Good morning, and welcome to Arthur J. Gallagher & Co.'s fourth quarter 2011 earnings conference call. Participants have been placed on a listen-only mode. Your lines will be open for questions following the presentation. If you require operator assistance, press star zero on your telephone keypad. As a reminder, 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 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, Jr., Chairman, President, and CEO of Arthur J. Gallagher & Co.. Mr. Gallagher, you may begin.
Thank you, Rob, and thank you everyone for joining us this morning on our fourth quarter conference call. Pardon me. I appreciate you being here. We're sitting here in beautiful 45-degree weather in Chicago. A year ago, we were settled under 22 inches of snow. 2011 was a great year. We finished, I think, with a very strong fourth quarter. At the beginning of 2011, things still looked to be really tough out there. During the year, we continued to build significant momentum, which culminated in a very strong finish to the year. I'm proud of our team's performance in the quarter and last year, and I want to cite some key highlights for the group this morning. All of our operating divisions across the entire globe contributed to our profit growth this year. Brokerage revenue on an adjusted basis was up 22%.
We're back with positive organic growth at 5.2%, which is really good work. I'm pleased with those results. Remember, in 2010, our organic revenues were down 2%, so a 7% turnaround is great work by the team. Adjusted EBITAC up 27%. If you look at that organic growth, it's a very simple calculation. We essentially had flat rates for the fourth quarter. We had a flat economy, zero really decline from the economy, the organic was made up of new business, less our loss business. Our risk management segment, adjusted revenues up 13%. Our organic growth was very strong at 12.6%, which Doug will make some comments on in a moment. Very good work by the team. Adjusted EBITAC in the risk management segment up 22%. During the year, our merger and acquisition activity, we had a record year. We purchased $277 million of additional revenue.
During the year, we did our largest acquisition ever, which was Heath in the U.K., which is integrating very well. We finished in the risk management segment, integrating the GAB acquisition. All those clients are now up and operating on our claim system, our client retention is very strong. 2011 adjusted EBITAC with our brokerage and risk management segments combined, we broke through the $400 million mark at $428 million. 2011 supplemental commissions and contingents came in over $94 million, which is outstanding work by our field management team. New business was strong throughout the year, especially strong in the fourth quarter. We finished the year with 12,000 colleagues and over $2 billion in revenue. During the second half of 2011, we finished 15 more clean coal plants that will contribute significantly to after-tax income in 2012 and beyond. Total return to shareholders in 2011 was 20%.
If you go back to January 1, 2008, what we view as the start of the Great Recession, total shareholder return is 70%, including our dividend. Our board of directors increased our quarterly dividend 3% at the last meeting. All in all, just a great year. I am very proud of our team. I think everyone contributed from all over the globe. Let me highlight three particular points that I'd like to add some color to. Those would be the property casualty rate environment, our economy, and mergers and acquisitions. I'll start with the PC rates. The Council of Insurance Agents & Brokers survey came out last week. It shows small accounts up 3.1%, medium accounts rates and cost going up about 3.5%, and large accounts about 1.8%, which averages out to 2.8%. That's pretty much exactly what we're seeing. There are some exceptions.
Catastrophe exposed property, especially the big wind exposed accounts, are virtually in a hard market. In some instances, we've seen 100% rate increases. Property in general across the board is increasing more than the 3%. Work comp as a line of coverage needs significant rate adjustments, especially in California, Illinois, and New York. Management liability, directors, officers, et cetera, in particular in the middle market, is showing some firming. I think it's fair to say, in general, carriers are resisting decreases. Having said that, I'm not declaring a hard market here, a great account with a good loss record, one that hasn't shopped every year, is likely to receive a very competitive proposal. Secondly, on the economy, I'm not an economist, but my own anecdotal evidence as I travel our network shows that our clients' businesses are improving.
I've talked to a number of clients across many of our offices, whether it's a small contractor or a medium-sized manufacturer, their businesses appear to be improving. We are actually seeing some additional premium audits. Finally, in mergers and acquisitions, as I said already, 2011 was a great year. Our pipeline remains very full. It does look like capital gains tax rates may reset in 2013. We think we're going to see a continued strong interest in joining our firm. I believe 2012 has all the potential to be even a stronger year than 2011. As I've already said, rate reductions appear to be over. Organic growth is back after three years of reductions. The economy does appear to be improving. Our merger and acquisition pipeline is strong. Most importantly, our team is incredibly energized. We're winning way more than we're losing.
