platform standpoint, Jay, this is Pat, I think we feel like we're in pretty good shape right now. We have found, going back to the Heath transaction in the U.K., that once you've got credibility in a geographic market, you can in fact find the smaller brokers that'll believe you're committed to that market, and you can bolt those on. I believe that we're pretty well complete. We've liked the fact that we've built out in English-speaking locations. As you recall, we do have a 21% investment in our Mexican partner.
The Latin American business, there's just not that much premium down there. Really, we see the opportunity. When we complete Wesfarmers, we'll have a 5% share of the Australian market, and we'll be one of the biggest firms in the market. Tons of fragmented broking being done in Australia, lots of opportunities to bolt on there. Similar in the U.K. and now in Canada. You add that to what we've been very successful with doing in the U.S., which is a high number of smaller, in many instances, family-owned or individual entrepreneurially-owned businesses into our company, having those people stay with us and continue to build out the company organically. We think we've really done a good job of spreading our wings.
True. Let me ask you one other question. I don't know the Canadian distribution that well. Is it as fragmented as what we see in the U.S.? Can you give us some level of what the structure of the brokerage business is like in Canada?
Well, the big players there, of course, are Hub, Aon, and Marsh, and we'll be now one of the top 5 in the market. To answer your question, yes, it's a very fragmented market.
Not that dissimilar than the U.S.
Correct.
Great, Pat. Thank you.
Thanks, Jay.
Thank you. Our next question today is coming from John Campbell from Stephens. Please proceed with your question.
Hey, guys. Good morning.
Good morning, John.
Good morning, John.
Doug, you touched on organic growth trends. I think you said recently in that low to mid-single digit range. I saw in the presentation where you guys mentioned, the expectations for upward pressure on rates in that Canadian market. I think you guys pointed to underwriter performance and then some cat events. Just my question here is, if you guys could just talk a little bit about that rate environment, what you're seeing there, and then maybe what that can mean for organic growth over, call it, the next several years, assuming that, it's just a general shift in the pricing cycle.
Yeah, actually, John, great question. I would say that it's not all that dissimilar to the U.S. I don't think property is quite as soft in Canada as what you're seeing maybe as in the U.S. right now in coastal exposed areas and everything. I think that by and large, the rationality of the carriers, I think that the state of the market there isn't dissimilar to the U.S. Probably the easiest way for you to think about it is just to think about it as like the U.S., but maybe coming into just slightly more of a firming spot than, maybe it's like where the U.S. was a year ago, something like that.
Great. Pat, you touched on this in your prepared comments, but on the M&A front, would it be accurate to say that you guys are now looking smaller and international versus few and large like we've seen over the past maybe two years?
Yes.
Okay, great. Thanks for taking my questions, guys.
Thanks.
Thanks, John.
Thank you. Our next question today is coming from Meyer Shields from KBW. Please proceed with your question.
Thanks. Good morning.
Good morning, Meyer.
Just to follow up on that last question, is that because you've got enough to worry about now or because there are fewer big properties available?
It's really, frankly, if I could've spaced the deals out that we've done at a little bit longer spacing, I would've, but you have to be prepared when these transactions are available to make your move. Frankly, we've kind of cleaned the cupboard. There aren't that many large ones out there left to be looked at right now. We never stopped, even though we were doing some of these more sizable transactions over the past year, two years, we've never stopped our prospecting and our continued efforts to attract smaller brokers into the fold. That's where our pipeline is very strong.
Okay. That's helpful. Let me ask this differently. Is there any change in the arrangements that you have with RSA following this deal, or is that component of your operations staying constant?
No, it'll be the same.
Yeah, Meyer, we don't have any protected products. We don't have any family rates or anything. The producers up there have been selling on a competitive basis. RSA has been treating their folks the same as they've been treating everybody else. We see that going on. We have a tremendous trading relationship with RSA in the U.K. We expect that to continue in Canada and even get stronger.
Yeah, I would say that this transaction will help that relationship strengthen.
Okay, fantastic. Thanks so much.
Thanks, Meyer.
Thank you. As a reminder, if you'd like to be placed in the question queue, please press star one on your telephone keypad. Our next question is coming from Quentin McMillan from Morgan Stanley. Please proceed with your question.
Hey, Doug and Pat, thanks for taking the time, and congratulations on the acquisition. Just had a quick question in terms of the $0.03 of additional synergy coming off the tax credits. Just wanted to kind of follow up to understand the 17% tax rate, if that's sort of as low as you guys expect that that could be or if there's additional potential upside on that, and what we should think about kind of going forward for that.
Great question, Quentin. There are two things. Let me step back for just a second. One of the great things, though, too, is this is a business that pays 27% tax, not 35% tax in the U.S. First and foremost, just the Canadian business itself, by itself, pays about a 10 point less in income tax. When you look at the multiple, that influences that on an apples-to-apples basis. When you get into the ability to repatriate money and bring it back into the U.S. and then use more tax credits, that is where that additional $0.03 of earnings arises. We will move money out of Canada into the U.S. Sure, it is a higher tax rate in the U.S., but then we will use more of our tax credits to reduce our taxes payable on it.
In answer to your question, yeah, it creates additional opportunities for us to keep more of our tax credits rather than not producing or selling those tax credits, actually selling the plants or portions of the plants. We see this as an opportunity to use more of our tax credits. We also are just excited to be in the Canadian market. The 17% rate, the low end, I do not know. We will have to take a look at that. We are always looking at Globally, I would like to be somewhere in the 10%-15% of tax rate globally. 17 might be a little bit on the higher end of it. Overall, if we can do some hard work over the next couple of years in our structure, maybe we can get it down a little bit less than that.
Great. Just one quick follow-up on that as well is, I apologize for moving off the acquisition. If you want to take this offline, it is fine. When do the tax credits finish up in terms of you are trying to pull in and use as much as possible right now? How long do we have before that is not going to be available to us?
Well, there are two answers to that question. We have the ability to generate tax credits through the end of 2021 for the lion's share of our more recent plants. That is generation. Those actually have a carry-forward capability. We could end up, let us say, over-generating credits between now and 2021. That would give us a glide path maybe into 2023, 2024, 2025, something like that.
Great. Thanks so much, guys, and congrats again.
Thanks, Quentin.
All right. Thanks, Quentin.
Thank you. Our next question is coming from Ken Billingsley from Compass Point. Please proceed with your question.
Yeah, good morning. Just on the financing of the transactions, I'm assuming this is new long-term borrowing, not any that's left over from prior transactions.
We have some available cash. We have availability on our line of credit, and we are looking at some new long-term borrowing alternatives. It'll be a mix of those when we get done with it. I think for purposes of our calculations that we show here, we've assumed all new long-term borrowings for purposes of creating the accretion schedules. Should we decide to use more of our line of credit, then obviously it'd become more accretive.
To follow on the $0.07 there. The accretion of $0.07 in 2015 assumes, so what you just said here is all new long-term borrowings.
That's right.
Be reduced. I'm assuming that that is after synergies and before integration costs.
That's correct.
Okay. Very good. Those are my only-
All right, thanks.
Good. Thank you very much. Thanks, Ken.
Thank you. We've reached the end of our question and answer session. I'd like to turn the floor back over to management at this time.
Thank you very much, operator. Thanks again, everybody, for being with us this morning. We really appreciate it. I think you can probably tell that we are very excited about the company that we're building. I want to thank our new teammates up in Canada for choosing to join Gallagher. We're excited to have you aboard, and we look forward to a great future together. Thank you very much, everybody, for being here this morning.
Thanks, everyone.
Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation.