Arthur J. Gallagher & Co.

Good afternoon, and welcome to Arthur J. Gallagher and Company's fourth 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 could cause actual results to differ materially. Please refer to the cautionary statement and risk factors contained in the company's 10-Q and 8-K filings for more details on its forward-looking statements. In addition, for reconciliations of the non-GATT 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 & Company. Mr. Gallagher, you may begin.

Thank you. Good afternoon, and thank you for joining us for our fourth quarter 22 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 terrific finish to cap off an excellent year. During the quarter, for our combined brokerage and risk management segments, we posted 16% growth in revenue, 11.7% organic growth, gap earnings per share of $0.83, adjusted earnings per share of $1.86, up 24% year-over-year, reported net earnings margin of 9%, adjusted EBITDA margin of 29.6%, up 120 basis points. We also completed 17 mergers totaling more than $140 million of estimated annualized revenues in addition to announcing our agreement to acquire Buck. Another fantastic quarter by the team and our best fourth quarter in decades. Let me give you some more detail on our fourth quarter performance starting with our brokerage segment. Reported revenue growth was 16%. Organic was 11%. Doug will explain it does include a point from our annual 606 review. Brokerage organic in double digits is outstanding. Acquisition rollover revenues were $107 million. And our adjusted EBITDA margin was 31.3%, up 120 basis points and in line with our December IR day expectations. Another excellent quarter for the brokerage team. Focusing on the brokerage segment organic, let me walk you around the world and provide some more detailed commentary, starting with our PC operations. Our US retail business posted 8% organic. Our new business was a bit better than last year, offset somewhat by less non-recurring business, client retention, and the combined impact of rate and exposure were both similar to last year's fourth quarter. Risk placement services, our U.S. wholesale operations posted organic above 9%. This includes more than 12% organic in open brokerage and about 7% organic in our MGA programs and binding businesses. New business was strong and retention was consistent with last year's fourth quarter. Shifting to outside the U.S., our U.K. businesses, both retail and specialty combined, posted organic of 17%. benefiting from excellent new business production, strong retention, and the continued impact of renewal premium increases. Australia and New Zealand combined, organic was 12%. Net new versus lost business was consistent with last year, and renewal premium increases were above fourth quarter 21 levels. Canada was up nearly 9% organically, reflecting solid new business and retention. moving to our employee benefit brokerage and consulting business. Organic was 3%, consistent with our December IR Day expectations. New business was similar to last year's fourth quarter, and retention remained excellent. And finally, to reinsurance. Our legacy reinsurance operations crushed it, with some hard-earned new business wins and quarterly organic well into double digits. And recall that December, It was the first month our newly acquired reinsurance operations were included in organic. And while off a very small revenue base, they too had a spectacular organic growth for the month. So combined, Gallagher Re team continues to deliver outstanding results. So again, brokerage segment all in organic double digits. And with our outstanding fourth quarter finish, Full year organic came in at 9.7%. That's our best full year brokerage segment organic performance in decades. And even more impressive when you consider we grew on top of the 8% organic we posted in 21. Next, let me give you some thoughts on the current PC market environment. Starting in the primary insurance market. Overall, global fourth quarter renewal premiums, that's both rate and exposure combined, were up more than 9%. That's consistent with the 8% to 10% renewal premium change we have been reporting throughout 22. Fourth quarter renewal premium changes by line of business were broadly consistent with the first three quarters of 22 with one exception, which is D&O. D&O continues to be the one area where rates are flattened down slightly, but in some cases our customers are using the weaker pricing to purchase more limit. Exposures also continue to be consistent with the first three quarters of 22, indicating continued strength in our customers' business activity. In fact, fourth quarter midterm policy endorsements, audits and cancellations were better than fourth quarter 21 levels. Looking ahead, these trends appear to be holding. Thus far in January, midterm policy endorsements and audit adjustments are trending higher than last year's level, and global renewal premium increases are consistent with fourth quarter. But remember, our job is to help clients mitigate premium increases and provide an appropriate level of risk transfer that fits their budgets. Shifting to reinsurance and the important January 1st renewals. As we discussed in our first view market report published earlier this month, it was a very late and complex reinsurance renewal season. Not surprising, U.S. peak zone property CAT reinsurance saw some of the largest price increases, but it's worth noting four additional trends within property CAT. First, attachment points were raised broadly. Second, reinsurers pushed to remove prepaid reinstatements from some contracts. Third, reinsurers in some cases were able to reduce coverage to name perils only. And fourth, top layers of many programs saw the largest percentage increases as reinsurers sought to push up minimum premium rates. On the casualty side, prices were up in the single to low double-digit range for most programs, while terms and conditions were more stable. Despite the tough market backdrop of higher prices, lower capacity, and tightening terms, the reinsurance team