Arthur J. Gallagher & Co.

Good afternoon, and welcome to the Arthur J. Gallagher & Company first quarter 2022 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 risks and uncertainties that can 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 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 and Company. Mr. Gallagher, you may begin.

Thank you. Good afternoon, everyone, and thank you for joining us for our first quarter 2022 earnings call. On the call for you today is Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions. We had a fantastic start to the year. For the first quarter, our combined brokerage and risk management segments posted 30% growth in revenue, more than 10% organic growth, net earnings growth of 28%, adjusted EBITDA growth of 34%, and adjusted earnings per share growth of 26%. And we were named a world's most ethical company for the 11th year in a row. An outstanding achievement on its own and a testament to our nearly 40,000 professionals around the globe. As you can tell, I'm extremely proud of how the team performed during the quarter. So let me give you some more detail on our first quarter brokerage segment performance. During the quarter, reported revenue growth was 32%. Of that, 9.6% was organic, which is just excellent. Rollover revenues of $380 million were pretty consistent with our March IR Day expectations and mostly driven by the December reinsurance brokerage acquisition. Doug will have some further comments on rollover revenues in his prepared remarks. That earnings growth was 27%. Adjusted EBITDA growth was 35%. And we expanded our adjusted EBITDA margin by about 50 basis points. an outstanding all-around quarter for the brokerage team. Let me walk you around the world and break down the 9.6% organic, starting with our PC operations. First, our domestic retail business posted 11% organic, driven by terrific new business, strong retention, and continued renewal premium increases. Risk placement services, our domestic wholesale operations, posted organic of 10%. This includes more than 20% organic and open brokerage and 6% organic in our MGA programs and binding businesses. New business was better than first quarter 21 levels and retention was consistent with prior year. Outside the US, our UK business posted organic of 14%. Within retail, fantastic new business and continued renewal premium increases helped drive 10% organic. And our London specialty business, including our legacy Gallaghery operations saw 17% organic Australia, New Zealand combined organic was nearly 10% driven by strong new business stable retention and higher renewal premium increases. And finally, Canada was up more than 12% organically and continues to benefit from renewal premium increases in great new business production. Moving to our employee benefit brokerage and consulting business, first quarter organic was up over 7%, more than a point better than our March IR day expectation. Our core health and welfare organic was in line with our expectations of 5%, and the upside in the quarter was driven by our international operations and our HR consulting, pharmacy benefits, and various other life insurance product sales. So 7% organic in benefits, 11% organic within our PC operations, an excellent quarter. Next, I'd like to make a few comments on the PC market. Overall, global first quarter renewal premium increases were 8%, consistent with the fourth quarter of 21 after controlling for line of coverage mix differences. Recall that renewal premium change includes both rate and exposure, so let me break that down around the world. About 10% in U.S. retail, including double-digit increases in property, professional liability, and casualty, somewhat offset by workers' comp and commercial auto. In Canada and New Zealand, renewal premiums were up about 8.5% with professional liability seeing the strongest increases. In Australia and U.K. retail, renewal premiums were up mid-single digits, driven by increases in casualty and package. Within RPS, wholesale open brokerage premium increases were up 11% and binding operations were up 6%. And in our London specialty business, we saw first quarter rate increases around 7.5%. Moving to reinsurance. As we noted in January, our 1-1 renewals showed price increases that varied by geography and client loss experience. And while rate tended to be based on client-specific attributes and loss history, even loss-free programs faced modest rate increases. Our April Gallagher-Ree first review report is more focused on Japanese renewals, which tend to dominate the April 1st renewal season. We saw pricing increases in property-related classes, while casualty pricing was flattish despite inflation being a key topic of discussion. You can access our April reinsurance market report on our website for more information. So whether retail, wholesale, or reinsurance, premiums are still increasing almost everywhere. Looking forward, we expect our mixed shift away from workers' compensation renewals in Q1 to U.S. property CAT renewals in Q2 will lead to premium increases in second quarter very similar to full year 2021. And we see these difficult PC market conditions continuing throughout the remainder of this year. Carriers will likely continue their cautious underwriting stance due to rising loss costs and increases in reinsurance pricing. This comes at a time when the conflict in Ukraine is elevating geopolitical uncertainty, courts are reopening, and global monetary policy is tightening. So from our seat, it looks like carriers will continue to push for rate, and don't see a dramatic change in the near term. Moving to our employee benefit brokerage and consulting business, I see domestic labor market conditions in 22 working in our favor. There are more than 11 million job openings in the U.S. That's 5 million more jobs available than people unemployed and looking for work. And that imbalance lays the groundwork for robust demand for our HR and benefits consulting services as