Patrick Gallagher - Chairman, President and CEO Doug Howell - CFO.

Elyse Greenspan - Wells Fargo Adam Klauber - William Blair Arash Soleimani - KBW Mark Hughes - SunTrust Robinson Humphrey.

Good morning and welcome to Arthur J Gallagher & Co.’s Second Quarter 2017 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 including answers given in response to questions may constitute forward-looking statements within the meanings 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.

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 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. Mr. Gallagher, you may begin..

Thank you very much and good morning, everyone thank you for joining us for our second quarter 2017 earnings call. With me this morning is Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions. As we do each quarter, today Doug and I are going to talk about the four key components of our value creation strategy.

Those are number one organic growth; two growing through mergers and acquisitions; three, improving our productivity and quality; and four, maintaining our very unique Gallagher culture. The team really delivered on all 4 of the strategic priorities this quarter resulting in excellent top and bottom line results.

I am extremely pleased with our first half performance which sets the stage for another outstanding year in 2017. Let me start with some comments on our broker segments. Second quarter all-in organic growth was 4.2% up nicely over our first quarter.

To the first two quarters 2017 organic stands at 3.5% right in line with the level of organic we experienced last year. Let me give you some granularity around our brokerage segment organic growth in the quarter. In the U.S. organic growth was about 3.5% for the quarter with retail growth stronger than wholesale.

Internationally all-in organic was about 5.5% for the quarter with Australia, New Zealand, Canada and the U.K. all delivering organic growth greater than 4% just a fantastic job by our international team. All of our brokerage operations that are on the globe grew organically in the quarter.

And my optimism for the remainder of the year is based on the broad strength of our operation. As I said in the first quarter I continue to see full year 2017 organic growth in our brokerage segment similar to 2016's result. Moving to the rate environment.

Our internal data shows global PC pricing down only a point in the quarter very similar to last quarter and when I look at the first two quarters combined pricing improved by 50 basis points compared to 2016 within our global retail business.

One really interesting observation is in Australia and New Zealand pricing has really turned as higher by 4% to 5% during the second quarter. By product line commercial auto is still experiencing highest rate increases up about 1.6% within the U.S. during the second quarter.

Professional liabilities experiencing positive pricing overall particularly within U.S. wholesale which was up 2.1% and U.K. retail was up 1%. The recent rate trends we are seeing in our own internal data were further validated by responses to our annual internal pricing survey which indicated global PC pricing as down about 80 basis points in 2017.

Further our midyear internal rate survey showed almost two-thirds of the respondents expecting no significant change in pricing for the rest of the year. So in the end up a point or down a point this is effectively a stable pricing environment. Second, let me talk about brokerage merger and acquisition growth.

We completed nine tuck-in acquisitions this quarter at a weighted average multiple of about 7 times EBITDAC. The average size of the 9 tuck-ins we completed in the quarter was $3.5 million of annualized revenue. As I look at our internal merger and acquisition report our pipeline remains full.

I see about $250 million of revenue associated with around 40 term sheets either agreed upon or being prepared. Not all these transactions will close, but we believe we have the right mixture of culture, service capabilities, niches and tools that will continue to attract talented independent sales and consulting professionals to our organization.

As I do every quarter, 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 professional. Third, I want to spend some time on our productivity and quality. Last month the entire senior leadership team was in London.

Now that our large merger integration is essentially behind us the focus was on the opportunities ahead for our U.K. operation.

By leveraging our centers of excellence, streamlining the back office, becoming more efficient on small business and standardizing process, we should be able to increase our margins, improve quality and delivery sustainable organic growth. It's an exciting time for our U.K. team.

So to wrap-up the brokerage segment, the team posted 9% total adjusted revenue growth and 4.2% organic. Adjusted EBITDAC growth of 11% and adjusted EBITDAC margin was 31% up 51 basis points over second quarter 2016, so really strong results sitting here at the half way market for our brokerage team.

Next, I would like to move to our risk management segment which is primarily Gallagher Bassett. Second quarter organic growth was 5.6% and reflects excellent organic growth domestically and internationally.

The team has notched a number of new business wins this year across all segments and geographies many of which were directly with insurance carriers. In terms of merger and acquisition growth, our risk management team completed two acquisitions in the quarter one in New Zealand and the other in the U.K.

Both of these new merger partners have unique capabilities that will increase and help round out our service offerings in these respective geographies. Risk management adjusted EBITDAC margins showed about 10 basis points of year-over-year improvement and fell within our expected range for the quarter at 17%.