was able to deliver favorable outcomes for our clients. Looking forward, the challenging reinsurance market conditions will no doubt put pricing pressure on the primary market during 23. And that's on top of our primary carrier partners dealing with catastrophe losses and secondary perils, including convective storms, floods and wildfires, high replacement cost inflation from raw materials to shortages in labor, social inflation combined with the easing of the judicial system logjam, escalating medical cost trends, and ongoing geopolitical tensions. So there's good reason to expect continued price increases and cautious underwriting for the foreseeable future. And as I mentioned before, we are not seeing any signs of exposure contraction. Rather, it seems our client's business activity remains unchanged from the past few quarters. Excuse me. Within our employee benefit brokerage and consulting business, the backdrop for 23 is also broadly favorable. Employers continue to add jobs and wages are growing. so demand for our services and offerings should remain robust. So as I sit here today, 23 could be another fantastic year with brokerage organic growth nicely in the 7% to 9% range. Moving on to mergers and acquisitions. We had a really active fourth quarter, completing 17 new tuck-in brokerage mergers representing more than $140 million of estimated annual 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. For the year, we completed 36 mergers representing annualized revenue of about $250 million. Additionally, we announced an agreement to acquire Buck, a very complimentary business providing retirement, HR and employee benefits consulting, and administrative services with estimated annualized revenues of $280 million. We expect the transaction to close during the second quarter and look forward to welcoming our new colleagues. Moving to our merger and acquisition pipeline, we have nearly 45 term sheets signed or being prepared, representing more than $300 million of annualized revenue. We know not all of these will close, however, we believe we will get our fair share. And before I conclude my M&A comments, let me give you a quick recap on our reinsurance acquisition now that we have a full year in our books. We had a fantastic 22 thanks to strong client retention, the expansion of existing client relationships, some great new business wins, and excellent growth in our pro rata business. The team is fully assimilated, is delivering for clients, and there's a lot of momentum. I believe we're on track for an even better 23. Needless to say, reinsurance continues to be an exciting story. Moving on to our risk management segment, Gallagher Bassett. Fourth quarter organic growth was 15.6% as a strong finish to the quarter pushed organic above our mid-December expectation. Core new arising claims increased during the quarter driven by recent new business wins and continued growth from existing clients, and fourth quarter adjusted EBITDAG margin was great at 19.3% so putting it all together Gallagher Bassett finished the year with an adjusted EBITDA margin of 18.5% and 13.3% organic benefiting from increased claim activity coming out of the pandemic and some really nice new business wins looking forward full year 23 organic should be pushing 10% and adjusted EBITDA margins should be around 19% that would be another Fantastic year. And I'd like to conclude with some comments regarding our bedrock culture. It's a culture of teamwork, client service, and excellence, captured and celebrated in the Gallagher way. It is the culture that drove full year 22 results for our combined brokerage and risk management segments of 24% growth in adjusted revenues, 10% all in organic, 25% growth in adjusted EBITDA, adjusted EBITDA margin in excess of 32%, and 20% growth in adjusted EPS. We have a culture that our people believe in, embrace, and live every day. It's a culture that will continue to drive us forward. That is the Gallagher way. Okay, I'll stop now and turn it over to Doug. Doug?

Thanks, Pat, and hello, everyone. a fantastic fourth quarter to close out another outstanding year. Today, I'll start with our earnings release, touching on organic, margins, and the corporate segment shortcut table. Next, I'll walk you through our CFO commentary document, point out a few items for the next quarter, and also provide a first look at our typical modeling helpers for 23. Then I'll finish up with some comments on cash, M&A capacity, and capital management. OK, let's flip to page three of the earnings to the brokerage segment organic table, all in brokerage organic of 11%, above the 9% to 9.5% that we foreshadowed in December. Two drivers of the upside. First, as Pat just discussed, we had a really strong finish within our P&C and reinsurance brokerage operations. Second, our annual update of 606 assumptions added about a point to our headline organic. Recall under ASC 606, we must routinely update our assumptions related to the amount of services provided before and after the placement of an insurance policy. Based on our most recent operational analysis, metrics, and time studies, more of our services being provided at the time of placement and more of the post-placement service is being handled faster in our lower cost centers of excellence. This causes less of our revenue to be deferred. and thus we recognized an additional $15 million of revenue in the quarter. That is a small amount relative to our total deferred revenue balance of nearly $435 million, but it does cause an additional point of organic, so worth a call out today. From an expense perspective, our updated 606 assumptions also caused some additional compensation expense to be recognized during the quarter. The punchline of all this, our fourth quarter organic revenues, EBITDA, and net earnings got a small boost, and adjusted EBITDA margin was not significantly impacted. So 11% headline organic, 10% controlling for 606, and 120 basis points of margin expansion. That's a terrific quarter. Looking forward to 23, we're currently not seeing a slowdown in our