Arthur Gallagher's CEO Discusses Special Clean Energy Investments - Special Call Transcript

Arthur J. Gallagher & Co. (AJG)

Special Conference Call

April 11, 2012 8:00 am ET

Executives

J. Patrick Gallagher Jr. – Chairman, President, Chief Executive Officer

Doug Howell – Chief Financial Officer

Analysts

Dan Farrell – Sterne, Agee

Mark Hughes – SunTrust Robinson Humphrey

Ray Iardella – Macquarie

Jay Cohen – Merrill Lynch

Arash Soleimani – Stifel, Nicolaus

Yaron Kinar – Deutsche Bank

Mark Dwelle – RBC Capital Markets

Justin Maurer – Lord Abbett

Keith Walsh – Citigroup

John Campbell - Stephens

Presentation

Operator

Good morning and welcome to Arthur J. Gallagher & Co.’s special conference call to provide background on its clean energy investments. 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 the conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to certain risks and uncertainties that will be discussed on this call and which are also described in the Company’s reports filed with the Securities and Exchange Commission. Actual results may differ materially from those discussed today.

It is now my please to introduce J. Patrick Gallagher Jr., Chairman, President and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin.

Patrick Gallagher

Thank you, Claudia. Welcome everybody and thank you for being with us on our special call this morning – we appreciate it. We think it’s important that we go through a detailed review of our clean coal investments. Before I turn this call over to Doug Howell, our CFO, I want to be very clear about one thing. The punchline in this presentation is that we hope to generate cash from these efforts. If you look at Page 27, 28 and 29 of our presentation, you’ll see that the use of that cash will be put to use in building out our core brokerage and risk management enterprises.

We’re excited about this effort, and I want to turn the call over to Doug to take you through the details of the presentation. Doug?

Doug Howell

Thanks, Pat, and good morning everyone. I’m going to spend about 30 minutes trying to push through the first 50 pages of this presentation, and then we’ll go to Q&A. We ask you to hold an hour and a half for this call, and we think that the Q&A is a very important part of that. We’re doing this presentation—oh, first of all, I hope you have the presentation open in front of you because I will be referring to pages in the presentation that we filed frequently throughout our call today. We’re doing this as a way to continue to improve transparency We have received a lot of questions over the last year or so about the investments, how they work, what do they look like, what are we going to do with the cash, how does the accounting work; and so I’m hoping that today will be a way to orient you in terms of what’s going on with these investments and what we’re intending on doing with the cash.

We picked this timing because we thought it would after the spring break period yet before earnings season really kicked off in full swing because we wanted you to be able to have an hour to an hour and a half to really understand these investments, and we just don’t get that amount of time when we’re doing our quarterly calls.

So what I want to do now is just move into the presentation. Page 3 is an outline of what we’re going to talk about today. My first page I want to talk about is Page 4. When we have a clean coal investment, Page 4 is a simplified overview. These investments between the physical plants and the chemistry, when combined with conventional coal and they’re used in a utility, they reduce mercury, nitrogen oxides and sulfur dioxide, and this process also provides other benefits to the utilities in making coal a cleaner source of fuel for the U.S.

So many people has asked me what do these things look like? So let’s turn to Page 5. Page 5 is a picture of a clean coal plant. You’ll see in the green circle, these are the storage units where we store the chemicals. In the orange oval, that’s the mixer. You can see a temporary conveyer belt putting the coal into the mixer, and if you look kind of behind that larger conveyer belt, you’ll see the clean coal coming out and being returned into the stack. This portion of the plant costs about $1 million to build and then obviously can be depreciated over time, so it’s about a $600,000 after-tax cost.

After those components are built, if you turn to Page 6, what we do is we put the components in housing and we connect it permanently to the host utility. In the red circle, you can see all the components that go into housing the clean coal plant. You’ll see how coal runs up a conveyer belt, it drops down into the mixer, the storage facility you can see there in green, and then as the refined coal returns back up into the utility where it’s burned. The cost to connect and house the plant is approximately $4 million, and then we get to depreciate that over time, so after-tax it’s about $2.4 million.

Page 7 shows an illustration of where this clean coal plant sits in a general schematic of a coal power facility. You can see the clean coal plant sits between the coal yard and the boiler or the furnace, and the rest of the schematic shows you how water turns into steam, steam turns the turbine, and electricity is generated and goes on a transmission line. So that’s the location, a generalized view of the location of the plant.

When it comes to building the plant and putting these investments together, Page 8 provides you the steps, and I think it’s important to go through these steps. Step 1 is we actually build the plant and we place it in service prior to December 31, 2011. That’s important that it’s in by that date, and all of our plants have been placed in service before 12/31/2011 because that makes them a qualified plant. Next, we connect the plant to the utility, we connect it and house it, and you can see that costs the 4 million. Then, because these are investments, we will sell off a majority portion of the investments. Generally in this schematic, what we’ve said is we’re selling off 51% of it and we end up holding 49% of it. At that time, we relinquish control. We become a minority partner, and really it runs like any other partnership or LLC would, and in this case the partners require unanimous approval to do anything further. So we step out of the control position in Step 4.

If we turn to Page 9, we get some questions from time to time about the operations – who’s running it? The piece to focus on is the LLC manager. It’s the third box down on the left side of the page. We have a professional manager that really manages the day-to-day operations of the plants going forward. They’re the ones that arranged for Taggart, who is our operations manager. They’re the ones that arranged for the logistics and the chemical. They coordinate much of the legal activity and the accounting and tax activity, so Gallagher then sits at the position of a non-controlling partner and basically the day-to-day operations are controlled by the LLC manager.

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