Arthur J. Gallagher & Co. (AJG) Q3 2018 Earnings Report, Transcript and Summary

Good afternoon and welcome to Arthur J. Gallagher & Co.'s Third Quarter 2018 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 are 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 & Co. Mr. Gallagher, you may begin. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Thank you, Devin. Good afternoon. Thank you for joining us for our third quarter 2018 earnings call. With me today is Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions. Before I get into our results, I want to acknowledge the devastation caused by hurricanes Florence and Michael. Our professionals now have the important task of helping our clients sort through their claims, get losses paid, and ultimately put their lives back together. And many of our own employees must do the same for themselves. I'm really honored to be part of the insurance industry, an industry which plays the lead role in repairing property, but more importantly restoring lives. Okay. Onto comments regarding our third quarter. Doug and I are going to touch on four key components of our strategy to drive shareholder value. Number one is organic growth, number two is growing through mergers and acquisitions, number three is improving our productivity and quality and fourth maintaining our unique culture. We had an excellent quarter and, once again, the team delivered on all four of our strategic priorities. Before I dive deeper into organic pricing and mergers and acquisitions, let me give some financial highlights for the quarter. For our core brokerage and risk management segments combined, 11% growth in revenues, 5.9% all in organic growth. Adjusted EBITDAC margin expansion of 67 basis points, excluding the roll-in impact of acquisitions and we completed 10 mergers in the quarter, nine in brokerage, one in risk management, totaling about $75 million of annualized revenues, a really, really fantastic quarter by the team. Let me start with our brokerage segment. Third quarter organic growth was 6.3% all-in with broad-based strength across all of our divisions globally. We did see some stronger than estimated contingents in the quarter, but even excluding those, organic was a really strong 5.9%. Let me break that down around the world. Our domestic retail PC operations had an outstanding quarter with organic of little less than 7% and, even after excluding the stronger than estimated contingents, we were up nearly 6%. Our retail PC operations in the UK and Canada each delivered organic of about 4.5%. Australia and New Zealand are really terrific quarter, up 7%. Our domestic wholesale operations posted close to 6%. And finally, our benefits business also had a strong showing this quarter, generating more than 5% organic growth. Overall, rate and exposure continue to be a modest tailwind, and these two items combined increased our organic by a little over a point in the quarter. Let me give you some more insight into the lines where we saw some movement in the quarter based on our internal data. In our U.S. retail PC business, rate and exposures flat or positive across most major lines. For example, commercial auto is up about 4%, property is up 3%, and workers' compensation is down a little less than a point. Moving to our domestic wholesale operations, a very similar story to the retail side. Property lines up 5%, casualty lines up 2%, and workers' comp down a little more than 1%. Canada is up 2.5% overall with property up 3%, and professional lines and casualty up about a point. UK retail is positive across most lines as well. Property, marine and commercial auto are off a bit over 2%, and casualty up a little less than 2%. Pricing in Australia, New Zealand remains the strongest, properties up 7% and is stronger than casualty and specialty lines, which were up 5%. So, overall, up a couple of points, down a couple of points, you've heard me say this many times before. It's essentially a stable market – one that is good for brokers, it's good for carriers and most importantly it's good for our clients. Next let me talk about brokerage merger and acquisition growth. We completed nine brokerage acquisitions this quarter, representing about $62 million of annualized revenue, an average size of about $7 million. Through the first nine months, our merger growth has been exceptional. We've completed 27 mergers, representing about $234 million of annualized revenue. That's more acquired revenue in the first nine months than we did in any of the previous three years. Looking forward, our pipeline of potential tuck-in merger partners is very, very full. Our internal M&A report shows over $500 million of revenues associated with about 70 term sheets either agreed upon or being prepared. We'll get our fair share of these mergers and I feel good about our proven ability to track tuck-in merger partners at fair prices who are excited about our capabilities, believe in our unique culture and realize that we can be more successful together. 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. Next, I would like to move to our risk management segment, which is primarily Gallagher Bassett. Third quarter organic growth was 4%, in line with the estimate we provided at our Investor Day in September. While organic growth can vary by quarter, we expect 2018 organic to be in the 6% to 7% range for the year. In the U.S., claim counts continue to inch higher. Workers' comp and liability claim counts are up about 2% year-to-date versus less than 1% last year. This is a result of increasing claim activity as our clients' payrolls and exposures grow. Moving to mergers and acquisitions, Gallagher Bassett completed one merger in the quarter, a U.S.-based risk management consultant focused on environmental and construction risks. This particular franchise will deepen our expertise and enhance our core loss prevention and mitigation capabilities ultimately furthering our mission of providing clients with superior claim outcomes, another great example of the type of partner we are trying to attract to the Gallagher Bassett family. And finally, I'd like to touch on what really makes Gallagher unique, and that's our culture. Even as we get bigger and more global, our unique Gallagher culture is as strong as ever. For example, we were recently recognized by Forbes Magazine as the World's Best Employer. This recognition is especially gratifying because it means we are treating people the right way and helping them to succeed. It's also noteworthy that we were the only insurance broker in the world to receive this distinction. And that is on top of being named as one of the World's Most Ethical Companies for seven straight years. I'd also like to thank our employees. They came together last year and set a goal of 90,000 hours of community service in celebration of our 90th anniversary. The team volunteered more than 110,000 hours to their local communities over the past year, far surpassing our 90,000 hour goal. This is another great example of our people and their unbelievable drive to do what's right. Our people underpin our culture – a culture that we believe is a true competitive advantage. Okay, an excellent quarter in all measures. We're well on our way to another tremendous year. I'll stop now and turn it over to Doug. Doug? Douglas K. Howell - Arthur J. Gallagher & Co.: Thanks, Pat, and good afternoon, everyone. As Pat said, another really excellent quarter. Today I'll make a few comments referencing the earnings release. I'll then move to the CFO commentary document we posted on our website and then I'll wrap