Arthur J. Gallagher & Co. (AJG) 2018 Q3 法說會逐字稿

Good afternoon, and welcome to Arthur J. Gallagher & Co.'s Third Quarter 2018 Earnings Conference Call.

(Operator Instructions) 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 security laws.

These forward-looking statements are subject to certain risks and uncertainties discussed on this call or described in the company's reports filed with the Securities and Exchange Commission.

Actual results may differ materially from those discussed today, and the company undertakes no obligation to update these statements.

In addition, for reconciliations of the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the 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.

Thank you, Devon.

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 4 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 4 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 role and impact of acquisitions; and we completed 10 mergers in the quarter, 9 in Brokerage, 1 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 a little less than 7%.

And even after excluding the stronger-than-estimated contingents, we're up nearly 6%.

Our Retail PC operations in the U.K. and Canada each delivered organic of about 4.5%.

Australia and New Zealand, a 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 2 items combined increased our organic by a little over 1 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 exposure is 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 1 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 1 point.

U.K. retail is positive across most lines, as well.

Property Marine and Commercial Auto are all up a bit over 2%, and Casualty up a little less than 2%.

Pricing in Australia and New Zealand remains the strongest, Property is up 7% and is stronger than Casualty and Specialty lines, which are 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 9 brokerage acquisitions this quarter, representing about $62 million of annualized revenue, an average size of about $7 million.

Through the first 9 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 9 months than we did in any of the previous 3 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 attract 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 1 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 7 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 on all measures.

We're well on our way to another tremendous year.

I'll stop now and turn it over to Doug.

Doug?

Thanks, Pat, and good afternoon, everyone.

As Pat said, another really excellent quarter.

Today, I'll make a few comments referencing the earnings release.

I'll then move to the CFO Commentary document we post on our website, and then I'll wrap up with some comments on cash and M&A.

Okay, let's turn to Page 4 of our earnings release to the Brokerage Segment organic table, and take a look at the footnote at the bottom.

This was 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 booked contingents when we received 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 acquisition.

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 cost.

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 were 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, but 2 items worthy of some highlight: Severance expense, about $0.01 more in the third quarter than we forecasted, but $0.01 -- we're forecasting about $0.01 lower in the fourth quarter.

So in total, it's 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 when 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 $1.00 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, on the clean energy line.

You'll see that we had a really strong quarter, even better than we thought at our September IR day.

But Hurricane Florence came with 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 last -- over the final 14 days of September.

This is a classic illustration of how weather plays a big part in our estimates.

So 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 routine -- 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 have lowered our fourth quarter estimates just a bit.

That said, it doesn't change full year at all and it looks like it will 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 nondeductible compensation items as we finalized our 2017 tax returns.

But as we have 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 $1-billion 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 tax -- 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 8.2x, 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 8x.

Okay, those are my comments.

An excellent quarter, an outstanding first 9 months, and we're in terrific position to continue our success in the fourth quarter and into 2019.

Back to you, Pat.

Thanks, Doug.

Devon, do you want to open it up for questions, please?

(Operator Instructions) Our first question comes from the line of Elyse Greenspan with Wells Fargo.

My first question, so just a couple of things on organic growth, so 5.6% year-to-date.

Pat, 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 will be kind of in that over 5.5% organic growth range?

Elyse, I think coming -- 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 '19 looks probably more similar than higher.

But similar to the 5.5%?

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 in the company.

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 retention.

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 business was 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 of M&A in the quarter.

I know in the past, you guys have said that that kind of 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 thinking through Q1 and Q2 of next year that you might see greater margin improvement driven off some of these deals?

Elyse, it's probably split between the 3 quarters.

The first, the second and the fourth, if you really look at the way they perform.

They'll raise -- they'll have higher margins in the fourth quarter than they did in the third, clearly, and that -- which should be about the margins they would have posted in the first and the second.

Okay.

And then just one last question.

In Risk Management, your book is about 2/3 in comp.

