Arthur J. Gallagher & Co.

Good afternoon. Welcome to Arthur J. Gallagher and Company's third 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 meetings of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the questionary statement 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 sections of the company's website. It is now my pleasure to introduce Jay Patrick Gallagher, Chairman, President, and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.

Thank you, Operator, and good afternoon, everyone. Thank you for joining us for our third quarter 2022 earnings call. On the call today is Doug Howell, our CFO, as well as the heads of our operating divisions. Before I get to my comments about our financial results, I'd like to acknowledge the damage and devastation caused by Hurricane Ian. Our professionals are working diligently to help our clients sort through their coverages, file claims, and ultimately get losses paid. At the same time, many of our own colleagues are doing the same for themselves. Our hearts go out to all of those impacted by the storms. In the aftermath of events such as Ian, the insurance industry's role and response is paramount to help families, businesses, and communities restore their lives. I'm really honored to be part of an industry with such important responsibility. Okay, on to my comments regarding our third quarter financial performance. For our combined brokerage and risk management segments, we posted 15% growth in revenue, 8.4% organic growth, Net earnings growth of 12%, adjusted EBITDA growth of 15%, and we completed or signed seven mergers in the quarter, totaling about $60 million of annualized revenues. Another fantastic quarter by our team. Let me give you some more detail on our third quarter performance, starting with our brokerage segment. During the quarter, reported revenue growth was 16%. Of that, 7.8% was organic. That's right in line with our September IR Day expectation when we previewed there would be about a full point of headwind related to timing from a tough 21 comparison within our benefits business. Acquisition rollover revenues were $162 million. Net earnings growth was 11%, and we posted adjusted EBITDA margins of 32.3%. a bit better than our IR Day guidance. Another excellent quarter for our brokerage team. Focusing on brokerage segment organic, it continues to be broad-based by both business and geography. Let me walk you around the world and provide some more detailed commentary, starting with our PC operations. Our US retail business posted 9% organic with strong new business and solid client retention, both consistent with last year's third quarter. Risk placement services, our U.S. wholesale operations also posted organic of 9%. This includes more than 20% organic in open brokerage and about 5% organic in our MGA programs and binding businesses. New business was strong at more than 27% of prior year revenue and retention was consistent with last year's third quarter. Shifting outside the U.S. Our UK businesses posted organic of 15% with excellent new business production and retention. Australia and New Zealand combined, organic was 9%. New business production remained very strong and retention improved relative to last year's third quarter. Canada was up 13% organically and continues to benefit from renewal premium increases, robust new business, and consistent retention. Moving to our employee benefit brokerage and consulting business. As I mentioned earlier, as we signaled last quarter and again at our September IR Day, our benefits business faced a tough organic comparison this quarter. Recall that due to last year's upward development in covered lives as employers resumed hiring coming out of the depths of the pandemic. Leveling for that, our benefits business organic was about 3%. That's consistent with our IR Day expectations and includes strong growth within our HR benefits consulting units and solid growth in our international businesses. And before I conclude my organic comments, let me give you a quick update on our December 21 reinsurance acquisition. Third quarter revenues were right in line with our expectations. And while not included in our brokerage segment organic yet, after controlling for breakage prior to closing, organic was around 8%. That's just outstanding. With expected revenues in EBITDA for full year unchanged, reinsurance continues to be a fantastic story. So headline brokerage segment all in organic of 7.8% and around 9% after controlling for the benefits comparison. Either way, an outstanding organic quarter. Next, let me give you some thoughts on our current PC market environment, starting in the primary insurance markets. Overall, global third quarter renewal premiums, that's both rate and exposure combined, were up 10.5%. That's a bit higher than renewal premium change in the first half of 22. As for rate, most lines of business and geographies saw increases in third quarters similar to the first half, with only one exception being D&O, where rates are now closer to flat, but our customers are buying more limits. Additionally, our customers' third quarter business activity was not reflective of any economic slowdown. In fact, revenue related to third quarter midterm policy endorsements, audits, and cancellations combined were above third quarter 21 levels. Looking ahead thus far in October, midterm policy endorsements and audit adjustments