up with some comments on cash and M&A. Okay. Let's turn to page four of our earnings release to the brokerage segment organic table and take a look at the footnote at the bottom. This is what Pat mentioned. We had some stronger than estimated contingents this quarter that had a net positive impact on our all-in organic growth of about 40 basis points. Excluding these contingents, our organic would have been more like 5.9% than the 6.3% shown in the table right above that. Either way, being nicely in the upper 5% range for organic is really, really terrific. I'm making a special point about this today because it does highlight a significant difference between old GAAP and new GAAP. Under old GAAP, we just book contingents when we receive the cash. Under new GAAP, we must now estimate these revenues. So, naturally, actual results will vary from our estimates. I harped about this during our Special Investor Call in April when we walked through the adoption of new GAAP and here it is. When I look to the fourth quarter, it is still early, but it is feeling more like 5% organic growth versus the 6% we posted this quarter. Recall that we had a really strong fourth quarter last year, so that creates a tough compare. Next, turn to page 6 of our earnings release to the brokerage EBITDAC table. In our July earnings call and during our September 13 IR Day, we foreshadowed that third quarter margins would be compressed because of the seasonality of our roll-in acquisitions. So we've added a table that levelizes for this roll-in acquisition seasonality. It's the middle table on page 6. It shows that we would have posted 81 basis points of margin expansion without the roll-ins. This is excellent operating leverage. We're always striving to improve our quality, increase our productivity and reduce our costs. Our service layer professionals continue to optimize our approach to small business, improve and standardize our workflows, shift work to our lower cost operating centers and reduce our real estate footprint. These productivity improvements were instrumental in allowing us to contract our workforce in September and early October, which we announced we're doing at our September IR Day. Our efforts will allow us to reinvest into additional production talent, more data initiatives and to build our brand, all done to help us sell more insurance, provide more consulting and deliver more risk management services. Moving now to pages 6 and 7 of the earnings release, that's the risk management organic table on page 6 and the adjusted margin table on page 7. You'll see that we posted 4% organic growth and 18% adjusted margins this quarter. This is also excellent performance by the team, coming off a strong compare from the third quarter of 2017 when we posted 7% organic and 18% margins and we discussed that it would be a tough compare in our September IR Day, but the team delivered. Looking forward to the fourth quarter, we're seeing risk management segment organic growth of 5% to 7% and margins more towards 17% than 18%. If that happens, our risk management segment will come in with full year organic of 6% to 7% and margins of about 17.5%, right in line with our targets we discussed during our January 2018 earnings call. Let's shift now to the CFO commentary document that can be found on our IR website, page 2 of that document. Most of the items were right in line with what we published at our September Investor Day. The two items worthy of some highlight: severance expense, about $0.01 more in the third quarter than we forecasted, but we're forecasting about $0.01 lower in the fourth quarter. So, in total, it is looking like we will be in line with what we forecasted at our September IR Day. Next, take a look at the amortization expense line. This one might be causing some modeling noise. It looks like Street estimates were a bit lower on expense than we provided at our September IR Day, call it about $0.01; likely arises because we have done considerably more M&A this year than last. So, in modeling future quarters, it's worth an extra few minutes to consider Note 2 at the bottom of the page. That note says that our amortization will increase about 1% for every dollar we spend in purchase price per quarter. So if you model that on your estimate for acquisitions that should get you close. Let's turn to page 3 to the corporate segment; three items to highlight there. First to the clean energy line, you'll see that we had a really strong quarter, even better than we thought at our September IR Day. With Hurricane Florence, came a lot of heat and humidity, causing our plants to run full tilt during the last half of the month. To illustrate, the average daily temperature in the areas serviced by our South Carolina plants was about 7 degrees warmer than average over the final 14 days of September. This is a classic illustration of how weather plays a big part in our estimate. It's always good for me to caution that our estimates are never set in stone. Looking forward, several of our utility partners will publish their fall maintenance routine soon and we expect that they will be pushing maintenance out of September into October and November. So you'll see that we've lowered our fourth quarter estimates just a bit. That said, it doesn't change full year at all and it looks like it'll be another great year provided, of course, the weather cooperates. And then, move to the corporate line. We came in $0.01 better than our September estimates. There's one reason for that: the tax benefit associated with stock-based compensation. With the run-up in our share price during September, there were more options exercised than we expected. And the final line in the corporate segment is the impact of U.S. tax reform. We came in a little better than we guided in the third quarter mostly because of true-ups related to the transition tax and non-deductible compensation items as we finalized our 2017 tax returns. But, as we've been saying all year, this line is mostly just a book expense. It doesn't really cause us to pay more cash taxes because we have an abundance of tax credits. In the end, tax reform has been a really terrific outcome for Gallagher. The rate is down, it's offset a tad by eliminating some deductions, but the billion-dollar win was that it preserved our historical AMT and clean energy tax credits, which totaled about $850 million at September 30. And it also preserved our ability to generate future tax credits through 2021. At current production levels, that may total another $700 million of tax credits. That will reduce our cash taxes paid well into the mid to late 2020s. Okay, some final comments on cash and M&A. At September 30, we have about $250 million of free cash. We expect to generate about $200 million of free cash in the fourth quarter and we have borrowing capacity of about $500 million. That gives us about $1 billion to do M&A without using stock. Thus far this year, our weighted average multiple is 8.2 times, showing that we can execute our tuck-in merger strategy at fair pricing, which gives us a nice arbitrage to our trading multiple. And if you consider that many of these mergers are in the U.S., if you factor in the benefit of our tax credits, it would effectively drop our multiple well below 8 times. Okay. Those are my comments – an excellent quarter, an outstanding first nine months and we're in terrific position to continue our success in the fourth quarter and into 2019. Back to you, Pat. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Thanks, Doug. Devin, we want to open it up for questions, please.