And I know you guys kind of highlighted a pickup in claims trends there.

Can you just -- claims trends continue to pick up, which we'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?

I hope so.

As our clients' businesses become more robust and they add new shifts 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 strength.

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

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 peak of increase has either slowed slightly or stabilized and wanted to get your outlook going forward.

Sarah, I think you've heard me say this for the last 8, 9 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 is 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 and New Zealand, I would just simply called 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 then is there a ceiling on the margin there?

Well, listen, trees don't grow to the moon, but I think that when you get into these 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 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 this stable market 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 can 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 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 are you going to do with the excess that you get from it, and that's reinvesting in the business so it turns into more organic.

Our next question comes from the line of Mike Zaremski with Crédit Suisse.

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 I'm just like -- so you may -- 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?

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, and 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 -- chase a lot of efforts and dump a lot of money into it.

But I think there's a lot of good things that are going on.

And I think the level of investment that we have today, it will now jump a little bit, specifically in data, but we're targeting about $5 million to $10 million-type of investment there, not $50 million, $60 million, $70 million.

Okay, got it.

And another follow-up on the margins.

So thank you for showing the margins, x the roll-in acquisitions.

But I just want to clarify, are those acquisitions lower margin and over time, they'll kind of -- their margin will increase more than the company-wide x them?

Or are those kind of permanently in the run rate?

I think they almost -- I think it's almost pari passu with our margins, when we -- 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 we stack them up at the end of the year, they'll be pretty close to our margins.

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 when you -- that the bigger you get, the more expensive -- or the higher the multiple.

Just curious, do you feel that there's some kind of big fish in the pipeline or I don't know if you can -- you agree with said about the bigger, the more expensive.

Just kind of curious around the M&A dynamics in the pipeline.

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.

Our next question comes from the line of Paul Newsome with Sandler O'Neill.

Obviously, congrats on the quarter.

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 in 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 there?

Okay, a couple of questions in there.

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 in 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 the reality 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.

So essentially, your contingent commission deal is better than the companies that your acquiring.

So you're getting a little bit better cut of the total piece as you acquire these companies in contingent?

Yes, that's correct.

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 would have in maybe a standalone independent.

(Operator Instructions) Our next question comes from the line of Kai Pan with Morgan Stanley.

So my first question, Doug, you mentioned about the restructuring programs, 350 person-plus.

That's 30 positions.

I just wondered if you could give a little bit of explanation for that.

Is it an ongoing process or it's just sort of one-off?

And any potential savings are coming from this restructuring?

Yes.

Okay, good question.

I think if you go back in our history, there's probably been 4 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 maybe -- 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 in a lot of our branding that we've been doing.

So how much of that will hit the bottom line?

Maybe 1/3 of it, something like that.

Okay.

When you mentioned tighten the belt, normally, we would associate it with the sort of top line growth probably slowing down, you need to sort of like tighten up the expense.

But now you're running pretty well, so why now?

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.

It has very -- it frankly, had very little to do with the timing of the strength of organic.

And sometimes the best thing to do is to get better when you're stronger.

That's great.

And then on your clean coal, for 2019 and 2021, the 2 like the 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-earning basis, how much you will lose, at which year?

And do you have any offsetting factors after 2019 and 2021?

All right, so there's about 4 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 and how much our clean energy contributes on a GAAP basis.

You're 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 0 for that.

So that -- 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 '19 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 sites.

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 '20 and '21.

Okay, that's good.

Last one, if I may, and Pat, when you did the big acquisition internationally back in 2014, you think this built a big enough platform you can do bolt-on acquisitions.

But now, sort of 4 years later, how do you think that bolt-on acquisition in international has been?

Seminal moment, Kai, probably one of the best things we ever did.

It was a big reach for us, I mean in terms of moving ourselves into really an international player.

And it's probably the best thing that we've ever done.

The number of acquisitions that are on our sheet right now for international location, strong in Australia, strong in Canada, strong in the U.K. New Zealand, frankly, I think that we might have 25% of the market already down in New Zealand, but surprisingly, there's 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.

