Arthur J. Gallagher & Co.

Good afternoon, and welcome to Arthur J. Gallagher and Company's second 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, and if you have any objections, you may disconnect at this time. Some of the comments made during this 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 earnings release and 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 & Company. Mr. Gallagher, you may begin.

Thank you, Mike. Good afternoon, everyone. Thank you for joining us for our second quarter 2019 earnings call. With me today is Doug Howell, our CFO, as well as the heads of our operating divisions. Today, as we do each quarter, Doug and I are going to report on the four key components of our strategy to drive shareholder value. Number one, organic growth. Number two, growing through mergers and acquisitions. Number three, improving our productivity and quality. And number four, maintaining our unique culture. Once again, the team delivered on all four of our strategic priorities, and I couldn't be more pleased. We really do have some terrific momentum. Let me give you some second quarter financial highlights for our combined core brokerage and risk management segments, 12% growth in revenues, 5.3% all-in organic growth, adjusted EBITDA margin expansion of 49 basis points, and we completed 13 mergers with about $195 million of estimated annualized revenues, just another outstanding quarter for the team. Let me break down our results by segment. Our brokerage segment second quarter organic was 5.8% all in. There was some geography change between base and supplementals in the quarter, so think of base organic more like 5.9% and organic for contingents and supplementals combined of about 4.5%, a really nice quarter. All of our divisions globally contributed. Our domestic retail brokerage operations had a great quarter with organic of about 5%. PCA operations were slightly better than that, and our benefits operations a bit below. Our U.S. wholesale and program business had an excellent base organic quarter, posting more than 5% with contingents and supplemental revenue growth above that. Internationally, our brokerage operations combined to post about 8% organic on very broad-based strength in the U.K., Canada, Australia, and New Zealand. Just fantastic results wherever I look in our business. Moving on to the rate environment, our internal data and our internal mid-year rate survey are indicating a trend of increasing property casualty pricing. Almost 75% of our producers surveyed indicated rates increased during second quarter renewals, colony approaching about 5%, with international a bit higher and domestic a bit below that. What caught my attention, though, is that about 15% of our surveyed producers indicated they were seeing rates up more than 10%. Very few indicated that level of increase last year. Let me give you some more detail by geography. I'll start in the U.S. Rate overall is up about 4% in our retail operations, with the greatest increases across commercial auto, property, and umbrella. Most other casualty lines are flat to up a few points, while workers' compensation rates remain in negative territory, down about 3%. Staying in the U.S., pure rate within our wholesale operations, RPS, is up 5% to 6%, with price increases in low double digits for many property-related lines, especially on large or lost impacted accounts. Additionally, medical malpractice, general liability, and umbrella are experiencing average price increases of about 5%, while comp, casualty, and some professional lines are closer to flat. Let me move to the U.K. Overall pricing is up about 5%. However, a different environment in retail and our specialty operations. U.K. retail pricing is up about 3%, while pricing is increasing in our U.K. wholesale operations by almost 8%. Carriers seem to be pushing for more rate in casually oriented lines, such as D&O and E&O and general liability, in addition to the property. In Canada, pricing is up 4.5% with property, auto, and medical malpractice rate increases in the high single digits. Most other casualty lines are closer to flat. And finally, in Australia and New Zealand, pricing is up around 7%, which is very similar to what we have been seeing for the past two years. So to sum it up, around the world, property casualty rates are up close to 5% and exposures are still growing. This is when we excel. Our talented production staff is fully engaged, helping clients and prospects mitigate the challenges of an increasing rate environment. Next, let me talk about brokerage merger and acquisition growth. In the quarter, we completed 13 brokerage acquisitions, which should add about $195 million of estimated annualized revenue. I was in the U.K. just three weeks ago and was able to meet with our new Stackhouse Poland and aerospace colleagues. I couldn't be more excited about them joining our team. Together, these two mergers account for about 75% of acquired revenues this quarter and give us a top-notch U.K. high-net-worth business and make us an industry leader in aerospace brokerage overnight. The other 11 mergers average about $5 million in annual revenues, which is more consistent with our historical tuck-in merger and acquisition strategy. I would 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. As I look at our merger and acquisition pipeline, I see more than $400 million of revenue associated with about 50 term sheets either agreed upon or being prepared. None of these 50 brokerage mergers have more than $40 million of annual revenues. We know that not all these transactions will close. but it illustrates our pipeline is still very strong and full of small, tuck-in opportunities run by entrepreneurs with excellent sales skills and client relationships. Next, I would like to move to our risk management segment. Second quarter organic growth was 3%, in line with the estimate we provided at our investor day in June. Recall we posted over 10% last year in the second quarter, so it made for a difficult comparison this year, but still very respectable. In the U.S., claim counts are increasing year over year as our clients' businesses