Arthur J. Gallagher & Co.

Good afternoon and welcome to Arthur J Gallagher and Company's third 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 meeting of the security 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 Jay Patrick Gallagher, Chairman, President, and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.

Thank you, Devin. Good afternoon. Thank you for joining us for our third quarter 2019 earnings call. With me today is Doug Hall, our Chief Financial Officer, as well as the heads of our operating divisions. Let me just start by saying we had another excellent quarter. Our combined brokerage and risk management segments delivered 13% growth in revenues, 5.8% all-in organic growth, adjusted EBITDA margin expansion of 66 basis points, and we completed 14 mergers with about $85 million of estimated annualized revenues, just a terrific quarter by the team. Today, Doug and I are going to spend our time focused on the four key components of our strategy to drive shareholder value. First, organic growth. I'll review organic by geography, comment on the pricing environment, and give you some insight regarding exposures. Second, growing through mergers and acquisitions. Third, productivity and quality. Doug will hit this topic after my remarks. And fourth, maintaining our unique culture. Okay, to organic. Let me start with the brokerage segment. Third quarter organic was 5.8% all in, which is similar to our organic performance through the first six months of 2019. I'm very pleased that all of our divisions globally contributed to this result. For example, Our domestic retail PC operations had another strong quarter with organic of about 5%. Our wholesale operations had an excellent quarter, posting about 6.5% organic. This includes over 10% in our domestic open brokerage operations. Our benefits operations also had a strong showing this quarter, posting base organic of about 4.5%. And then internationally, our retail brokerage operations combined to post 7% organic with Canada up more than 10%, Australia and New Zealand up about 6%, and the UK up 5%. Another really strong quarter of production by the team. Let me move to the rate environment. We've been hearing a consistent message, whether it's from our carrier partners at the CIAB and the WSIA conferences, or from our global leaders during our recent strategic planning sessions. Rates continue to increase across nearly all areas of the market. Our own internal data also points to an increasing PC rate environment, with global PC pricing up about 5%, which is a bit stronger than what we saw in our mid-year internal pricing survey. Let me break down what we are seeing. I'll start in the U.S. Rate overall is up around 5% in our retail operations, with workers' compensation the only line not showing incremental pricing strength relative to the second quarter. Within our domestic wholesale brokerage operations, pricing is approaching 6%. Moving to the U.K., U.K. retail pricing is up over 3%, a touch higher than the second quarter. In our U.K. wholesale operations, pricing is approaching double digits across many lines. In Canada, pricing is up around 8%, with property increases more than 10%, And finally, in Australia and New Zealand, pricing is up around 5% to 6%, about a point lower than what we had been seeing over the previous two years, but still a substantial increase. Moving to exposures. In early October, we surveyed our producers, specifically asking questions related to their clients' payroll and exposure units. Over 75% said their customers' payrolls and exposure units grew during the third quarter. And more than 95% of these respondents said they were seeing similar or stronger client exposure growth as they begin working on 2020 renewals. This is consistent with the results from our May 2019 benefits benchmarking survey, where more than 70% of the 3,900 employers believed that their revenue would be increasing over the next two years. So when I look around the world, PC rates and exposures continue to move higher. This is an environment in which our talented production staff excels by delivering the best insurance, risk management, and benefits consulting advice by leveraging our vast array of resources and capabilities. As I sit here today, I see our fourth quarter organic nicely in the mid 5% range. Next, let me talk about our brokerage merger and acquisition growth. In the quarter, we completed 11 tuck-in brokerage acquisitions with estimated annualized revenue of $70 million. I would like to thank all of our new partners for joining us, and I extend a very warm welcome to our growing family of professionals. The brokerage team has had a very busy M&A year, completing 35 mergers with more than $330 million of annualized revenues during the first nine months. Adding to that, we have already announced the number of mergers in October and that should add an additional $90 million of annualized revenue. This is on top of our M&A pipeline report that shows $400 million of revenue associated with about 50 term sheets either agreed upon or being prepared. While not all these transactions in the pipeline will ultimately close, as I look around the world, it's clear that our tuck-in merger opportunities remain very robust. Next, I would like to move to our risk management segment. Third quarter organic growth was 5.7%, with similar results in both our U.S. and international operations. The growth we are experiencing is also broad-based by client type, including large commercial, public sector, alternative markets, and insurance carrier clients. Our investments in innovative products, like the award-winning mobile app GBGO, combined with our expertise by product and industry, continue to set Gallagher Bassett apart from the competition. Looking forward, we see mid-single-digit organic growth in the fourth quarter. In terms of mergers and acquisitions, we completed three risk management acquisitions this quarter, adding annualized revenue of about $15 million. These acquisitions provide us with incremental capabilities and services that will benefit our clients in Australia, the U.K., Europe, and the U.S., I'd like to extend a very warm welcome to our new Gallagher Bassett professionals. Lastly, I'd like to touch on a true competitive advantage that's Gallagher's unique culture. It is a culture that helps us attract and retain the very best talent, a culture that promotes our relationships with our carrier partners, a culture that distinguishes us from others in a highly competitive merger environment, And it is the basis for our people coming together as a team to service clients focused on doing the right thing. Nowadays, we are hearing a lot about company culture and purpose. This is nothing new to Gallagher. We've long valued all of our stakeholders as defined in our mission statement. Ultimately, we believe if we provide value to our clients, take care of our employees, and build strong relationships with our insurance carrier partners, our shareholders will be rewarded. Bottom line, our culture always has been and will continue to be a true competitive advantage. Okay, a great quarter in the first nine months. I'll stop now and turn it over to Doug.