Absolutely. Thank you. Our first question comes from the line of Elyse Greenspan with Wells Fargo. Please proceed with your question.

Good evening. My first question, so just a couple things on organic growth. So 5.6% year-to-date and I know in September you kind of pointed to 2019 looking better than 2018, obviously another stronger-than-expected quarter in the third quarter. So does 2019 still seem like it'll be kind of in that over 5.5% organic growth range? J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Well, Elyse, we were about 4.5% to 5% when we met last. And I think about 5.5% is really terrific. So I'd say I think 2019 looks probably more similar than higher.

But similar to the 5.5%? J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Yes.

Okay, great. And then, a little bit more color on the quarter, pretty strong broad-based growth in the U.S. and internationally. How was the new business growth in the quarter? Would you attribute more of the growth to new business versus retention or just greater purchases by some of your existing clients? Just trying to get an understanding of what really continues to drive the strong organic growth within the company. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Well, first of all, I think you know this, I'm extremely proud of the fact that we are an aggressive new business company and we did have a good quarter. But I think this quarter an awful lot of it was also just down to (00:19:10). We're doing a better and better job of keeping our clients and that's critical to organic growth. You can't fill a bucket with a hole in it. So proud of the team, retention was up nicely and new businesses were strong.

Okay, great. And then, in terms of the margins, you guys did have that table in the press release kind of showing the drag, about 60 basis points for M&A in the quarter. I know in the past you guys have said that that is kind of equal to your margins on a full year basis. So when are these deals seasonally stronger? Like, will they help your margins in the fourth quarter or is it more taking into Q1 and Q2 of next year that you might see greater margin improvement driven off some of these deals? Douglas K. Howell - Arthur J. Gallagher & Co.: Elyse, it's probably split between the three quarters: the first; the second and the fourth if you really look at the way they perform. They'll have higher margins in the fourth quarter than they did in the third clearly and that should be above the margins they would have posted in the first and the quarter.

