Arthur J. Gallagher & Co.

Good afternoon, and welcome to Arthur J. Gallagher and Company's first quarter 2019 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 discussed on this call or described in the company's reports filed with the Securities and Exchange Commission. Actual results may differ materially from those discussed today, and the company undertakes no obligation to update these statements. In addition, for reconciliations of the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the most recent earnings release and the other materials in the investor relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President, and CEO of Arthur J. Gallagher and Company. Mr. Gallagher, you may begin.

Thank you, Jeremy. Good afternoon. Thank you for joining us for our first quarter 2019 earnings call. With me today is Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions. As we do each quarter, today Doug and I are going to touch on the four key components of our strategy to drive shareholder value. Those are, number one, organic growth, number two, growing through mergers and acquisitions, three, improving our productivity and quality, and four, maintaining our unique culture. The team delivered on all four of our operating priorities to begin the year, resulting in a great first quarter. Let me give you some highlights. Our core brokerage and risk management segments combined to deliver 14% growth in revenue, 5.5% all-in organic growth, an adjusted EBITDAG margin expansion of 75 basis points, We also completed 11 tuck-in mergers in the quarter, and our culture was recognized again by the Ethisphere Institute as one of the world's most ethical companies. I couldn't be prouder of the team, just a great performer. My comments today will be focused on revenue growth, insurance pricing, and our dynamic culture. Doug will go into greater detail on productivity, quality, clean energy, and capital management. So let me start with our brokerage segment. First quarter all-in organic growth was 5.7%, including base commission and fee growth pushing 5% and strong contingent and supplemental revenue growth. Organic was solid across all of our divisions globally. Let me give you some more detail. In the U.S., our retail brokerage operations generated around 6% organic in the first quarter, with benefits a bit lower, PC a bit higher. Domestic retail PC pricing was positive across all our major lines of business except for workers' compensation. For example, property and commercial auto pricing were up over 5%, and casualty and specialty lines were up a couple of points. Within our domestic wholesale PC business, organic was about 4%, and relative to retail, pricing is similar or stronger across most lines of business. Moving to the U.K., Our organic was around 5% in the quarter, with retail a bit lower and wholesale a bit higher. Our retail PC pricing in the U.K. is up 3% on average, with professional liability pricing up over 5%, and most of the lines up a point or two. The U.K. specialty market is seeing rates up 5% on average, and pricing on catastrophically exposed classes is up over 10%. Next, in Australia and New Zealand. Organic was about 8%. Rates there continue to trend in the single digits across most lines. In total, I would characterize the market very similar to recent quarters, but we do see rate trending just a little higher than we saw in the fourth quarter of 2018. As we look forward, 2019 brokerage base commission in fee organic feels like it will be around 5%. Next, let me talk about brokerage merger and acquisition growth. In the quarter, we completed 11 brokerage acquisitions at fair prices, which should add about $70 million of annualized revenue. So far in the second quarter, we have completed three brokerage mergers, including Stackhouse Poland, with estimated annual revenues of almost $80 million. I'd like to thank all of our new partners for joining us, and I extend a very warm welcome to our growing Gallagher family of professionals. Looking forward, our merger and acquisition pipeline is very full. In addition to the previously announced JLT Aerospace acquisition that we hope to close late in the second quarter, our pipeline has around $350 million of revenues associated with about 60 term sheets either agreed upon or being prepared. While we won't close all these mergers, we continue to be the partner of choice for brokers that are excited about our capabilities, align with our unique culture, and realize that we can be more successful together. Next, let me move to our risk management segment, which is primarily Gallagher Bassett. First quarter organic growth was a solid 4.1%, with no significant variance between domestic and international operations. We recently announced our new GB Specialty Division, which is focused on the resolution of complex claims in construction, healthcare, transportation, and products liability. This has been an area of growth for Gallagher Bassett, and the new GB specialty team will be showcased at the annual RIMS conference in Boston next week. Also on display at RIMS will be our new treatment quality index and our smart claim benchmarking methodology, two recent examples of innovations that GB is utilizing to drive superior claim outcomes for our clients. And finally, I'll touch on what really makes our company unique, and that's our culture. It's a culture that emphasizes doing things the right way for the right reasons with the right people. Just last month, Gallagher was recognized by the Ethisphere Institute as one of the world's most ethical companies, an award that underscores our commitment to ethical business standards and practices. This is our eighth year in a row receiving the award, an accomplishment less than 40 companies globally can claim. And we were once again the sole insurance broker recognized. This distinction is a direct reflection of our 30,000-plus colleagues united, working as a team, grounded in the Gallagher way. Every day, all of our people get up and work diligently to maintain our culture, to promote our culture, and to live our culture. Okay, an excellent quarter on all measures. I'll stop now and turn it over to Doug.