Doug? Thanks, Pat, and good afternoon, everyone. I'd like to start by thanking the team for another outstanding quarter. It really does position us very well to close out an outstanding 2019 here in the fourth quarter. Today I'll make a few comments from the earnings release. I'll walk you then through the CFO commentary document we post on our website, and I'll conclude with some comments on cash and M&A. Okay, let's go to the bottom of page five of the earnings release, the brokerage segment margins. For the quarter, we delivered 68 basis points of adjusted margin expansion. That's terrific results on 5.8% organic growth. And this marks the 32nd straight quarter of brokerage segment margin expansions. a truly amazing run and an excellent illustration how we're constantly focusing on raising our quality and productivity. Looking forward, we would expect to see about 50 basis points of margin expansion if organic growth is in the low to mid-5% range. Let's flip to page six of the earnings release to the risk management segment margins. During the quarter, we posted 18 points of adjusted EBITDA margin. That's really great work by the team, but well above the upper end of our targets. So we wouldn't expect to see that in the fourth quarter. Perhaps more like 17 to 17 and a half percent, which would finish off a year nicely towards the higher end of our full year target, also in that 17 to 17 and a half percent range. Let's now move to the CFO commentary document that we can find at our website. Let's turn to page two. Relative to third quarter estimates that we provided during our September IR day, Nearly all of the lines came in very close. A few other comments. First, our integration efforts, mostly related to the aerospace and stackhouse mergers we did this summer. Both are moving along as planned and on budget. Second, we're making nice progress on our back office support layer transformation project we discussed at our IR day. We've already contracted a few hundred positions, and we have a nice line of sight into areas where we can lower our costs and improve our service quality by centralization, standardization, and automation of most of our back office functions. We're redeploying these savings into processes to help us drive our organic growth. Sales support and sales management systems and tools, data and sales analytics, additional production talent, marketing and branding. In other words, all our efforts that will help us sell more, hire more, and acquire more. And finally, still on page two, a modeling note. Please make sure your models are picking up our estimates for changes in estimated earnouts and also earnings from non-controlling interests. Neither are big numbers, but still can move your estimates by a penny or two. We'll stay in the CFO commentary document, but flip to page three, to the corporate side. Relative to the estimates we provided during our September IR day, interest and corporate expense lines were both within the range, Acquisition expense was just a touch higher, mostly due to a couple smaller international deals. And then finally to clean energy. You'll see that the third quarter adjusted results came in a couple million dollars above the midpoint of the range, a great quarter. Looking forward, fourth quarter is looking a bit lower than what we were seeing during our IR day. Weather thus far in October is not nearly as hot as last year. So we moderated our fourth quarter outlook just a bit. That said, it's stacking up to be another $100 million year for this investment strategy. You'll also see a clean energy adjustment line this quarter. The clean energy had a very busy quarter. Footnote 2 describes four items. We resolved a five-year patent squabble with a great outcome. We prevailed in tax court. We opened new patent defense litigation, which we think is without merit, but we intend on defending it vigorously. And finally, we're making terrific progress in moving three of our 2011 era lower production machines into really great 2009 era locations. You can see this clearly on page four of the CFO commentary. It's in the fourth row on that page. Shows the machines are currently producing less than a million dollars of earnings here in 2019, but by moving them, we could achieve 10 to 15 million dollars of earnings. Hats off to those engineers and operators that we used to make this happen. Really a great job. It's also affirmation from our utility partners that we truly have an excellent process and that we are delivering substantial environmental benefits. Let's stay on that page four. You'll see that we are also providing numbers around what we think is possible for clean energy earnings in 2020. That's the far right columns. These numbers are still in line with what we said as a very early look during our September IR Day. You'll see that by moving these machines, we can counteract the natural trends in power production towards renewables and natural gas. It's an early look. A lot can change, but here we are a decade later and still looking at an investment strategy that can deliver great returns for a couple more years. At the end of the quarter, we have over $950 million of credit carryovers on our balance sheet and at least another two years of production ahead of us. so we're well-positioned to harvest those hard-to-earn cash flows well into the mid to late 2020s. Finally, let's move to cash and M&A. At September 30, we had about $300 million available cash on our balance sheet. This, plus our free cash flow through the end of the year and our borrowing capacity, should round out a year where we can still invest deeply in our business, pay a great dividend, and still fund about $1.5 billion of M&A before using any stock. When I look at our pipeline through year end, I think we'll be close to that level. And if we happen to go over, it would only mean using a very small amount of stock. This clearly demonstrates the strength of our growing cash flows. When I look out towards 2020, it looks like we can easily do another $1.5 billion of M&A without using any stock. So those are my comments. An excellent quarter, an excellent nine months. Back to you, Pat.