We're focused, we're turned on. The team is producing. We have a strong new business culture. Everyone, from myself through the entire organization, is involved in serving our existing clients and producing new accounts. We all realize nothing happens until someone rings the cash register. Doug?
Thanks, Pat, and excuse me. Good morning, everyone. It's really nice to wrap up 2011 by delivering excellent financial results. Today, I'm going to flip through the earnings release like I do, I'll give you some flavor on a few items and help you with some of your thinking as it comes to building your 2012 model. Okay, on the first page, looking at the brokerage segment, the big item is the Heath Lambert integration cost of $0.04 per share, which is in line with what we were expecting. Looking forward to 2012, we anticipate about $0.08 of integration costs for the year in 2012, then about $0.04 in 2013. Staying on the first page moving down to risk management, as we forecasted in the third quarter call, we had about $0.01 of integration costs related to wrapping up GAB Robins.
We're done, we don't expect any integration costs in 2012. I'll also echo what Pat said earlier. The GAB Robins deal really turned out to be a nice deal for us, we have lots of positive thoughts about Heath going forward, too. Flipping to the organic revenue table on the second page for the brokerage segment. As you model 2012, please apply your organic growth pick to only the commission and fee line. Please think about supplementals and contingents separate from core commissions and fees. At this point in the pricing cycle, we are not expecting supplemental and contingents to go up in 2012. Holding them flat in 2011 should be viewed as good work in this environment. Flip to page three, to the brokerage segment margin table. Posting margin expansion this quarter is consistent with what we've been telling you.
If organic is over 3%, you'll see a bit of margin expansion, assuming a low inflationary environment. Below 3%, don't expect margin expansion. Also, one other important modeling point for 2012. Because our first quarter is seasonally our smallest revenue quarter Heath Lambert is also seasonally smallest in the first quarter, please do not expect any margin expansion in the first quarter of 2012. Moving to the bottom of page three to risk management organic table. We've added a line at the bottom of that table that shows you organic without both the performance bonus revenues and without the New Zealand earthquake claim settlement revenues. Effectively, that is organic for core fees. We think that's a better number to focus on because performance bonus revenues can be lumpy, we've been discussing that the New Zealand earthquake claims will begin to dry up later in 2012.
When modeling 2012 revenues for risk management, apply your organic growth pick to the fee line only. Next, assume between $2 million-$4 million of performance bonus revenues per quarter. Finally, grade down the New Zealand earthquake revenues from about $4 million in the first quarter to about $1 million in the fourth quarter. That should get you close. Turn to page four. I want to spend a little time on how we are viewing margins for the risk management segment. You've heard us say before that we are targeting adjusted EBITAC margins between 15%-16%. We've essentially hit the upper end of that range for the last two years, we hope to hit that again here in 2012. Let me explain why you shouldn't model margin expansion in this segment in 2012. First, remember the business model.
As claim counts grow, we need to hire more adjusters. Accordingly, as a general rule of thumb, 20%-25% of incremental revenues hit the bottom line. If you do the math, you'll see that organic growth before 5% would not move overall margins much at all, especially if you factor in a bit of inflation. Even organic growth between 5% and 10% doesn't have that much impact on margins, again, if you contemplate a little bit of inflation. Second, also contributing to a flattish margin in 2012 is our risk management team is planning to invest about $5 million during 2012 to improve our service offering to our clients. Two examples include developing predictive models focused on medical management and fraud detection. Another example is building some new litigation management and return to work tools.
We think these client centric investments will help us improve our retentions and attract new customers over the long haul. Let's flip to page five for a minute, and then I'll come back to the corporate segment on page four. On page five, we provide a detailed update on all of our clean energy investments. In a nutshell, we successfully built and placed in service all 15 of the 2011 era clean coal plants in the fourth quarter. Five of the new plants are burning coal under long-term contracts. We've got an agreement in principle for another plant, and we're making headway on deploying the remaining nine 2011 era plants and the remaining two 2009 era plants. It will take most of 2012 to get most of the other plants deployed, but progress is encouraging.