Doug? Thanks, Pat, and good afternoon, everyone. As Pat said, another really excellent quarter of top-in-line results and a strong way to start off 2019. Today I'll make a few comments referencing the earnings release. I'll then move to the CFO commentary document we post on our website, and then I'll wrap up with some comments on cash and M&A. Okay, let's turn to page two of the earnings release to the brokerage segment. You'll see that we posted $1.45 of adjusted earnings per share. As you compare our results to your models, looks like there are about three puts and takes compared to consensus. First, it looks like contingents came in better than most of you thought. Call it an additional $8 million or about two cents after incentive compensation and taxes. However, there are two offsetting items. First, It looks like your picks for M&A rollover revenues were above our March 12 guidance by about $8 or $9 million. And second, non-controlling interest picks were lower than our March 12 guidance by about $2 to $3 million. Combined, that's $10 to $12 million, or about $0.03 after expenses and taxes going the other way. So net-net, these items about offset, bringing us back to about $1.45 of EPS or even $1.46. One last comment on page two of the earnings release. Only one significant non-GAAP adjustment this quarter. A one-time 17-cent net gain from divesting of some smaller brokerage operations in the first quarter. It's a bit of old news given we discussed the largest one during our January earnings release and conference call, but you can see it there now. Otherwise, a very clean quarter. Next, let's turn to page three of the earnings release, to the brokerage segment organic table at the top of the page. and then go down a little bit to the contingent revenue section. That's where you'll see contingents being organically up $8 million in the first quarter, as I just mentioned. About half of that arises because 2018 developed more favorably than previously estimated. The other half is due to new agreements and a slightly more bullish outlook for 2019 based on our view of premium growth and rate increases. But remember that new GAAP accounting requires us to estimate these amounts many times a year or so before we receive them. So it does create a lot of estimation risk. Loss ratios look decent now, but if those deteriorate over the year, contingents might not develop as we currently expect. Next, let's turn to page four, to the Brokerage EBIT Act margin table in the middle of the page. Terrific margin expansion this quarter, up by 61 basis points. actually would have been even better given stronger contingent commissions, but offsetting that is the roll-in impact of M&A, which did compress margin expansion by about 60 basis points. The dilutive impact of mergers on our first quarter may actually happen annually. With first quarter now seasonally our largest, you'll see margins are over 35%, and then they drop into the mid-20s in later quarters. You can see that in last year's numbers. Very few of our merger partners have that type of seasonality, especially in our P&C mergers. Nor do they run annual margins that high. So most of them will naturally be diluted to margin in the first quarter, but wouldn't have that impact on a full year basis. In the end, stronger contingent revenues offset by M&A roll-in margins about wash. So being up 61 basis points feels about right when posting base organic growth of about 5%. Still on page four, but moving to the risk management segment organic growth table at the bottom of the page. You'll see that we posted 4.1% organic growth. That feels right for the full year. However, we see it a little lumpy. We see more like 2% in the second quarter because of a difficult comparison to last year's second quarter when we posted over 10% organic. So again, it'll be a little lumpy quarter to quarter, but somewhere around 4% to 5% for the year. Turning to page five to the adjusted margin table at the bottom of the page. 17 points of margin, that's up over 60 basis points and right at the lower end of our 17 to 17.5% range for the full year. We still feel that that range seems about right for an entire year. Turning to page six to the corporate segment tables. Interest in banking line and the acquisition line right in line with the guidance we provided at our March 12 IR day. Clean energy actually came in a little better than we thought at that time, mostly due to better production in the last half of March than we saw in the first half of the month. And finally, to the corporate line. With tax reform settling down, we have collapsed the line we previously called impact of US tax reform into the corporate line. During our March IR day, we forecasted those two lines would combine to a $14 million after-tax loss. You can see we came in about $4 million better. But much of that is timing of a couple tax related items. So when you get to the CFO commentary document, our full year 2019 forecast for this corporate line hasn't changed that much. So let's go ahead and shift to the CFO commentary document that can be found on our IR website to page two. You'll see that most of the first quarter items were in line with our March 12th forecast. And looking forward, foreign exchange integration and amortization are fairly straightforward. Then, when you get to page five, that's where we provide our estimate for rollover revenues from M&A. As I mentioned before, please take an extra few minutes to tighten up your models for your roll-in revenue picks. And finally, cash and M&A. At March 31st, we have around $700 million of available cash on our balance sheet. About $350 million was used in early April to close on the Stackhouse merger, leaving $350 million as free cash. That plus expected free cash for the remainder of the year and maybe some more debt should bring our full M&A capacity to around $1.5 billion before using any stock. So those are my comments. A truly excellent quarter, and we're in terrific position for another successful year. Back to you, Pat.