grow. Call claim counts up about 2%. Our expanded specialty offerings are generating encouraging new business leads and wins, while our insurance carrier business continues its positive momentum. In fact, last year alone, we paid out claims totaling over $1.5 billion on behalf of our insurance carrier clients. Growth in these areas has been driven by investments in analytics and innovative technologies that are delivering positive claim outcomes for our clients. Outside the U.S., growth was strong in the U.K., while Australia was weaker due to lower performance bonus fees, which can be lumpy from year to year. Looking forward, we are expecting stronger organic growth in the second half of 2019 due to some new client wins, and we think organic for the full year should be in the mid-single-digit range. Lastly, I'd like to touch on Gallagher's unique culture. Our culture is really about our colleagues and the rock-solid foundation they form based on every interaction we have with clients, with underwriters, and with each other across divisions and around the world. Our culture makes our franchise distinctive, and it's why we are constantly looking for the right people to join us, whether through new hires, mergers and acquisitions, or internship programs. Next month, we will conclude our 54th year of the Gallagher Summer Internship Program. This rigorous two-month program for nearly 500 young men and women is an essential investment in our future to ensure our unique culture thrives for many years to come. Okay, a great first half, which bodes well for another excellent year. 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 and bottom line results. Combine it with a terrific first quarter, it puts us in a great spot halfway through the year. Today, I'll amplify a few comments that Pat made from the earnings release. I'll move to the CFO commentary document that we post on our website, and I'll conclude with my usual comments on cash and M&A. All right, to the brokerage segment, organic growth on page three of the earnings release. A great quarter at upper 5%, nearly 6%. As we look forward, we see it more like 5% than 6% as we had a really strong third quarter last year. So that creates a tough compare this year. As for brokerage margin, for the quarter, we delivered about 50 basis points of adjusted margin expansion. Looking forward, that seems about right in this environment. Organica 5% should yield about 50 basis points. Risk management, we posted 3% organic growth and 17.5% adjusted margins this quarter. That's right in line with what we forecasted at our June IR day, and great performance by the team, especially considering the second quarter of 2018. As Pat said, we posted over 10% organic and 17.6% in adjusted margins. Looking towards the second half of our risk management segment, we're seeing organic over 5% and margins still north of 17%. As for the corporate segment, turn to the table at the top of page seven of the earnings release. Relative to the midpoint of the range we provided at our June IR day, interest expense came in a little lower due to stronger cash flows, clean energy earnings a little higher. I'll add some flavor to that when we get to the CFO commentary. Acquisition expense a little higher due to the JLT aviation transaction, and then corporate expenses about $3 million lower due to three items, a one-time refund of some XPAC taxes, we had an FX adjustment, and a little more tax benefit due to option exercises, each amount of $1 million. Let's turn now to the CFO commentary document, like we said, that's found on our IR website. Go to page two. Relative to the estimates we gave at our June IR day, most of the items pretty much are in line, except for the non-cash items, that's amortization and depreciation, coming in a touch better. That's simply because we were just a little conservative when we were making our initial estimates on the aviation business that had closed just 12 days earlier on June 1st. Next, turn to page three. Again, we're in the CFO commentary document. Looking out towards the third and the fourth quarter, our estimates for interest, M&A costs, and corporate expenses are still consistent with what we provided in June. As for clean energy, while we posted better than our midpoint estimates in the second quarter, we're widening our range for the next couple quarters. There's three reasons for that. We're not seeing the extreme weather like we had last year. One host utility had a fire taking the plant offline for several months, and we are feeling the impact of lower natural gas prices. So there is a lower side scenario leading us to drop the lower end of the range by about $5 million. That said, we're still on track to produce over $200 million of tax credits this year, and at June 30, we have nearly $950 million of carry-forward credits. So we are clearly in a terrific position to have very low cash taxes paid well into the mid to late 2020s. One operational comment before we get to cash and M&A. You'll see in our earnings release that we took about a $7.2 million or 4 cent after-tax charge for severance this quarter. We're seeing some real opportunities to bring efficiencies and productivity lift to our back office support layers. We've started a transformation journey similar to what we did with our middle office layers. Centralization, standardization, automation, and further use of our centers of excellence all focus on lowering costs and improving quality. The charge we took this quarter is the first step in that transformation journey. I'll have a more detailed update on our September IR day, but needless to say, we are excited about some early views of the opportunity. And finally, as for cash and M&A, at June 30, we have about $250 million of available cash on our balance sheet. That, plus expected free cash flow for the remainder of the year and some more debt, should bring our full-year M&A capacity to around about $1.5 billion before using any stock. So, okay, those are my comments. A truly excellent quarter, a truly excellent first half. We're in a great spot for another successful year. Back to you, Pat.