Also, it's important to note that the quarterly earnings estimates we provide on page five are ultimate run rate amounts. There will be some operational tweaking that happens during the first half of this year. We don't expect to hit those numbers immediately out of the gate here in 2012. Also, near the bottom of page five, we've added a paragraph about forecasted earnings from our 42% investment in ChemMod. Recall that ChemMod is the entity that owns the technology recipe used in the clean coal plants that we built and is also being used in plants built by other unrelated parties. As of today, we believe we could earn $2 million-$2.5 million of net after-tax earnings per quarter from ChemMod.
Looking forward, as we deploy our remaining plants into long-term contracts and other unrelated licensees do the same with their plants, we expect our earnings from ChemMod to grow, but we are not in a position at this time to make an estimate. All right, with that on the clean energy, let's turn back to page four and look at the corporate segment. We believe that the best way to view the corporate segment is a shortcut table we put on page four. Looking back, as for the fourth quarter, the interest line, clean energy line, and acquisition line came right in where we forecasted in our October conference call. The corporate line beat by $0.02, and the legacy investment line beat by $0.01.
The beat on both of those lines was because we favorably resolved some tax positions in the fourth quarter. You should view that beat as one-timers. Looking forward to 2012, here's what you should model for the corporate segment. The numbers I'm going to give you here are net of tax, so the right column in that table. Assume about $7 million of interest in banking costs per quarter. Assume about $1 million of acquisition costs per quarter. Assume about $2.5 million of corporate costs per quarter. Assume about $9 million of clean energy earnings in the first quarter and grade that up to about $17 million of earnings in the fourth quarter. I wouldn't assume anything for legacy investments at this point. When you get done with that, fact check what you end up with.
You'll end up with a corporate segment that should about break even in the first quarter, show about $0.02 of earnings in the second quarter, $0.04 of earnings in the third, and $0.06 of earnings in the fourth. Clearly, a lot can happen to cause those numbers to change, but that's our best guess based on what we know now. For my last comment, just a reminder that our first quarter seasonally are our smallest. Once again, I really encourage you to convert your models to closely follow our financial supplement that we post on our website. When you do, please make sure you're using the adjusted numbers as your baseline for projecting future results. There's not that much difference between reported and adjusted in the first quarter of 2011, but there are significant differences in the last three quarters.
Those are my comments. The team did obviously a great job closing out 2011. I'm looking forward to 2012. Back to you, Pat.
Thank you, Doug. Rob, we're ready for questions and answers. Hopefully, some answers.
Thank you. The call is now open for questions. If you have a question, please pick up your handset and press *1 on your telephone at this time. If you're on a speakerphone, please disable that function prior to pressing *1 to ensure optimum sound quality. You may remove yourself from the queue at any point by pressing *2. Again, that's *1 for questions. Our first question is coming from Yaron Kinar from Deutsche Bank. Please proceed with your question.
Hey, good morning, everyone. Congratulations on a great quarter.
Thank you, Yaron.
I have a question. Maybe the first question would be on kind of the P&C markets and exposures. Listening to a lot of the underwriters, seems like they're expecting additional improvements, and we're already at roughly 2%-3% rate improvement. I think, Pat, you had mentioned in the past that you were expecting kind of very slow and modest but longer-term improvement in this cycle. Do you still see that as the case? If rates actually do improve more than, let's say, the 2%-3% rate improvement that we're currently seeing, do you think that's going to start hurting your client's ability to buy insurance?
Yeah, Yaron, I think you raise a great question there. What we're seeing at the present time is, in fact, the 3%, 4%, 5%, 6% increases, where accounts have hurt underwriters, you can see more than that. In fact, where the market is hard, as I mentioned, in catastrophe-exposed, wind-exposed property on any of the coasts, we're seeing exactly what we predicted. If the rates are up 100%, they're dropping coverage is 50%. I mean, we do not think that our clients in this economic environment can take a spike recovery as we saw in 2001. We are in fact seeing a kind of a slow, steady increase in that 3%-5% area. It's interesting. I've been to a number of our production meetings across the country. There have been times when carriers have asked for an increase.
We've said, "This doesn't seem warranted." We've gone out to the market and, in fact, bound the coverage back with the originating carrier. Rates are moving up slowly, but they are steady. It's across virtually all geographies and most classes of business, with some additional costs for property and some of those other areas I mentioned in my prepared remarks. We don't think that the economy and the clients can take a big spike.