The team has done really a fantastic job managing headcount as the segment was experiencing lower levels of organic growth over the past couple of quarters.

Lastly culture, our culture is the key differentiator of our company and we are constantly looking for the right people to join us whether through new hires, mergers and acquisitions or internship program. In August, we will conclude our 52nd year of the Gallagher summer internship program.

This extensive two month program for over 300 young men and women is an essential investment in our future and is forming a rock solid foundation for our culture for many, many years to come. Okay, an excellent quarter, a great half for the year, I will stop now and turn it over to Doug.

Doug?.

Thanks, Pat, and good morning, everyone. Like Pat said, a really terrific second quarter and first half of 2017. This morning my comments are going to cover some modeling items using the CFO commentary document that we posted on our investor website as well as my typical commentary and margins, clean energy, M&A and cash and capital management.

Okay first page 2 of the CFO commentary. You will see that most all of the second quarter 2017 actual numbers came in very close for the estimates that we provided during our June 13th Investor Day.

In addition, you will see that our third and fourth quarter commentary is right in line with what we provided in June also, so really no new news on page 2. Next please turn to page 5 of the CFO commentary to the table showing you roll-in revenues from M&A. During our June 13 IR Day we provided our updated estimate of $43 million of roll-in revenues.

Now we posted right about that number 42 million. However, it looks to us like [indiscernible] consensus was about $50 million with some having a much wider range around that number. While $8 million of difference to the consensus isn't a huge number, it does cause about a penny of difference in EPS.

We fully understand that making an estimate for roll-over revenues is a difficult pact. So we will continue to provide an update towards the end of each quarter during our quarterly IR meeting. Meanwhile please take a few minutes extra when you are updating your models between now and then.

Okay let’s move back to the earnings release and some comments on the brokerage segment margin. Adjusted brokerage EBITDAC margin expanded 51 basis points in the quarter. Nearly all of our operating units around the world held or improved margins and nice healthy results reflecting strong operational discipline.

Natural question might be why did adjusted margins expand a 120 basis points in the first quarter and 2.7% organic, net expense 51 basis points and 4.2% organic here in the second quarter. It has to do with our seasonality and the roll-in of M&A.

First is understanding that our second quarter is by far our highest margin quarter at 31%, first 24.6% in the first quarter. Second, to understand that the tranche of mergers that are moving in this year do not have the same second quarter seasonality.

In fact this tranche of M&A rolling in is posting about 25% margins both in the first and second quarter. Accordingly, they didn't really impact margins in the first quarter and overall we were at 24.6%. But here in the second quarter, when overall we're poking 31%, they do bring down margins.

If I were to levelize for this in the second quarter, we would have posted about 80 to 90 basis points on margin expansion here in this second quarter. I hope that answers the natural question that might arise. Now, looking forward. Last year, the brokerage segment adjusted margins were 27.9% in the third quarter and 25.8% in the fourth quarter.

Again you can see some seasonality there and we posted about 20 to 30 basis points of margin expansion last year in those quarters over 2015. That expansion came on organically about 3.5% in each quarter.

So, this year we're targeting similar margins in the third and fourth quarter, so please don’t model much of any margin expansion in the second half. Now, let's move to our risk management segment. We posted adjusted EBITDAC margin of 17%.

As Pat mentioned, the team did a great job of controlling the headcount as we move past a lower period of organic growth, which but it still resulted into margin expansion here in the second quarter. We continued to see margins for the full year in the range of 17% to 17.5%. Let's turn to clean energy.

With a warm June, we had a great second quarter and our earnings came into the high end of our estimate. You can see on page 3 of the CFO commentary that if we hit the midpoint of the full year range, it will be a nice step up in 2016 but also I have to say we all understand that weathers going to impact those estimate.

A cooler summer or a warmer early winter can move our estimates by a million. At June 30, 2017, we have about $550 million of tax credits on our balance sheet. Effectively a $550 million receivable from the government. This assets will reduce our future cash taxes paid for many years to come, even with or without tax reform. Next, M&A.

we're still seeing fair pricing on tuck-in merger. With a weighted average multiple through June 30 of below a time, it shows that merger partners are choosing Gallagher because they value our capabilities and our culture and they know that we will be better together. When I look at our pipeline I see similar pricing for the rest of the year.