Okay. And then just one last question. In risk management, your book is about two-thirds in comp and I know you guys kind of highlighted a pickup in claims trends there. Claims trends continue to pick up, what you're hearing across the industry. Do you think that that could lead potentially to stronger organic growth within that segment when we start thinking about 2019? J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: I hope so, but as our clients' businesses become more robust and they add new ships and things like that, the more hours worked – and we work hard to mitigate this, the more claims occur. And so, yes, I think a trend from 1% of growth to 2% is good. Do I predict it will go higher than that? I do not. But our clients' businesses are showing strengths.

Okay, great. Thank you very much. I appreciate the color. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Thanks, Elyse.

Our next question comes from the line of Sarah DeWitt with JPMorgan. Please proceed with your question.

Hi. Good evening. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Good evening.

First just on P&C insurance prices, you commented how you continue to see those increase. I was curious on your thoughts on how you expect that to persist going forward. We've heard a couple insurers this quarter say that the pace of increase has either slowed slightly or stabilized and I wanted to get your outlook going forward. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Well, Sarah, I think you've heard me say this for the last eight, nine years. I grew up in an era where markets were hard and soft. A hard market was seeing increases of 25% to 50% to 75% and probably not able to fill out the line of insurance. Soft markets were down 15% to 17% to 20% and would go on like that for years and years and years. What we're in right now and have been for almost a decade is what I would refer to as a flat market. So I wouldn't be all that concerned as an analyst as to whether or not we're seeing a break from 2% to 1.5%. If the market's down 2% to up 2%, I look at that as flat. And so I just think – you look at this and the reason we give the color we did around the world is, with maybe the exception of Australia, New Zealand, I would just simply call the market flat. Now, within that, you have certain lines that will exhibit the strengthening they need. For instance, transportation right now is difficult to place and the prices are moving up. On the other hand, workers' compensation is softer and clients deserve a break there. So I think you've got a really rational market. It's been rational for 8 to 9 to 10 years. If that's the new norm, that's as good as it gets for clients because clients don't need hard markets and no one benefits from softening markets that are just having the premium erode out from under them at huge chunks. And so I think it's been a pretty interesting decade and I think you'll see it continue to be flat.

Okay, great. That's helpful. And then just on the brokerage margin, if you can continue to generate the strong organic growth of 5% to 6% or so, how much higher do you think brokerage margins can expand over time, and is there a ceiling on the margin there? Douglas K. Howell - Arthur J. Gallagher & Co.: Well, listen, trees don't grow to the moon, but it think that when you get into the short term bursts of 5% or so, you can drop some of that to the bottom line. The bigger question is what can you do with the excess proceeds to help you fuel future organic growth. The efforts that we have to put more boots on the ground is to sell insurance, the efforts we have to harness our data and our digital efforts to sell more insurance, the ability to expand our brand that allows us to hire more, to acquire more and to sell more, those are opportunities that you can invest in at this point. There is underlying wage inflation that's happening, but we believe that we can control that. So, as we get extra organic growth, it's really more about the opportunities to invest in the business that should lead to further organic growth. I think that right now clients in a stable mode that we have, they see our capabilities, they see our resources, they understand they get more from Gallagher, and our ability to show them that to compare their pricing to what they could get elsewhere, et cetera, that's a really important thing and ultimately that will lead to better organic growth. Just like the efforts that we invested in improving our middle office layer, I believe that's directly attributable to the increase in retention. We just don't make mistakes for clients anymore. They have a higher quality service because of the efforts that we launched 12 years ago to improve our middle office operations. So, can margins go up? Sure. The more important thing is what you're going to do with the excess that you get from it and that's reinvesting in the business, so it turns into more organic.

Okay, great. Thanks for the answer. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Thanks, Sarah.

Our next question comes from the line of Mike Zaremski with Credit Suisse. Please proceed with your question.