Okay. With that in mind, looking forward, should we expect mid-single-digit organic growth in brokerage? Now that you're also facing a little bit of a more difficult prior year comp as opposed to the last couple of years?
Well, let me put it this way. If I get a flat economy and flat rates, you see exactly what the organic was in the fourth quarter. We're a new business machine. That's what we do every day. Every single one of us gets up every day and thinks about taking care of the clients we've got and getting new ones. If I don't have the headwinds of a bad economy, think about that, 2008, 2009, many of our businesses lost 50% of their business. If I don't have a 5%-6%-7% rate decline, yes, I will maintain organic growth.
Okay. Then, maybe one final question, again, on brokerage. You talked in the past about how anything above 2% organic growth, you should see some modest margin improvement or more. I guess I was just a little bit surprised that with 5% organic growth, margins only improved by 50 basis points.
This is Doug. I think actually we improved basis points in the fourth quarter, 140 basis points. If you exclude the Heath Lambert acquisition, we improved it 70 basis points, if you include Heath Lambert, which we know has lower margins. A point to a point and a half with 5% organic growth, that hangs together pretty well.
Let's get this straight. What Doug's been saying to the street forever is 3% organic, no margin expansion.
Right.
Not two.
Okay. The Heath Lambert, I did not factor that in. That's a good point. Well, thank you very much.
Thank you.
Our next question is coming from Adam Klauber of William Blair. Please state your question.
Thanks. Good morning, Pat.
Good morning, Adam.
Again, great growth. In the first half of 2011, what was the headwind from rate and exposure?
Oh, boy.
I can pull that out.
Hold on. Let Doug.
Do you have another question? Let me pull it up.
Yeah. Pull up another question, Doug will dig.
Sure. 5% net new. That's great. Any big wins in there or is that just a lot of?
No.
Great plugging out?
Singles and doubles across the whole network.
Great.
I'm very pleased. I think what we're seeing, Adam, is that we've talked a long time about our niche focus, understanding our clients' business, being out talking about our capabilities. Those things are really paying off.
I would have to imagine that RPS is doing really well in this environment. Did that help growth in this quarter, or is that something we'll see more in 2012 than 2011?
Helped very nicely in the quarter.
Okay.
Adam, the answer to your question is between exposure units and renewal, we are seeing negative three, negative two, if you combine those two numbers together, and we're flattish now between that. In the past, we've said it was about 50/50. I would say that's probably a pretty good guess for the first half.
Okay. Heath Lambert, obviously, that's not included in organic, but how is that doing from an organic standpoint?
Right now it's flattish. It's hanging together very well. The integration is going well. It's a difficult integration. We've probably moved 400 people's desks in London alone. Just where they sit, who they sit with, where they're located, what have you. It's been a very active six months of integration. I think we've done a terrific job of making sure those people feel like a welcome part of the family, and we've worked very hard on that. I think things are settling in, and we'll start to see some new business production. We're also seeing some teams of people and other acquisition opportunities emanating out of that.
One last question. Other expense growth in the brokerage was materially less than revenue growth. That's great to see. Anything unusual in there, or can you keep other expense growth at a relatively low rate?
In the fourth quarter, we did tighten our belts on some travel. In the fourth quarter, we saw an opportunity to maybe pull back a little bit on that compared to our first three quarters run rate. The team did an excellent job of really targeting where they need to go and who they need to see. We also had some pretty favorable business insurance experience in the quarter, too.
Okay, great. Thanks, guys.
Thanks, Adam.
Our next question is coming from Arash Soleimani of Stifel Nicolaus. Please state your question.
Hi, how are you doing?
Good morning.
Good morning. Just a couple of quick questions. Just looking back, it looks like natural gas usage has been increasing while coal usage has been decreasing. Just looking forward into the future, I'm just trying to get an idea of how big of a risk factor you think that is when it comes to the clean coal tax credits going forward.
Right. Good question. Well, there's a lot of different risks that affect our clean coal investments. One of them is that coal could be displaced at a plant with natural gas.
Right.