Finally, cash. At June 30, we're pushing $300 million or pushing up towards $300 million of available cash on our balance sheet. Combined with a debt offering announced in June, it looks like we can fund it 2017 M&A with free cash in debt.

So, those are my comments, outstanding organics, solid execution and our tuck-in M&A program, excellent operational discipline and margin expansion at a strong cash position. A terrific quarter and terrific half on all measures. Thank you, Pat..

Thank you, Doug. And operator, we're ready to open up for questions, hopefully some answers..

Thank you. [Operator Instructions] Our first question is coming from Elyse Greenspan of Wells Fargo. Please go ahead..

Hi, good morning..

Good morning, Elyse..

My first question on is just on the organic outlook just combined with a broad I guess more color on the market. As you think to the back half of the year to hit your full year target would imply maybe just a little bit of a step-up in the first half of the year.

As you think about that, how are you thinking about organic, internationally should it remain as strong as we saw in the second quarter. And then, also what are you seeing on exposure growth in the U.S.

but also around the world?.

Well, as it relates to organic internationally, I'm pretty bullish. We got rate improvement in New Zealand and Australia, those businesses are doing very well. We've got positive organic in Canada and the U.K. at a level that's greater than the United States. In the U.S. is in very nicely positive organic.

So, I feel the 2017 should look and feel a lot like 2016..

And then what about exposure growth?.

Exposure growth is interesting. It's not having much impact yet. When I look at the worldwide employment figures, I keep wondering when exposure is going to show some nice shoots but it has an impact that is by more than a percent..

So, the exposure growth does start to pick up, that would be additive to your debt and close outlook?.

Absolutely..

Okay, great. And then, you guys in the commentary pointed to flat margins in the brokerage business for the second half of the year.

I guess, if you continued hit, say about 3.5% organic, I know there are some of those acquisitions Doug, that you pointed to coming in but why won't you be able to expand margins or is it just a matter of some investments.

I know that you've spoken about in the past that you're making on within the company?.

Yes. Historically in the second half of the year, margins expansion has not been as much in the first half. Thus far year-to-date we're up 84 basis points. We're in a similar position last year this time we brought it in right around 50 basis points for the full year.

Part of the reason for that is we typically give our reasons during the second half of the year. Those will be coming in, so that does have a little bit of a -- it keeps margins from expanding as much because that's when we give the raises and then we see the result of that as what's full there.

So, basically like we're saying, this year feels a lot like last year. If we end at 35 for the year, if we end up with just a little bit of margin expansion in the third and fourth quarter, we'll bring it in somewhere around 50 basis points of margin expansion on 3.5% organic growth. That's pretty much so how the model work..

Also, in September, typically when we bring our into our new hire's on..

Okay, great. And then in terms of the weighted average share count went up a little bit in the quarter. Is that due I think last quarter you pointed out the stock comp accounting I think has a weight as your share count.

Am I thinking about that correct, is there something else going on there?.

Yes. Let me clarify in that. It really doesn't, this stock option the new stock option accounting produces a little bit of a gain in the corporate segment that used to go through, it goes with the P&L now, it used to go through other comprehensive income. It doesn't really impact the number of shares outstanding.

The reason why shares are creeping up a little it right now is we do have -- we did have more stock option exercises in the first half of the year. So, that puts more shares out of the market. Our employee stock purchase plan puts them out into them. So, that increases it. We did use some shares in M&A this quarter in tax reexchange.

So, that puts it out but recall we purchased those last year. So, I think we're still above flat when it comes to shares purchased last year versus those years we've issued an M&A. So, we're pretty bottom.

So, that's the three pieces that caused the slight creep from I think we're at a 181 million last quarter and we're pushing a 182 million this quarter..

Okay, great. Thanks very much for the color..

Thanks, Elyse..

Thank you. Our next question is coming from Kai Pan, Morgan Stanley. Please proceed with your question..

Hi there, thanks, good morning. Actually it's Mike Phillips sitting for Kai Pan this one. Good morning, everybody..

Good morning, Mike..

Question on -- good morning. Supplemental continued to commissions as they grew pretty well in the quarter. I guess, just of your outlook on there for the second half of the year how that varies by quarter and seasonality.

And then how much did that impact the margin growth in the quarter?.

Yes, all right. First and foremost, the different three ways in supplemental I've always said is kind of it's a blurry line between that. So, I wouldn't read too terribly much into the fact that it grew 10% year-to-date in base of that pack 3% and there is some blurred lines there.