Hey, thanks. I'll try a follow-up to Sarah's question on the investments. So, organic has clearly been excellent year-to-date. The margins ex the roll-in acquisitions have improved, I think, under 50 basis points. And so, just curious if we're thinking into 2019, it sounds like we should expect a similar level of investments to last year, should organic stay at excellent levels, is that what you're saying, Doug? Douglas K. Howell - Arthur J. Gallagher & Co.: Well, I think there's opportunities for additional investment, but I don't see us spending more than last year, if that's your question. And to clarify in the front end, in the table that we provide on page 6, actually, we've expanded margin 53 basis points excluding the impact of roll-in acquisitions for the year. So our level of investment is controlled. It's not like we're going to plow in and just dump it – chase a lot of efforts and dump a lot of money into it. But I think there is a lot of good things that are going on and I think the level of investment that we have today, it'll notch up a little bit, specifically in data, but we're talking about $5 million to $10 million type of investment there, not $50 million, $60 million, $70 million.

Okay. Okay, got it. And another follow-up on the margins. So, thank you for showing the margins ex the roll-in acquisitions. But I just wanted to clarify, are those acquisitions lower margin and, over time, they'll kind of – their margin will increase more than the company-wide ex them or are those kind of permanently in the run rate (00:27:12)? Douglas K. Howell - Arthur J. Gallagher & Co.: I think it's almost pari passu with our margins by the time you get a full year in and by the time we get a little bit of our synergies and efficiencies there. So this happens to be in a quarter where they're just seasonally smaller and that will probably keep going in the seasonality. But when you stack them up at the end of the year, they'll be pretty close to our margins.

Okay. Okay, got it. And my final question is on the M&A pipeline. We've seen some sizable kind of top 50 business insurance deals this year and it seems like the bigger you get, the more expensive – the higher the multiple. Just curious do you feel that there is some kind of big fish in the pipeline or I don't know if you agree with what I said about the bigger, the more expensive, just kind of curious around the M&A dynamics in the pipeline. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Yeah. This is Pat. I think that it's clear that as you get to what private equity firms might consider a platform acquisition or you get someone that's publicly traded or you get someone that's in the top 100, those multiples are higher. Doug went through the multiple that we're spending, but you also have to realize that the average revenue for what we've done so far this year is $7 million. Those people we can really get to touch and feel their culture. We're looking for folks that want to stay in the business that love the business and love our capabilities and that will come aboard and grow faster than they can grow on their own. And our pipeline has never and, I mean, in my career, never been this full.

Okay. Thank you, guys. Nice quarter. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Thank you. Douglas K. Howell - Arthur J. Gallagher & Co.: Thanks.

Our next question comes from the line of Paul Newsome with Sandler O'Neill. Please proceed with your question. Jon Paul Newsome - Sandler O'Neill & Partners LP: Good afternoon. Obviously, congrats on the quarter. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Thank you. Douglas K. Howell - Arthur J. Gallagher & Co.: Thanks, Paul. Jon Paul Newsome - Sandler O'Neill & Partners LP: I wanted to ask about the contingent commissions in a little bit more of a broad way. I would have assumed that contingent commissions would slow down as profitability of the industry decreases and, obviously, we had some pretty heavy cat losses last year. What is offsetting that profit-related contingency piece? Is it just growth? Or is there something else that I'm missing here? Douglas K. Howell - Arthur J. Gallagher & Co.: Okay. A couple questions. We actually did have about $2 million to $3 million of lesser contingent commissions as a result of the catastrophes. In particular, Hawaii really hurt us on one of our programs. I think we lost $1.5 million on that one. So, what's happening right now to still cause the growth in contingent commissions, I think that the reality is, is as we continue to grow as our acquisition pipeline comes on, there is actually we can improve the business of those acquisitions. And as they roll into our contracts with the carriers, you can pick up some additional contingent commissions that way. Jon Paul Newsome - Sandler O'Neill & Partners LP: So, essentially your contingent commission deal is better than the companies that you're acquiring. So you're getting a little bit better cut of the total piece as you acquire these companies in contingent. Douglas K. Howell - Arthur J. Gallagher & Co.: Yeah. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: That's correct. Douglas K. Howell - Arthur J. Gallagher & Co.: Yeah. I think that the carriers – I mean, some of the things that we do with loss control, our knowledge on risk management, I think the carriers are a little more comfortable with paying us more than what you'd have in maybe a standalone independent. Jon Paul Newsome - Sandler O'Neill & Partners LP: Okay. That makes sense. Thank you. That was my question. Appreciate it. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Thanks, Paul. Douglas K. Howell - Arthur J. Gallagher & Co.: Thanks, Paul.