In our case, I believe that the utilities that we're putting these plants in have a good idea about whether they're going to immediately replace those plants with natural gas and probably would not be putting these plants in place if they had that expectation.
Right.
That's the first thing. Second thing, if they do displace coal with natural gas, those plants are movable.
Right.
We would find another utility to put them in, or hope to find another utility to put them in and resume production. It could take us out of service for a year.
Right
on them. At this point right now, we don't see that the current ones that we've got in place are high exposure to displacement of natural gas.
Okay. The numbers that you had provided on page five for the clean coal, are those best case scenario or the quarterly after-tax?
I think that they're reasonable run rate expectations based on the plants that we know.
Okay
based on their historical production rates. It's a nice down the middle number.
Down the middle. Okay. My next question, just onto Risk Management. I guess right now, I think CIAB had workers' comp rates around 7%, MarketScout had them around 3%. How high do those really need to get for you to see an uptick in business in Risk Management?
Well, it's a great question. I really don't know the answer to that. I think that anytime rates begin to run in the workers' comp world, we see more people enter into self-insurance and the alternative market.
Right.
That's been a historical fact for the last 40 years. Do I have a specific number, like 5%, and then it's Katie bar the door? No. What ends up happening in the work comp line is when it goes bad, it seems to get really bad, and those rates tend to not run three, four and five, but you tend to see customers really being pushed hard, and that's when they will jump to the alternative market. Any rate increase bodes well for Gallagher Bassett.
Right. Okay. I guess the main reason for the lack, I guess the reason it's more difficult to see margin expansion within Risk Management is that just what you were saying before, having to hire more adjusters, whereas in Brokerage you don't have to hire necessarily more producers?
Yes, exactly. It's a very labor intensive business. With every dollar of revenue comes claims work.
Right. Okay. That's all for me. Thank you so much.
Thank you.
Our next question is from Bob Glasspiegel with Langen McAlenney. Please state your question.
Good morning, everyone.
Morning, Bob.
A quick couple of, I guess three areas of questions. On your risk management, do we look at Q4 as a reasonable run rate, ex the extra Australia, New Zealand claims, or is there something else we should be considering thinking about the quarter? Because that was certainly a mini breakout relative to several years of results there.
Yeah. I think, Bob, maybe a penny's worth. By the time you look at page three of 14 and you see the adjusted fees related to international disasters, it's not all that rich in margin. The additional performance bonus fees, that's heavy margin business. By the time you factor it out, yeah, I'd say that the risk management was a little hot this quarter.
Okay. On the tax line, if I use, sorry about this, on page six, if I divide the $17 million federal statutory rate into my calculation of pre-tax, that gets to about a 36% rate before we get to the good guys. Was that sort of penny in brokerage that was a little bit lower that you sort of backed out, or? You're sort of saying 38%-40% is the normal stat rate.
Bob, I'd have to retrace your math to see how you got it there, but that number is intended to be somewhere around 38% of the number.
Okay. My model says that you had $47 million of aggregate pre-tax earnings. Actually, I can't find a complete pre-tax company-wide model in all your great releases.
I'll work on it if you want to go to the next question.
We got the $1.7 million and the $3.8 of other items. The $1.7 is prior year and the $3.8 other net. What's in that?
The other net, we resolved some tax positions because of the mix of our business in certain states in the U.S., as a result of our clean coal production efforts and some other corporate realignments, it reduced our state taxes.
Okay. That five and a half million isn't broken out as a good guy on the front page, right? Because you only do that for brokerage and risk management?
Pieces of those numbers are taken out. If it was released through the brokerage or risk management segment, we chiseled that out and we put it on a separate line item.
There are $0.02 isolated out, but there's another $0.03 in sort of Corporate, I guess?
Yeah, that's what I said.
Okay.
If you look at the Corporate segment, there was $0.02 of beat in the Corporate line and $0.01 of beat in the legacy investment line, and that comprises the difference.
Okay. Last question is your run rate for financial services for Q4, is that sort of a quarterly run rate into 2013, or is there some seasonality in the pace of that?
Say your question again, Bob, because you said 11 and then you went to 13, I thought.
No, you said two, four, six. You break even two, four, six is sort of the financial services corporate trend line for 2012. As we go into 2013, is that $0.06 quarterly run rate a good one or is there seasonality in that $0.06?
