Arthur J. Gallagher & Co.

Good afternoon, and welcome to Arthur J. Gallagher and Company's fourth 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 with 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 very much. Good afternoon. Thank you for joining us for our fourth quarter and full year 2019 earnings call. With me today is Doug Hall, our Chief Financial Officer, as well as the heads of our operating divisions. We finished 2019 on a high note. The brokerage and risk management teams delivered outstanding results on all measures. In the quarter, we combined to post 17% growth in revenue, 5.8% all-in organic growth, expanded margins 134 basis points, and we completed 11 mergers during the quarter representing about $117 million of annualized revenue. This caps off an excellent full year where our combined brokerage and risk management teams posted 14% growth in revenue, 5.6% all-in organic growth, expanded margins 76 basis points, and we completed 49 mergers representing about $468 million of annualized revenue. An outstanding quarter, an excellent full year, and I'm more confident today that this momentum will continue in 2020. I want to thank every Gallagher professional for their relentless focus on delivering the very best insurance, brokerage, consulting, and risk management services to our customers around the world. Let me peel back our fourth quarter results a bit more by segment and give some thoughts on why I have reason to believe that 2020 will be as good, if not better, than 2019. Our comments today will focus on the four key drivers of our long-term value creation strategy. Those four are number one, organic growth, including what we are seeing around the world in terms of rate and exposures. Number two, merger and acquisition growth and our current merger pipeline. Number three, improving our productivity and quality. And four, what makes all this happen, which is our bedrock culture. Now let's move to our brokerage segment performance, starting with organic. Fourth quarter organic growth was 6.1% all in. Base commission and fee growth was a little lower than that due to the repricing of a wholesale program, which we discussed at our December IR day. but contingents performed a bit better than we expected, not an exact offset, but close. Let me break down our organic growth by geography. First, our domestic retail P&C operations were very strong, above 6%, and retail benefits were up around 4%. Our domestic wholesale operations, that's our open brokerage program manager and underwriting business, were up about 7%. Outside the U.S., Our U.K. operations posted 6% organic, Canada was up more than 10%, and Australia and New Zealand grew around 6%. PC rates and exposures continue to be a tailwind to our organic growth, with renewal premium change now comfortably above 5%. Let me give you a few noteworthy sound bites for the quarter. Starting in the U.S., our retail PC and wholesale business up about 5.5%. Property lines are up about 9%, while casualty lines are up about 6%. Workers' compensation is down a couple points. Renewal change in our open brokerage wholesale business is the strongest domestically, up about 7%. Moving to the U.K., retail is up about 3.5%, with continued upward pressure on professional liability, which is up close to 7%. London's specialty is up around 5% to 10% in many classes. In Canada, up about 5% across most lines of business with property. New Zealand is up around 4%, but has been drifting lower from 2018 levels. And finally, Australia is up about 7%. So after trending higher in geographies for the past two years, I would characterize the PC market as having moved from stable to firm. not hard like we saw in the mid-'80s and in the early 2000s, but certainly firm. A recent survey of our PC producers suggests that the 2019 rate momentum has continued into 2020. Further, unemployment remains at historically low levels nearly everywhere, and our clients' businesses are expanding in a favorable economic environment. Taken together, these market conditions should continue to provide us with a nice organic growth tailwind. That said, we are still in an environment where our professionals can develop creative solutions that help our clients mitigate or partially mitigate rate increases. In addition, clients will ask us to deliver a risk management program within their budget that might be flat or up only a percent or two. That means they might opt out of certain coverages, increase deductibles, reduce limits, et cetera. In other words, not all the rate tailwinds show up in our organic growth. So as I sit here today, I see 2020 brokerage organic growth again in the upper 5% range and might very well tick over 6%, especially if we don't have a deterioration in economic confidence. Now let me talk about brokerage fourth quarter merger and acquisition growth. We had another active quarter completing 11 brokerage acquisitions with average revenues of about $10 million. Our merger and acquisition momentum continues. Already this year, we've announced four tuck-in mergers and also moved to 100% ownership of Capscom Re. We're excited to be fully together now with the Capscom team, and 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. Looking forward, our internal M&A pipeline report shows around $250 million of revenues associated with about 50 term sheets either agreed upon or being prepared. This is down a little bit from the last few quarters, as the first quarter deal activity can be a little slower than later quarters. But I'd still believe that 2020 should be another strong year for our tuck-in merger and acquisition strategy as we continue to attract entrepreneurial partners that believe in our unique culture and realize that we can be more successful together. Moving to productivity and quality. Brokerage adjusted EBITDAG margins expanded 151 basis points this quarter, helped by higher contingent commissions and acquisitions. This marks the 33rd consecutive quarter of margin expansion and is a reflection of all the hard work the brokerage team has done to find efficiencies and increase quality. So to wrap up the brokerage segment, for the full year we delivered 15% growth in revenue, 5.8% all-in organic growth, adjusted EBITDAG margin expansion of 75 basis points, and we completed 46 mergers representing about $452 million of annualized revenues. What an outstanding year for our brokerage team. Next, I would like to move to our risk management segment. Fourth quarter organic growth was a solid 4.7%, in line with the mid-single-digit organic guidance we provided at our December IR date. Underlying the organic results, we saw workers' compensation and general liability claim counts growing in the 1% range for the full year. Pricing increases are modest, but new business wins highlight that our highly effective and customized claims handling capabilities are being recognized as driving better outcomes. We continue to see carriers outsourcing a portion of their claims operations as a great long-term opportunity for Gallagher Bassett. As we look forward to next year, we estimate 2020 risk management organic will be in the 5% to 7% range. So to wrap up my risk management comments for the full year, we posted 5% growth in total revenue, 4.4% all-in organic growth, adjusted EBITDA margin of 17.4%, and we completed three mergers representing about $16 million of annualized revenue. Another really solid year for the Gallagher Bassett team. And finally, I'll touch on our unique Gallagher culture. You can see from the results that we've shared today that Gallagher Way continues to drive our consistent growth. Our shared values help maintain our culture and encourage employees worldwide to push for excellence in everything we do. Our culture has earned us recognition in 2019 as a world's most ethical company, eight consecutive years running. Just last week, we also received a top score of 100% on the Human Rights Campaign Foundation's Corporate Equality Index. This is the second consecutive year we've received this honor. As proud as I am of the outstanding performance we had this last quarter, this last year, and this last decade, I'm more proud of the way our culture has stayed true throughout all of that. We've always been guided by the Gallagher Way. And for 92-plus years, we've been building this unique culture. I'm looking forward to seeing our culture thrive in this new decade. Okay, a great quarter and a fantastic year across the board. I'll stop now and turn it over to Doug. Doug?

Thanks, Pat, and good afternoon, everyone. Before I dive into our results, I, too, would like to thank all of our professionals around the world for such a strong finish to a great year. It is especially exciting to report back-to-back years of more than 5% organic growth, and the environment is right to make that a three-peat here in 2020. When I step back and look at our adjusted results for the quarter, our brokerage segment posted $0.67, our risk management segment $0.09, and our corporate segment a loss of $0.18. So total adjusted EPS of $0.58. Risk management and the corporate segment were in line with our December investor day expectations, and our brokerage segment came in even better. When you look at the brokerage organic table on page five and the EBITDA margin table on page six, you'll see that strength in our brokerage segment came from strong organic growth of over 6% and adjusted margin expansion of 151 basis points. Of that 151 basis points, about a third was related to higher contingents, about another third due to seasonality of a couple recent acquisitions, and the remaining third is margin expansion we would expect in a mid-5% base commission and fee organic environment. Having now been through our 2020 budgeting process, it is clear that we're seeing the benefits of our constant focus on improving our productivity, lowering our costs, all the while ensuring that we raise our quality also. In an environment where rates are increasing, it takes more work by our teams to develop creative solutions, shop the market, and guide our clients. That increases our costs somewhat. In addition, we're making substantial investments in hardening our IT environment, building our data and analytics capabilities, investing in marketing and brand awareness, growing our producer ranks, and other investments that help us sell more, hire more, and acquire more. However, we can offset these rising costs and still expand margins. Our businesses are proving at scale and our efforts over the last 15 years to standardize and shift work into our