remain higher than last year's level, and renewal premium increases are also consistent with the third quarter. But remember, Our job is to help our clients mitigate that overall 10% increase in premiums by developing creative risk management solutions that fit their budgets. Let me move to the reinsurance market. Let me provide you with some broad observations regarding the upcoming 23 and reinsurance renewal season. First, there is no question that rates, terms, and conditions will vary depending on geography, Individual seed and loss history, risk characteristics, and line of business. Second, pricing on peak zone property catastrophe cover is moving higher, and tightening terms and conditions are highly likely. Third, while we haven't witnessed the impact of Hurricane Ian spillover to non-property lines yet, it is possible that that could happen if there's a broad shift in reinsurance risk appetite and capacity deployment strategies. Fourth and finally, the amount of property reinsurance capacity available remains an open question. Some reinsurance providers had already planned to pull back their CAT capacity priority, and now it is likely the significant level of ILS capital will be trapped into 1-1 renewals, further pressuring potential capacity. Ultimately, supply will depend on expected returns from changes in pricing, terms and conditions, and perhaps expected returns will reach a level that will attract additional reinsurance capital. While we have yet to see any significant third-party capital enter the market, given ILS capital can move quickly, there is still time before the January renewal season. This will play out over the next two months, but at this point, it seems the stage is set for a hard or even harder reinsurance market as we enter the important 1-1 renewal season. Reinsurance conditions will no doubt influence primary markets in 2023, and carriers are already facing rising loss costs in property and casualty lines. We see good reason for our carrier partners to continue to underwrite retail and wholesale risks cautiously for the foreseeable future. Moving to our employee benefit brokerage and consulting business, U.S. labor market conditions remain tight but broadly favorable. During August, while U.S. employers reduced job openings by a million positions, there are still more than 10 million job openings according to the most recent data. And the level of open jobs remains well above the nearly six million people unemployed and looking for work as of the end of September. So we see tight U.S. labor market conditions lingering for some time and expect strong demand for our HR and benefits consulting services to continue as businesses prioritize attracting, retaining and motivating their workforce. Let me wrap up my brokerage segment organic comments with three terrific quarters in the books. Year-to-date brokerage organic growth stands at 9.3%. And as I look to the fourth quarter, I see us posting another quarter above 9% that would deliver a fantastic year. Moving on to mergers and acquisitions, during the third quarter, We completed six new tuck-in brokerage mergers representing about $20 million of estimated annualized revenues. We also signed another merger late in the third quarter representing an additional $40 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 about 50 term sheets signed or being prepared, representing nearly $400 million of annualized revenue. We know not all of these will close. However, we believe we'll get our fair share. Next, I'd like to move to our risk management segment, Gallagher Bassett. Third quarter organic growth was 12.2%, a strong finish to the quarter, pushed organic a bit higher than our IR day expectations. We also continue to benefit from increases in new arising claims across general liability and core workers' compensation during the quarter. That's both on an organic, existing client basis and also due to some recent new client wins, including this significant insurance company client we added to our fast-growing insurance carrier practice. And profitability remains excellent. Third quarter adjusted EBITDAG margin was 18.2% in line with our expectations. that would have been closer to 19% without the impact from the new large client ramp-up that we spoke about at our September IR meeting. Looking forward for the fourth quarter, we believe organic revenue growth will be about 10% and adjusted EBITDA margins between 18.5% and 19% that would close out a great year for the Gallagher Bassett team. And I'll conclude my remarks with some thoughts on our bedrock culture. October 2nd, marked Gallagher's 95th anniversary. I took note on that day that our teams were hard at work helping our clients assess damage, file claims, and ultimately start the repairing and rebuilding process from Ian. If not directly assisting individuals and communities impacted, many Gallagher colleagues around the world donated their own money to help those impacted by Ian. What a fitting way for us to silently celebrate this incredible milestone. My grandfather would be proud of the company he founded, the employees that embodied the culture he started, and the industry in which we toil. It's our people's actions in challenging times that bring our unique Gallagher culture to the forefront, a culture that we believe will thrive for another 95 years. Okay, I'll stop now and turn it over to Doug.