I'm not giving any guidance on 2013 yet, those numbers that I gave you have no new plants being signed up under long-term contracts.
Okay. it could even go higher than that in future years or lower.
Yes, it could go either way, Bob.
Okay. Appreciate it.
All right.
Okay, Bob.
Our next question is from Brian DiRubbio of YCAP Management. Please state your question.
Good morning, guys. How are you doing?
Good, Brian. How are you?
I'm okay. A couple of questions for you. On risk management, Pat, how much of that was from increased claims activity versus new business that you guys brought in?
I'm going to throw that to Scott Hudson.
Okay.
A significant percent was related to the claim increases. We were seeing through the fourth quarter, somewhere in the neighborhood of about 2+ percentage points just in claim count increases. We're also seeing marginal increases in rates with existing clients, somewhere in the neighborhood of 2%-2.5%. A lot of that is on the existing book. If you think about the new business, it takes a while for that to take hold. Even though it was coming throughout the year, we had a good new business year, we won't see the majority of the effects of that until this coming year.
Got you. You have to forgive me, I'm fighting a little bit of a head cold this morning. The 2% claims increases, is that the biggest that you've seen in a while? Claims have been sort of flattened down.
Oh, yes.
a bit in that business.
Claim counts were going down through 2008, 2009, 2010.
Yep. Is this the inflection path that you've been sort of looking for?
Yep.
Okay.
Brian, that hangs together. The Business Insurance came out this week and talked about more frequency in the workers' comp lines.
It's another one of my anecdotal areas where I look at the economy, Brian.
Yeah.
One of the big reasons for claim count drops was the fact that you're going from three shifts to two, to one.
Got you. That makes a lot of sense. Doug, as I was going through the release, are we now more comfortable with, I guess, Heath Lambert's contribution to the lower overall tax rate in brokerage?
It will, yeah. If you go to top of six of 14, we've actually moved it down a full percentage point. We used to give a range of 39%-41% for that segment, we're down to 38%-40%. As that business starts to contribute more, it will have the impact of bringing the rate down slightly, even more, maybe in 2013 or 2014.
Got you. Maybe longer out, we can think maybe 37%-39%?
I'm not willing to go there yet, but you're welcome to think what you want.
Got you. Just finally, was there any FX headwinds for you guys in the quarter with the U.S. dollar strengthening?
Nothing of significance.
Great. Thanks a lot, guys.
Thanks, Brian.
Thanks, Brian.
Our next question is from Dan Farrell, Sterne Agee. Please state your question.
Hi, good morning.
Morning, Dan.
Could you just comment on the current trends in the employee benefits business, and if organic growth is materially different from the overall organic in the brokerage segment, and then also just your outlook for that area going forward?
Yeah, we're very bullish on the benefits business. Our benefits business has had a higher organic than the PC business, even including in the fourth quarter. I've said many times that the new law that we're all facing now under the healthcare regs is providing us with tremendous amounts of additional work. Our clients are now having to face up to the fact that these regulations are coming into being. It's, I think, putting tremendous pressure on the smaller agents and brokers out there, which is helping us with our mergers and acquisitions, and underlying costs in health and welfare accounts are up. Our organic there is a little bit stronger than the PC business.
Okay, great. Thanks. Just another question just on the clean energy. Doug, when you guys are coming up with your estimates for what these can generate, I'm assuming you have some assumptions for what you think coal price will be versus the other commodities. Is there any sensitivity that you guys do around the fluctuations, then any sort of ranges that we can think about tracking ourselves from the outside looking in?
There's two things to think about. Longer term, tax credits can go away if coal prices get too high compared to a reference price. There is a phase-out. We're well below that number at this point. It's not a real easy number to track, and at some point, I'll have to figure out a way to be able to provide you guys that information so you can just monitor. It's not like you can pick up The Wall Street Journal and find the reference price. There is that sensitivity, but really, that doesn't impact the production of the coal. That's a risk for the credit to go away. Do you have a second part of the question?
No, I think that essentially hit it.
Yeah, I think right now, we believe coal prices are well below any type of phase-out level at this point. We think that we should have a clear sight to produce over the next few years, so.
Okay. All right. Thank you very much, guys.
Our next question is from the line of Ray Iardella with Macquarie Bank. Please proceed with your question.