And the proof's 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.

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

You had mentioned how you pick up extra contingents when the acquisitions roll into your program.

Generally speaking, how well did those acquisitions do, just more broadly, in organic growth if you look out a year or two?

Is there 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?

Yes.

Good.

I think that if you look at it in the first year, our organic and our -- right when some of the merger partners come on, the first few months, it takes them a little while to get themselves organized and that.

But we do have some nice organic that happens in the first year that we own them that we never report in our organic numbers because we keep them out of our organic numbers for a full year.

Then what happens in years 2 and 3, there's some pretty good momentum for that -- from them.

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 can join us that are excited about our capabilities really do well over the 3 or 4 years after we own them.

And that's evidenced by us paying in on earn-outs.

They're hitting their earn-outs because they're growing better than we expected.

Then I've got a question.

This may be too 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?

Well, we've got good data on our own book of business and I think probably expenses are up.

But it's -- we know what the rates are doing by geography by line around the world.

The other thing too, Mark, to make sure you understand when we quote rate, we're actually quoting rate in exposure.

So there's -- as payrolls rise, the exposures are offsetting the decreases in the rates too.

Right.

So net-net, down 1%?

Right.

(Operator Instructions) Our next question comes from the line of Greg Peters with Raymond James.

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'm just curious if you're going to use that as an excuse to ride off into the sunset or do you plan to keep on going from here?

Greg, you know me well enough that you could answer that question for me.

Do I sound like someone that's headed to the beach?

I just saw all this press about it.

It was worthwhile just checking in to make sure I wasn't missing something.

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.

Perfect.

Well, on a, I guess, slightly more serious note.

So a couple of people have referenced this before and you have as well.

There's 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, in the 2 deals that I'm talking about and you know of.

But I'm curious if you're thinking about anything in those terms.

Here's the thing, Greg.

Whenever -- and you've followed us for years now.

Whenever there's change in the marketplace, when there is 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 noncompetes, abrogating 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 3 years into their career.

And so yes, those acquisitions will clearly give us opportunities and we will continue to be very opportunistic.

Okay.

The final question just around M&A because the multiples you're paying are considerably lower than what's we're hearing about these larger deals go [on 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 are paying on.

And I think, Doug, you've answered this question before, but maybe you can just remind me.

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 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 of them around the company.

If it's a $3 million branch, they're going to make x. And they're going to -- 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 hit -- 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.

Our next question comes from the line of Meyer Shields with KBW.

Pat or Doug, I was hoping you could talk about whether pricing trends in Workers Compensation in particular had any meaningful impact on risk management organic growth?

Typically, when you have a harder market on Workers Comp, people will look more for -- 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's 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 modestly lower market.

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.

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.

It's pretty impressive thus far this year.

Really trying to figure out if there was a headwind sort of baked in there that you've been overcoming.

Second question...

I would say yes, a little.

Okay.

Second question, employee benefits.

I was wondering whether you could break down the overall growth conceptually into employee counts or pricing or client retention.

No 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 there's no -- 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's 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 on to 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.

Our last question comes from the line of Kai Pan with Morgan Stanley.

Just a quick follow-up on the tax rate.

Doug, in your CFO Commentary, looks like the range you narrow a bit, the low end going up 1 point.

Is that good rates going forward to 2019?

Yes.

Actually, good catch of price.

I should have mentioned it in my opening comments.

It actually -- the tightening from a 24 to a 26, to 25 to a 26 rate is basically because we're 9 months through the year right now, so I think our insights into what our full-year rate and our blend of our domestic versus international is going to be -- that's the reason why we tightened it.

What would 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 should have repeated 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 and 2019.

So the cash taxes paid are well below that 24%, 25% number you're looking there on the sheet.

All right, Devon I've got just one quick remark as I wrap up here.

I want to thank everybody for being on the call again this afternoon.

I think you can 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 of 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.