clients' business activity. We're not seeing signs of price moderation from the carriers. And we still have lost cost inflation and labor market imbalances. Add that to our client first sales and service culture, we are still seeing 23 organic in that 7% to 9% range, as we stated during our December IR day. Same with our margin outlook for 23. We are still comfortable with our December commentary. We think we can deliver about 50 basis margin expansion at 6% organic. And fiduciary investment income could be a nice margin sweetener, provided there isn't a surge in wage and cost inflation. One other money heads up for 23. On December 20, we announced our acquisition of Buck. The business operates at an adjusted EBITDA margin around 20%. So please make sure a portion of your pick for future M&A revenues reflects that, versus what you might pick for other markets. Moving on to the risk management segment and their organic table at the bottom of page six. You'll see 15.6% organic in the fourth quarter and full year organic in excess of 13%. Some of that growth this year comes from our clients business activity still rebounding out of the pandemic and getting back to levels they saw before the pandemic. Accordingly, for 23, we're seeing organic revenue approaching 10%. Flipping to page seven, The risk management adjusted EBITDA at a margin of 19.3% in the quarter and 18.5% for the full year. We see a nice step up in 23 with margins around 19%, even as we continue to make investments to enhance the client experience and in analytics and tools to drive better claim outcomes. Another year of double-digit growth and margin expansion would be another terrific year. Turning to page eight to the corporate segment shortcut table. In total, adjusted results were at the favorable end of our December IR day forecast. You'll also see two non-GAAP adjustments this quarter. First, our M&A transaction costs of $5 million after tax, most relate to Buck and a little relates to Willow Tree. And second, as we discussed previously, you'll see a $31 million after tax gain related to legal and tax matters. Now shifting to our CFO commentary document we posted on our IR website, starting on page three. As for fourth quarter, you'll see most of the brokerage and risk management items are close to our December IR day estimates. On the right-hand side of the page, we're providing our first look at 23. A couple things worth highlighting. First, FX. With last year's mid-year strengthening in the U.S. dollar, you'll see some volatility in how FX will impact our brokerage and risk management results in first half or second half of 23. Please make sure to consider these impacts as you're planning your models. Second, our adjusted tax rate. With the UK corporate tax rate increasing to 25% effective April 1st, we're providing our current estimate for full year 23 tax rates. More of an impact to our brokerage segment than it is to our risk management segment, given the size of our UK retail London specialty and reinsurance brokerage operation. And one other thing, the left side of this page might be a nice reference when making your picks for quarterly margins, giving our quarterly seasonality. And finally, when you do make your margin picks, recall we were still in the Omicron portion of the pandemic during the first quarter of 22. So we're not expecting as much margin expansion in first quarter as we are in the second, third, and fourth quarter of 23. Okay, moving to page five. This page is here to highlight the incremental cash flows from our clean energy investments over the coming years. And remember, those come through the cash flow statement, not the P&L. You'll also see that we have $773 million of available tax credits as of December 31st, 22, and that we forecast using about $180 to $200 million in 23, and that should step up a bit in 24 and each later year. That's a really nice cash flow boost to help fund our M&A. The way I look at the math, it might say that an additional $773 million of free cash could buy maybe another $70 million of recurring EBITDA at that 10 to 11 times multiple, which would then have a nice arbitrage for our current trading multiple. Moving to page six on the rollover revenue table, for the fourth quarter, rollover revenues came in higher than our December IR date guidance. Most all of that came from reinsurance. Over the last three weeks, seedings have been closing their books for 22, and we're getting updated seeded premium figures. That translated into additional commission revenue for 22. For the sake of clarity, nearly all of that upside is excluded from our organic results because it likely relates to pre-December 1st, 22, which marked the first year anniversary of the acquisition. And also, please note that not all of that hits the bottom line because of production and incentive comp expense on that additional revenue. That said, it's terrific to get the bump up. Staying on page six, but moving down to the bottom table, that table shows our actual reinsurance acquisition results. In a transition year, the team overperformed our pro forma expectation. That's impressive and terrific work by the team. So now let me move to some final comments on cash, capital management, and future M&A. At December 31st, available cash on hand was about $325 million. Our current cash position, combined with strong expected cash flows and incremental borrowing, positions us well for our pipeline of M&A opportunities. In total, we estimate towards $3 billion to fund potential M&A opportunities during 23, which would include paying for Buck. And also, yesterday our board of directors approved an increase in our quarterly dividend by 4 cents per share. That would imply an annual payout of $2.20 per share. That's a 7.8% increase over 22. So with a strong organic outlook, margin expansion opportunities, and an ever-growing M&A pipeline, from my vantage point as CFO, we are extremely well positioned for another fantastic year in 23. I'd like to thank the entire Gallagher team for another great quarter and outstanding year. Back to you, Pat.