Doug? Thanks, Pat, and hello, everyone. Today I'll touch on organic and margins using our earnings release. Then I'll move to the CFO commentary document that we post to our website and make some comments on our corporate segment. I'll conclude my prepared remarks with some thoughts on M&A, debt, and cash. During my comments today, I'll also provide some thoughts on our fourth quarter and some first thinking around how we are seeing 2023 now that we have started our budget process. Okay, starting with earnings release and the brokerage segment organic table on page three. Headline all-in brokerage organic of 7.8%. That's over 9% when controlling for the tough benefits compare. Brings us to a strong 9.3% year-to-date organic growth. When I look at our organic quarter-to-quarter, it's fairly consistent at that 9% range. We boast 9.6% organic in first quarter, about the same in the second quarter when you exclude that infrequent large life sale we discussed last quarter. Now we're at about 9% here in the third quarter when adjusting for the benefits headwind. And it's looking like over 9% in the fourth quarter. That would deliver a full year 22 organic above 9%. A little noisy on the quarters, but very consistent and actually a fantastic performance by our sales team. As for 2023, early feel is in that 7% to 9% organic range for our brokerage segments. Next, turning to page five to the brokerage segment adjusted EBITDA margin table. Recall, this is a year of quarterly margin change volatility due to the roll-in impact of the acquired reinsurance operation, expenses returning as we come out of the pandemic, and the impact of a stronger dollar. Specifically, we've been saying to expect year-over-year margins to be up 50 basis points in first quarter, down 100 in the second quarter, down 125 basis points in the third quarter, and up about 125 basis points in the fourth quarter. Well, that was about right for our third quarter. We posted 32.3%, which was in line with our IRDX guidance, and we are still comfortable with our fourth quarter outlook of around 125 basis points of margin expansion relative to the FX-adjusted fourth quarter 21 EBITDAX margins. That would suggest a fourth quarter margin of around 32% at today's FX rates. In the end, since early 22, we've been targeting around 10 to 20 basis points of full year 22 margin expansion, and we're on track to deliver that. More importantly, that would mean we improved margins around 570 basis points since 2019. As we look ahead to 23, we continue to expect margin expansion next year starting around 4% or better organic growth. Call it maybe 50 basis points at 6%. Moving on to the risk management segment on pages 5 and 6, as Pat said, 12.2% organic and 18.2% adjusted margins, both pretty close to our September IR Day expectations. And looking forward, we see these excellent results continuing in the fourth quarter. Organic revenue growth of about 10% and margins in the mid to upper 18% range. That would mean full-year organic growth of about 12% and full-year margins around 18.5%. Looking to 23, we will see the roll-in of the new large carrier client, and we have already had a nice new business win in Australia that will incept mid-year. Add continued strong new business production combined with continued growth and new arising claims, we see organic at least in the high single digits and margins around 19% in 23. All right, let's shift now to the CFO commentary document. Starting with page three, which shows our typical brokerage and risk management modeling helpers. A few things to highlight. First, with the continued strengthening of the US dollar since our September IR day, please take a look at our updated FX guidance for the fourth quarter of 22. As for 2023, perhaps the best start is just to assume what we are projecting for full year 22 repeats in 23. but most of that will be seen in the first half. Second, you'll see our current estimate for fourth quarter integration costs. Most all of this relates to the reinsurance acquisition. The team is making really excellent progress on this and is executing at a faster pace than our original plan. It was terrific to see our new reinsurance colleagues located with our other brokerage operations when I was in London a couple weeks ago. As for technology and system rebuilds, we still see being done by the end of 23 or early 24. Turning to the corporate segment on page four, relative to our September outlook, interest in banking, clean energy, and M&A costs, after adjusting for the large transaction-related expenses, those three lines totaled to about the midpoint of our outlook. Within the corporate line, most of the upside was due to some favorable tax items and a favorable FX remeasurement gain. Looking towards the fourth quarter, moving down that page, only one significant change to our outlook. As you'll see in the fourth quarter corporate line and read in footnote seven on that page four, here in October we settled litigation resulting in Gallagher receiving $55 million in cash. Now the litigation costs and taxes, we will record a gain of approximately $35 million and you'll see a few lines down that will adjust that gain out of our GAAP results. As for the cash proceeds, which because of our tax credits is actually closer to $40 million, We'll put that to good work over the next couple years to fund incremental production hires and make incremental investments in technology. I'll break down our thinking a little more during our December IR day. Moving now to page five, clean energy. This page should be familiar to everyone by now. It highlights that we have close to a billion dollars of tax credit carry forward. The pinkish column shows that we expect to harvest $125 to $150 million of cash flows here in 22. And the peach column shows that we could be even greater in 23 and beyond. And as a reminder, that would come through our cash flow statement, not our P&L. Turning to page six, the top of the page is the rollover revenue table. Third quarter revenues of $162 million. That's right in line with our expectations six weeks ago. Shifting to the lower half of the page, this table is an update on our December 21 reinsurance acquisition. Third quarter revenue of $120 million is consistent with our September IR day estimate. As for EBITDA, a tiny, tiny difference between third and fourth quarter. Punchline is full year revenue and EBITDA should come in very close to our purchase pro forma. That's a really terrific story and great credit to the team. Okay, as to cash and capital management and future M&A, at September 30, available cash on hand was about $500 million, and we've been saying that we might have around $4 billion of M&A capacity in 22 and 23 combined without using stock. That still seems about right to us today. Okay, those are my comments. Another fantastic quarter and nine months is in the books. Another strong outlook for the fourth quarter, and it's looking like we're well positioned for a terrific year in 2023. Back to you, Pat.