Our next question comes from the line of Kai Pan with Morgan Stanley. Please proceed with your question. Kai Pan - Morgan Stanley & Co. LLC: Thank you and good evening. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Good evening. Kai Pan - Morgan Stanley & Co. LLC: So, my first question, Doug, you mentioned about the restructuring programs, 350-person plus, that's 30 positions. I just want you to give a little bit explanation for that is ongoing process or (00:31:33) sort of one-off and any potential savings were coming from these restructuring? Douglas K. Howell - Arthur J. Gallagher & Co.: Yeah, okay. Good question. I think if you go back in our history, there's probably been four times where we've kind of taken an opportunity to tighten our belts. Usually, it's when we get an opportunity – when a lot of our improvements are happening in the middle office layer, we get the opportunity to increase the span of control for the management ranks. That's usually when we have the opportunity to tighten our belts a little bit. You'll see in there that we think that this effort can save us $25 million to $30 million and we'll reinvest that into data, some additional production talent and a lot of our branding that we've been doing. So how much of that will hit the bottom line? Maybe a third of it, something like that. Kai Pan - Morgan Stanley & Co. LLC: Okay. When you mention tightening the belt, normally it will associate with the sort of top line growth probably slowing down, you need to sort of like tighten up the expense, but now you are running pretty well. So, why now? Douglas K. Howell - Arthur J. Gallagher & Co.: It just was the time when some of our technology initiatives and some of our work shifting to our lower cost labor locations came online. Frankly, it had very little to do with the timing of the strength of our organic and sometimes the best thing to do is to get better when you're stronger. Kai Pan - Morgan Stanley & Co. LLC: Okay. That's great. And then on your clean coal for 2019 – 2019-2021, the two tax credit will expire. Could you lay out sort of like the process that impact on your GAAP earnings? I know probably not impact much of your cash earnings, but on GAAP earnings basis, how much will you lose at which year and do you have any offsetting factors up to 2019 and the 2021? Douglas K. Howell - Arthur J. Gallagher & Co.: All right. So there's about four questions in there. First and foremost, if you want to understand how much of our GAAP earnings are contributed by the clean energy efforts, you can go to the page 8 of the earnings release and you can see the table in there on how much our clean energy contributes on a GAAP basis. You are right to say that there is a significant difference between a GAAP basis and a cash basis. Interestingly after 2021, if these all go away at that time, we'll actually have a substantial increase in our cash earnings at that time, although the GAAP earnings will go to zero for that. So you're right on point on that one, Kai, that we will actually increase the cash that flows from these once we stop producing new credits. So how much is going to go away at the end of 2019 when some of our plants cycle off, we're working on ways in order to try to extend some of those locations by redeploying some of our lower volume 2021 plants back into the 2019 site. So I really can't give you that answer now. We do know that 2019 looks as good if not better than 2018. But I need another year to work on it in order to give you what the impact is in 2020 and 2021. Kai Pan - Morgan Stanley & Co. LLC: Okay. That's good. Last one, if I may. And Pat, when you did the big acquisition of the international back in 2014, you're seeing this build a big enough platform you can do bolt-on acquisitions. But now sort of four years later, how do you think the bolt-on acquisition international has been? J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Seminal moment, Kai. Probably one of the best things we ever did. It was a big reach for us in terms of moving ourselves into really an international player and it's probably the best thing that we've ever done. Douglas K. Howell - Arthur J. Gallagher & Co.: The number of acquisitions that are on our sheet right now for international location, strong in Australia, strong in Canada, strong in the UK. New Zealand frankly I think that we might have 25% of the market already down in New Zealand, but surprisingly there is a lot of little brokers still that we have the ability to partner up with there too. So, in those geographies, the opportunity to continue to do acquisitions the same way we've been doing it in the U.S. is very high. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: And the proof is in the pudding here, Kai. When we bought Australia in particular, we knew that that business in the form that it was before we bought it was going backwards over 5% a quarter. They're now nicely in positive territory. Kai Pan - Morgan Stanley & Co. LLC: Thank you very much. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Thanks, Kai.

Our next question comes from the line of Mark Hughes with SunTrust. Please proceed with your question.

Thank you very much. Good afternoon. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Good afternoon. Douglas K. Howell - Arthur J. Gallagher & Co.: Hi, Mark.

You had mentioned how you pick up extra contingents when the acquisitions roll-in to your program. Generally speaking, how well do those acquisitions do, more broadly in organic growth if you look out a year or two, is it usually a pretty meaningful uptick? And if so, now that you've accelerated the pace of M&A, will that be a tailwind on your overall organic? Douglas K. Howell - Arthur J. Gallagher & Co.: Yeah, it could. I think that if you look at it in the first year, our organic right when some of the merger partners comes on, the first few months it takes them a little while to get themselves organized in that, but we do have some nice organic that happens in the first year that we own them, but we never reported in our organic numbers because we keep them out of organic numbers for a full year. Then what happens in years two and three, there is some pretty good momentum from then. Does it move the needle on our total company organic? Not that much just because of the sheer size differential from what's coming on versus the mass that's here already. But those that join us that are excited about our capabilities really do well over the three or four years after we open them. And that's evident by us paying in on earn-outs. They're hitting their earn-outs because they are growing better than we expected.