employers look to attract, retain, and motivate their workforce. So we finished first quarter with organic of 9.6%. Given our first quarter result and the current insurance market conditions, as we sit here today, we think 22 organic should end up even better than 21. Moving on to mergers and acquisitions. Starting with some comments on our recent reinsurance acquisitions. Integration is progressing at a fast-paced and is ahead of schedule. Alongside the speed that we are executing comes the pull forward of some of the future integration costs, which Doug will cover in his remarks. Also, we had a strong first quarter with the Legacy Gallaghery team growing 30% and our new reinsurance operations delivering towards $340 million of revenue and over $170 million in EBITDAG. and our reinsurance colleagues are melding together extremely well. So it continues to be a really good story. During the first quarter, we completed five new tuck-in brokerage mergers representing about $32 million of estimated annualized revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in merger and acquisition pipeline, We have around 40 term sheets signed or being prepared, representing nearly $250 million of annualized revenue. We know not all these will close. However, we believe we will get our fair share. Next, I'd like to move to our risk management segment, Gallagher Bassett. First quarter organic growth was 15.2%, better than our IRJ expectation due to a strong March, some new business wins, and higher than expected COVID claims. Adjusted EBITDAG margin was 17.3% and would have been 18.5%, but we had a litigation settlement late in the quarter. Moving forward, we think the remaining 22 quarterly margins will be closer to our 19% expectation. We again saw increases in new arising claims across general liability, property, and to a lesser extent, core workers' compensation during the quarter. Newer rising COVID claims were well above what we saw during the fourth quarter. However, core claim counts, which tend to have a greater impact on results, still have room to rebound fully to pre-COVID levels. Looking forward, we see ample opportunity for organic revenue growth from existing clients, growing claim counts, and new business and expect organic to be around 10% per quarter for the remainder of the year. And let me finish with some thoughts on our bedrock culture. I believe our outstanding financial results are made possible because we're able to act as one company, united by one set of values, the Gallagher Way. As I mentioned earlier, we were once again named a world's most ethical company by Ethisphere, a truly global effort that reflects our colleagues' care and integrity to each other and our clients. Every day I hear stories of our colleagues working together as one team to give our clients exactly what they need all around the world. That collaboration is possible because we genuinely want to deliver the best possible service at all times. When one team wins, we all win. And then there's the way our people give back to their communities. In March, we announced a special matching donation to provide humanitarian relief to the people of Ukraine. Thanks to the generosity of my Gallagher colleagues, we're able to donate over a million dollars for necessities like food, water, supplies, and first aid. I'm proud to stand together with my Gallagher colleagues, impacting communities around the world, and that is the Gallagher way. Okay, I'll stop now and turn it over to Doug. Doug?

Thanks, Pat, and hello, everyone. As Pat said, a fantastic first quarter and start to the year. Today, I'll get to my typical comments on organic margins, clean energy, cash, et cetera, and I'll also do a financial recap of the Willis-Ree acquisition. But first, a modeling heads up regarding rollover revenues this quarter. We typically don't comment on consensus estimates, but this quarter looks like there is a large variance in brokerage segment rollover revenues relative to the guidance numbers we provided within our CFO commentary document during our March 16th IR day. When we get to page six of today's CFO commentary document, you'll see we've added a table that shows consensus overstates rollover revenues by approximately $40 million versus the number we provided in March. That has an impact of overstating consensus EPS by six cents. We hope you take this into consideration as you analyze our performance relative to consensus and to your model. Okay, with that housekeeping behind us, let's shift to the earnings release, to the brokerage segment organic table on page three. All in brokerage organic of 9.6%. We had a really strong finish to the quarter. Some nice new business wins by the PMC team and a terrific finish by our benefits consulting teams. You'll also see strong growth in both contingents and supplementals. The Ukraine-Russia conflict impact was small, about $5 million of revenue, which is about a one penny hit this quarter. Looking forward, it's looking like it's small also. Maybe another $5 million revenue impact spread over the next three quarters. Given our strong start and given our current favorable outlook of the market as Pat discussed, we could be pushing nicely towards upper 8% to 9% full year organic growth here in 22. Next, let's turn to page five to the brokerage segment adjusted EBITDA margin table. Headlined all-in adjusted margin expansion for first quarter was 49 basis points, right in line with our March IR day expectation. Recall that expansion includes a favorable seasonal impact from reinsurance roll-in, offset in part by return of expenses as we come out of the pandemic. And it also has a little more incentive compensation given our stronger first quarter organic growth and full year expectations. Repeating what we said during March, we are well positioned to deliver around 10 to 20 basis points of full year adjusted margin expansion. But remember, as we discussed here in 22, there'll be margin change volatility quarter to quarter. That's due to expenses returning as we come out of the pandemic and the role and impact of acquired reinsurance revenues. So let me walk through what we said in March. 