offshore centers of excellence can lead to steady improvements that offset wage increases and inflation, and yet still allow us to make very important investments. So when I look at 2020, I see another year like 2019. If we have organic in the upper 5% range, margins should expand 50 to 70 basis points. One other small net. When you get back to page 12, you'll see that the impact of minority interest on our brokerage segment EPS is better than our December IR day estimates. On the surface, that gives the appearance of a couple million dollars or a penny or so better. But that's not really the case. You can't see it, but there's a like for like unfavorable amount in our base numbers. So that washes out to nothing, so no impact on EPS. Moving to the risk management segment on pages six and seven, you heard Pat talk about the solid organic growth, and we posted margins above 17% despite lesser performance revenues, and I think that's really good work by the team this quarter. Looking towards 2020, we're a bit more optimistic about organic, and we're also targeting margins in the upper 17% range. Our risk management team is also seeing scale advantages which is allowing us to provide deeper and more specialized services that deliver better claim outcomes for our customers. As for the non-GAAP adjustments this quarter, most are very close to what we forecasted during our December IR day. There was one new item for the fourth quarter. Our full year 2019 effective tax rate dropped during the fourth quarter when we filed our state tax returns. These filings triggered a benefit primarily due to reapportionment, and some changes we made in our legal entity structure. It's a real drop for the full year and going forward, but we did adjust out the favorable catch-up amounts from earlier quarters. Moving now to the corporate segment on page eight of the earnings release. Nothing significant here from our December IR day. Interest is in line, clean energy a little better, M&A costs were a little higher, yet corporate costs a little lower. So now let's move to the CFO commentary document we post on our website. On page two, you'll see that we have now provided our first look at 2020 for items related to the brokerage and risk management segments. As an overall comment, we have the capacity to do another $1.5 to $1.6 billion of mergers again this year with cash and debt. But you should know that we don't include any future mergers in any of the estimates we're providing in this CFO commentary document. Our estimates only include mergers that we've closed by today and debt that we have borrowed as of today. So this means you should start with our estimates for amortization expense, estimated earn-out accretion expense, and interest expense, but you must then make an estimate for additional amounts for each of those line items that arise from future M&A. So for example, if we do $1.6 billion of M&A this year, And let's assume that it all happens equally each quarter, call it $400 million a quarter. You'll see in footnote one that it says amortization should increase about 1% per dollar spent on M&A. So call that an additional $4 million in the second quarter, $8 million in the third, and $12 million in the fourth. As for earn out accretion, that should grow about $1 to $2 million a quarter on that example. And then as for interest expense, We just closed a $575 million round, so our numbers already include interest for that. But if you assume we borrow another, say, $300 million on June 30th, that would mean your interest expense estimates should go up by $3 million in the third and $3 million in the fourth. Again, these are just examples for illustration. My point is simply to make sure that your assumptions for M&A factor in the non-cash amortization and accretion and also the interest expense. Two other items on page two of the CFO commentary. Non-controlling interest. Much lower going forward, especially in the first quarter, because we now own 100% of Capscom. And you'll see that we lowered our expected tax rate to reflect the state tax benefit I mentioned earlier. Moving into page three of the CFO commentary, we've now added the light reddish column, which provides our first look at 2020 quarterly estimates and also updates our full year estimates that we provided during our December IR day. Two matters to note. First, when you update your brokerage and risk management segment for a lower tax rate, you'll need to also update for a lower state tax benefit in the corporate segment. We've done that for you in the reddish column. The total company is actually a two to three cent benefit, but there is some geography between segments. Second, our 2020 quarterly comparatives to 2019 will change. Recall that in early 2019, we sold a non-core brokerage operation. That triggered a large gain, which then caused us to recognize the large amount of credit in the first quarter of 2019. We don't have any meaningful sales in process, so we are not anticipating recognizing as many tax credits in the first quarter of 2020. That will also cause all of the 2020 quarters to be proportionally different than 2019. Okay, I'll wrap up. It was an outstanding quarter to close out a really terrific year, setting us up for even a better year here in 2020. Back to you, Pat.