I've got a question just maybe to narrow gauge, but you talked about workers' comp being down 1%. Some of these loss cost numbers state by state are down high single and even low double-digits. I'm always surprised to hear people say pricing is down 1%. It seems like it's probably down more than that if you look at what clients are actually paying. How do you square that? J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Well, we've got good data on our own book of business and I think probably expenses are up, but we know what the rates are doing by geography, by line around the world. Douglas K. Howell - Arthur J. Gallagher & Co.: The other thing (00:38:24) understand when we quote rate, we're actually quoting rate in exposure so, as payrolls rise, the exposure are offsetting the decreases in the rates too.

Right. So, net-net down 1%. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Right.

Thank you. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Thanks, Mark.

Our next question comes from the line of Greg Peters with Raymond James. Please proceed with your question. Charles Gregory Peters - Raymond James & Associates, Inc.: Good afternoon. Thanks for squeezing me in. I wanted to start off, Pat. I noted with interest this announcement earlier this month about your being named to the Hall of Fame by the Katie School and I am just curious if you're going to use that as an excuse to write off into the sunset or do you plan to keep on going from here? J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Greg, you know me well enough that you could answer that question for me. Do I sound like someone who's headed to the beach? Charles Gregory Peters - Raymond James & Associates, Inc.: I just saw all this press about it. It was worthwhile just checking in to make sure I wasn't missing something. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Well, thank you for mentioning it. It was a great honor and we raised a lot of money for Katie School, which is a very important educational institution for our industry. Charles Gregory Peters - Raymond James & Associates, Inc.: Perfect. Well, on a, I guess, slightly more serious note. And a couple people have referenced this before and you have as well. There has been a couple of large transactions by your competitors – one in the U.S. and one internationally. And if I think back in your company's history when your peers have made large transactions, it's usually been an opportunity for you to pick up dislocated brokers and sometimes customers and you've been pretty good at it. And I'm curious if you're hearing any noise in the market, and granted it's early in both cases and the two deals that I'm talking about and you know of, but I'm curious if you're thinking about anything in those terms? J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Here's the thing, Greg, whenever – and you've followed us for years. Now, whenever there's change in the marketplace, when there's dislocation of any kind, up or down, people combining, what have you, it always creates opportunities and we're an opportunistic company. Now what we don't believe in doing is violating non-competes, advocating against gardening leaves or any of that stuff. You're also not going to see us pick up 250 people, shift and lift them and ignore their contractual obligations. But we provide I think a very unique place to work. I think we've got an unbelievable team and our team, you've seen this because you know the company well, goes from folks like myself that have been around for 45 years down to what we call externs who are now starting to be accretive three years into their career. And so, yes, those acquisitions will clearly give us opportunities and we'll continue to be very opportunistic. Charles Gregory Peters - Raymond James & Associates, Inc.: Okay. The final question just around M&A, because the multiples you're paying are considerably lower than what we're hearing about these larger deals (00:41:46) at. Curious if your multiples are an adjusted multiple based on your assessment or after you right-size the organization or if that's just as is type of multiple that you're paying on? And I think, Doug, you've answered this question before, but maybe you can just remind me. Douglas K. Howell - Arthur J. Gallagher & Co.: Yes, as is adjusted for excess owners' comp. So, in some cases, you'll have an owner that pays himself $1 or herself $1, and then some will say they'll pay themselves a 100% of whatever the EBITDA profits are of the company, right? And so what we do is adjust that down to what the fair compensation level would be for somebody that's running a branch or a unit of that size and we have so many around the company, it's a $3 million branch, they're going to make x, if it's a $6 million maybe they make 1.5x or whatever, and then we pay a multiple on that. We usually target 5% growth in order for them to get a little bit of an earn-out and then if they can grow 10% or 15%, they can max their earn-out on that. And so it's a proven method. And I'll tell you what we do is we quote on the page here what we pay initially. Every year, we take all the deals and we stack them up against our earn-outs to see what the multiple is at the end of it. And it's actually no greater than what we paid on the front end. So we're not paying – the earn-outs don't elevate the multiple. Charles Gregory Peters - Raymond James & Associates, Inc.: Got it. Thanks for the answers. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Thanks, Greg.