I think that continue commissions of the one that there really kind of have a little bit more impact to the bottom line and they're up 2.7% in the year-to-date. So, it does have a little impact on margin expansion, maybe 10 or 15 basis points by the time you look at after compensation elements that are associated with that..

Okay, great, thanks. And then I guess second one just more broadly.

What impact do you think will have on you guys of the USO and Wells Fargo deal, I guess acquisition activity and maybe organic growth as well?.

Well, I mean I wouldn’t comment on what it'll do for organic growth. But whenever there's change in the business and people are looking for another place to maybe rest their head, we try to provide a pretty nice house..

Okay. So, no major impact. I guess lastly, on clean coal with its sunset coming. Just refresh us again on your view of the prospects for tax reform and kind of what you're pursuing other tax wedded fields to keep your cycle tax rate down..

Great question. I don’t really have any views on tax reform at this point. I think it's a crap shoot anyway you look at it. I think that regardless what happens, we have generated a substantial amount of credit carry forwards, 550 million of them. We'll use those going into the future. We can produce new credits all the way through 2021.

By the time we get to that in the current tax environment with our current balance sheet, I don’t think there will be a paying meaningful taxes in the U.S. until late in the 20's. What do we have wind up between 2025 and 2030 for further reductions and taxes, I don’t know at this time.

But we've been very good over since the history of Gallagher build always find some new tax credit strategy. So, we'll see how the, that's something we'll start working on in 2022..

Okay, great. Thanks, very much. I appreciate it..

Thanks, Mike..

Yes..

Thank you. Our next question is coming from Adam Klauber of William Blair. Please go ahead..

Thanks, good morning everyone..

Good morning, Adam..

Just a couple of different questions. Did I hear correctly, did you say U.S.

wholesale rates were up 1% to 2%?.

On professional lines..

On professional lines, okay.

Well, in wholesale, what's the just generally the ballpark the level of submissions and how does that compare to a year ago?.

Submissions were up nicely, probably up 3%, 4%. Finding continues to hit ratio, continues to be pretty significant. And the business is very, very healthy..

Okay. And then how about the benefit business, is that growing more or less in the overall U.S.

retail business?.

A little bit more..

Okay..

Yes. Not measurably more, I mean, maybe just 4.5 this quarter versus 4.2 all in..

Okay. And then I think you mentioned exposures are doing generally okay.

How about audit premiums, are those more a tail wind today than a year ago?.

No, they're not a tail wind, it's kind of flattish. That's why the, that's kind of the quandary. We're seeing employment figures look strong and I see that globally and yet we're really not seeing payrolls jump and we're not seeing sales jump. So, it's the audits are kind of flattish..

Okay. Thanks, that's all I had..

Thanks, Adam..

Thanks, Adam..

Thank you. Our next question is coming from Arash Soleimani of KBW. Please go ahead..

Hi, thanks..

Good morning..

Good morning. Couple of quick questions. I know you had mentioned that $250 million pipeline and the brokerage M&A, within the risk for Gallagher Bassett I think you said that you had recently hired a full time M&A person and you didn’t have a full time person in that capacity before.

I'm just wondering how should we think given that how should we think of the pipeline there..

I don’t know if we actually said there's a full time person inside a Gallagher Bassett. I have a team of folks that are really good about looking for opportunities. I remember in Gallagher Bassett, what we're looking for is geographic expansion and where our multinational clients we want to have us have places to do business.

That's one thing we look for. The other thing is there are some nice specialty claim related businesses out there that can round out our product offering and offering to our client. Those are the two types of things that we're looking for there. And so, but it’s Gallagher Bassett provides a full array of services.

So, those are they are out there but there is not an abundance of them..

And you're not going to see the level of activity out of Gallagher Bassett that you see in a brokerage unit. The brokerage, the brokerage world is incredibly fragmented, it's virtually huge and the opportunities are limitless..

And that's not a business where we're just trying to acquire people for our customer list. We do really well on competing every day for that type of business organically. So, just to be able to pick up scale through a customer list is not something that's all that interesting to us..

Okay. That's helpful, thanks.

And my other question is, and within your interim program, how many of those interims typically come on full time?.

So, you take, we are 300 instance this summer and the split between people who finished their sophomore year in college and people who finished the junior year. And the juniors are probably will be something on the order of a 100 out of that 300. So, they're going back for their senior year, we'll probably recruit of about 80 of those.