50 basis points of expansion here in the first quarter, then expecting second and third quarter margins to each be down around 100 basis points. But then that flips and we expect fourth quarter margins to be up around 100 basis points. The math, given that we are seasonally larger in the first quarter, gets us back to that 10 to 20 basis points of full year margin expansion. Looking way out towards 23, That quarterly margins change volatility should go away with the pandemic behind us and reinsurance fully in our books. Okay, let's move on to the risk management segment and the organic table on the bottom of page five. You'll see 15.2% organic in the first quarter. That's just terrific by the team. And with continued strong new business and rebounding claim counts, it's looking like organic revenue growth of about 10% each quarter for the rest of 22. On the next page, you'll see that our risk management segment posted adjusted EBITDA margin of 17.3%. That was compressed by about 120 basis points due to an unusual late quarter litigation settlement. As Pat said, moving forward, we would expect margins for the remainder of 22 to be closer to 19%. Moving to page 7 of the earnings release in the corporate segment shortcut table, most adjusted first quarter items were in line with our March IR day estimates. Within the corporate line, we did also benefit from an FX remeasurement gain and a larger tax benefit related to employee stock option exercises given the strong performance of our stock late in the quarter. You'll also see a couple non-GAAP adjustments. The first relates to transaction costs and professional fees associated with buying Willis-Ree. And the second was a state tax benefit related to the revaluation of our deferred income tax balances. All right, let's now go to the CFO commentary document. Page three has our typical brokerage and risk management modeling helpers. We've updated our outlook for integration. I'll get to that tomorrow in a minute. We've updated FX, and you'll see a slight checkup in our expected brokerage segment tax rate. Call it a half a percentage point. In addition, the amortization lines in both brokerage and risk management are now highlighted in yellow. This means the item is now being treated as a non-GAAP adjustment. If you missed our March IR day, we did a vignette on this change and how we're reporting adjusted EPS. This is the first quarter reporting under that revised method. On page four of the CFO commentary, that's our corporate segment outlook. You'll see there is no change in our outlook for second, third, and fourth quarters. When you turn to page five to clean energy, the purpose of this page is to highlight that we have over a billion dollars of credit carry forwards and we are now in the cash harvesting era of these investments. There's no gap earnings anymore other than a little bit of overhead expense, but rather now substantial cash flows. You'll see in the pinkish column that the 22 cash flow increase should be substantial. We should be able to harvest 125 to $150 million a year of cash flows and perhaps more in 23 and beyond. At that rate, a really nice seven year cash flow sweetener. And there still is a possibility of an extension in the law. So we remain well positioned to restart production if that happens. Okay. Flipping to page six of the CFO commentary document. Top table is the rollover revenue table. Recall that we update this each earnings release day and also each quarter during our late quarter IR meetings. The next box highlighted in yellow is the math behind the six cent impact of consensus versus our March guidance that I touched on in my opening. Then at the bottom table is an update on our December reinsurance acquisition. Revenue this quarter was $337 million and EBITDA was $172 million. The very small difference to the numbers we provided during our March IR day reflects two items. First, the quarterly timing related to further refinement in our ASC 606 accounting for both revenue expense. And second, some further movement in FX rates. In the end, if you go all the way back to our original August 21 projections, There is very little change to our first year of ownership expectations other than a small impact from Russia, Ukraine, and FX. As for integration, the good news is that our original estimate of around a total of $250 million for integration charges through the end of 2024 is holding close. The even better news is we're making progress at a faster pace than we originally thought. Integration efforts around people, real estate, back office transition services, et cetera, are targeted to be mostly done by late 22 versus mid to late 23 as originally planned. When it comes to technology rebuilds, we think most of it will be done by the end of 23 or early 24. So what that means is that we will see integration costs lumped more into 22 and 23 than spreading deep into 24. You'll see the bump up of our 22 quarterly integration estimates back on page three of the CFO commentary, but it's important to remember it isn't changing our in total view. So that continues to be a really good story. As for cash, capital management, and future M&A, at March 31st, available cash on hand was about $450 million and no outstanding borrowing in our line of credit. With strong operating cash flows expected in 22, and a nice bump in cash flow from our clean energy investments, we are extremely well positioned to fund future tuck-in M&A using cash and debt. We continue to see our M&A capacity at more than $4 billion through the end of 23 without using any stock. So those are my comments. We're off to a great start in 22. From my vantage point as CFO, we're positioned for another great year. A huge thank you to the entire Gallagher team for another terrific quarter. Back to you, Pat. Thank you, Doug.