Arthur J. Gallagher & Co.

Good afternoon and welcome to Arthur J. Gallagher & Co's first quarter 2021 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 security laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company's 10-K, 10-Q, and 8-K filings for more details on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the earnings relief 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 & Co. Mr. Gallagher, you may begin.

Thank you, Laura. Good afternoon, and thank you for joining us for our first quarter 2021 earnings call. On the call with me today is Doug Howell, our CFO, as well as the heads of our operating divisions. What a fantastic quarter. We executed against our four long-term operating priorities to drive shareholder value. First, we grew organically. Second, we grew through acquisitions. Third, we improved our productivity while raising our quality. And fourth, we continued to reap the benefits of our unique Gallagher culture. I'm extremely proud of how our team continues to execute and deliver world-class expertise and service day in and day out. We're off to a great start in 2021. So let me give you some more detail on the quarter, starting with our brokerage segment. Reported revenue growth of 12.2%. Of that, 6% was organic revenue growth, better than our recent IR day expectations, thanks to an excellent March. Our cost containment efforts saved about $60 million in the quarter, helping drive our net earnings margin higher by 94 basis points and expand our adjusted EBITDA margin by 480 basis points. and net earnings were up 17%, and adjusted EBITDA was up 24%, an excellent quarter from the brokerage team. Let me walk you around the world and give you some sound bites about each of our brokerage units, starting with our PC operations. In the U.S., retail organic growth was strong at about 5%. New business was excellent, and retention remained strong. In our U.S. wholesale operations, risk placement services, organic was about 6%. Open brokerage organic was 15% due to rate increases, higher levels of new business, and improved retention. Our MGA programs binding businesses were up about 4%. Retention and new business were similar to the first quarter of 2020. However, we did see a little bit more tailwind from rate and exposure during the quarter. Moving to the U.K., over 7% organic for the quarter. In both our retail and specialty operations, new business was up over prior year, while retention held pretty steady. Australia and New Zealand combined posted organic of 3%. New business and retention were both similar to prior year. And finally, our Canadian retail operations, excellent organic of 13%, fantastic new business and rate all added to our stellar performance again this quarter. So, overall, our global PC operations posted more than 7% organic, which is better than the 5-6% we discussed at our investor day thanks to a really strong March. Moving to our employee benefit brokerage and consulting business, first quarter organic was up slightly, which is better than our March IR day expectations. Revenue from our traditional health and welfare business held up well, while fees from consulting arrangements, special project work, and our life business were up slightly. So when I bring PC and benefits together, total brokerage segment organic was 6%, a really strong start to the year. Next, I'd like to make a few comments on the PC market, starting with the rate environment. Global PC rates remain firm overall, and the increases we saw during the first quarter of 2021 are consistent with the past couple of quarters. Rates in Canada led the way up double digits driven by property and professional liability. In the U.S., rates were up about 7%, including double-digit rate increases within our wholesale open brokerage operations. Our U.K. retail and London specialty operations combined, rates are up about 5%. And finally, Australia and New Zealand combined, rate increases are in the low single digits. At the same time, capacity is constrained in certain lines, and carriers are pushing for tighter terms and conditions. There are also quite a few pockets in the U.S., Canada, and London specialty market that I would describe as hard, such as cat-exposed property, cyber, umbrella, and public company D&O, just to name a few. So the global PC environment remains difficult, but is giving us some tailwinds. Looking forward, we don't see conditions that would indicate this rate environment will change anytime soon. And we are seeing more and more economic activity across our client base. For example, Customers are adding coverages and exposures to their existing policies, and through yesterday, April endorsements, premium audits, and other midterm policy adjustments are a net positive overall. That, too, is an encouraging sign. On the benefits side, a recovering labor market in 2021 should favorably impact our core health and welfare business, and we remain optimistic that we will start to see some incremental HR consulting and special project work. This is a terrific time for our team to shine. Firm global rates, increasing exposure units, and recovering employment. Our clients need our expertise, and we are there with the very best insurance, consulting, and risk management advice. So while there's a lot of year left, I have greater conviction that our full-year 2021 brokerage segment, Organic, will be equal to or perhaps even better than pre-pandemic 2019 Organic. Moving on to mergers and acquisitions. We finished the first quarter with five completed brokerage mergers representing about $90 million of estimated annualized revenues. I'd 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. As I look at our tuck-in M&A pipeline, we have more than 40 term sheets signed or being prepared, representing about $250 million of annualized revenues. Our global platform is a great fit for savvy and successful entrepreneurs. We have the tools, data, products, niche expertise, and carrier relationships to help these owners support their current clients and take their business to the next level. Next, I'd like to move to our risk management segment, Gallagher Bassett. First quarter organic growth was 0.6%, which is in line with our March IR day expectations of about flat. It was still a tough compare to pre-pandemic first quarter 2020. However, there is no doubt we are starting to see more and more core workers' comp claim activity when compared to what we were seeing last year at this time. Traditional workers' comp claims are returning, and we are seeing fewer and fewer COVID-related claims. Our cost containment efforts paid off again this quarter. We saved around $4 million and expanded our adjusted EBITDA margin by 180 basis points to 18.4%, another great quarter of execution by the Gallagher Bassett team. Looking forward to the next three quarters, we would expect new claims arising to be higher than what we saw last year, perhaps not back to pre-pandemic levels quite yet, but certainly higher than last year. So when I combine that with some really nice new business wins, we should be back to seeing organic, in the upper single digits for the next few quarters. That would also bode well for keeping margins above 18% for the remainder of the year. Let me wrap up with some comments regarding our unique Gallagher culture. It's a culture that emphasizes doing things the right way for the right reasons with the right people. It's a culture of service, service to our clients, to one another, and to the communities where we work and where we live. and our culture continues to be recognized externally. Just last week, Forbes named Gallagher one of the best U.S. employers for diversity. And that's on top of Gallagher being recognized by the Ethisphere Institute as one of the world's most ethical companies for the 10th year in a row, 10 straight years. And once again, the sole insurance broker recognized. These recognitions are a direct reflection of our more than 30,000 global colleagues working together as a team guided by the 25 tenants of the Gallagher Way. Culture is a key differentiator for our franchise. Every day, all of our people get up and work diligently to maintain our culture, to promote our culture, to live our culture, and I believe our culture has never been stronger. Doug, over to you.