There will be starters in September of 2018. And by the way, five years later we'll have 80% of those still with us and 20 years later we'll have 80% of those..

Okay, great. Thank you very much for the answers..

Take care..

[Operator Instructions] Our next question is coming from Mark Hughes of SunTrust Robinson Humphrey. Please go ahead..

Yes. Thank you, good morning..

Good morning..

Any change in underlying claims frequent your severity within the risk management business?.

No, not really. I mean, claims frequency's probably up 1% and that severity has not shown any real change..

And then the medical professional liability, you talked about professional lines being up about medical professional?.

Medical professional's kind of flat..

And then whole sale, I think you had in your opening comments that retail was above average wholesale, below average in terms of growth.

Is that a change from the recent trend that it decelerated this quarter?.

Yes. There is that, no, it's been about this same. There is one program in particular in our trucking business that if you recall we've talked about this before that the carriers have kind of come in and out of that and so we lost our market on it.

That pushes back a little bit, there's markets that are coming back into the space now when pricing's a little bit more reasonable. So, I would say that we see that it tends to be a little bit more of a volatile business than let's say our basic brokerage retail space. So, when a market comes in and out of a space it does tell you.

Till the last few quarters the trucking business kind of held us back a little bit on that but still close in those single digits is good for that space right now..

And then, what did you say your available cash was at the --..

We're pushing $300 million right now..

$300 million, okay. Thank you, very much..

Thanks, Mark..

Thanks, Mark..

Thank you. Our next question is coming from Ryan Tunis of Credit Suisse. Please go ahead..

Hi, this is Crystal Lu in for Ryan. I just have a question on the acquisition this quarter. The case of acquisition seem to upload a little bit and even though the year-to-date is basically on pace as a year ago. I thought that the target is goal is to spend about $800 million on acquisitions this year.

Is that still what you're targeting to spend more than you spend in 2016?.

Well, Crystal, this is Pat. Let me address the number of deals and then I'll let Doug talk about the amount we'll spend on them. The merger and acquisition process is a sales process just like when we go out and get new cars. And these things it's not like you get to turn on this big and say we'll do six this month and next month we'll do seven.

I mean, these are entrepreneurs that are selling their baby and we get that. And they're not coming aboard until they're ready and we got to do out due diligence. So, doing the number that we've done this year is still a very good pace for us. And if it accelerates a little bit in the second half great and if it slows down a little bit that's fine too.

We want to get the right partners on the boat and we're not just trying to do deals..

No, I think from cash flow standpoint we do still see ourselves spending $700 million to $800 million on deals this year if they -- if depending on the pipeline develops the way we think it will, we still see a lot of deals in that sub eight multiple range that we really like tuck-in acquisitions.

And if it's a little lower than last year, it wouldn’t be by much, if it's a little more than last year, it wouldn’t be much either. And triply if we ended up with a situation where we didn’t have so much, may we buy stock back with that, would have to look at what our pipeline would be for the first quarter.

And remember, the one thing to remember is that historically our first half of the year is slower when it comes to M&A in the second half of the year..

Great, that's helpful. And the one other question was, I've noticed as sum of the margin expansion this quarter came from headcount control.

Is this part of something that is a broad initiative that's happening across the company that you think will continue to the rest of the year or is it just something that happens periodically just one time?.

Now, we've actually had nice headcount controls for last couple of years on that. I think as our technologies are innovative technology that we put into the middle output layer come online allows us to contract our domestic workforce with having very good success with pushing work into our offshore centers of excellence.

So, that's helping us control our headcount. So, it's with the operational discipline of harvesting the hard work that we put in over the last decade become an operationally excellent company. And that's really what's happening, it's allowing us to control the headcount which is really important.

If we get into an inflationary wage environment, that's a competitive advantage for us in that we've proven that our technology's work and that we can control our headcount for it..

Okay..

And what's interesting is our quality with our customers has gone up dramatically even during this time..

Great. Thank you, so much..

Thank you, Crystal..

[Operator Instructions].

I'll just make a few comments and then we'll say thank you for being with us. That's what I'd like to say is thank you again for being with us this morning. In closing, I'm extremely pleased with our first half performance and I believe 2017 is shaping up to be another outstanding year.

We look forward to speaking with you again in October and having a good second half. Thank you, for being with us this morning..

Ladies and gentlemen, thank you for your participation. You may disconnect your lines at this time. And have a wonderful day..