Good morning, guys.
Ray.
Quick question, I guess, on the M&A front. I know you guys had mentioned in your prepared remarks that 2012 could be a pretty active year from an M&A standpoint, and it already seems like you guys are off to a good start. Just curious, how much cash do you think you have available to do acquisitions in 2012?
Well, we think that now that we've got significant amounts of tax credits coming in also, we think a pretty good proxy for that is half of our reported EBITDA is what we generate.
Okay.
Could be used for acquisitions.
Okay. That's helpful.
Maybe 40% is a better number.
Okay. Just one other quick question. Looking at your balance sheet, it looked like AOCI declined a little bit. Is there something maybe pension-related? I know you said FX wasn't a big deal in the quarter, maybe could you guys just remind us about your pension plan and kind of your assumptions there? That would be useful.
Yeah, it's great. Good question. Yes, we did have, if you look at the other comprehensive income line in our balance sheet, it's a negative $47 million. 15 of it relates to FX and the balance of it relates to underfunded pension liability. The reason why that changed, and this is going to impact probably the rest of the world too, is the discount rate assumption. We moved down from 5.5% down to 4.5%, and that produced basically an underfunded pension by $30 million, which is really kind of peanuts in our environment here. We froze that plan in 2005, which in retrospect looks like a good move, but that's the difference that you're seeing there, Ray.
Okay, great. Return assumptions on the assets. Did that change year-over-year, or is that something you guys are keeping consistent?
Not dramatically. The recovery of the equity markets probably took a little pressure off of that line. The number 7.5% is our return expectation, and I think that's pretty well in the middle point of the range for what people will be using, again, because of the equity balance in the portfolio.
Okay, thanks a lot.
Again, ladies and gentlemen, as a reminder, that's star one for questions. Our next question is from Mark Hughes of SunTrust Robinson. Please state your question.
Good morning. Thank you.
Good morning, Mark.
Any way you can shape up for us, perhaps the other opportunities within the clean coal technology? I think you had talked about you expect maybe the ChemMod to make more of a contribution, but you can't shape it up right now. Could you give us a sense of the magnitude of the business that you're pursuing? Maybe what your historical win rate has been? Just something to shape it up for us a little better.
Mark, I think that anything that I gave you on that right now would be subject to such a wide range of possibilities. I'd rather not do it now. I think I can give you a better answer in our April call. I think that I'd rather just wait to see. We're a little downstream on that because ChemMod, while we manage that company here, and that's why we consolidated, even though it's only 42% owned. The other third-party licensees of that, they report to us on a lag basis, and they're not all that forthcoming in how their pipeline looks. Because to a certain extent, we compete with them because we have other plants that we're going to put in place. I really can't give that to you now until April. We have some cautious optimism on that.
Okay. Do you have a number for cash from ops for the full year?
Cash generated from operations?
Yeah, exactly.
Let me see if I can dig that out. Do you have another question?
No, I think that was it.
Okay. Well, we'll dig for that answer. Bob, let's move on to the next question.
Yes, sir. Our last question is from Scott Heleniak of RBC Capital Markets. Please state your question.
Hi. Good morning.
Good morning, Scott.
First question I had was on M&A. Obviously, the entire sector, there's been a lot of consolidation going on. I'm just wondering if you're seeing any newer players in there, banks and private equity, and some of the other guys that haven't been as active coming back in. If so, what is that doing to multiples in general that are paid for deals? Are you seeing any kind of big movements? I would think that multiples have to be going up a little bit.
No, actually, we're not seeing a lot of multiple move. You've got our usual competitors. We have a very interesting kind of market out there when you look at M&A. As I said in my remarks, there's 18,000 agents and brokers or some number like that, we get that number from Hales & Associates, in the U.S. alone. You've got to at least have double that globally, and we are active in the acquisition world globally. Most of these businesses are run by baby boomers. There's probably five very active acquirers, and there are others as well. There is some private equity activity. Very little activity on the side of the banks, with maybe one exception with Wells. Really what you've got is a huge supply of interested parties. I don't want to diminish the amount of work this takes.