Thanks, Pat, and good afternoon, everyone. I'll echo Pat's comments. An excellent quarter and a terrific start to the year. Today I'll spend most of my time on both our cost savings initiatives and our clean energy cash flows, then highlight a few items in our CFO commentary document, and I'll close with some comments on M&A cash and liquidity. Before I plunge in on cost, one quick comment on page three in the brokerage segment organic table. You'll see that we had a great quarter for contingent commissions. There is a little bit of favorable timing in there. Call it about 50 basis points on total organic. That will flip the other way next quarter, but regardless, a really solid quarter. Okay, let's go to page five, the brokerage segment adjusted EBITDA table. You'll see that we grew adjusted EBITDA by $122 million over last year's first quarter, resulting in about 480 basis points of adjusted margin expansion. That would have been closer to 550 basis points, but as we discussed in our March IR day, M&A rolling isn't as seasonally large, and we did strengthen bonus a bit, given our outlook for 2021 is considerably more optimistic today than it was last year at this time, standing at the gates of a global pandemic. Within that $122 million of EBITDA growth is about $60 million in that is directly related to our cost savings initiatives. Call that about 370 basis points of margin expansion. So when controlling for these three items, we see underlying margin expansion of about 180 basis points on that 6% all in organic. Once again, absolutely terrific execution by the team. Moving on to the risk management segment on page six, We grew our adjusted EBITDA by $4.3 million, resulting in about 180 basis points of adjusted margin expansion, leading us to post margins nicely over 18%. Most of that was due to our cost savings initiatives. So when I combine our brokerage and risk management segments, savings were around $64 million, pretty similar to the last three quarters, and that consists of reduced travel, entertainment, and advertising, about $25 million. reduced consulting and professional fees, about $15 million, reduced outside labor and other workforce costs, about $15 million, and then reduced office supplies, consumables, and occupancy costs of about another $9 million. But remember, first quarter 2021 is the last quarter we have a favorable comparison to pre-pandemic spend levels. So now it's all about how much of the cost savings we can hold going forward. As I look at it today, I still believe we will hold a lot of it. As we have said before, we do see certain costs coming back, but that won't happen overnight. Our best guess is maybe $15 million coming back in the second quarter 21, then step that up by about $5 to $7 million in the third quarter, and a similar step up again in the fourth quarter. Those amounts that I've given are relative to 2020 same quarters adjusted for the role and impact of M&A. As for how that translates into margins, that's really dependent on where we land on organic. But say you assume organic is around 5% or above for the remainder of the year, the math would say that would be enough to show some full-year margin expansion. And regardless on where we land, let's keep this in perspective for the longer term. The pandemic has allowed and perhaps even forced us to accelerate a lot of the improvements we had on the drawing board and also served as an opportunity to design new and better ways to run our business. Both of these make us more productive today than we were 15 months ago, and our service quality has even improved. This will provide a lasting benefit for years to come. So let's move now to the CFO commentary document we post on our investor website. On page three, most items are very similar to what we provided at our March IR day. On page four, both clean energy and the corporate line came in better than we had provided in March. The corporate line is just timing between first and third quarters for certain tax items, but the clean energy investments had a much better quarter and we've bumped up our full year estimate. It's now looking like 70 to 80 million dollars of full year after tax earnings, which is really good news. Next, flip to page five of the CFO commentary. If you missed the clean energy vignette that I gave during our March IR day, it might be worth a listen to the replay on our website. Starts at the hour and nine minute mark. Here are the punchlines. First, recall 2021 is the last year of what we call the credit generation era. Second, 2022 will be the first meaningful year in the cash harvesting era. This means 2021 is the last year we will report GAAP earnings, and 2022 will be the first year meaningful cash flows show up in our cash flow statement. You'll see here on page five that we think 2022 annual cash flows could increase by around $125 to $150 million. And finally, this is not a one-year benefit to cash flow. We have more than $1 billion of tax credit carry forwards on our balance sheet that should favorably impact cash flows for the next six to seven years. As for M&A capacity, at March 31st, available cash on hand was more than $400 million, and we had no outstanding borrowings on a revolving credit facility. So with cash on hand, our untapped borrowing capacity, and another year of strong cash flows, It means upwards of $2.5 billion of M&A capacity here in 21. With a nice M&A pipeline, we are in good shape to continue with our tuck-in strategy. Before I pass it back to Pat, and that was a mouthful, as I sit here today, I see a lot of positives. Organic has nice tailwinds from rate and exposure growth. Add to that a lot of pent-up consumer demand and perhaps a wave of governmental spending, Both could be additional growth catalysts. We have a robust M&A pipeline that should continue to grow, especially if an increase in capital gains tax gets momentum. And we've learned a lot from the pandemic on how to operate better, faster, and cheaper, all the while improving service quality. And our productivity gains we achieved over the last year appear to be sticking. This all bodes well for another year of strong cash flow generation, with a kicker starting in 2022 from our clean energy investments. So we are very well positioned operationally and financially. I can feel the excitement out in the field about coming out of the pandemic stronger than ever before. It's setting up to be another great year. Back to you, Pat.