Our next question comes from the line of Meyer Shields with KBW. Please proceed with your question. Meyer Shields - Keefe, Bruyette & Woods, Inc.: Great. Thanks. Pat or Doug, I was hoping you can talk about whether pricing trends in workers' compensation, in particular, have any meaningful impact on risk management organic growth? Douglas K. Howell - Arthur J. Gallagher & Co.: Well, typically, when you have a harder market on workers' comp then people will look more to the self-insurance arena. So, if anything, a softer workers' comp market right now would say that fewer people are looking at self-insurance or high deductible insurance. On the other hand, there is a lot of educated buyers out there right now that see that Gallagher Bassett can deliver a much better claim outcome. So I think they're getting just as many shots even in what I consider kind of a lower or a modestly lower market. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: And I think it's fair to say, Doug is right. 1% up, 1% down, go back to my earlier comments. It's a flat market. That's not driving Gallagher Bassett organic growth. Douglas K. Howell - Arthur J. Gallagher & Co.: Right. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: We're out selling in the marketplace every day that if you move your work to Gallagher Bassett, we'll deliver better outcomes on your claim costs. And that's what's moving the organic needle there. Douglas K. Howell - Arthur J. Gallagher & Co.: And it's been pretty impressive thus far this year. Meyer Shields - Keefe, Bruyette & Woods, Inc.: Yeah. No, I'm really trying to figure out if there was a headwind sort of baked in there that you've been overcoming. Second thing... Douglas K. Howell - Arthur J. Gallagher & Co.: I would say, yes, a little. Meyer Shields - Keefe, Bruyette & Woods, Inc.: Okay. Thank you. The second question is just employee benefits. I was wondering whether you could break down the overall growth conceptually into employee counts or pricing or client retention. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Not really. Our employee benefit consulting division now is so diverse, it goes from communications to where we have some really very large unique companies that I won't mention names, to health and welfare, which is of course our cornerstone and traditional product offering across voluntary and now across geographies internationally. So our retention there is very good. It mirrors what we do across the rest of the organization. And frankly we just have so much to offer our clients now. When you think about property/casualty, there is no pain in property/casualty. We're not going out and solving a lot of pain point problems, but you get the benefits and you get clients trying to hold onto employees in this full employment environment and, at the same time, balance their employee benefit costs, which are huge and painful and going up, that's what's driving that growth. Meyer Shields - Keefe, Bruyette & Woods, Inc.: Okay. No, that's very helpful. Thank you. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Thanks. Douglas K. Howell - Arthur J. Gallagher & Co.: Thanks, Meyer.

Our last question comes from the line of Kai Pan with Morgan Stanley. Please proceed with your question. Kai Pan - Morgan Stanley & Co. LLC: Yeah. Thanks. Just quick follow-up on the tax rate. Doug, in your CFO commentary, looks like the range you narrowed that, the low end going up 1 point. Is that good rate going forward to 2019? Douglas K. Howell - Arthur J. Gallagher & Co.: Yeah, actually, good catch (00:46:35) I mentioned in my opening comments. Actually the tightening from a 24% to a 26% to a 25% to a 26% rate is basically because we're nine months through the year right now. So I think our insights into what our full year rate in our blend of our domestic versus international is going to be, that's the reason why we tightened it. What will we look at next year, probably go back for the full year, in January we'll probably get 24% to 26% again. The important thing to remember on that, however, is that that's the book tax rate, that's not the cash tax rate. We said this in the last call, maybe I shouldn't repeat it again here. Because of our tax credits we really don't see ourselves paying more than 5% cash taxes paid, 5% of our EBITDA in 2018 or 2019. So the cash taxes paid are well below that 24% or 25% number you're looking there on the sheet. Kai Pan - Morgan Stanley & Co. LLC: That's great. Thank you so much and good luck. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: Thank you, Kai. Douglas K. Howell - Arthur J. Gallagher & Co.: Thank you, Kai. J. Patrick Gallagher, Jr. - Arthur J. Gallagher & Co.: All right, Devin, I've got just one quick remark as a wrap up here. I want to thank everybody for being on the call here this afternoon. I think you could tell from Doug's and my comments, we're extremely pleased with our 2018 performance so far. I believe we have a very strong finish to the year coming up and we look forward to speaking with you again at our IR Day in December. So thank you, everybody, for being with us today.

This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.