We've got people out working hard every single day, and every deal we do, even if it's a $3 or $4 million deal, is, in fact, a marriage that's taken a lot of courting to get it done. Our people are working very, very hard. Having said that, what's interesting about the process is the five main acquirers, each of us have very unique personalities as companies. Through the process, we generally get to a point where that seller has decided where he or she wants to land. We're very lucky and very pleased with those people that have decided to join our company. That has produced no shortage of opportunities for our competition.
I look out over the next decade, frankly, and see just a tremendous amount of consolidation that's going to occur, both because of the baby boomer age situation, as well as the fact that the buyers, the clients are demanding a higher level of expertise. It's just no longer going to be I think a decade from now, just that relationship purchase is going to be far diminished from what it is today. Lots and lots of opportunities, and no, we're not seeing a lot of expansion in multiple.
Okay. The next question I had was on the, you mentioned the risk management, the increase in the claims count up 2%. I was wondering, obviously, you guys see a lot of the claims activity that comes in. Was wondering, was there any particular class where you're seeing frequency uptick more so than others? Obviously, workers' comp in the market, we've kind of heard that anecdotally. Is there any particular class where the trend is kind of going much higher?
No, the major line of business that we adjust is workers' compensation, but it is across all client types.
Okay. The $4.6 million amortization write-down from the two acquisitions, I was wondering if you could touch on that a little bit more. When those two acquisitions happen, do you expect any additional write-downs for 2012 at all based on what you see here?
Okay. First of all, let me go back to Mark's question. We had $283 million of cash generated from operations. Let's go to the four point. The $4.6 million write-down was two or three deals that we took small impairment charges on their unamortized intangible. Probably, $3.5 million-$4 million of it related to one particular broker that we bought. He's still with us. He's a tremendous deliverer. They were selling a product, a life insurance product, that was dependent on borrowing some leverage from banks. That availability of lending has dried up for the time being. We expect that product to be back. It's a nice product used for estate planning. It's not viaticals. We didn't meet the recoverability test. I would say this is as much an accounting write-down. It's not a bad deal.
He just has to wait for lending to become a little looser for him to get back into selling these products.
Okay. That makes sense. My last question was just, Pat, you mentioned a comment about some of the clients that you're seeing around the country feeling better about their businesses. Was there any particular sector, geography where that was true more so this quarter than last quarter, and any change in customer buying behavior as a result?
I think probably where I've had the most opportunity to interact with clients has been in the Midwest, and I think the Midwest has sort of led the improvement. We are seeing improvement in a number of our businesses across all of our geographies. The buying pattern that we are seeing that is important to note is that where we are seeing a spike in pricing, and this is particularly catastrophe-exposed property, clients are buying less cover. That's what we've been saying all along. If this thing spikes, as it did in 2001, if we have a violent rate increase environment, clients are going to buy less coverage.
All right. Thanks for the answers.
Okay, Scott. Thanks. Anybody else, Rob?
We have no further questions, Mr. Gallagher.
All right. I'd like to make just a few quick wrap-up comments. Again, thank you everybody for being with us this morning. I want to just remind all the listeners that we're very focused on four things strategically. Number one, organic growth. Number two, mergers and acquisitions. Number three, productivity and quality. Finally, maintaining what we know is a very unique culture. I want to touch on each of those very briefly. As it relates to organic growth, every single office, every division, every person, every day is taking care of clients and looking for new ones. When it comes to mergers and acquisitions, I've already mentioned the fact that the pipeline is very full.
Most of these are baby boomers, but more importantly, I think it's the capabilities that we've built as a company that are attracting people because they know once they join Gallagher, they can actually grow their business significantly. That pipeline is strong. As it relates to productivity and quality, if you go all the way back to 2008, which is essentially what we believe the beginning of the Great Recession, we've built our high-quality service centers offshore, and we've actually increased our margin in this very difficult economic time. Fourthly, we work very hard to maintain what we know is a unique culture. This company has something special. It is the ball team. We're together. This culture keeps us together in good times and in tough times.
In good times and bad times, we've stayed focused on those four strategies that we continue to believe will create growth for our shareholders. We've never wavered in that belief, and that's what we're concentrating on as we go into 2012, which we believe we can build on the success of 2011 very well. We're looking forward to 2012. We appreciate your being with us this morning. Thanks very much and have a great day. Thanks, Bob.
Thank you. This does conclude today's conference call. You may disconnect your lines at this time.