Arthur J. Gallagher & Co.

Good afternoon and welcome to Arthur J. Gallagher and Company's first quarter 2023 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. The company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward-looking statements and risk factor sections contained in the company's most recent 10-K, 10-Q, and 8-K filings for more details on such risks and uncertainties. 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 investment relations section 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 very much. Good afternoon, and thank you for joining us for our first quarter 23 earnings call. On the call today is Doug Howell, our CFO, as well as the heads of our operating divisions. We had an excellent first quarter to start the year. For our combined brokerage and risk management segments, we posted 12% growth in revenue, 9.7% organic growth, gap earnings per share of $2.52, adjusted earnings per share of $3.30, up 12% year over year. reported net earnings margin of 21%, adjusted EBITDA margin of 38%, up 29 basis points. We also completed 10 mergers, totaling $69 million of estimated annualized revenue. And we were recognized as the world's most ethical company for the 13th time, an outstanding quarter from the team. Let me give you some more detail on our first quarter performance, starting with our brokerage segments. Reported revenue growth was 12%. Organic was 9.1%. Acquisition rollover revenues were $61 million. Adjusted EBITDA growth was 15%. And we posted adjusted EBITDA margin of 40.4% right on our March IR day expectations, a fantastic quarter for the brokerage team. Let me walk you around the world and provide some more detailed commentary on our brokerage organic, starting with our retail brokerage operations. Our US PC business posted over 7% organic. Core new business was up year over year, even growing over the tough renewal compare in D&O lines, while retention was similar to last year's first quarter. Our UK PC business also posted more than 7% organic. due to strong new business production, stable retention, and the continued impact of renewal premium increases. Our combined PC operations in Australia and New Zealand posted organic of 10%. Net new versus lost business was consistent with prior year, and renewal premium increases were ahead of first quarter 22 levels. Rounding out the retail PC business, Canada was up 6% organically, reflecting solid new business and consistent year-over-year retention. Our global employee benefit brokerage and consulting business posted organic of nearly 7%. New business remained strong and client retention was excellent. We saw growth across many of our practice groups with particular strength in HR consulting and pharmacy benefits. Shifting to our wholesale and specialty businesses, risk placement services, our U.S. wholesale operations posted organic of nearly 8%. This includes 16% growth in open brokerage and about 5% organic in our MGA programs and binding businesses. New business production and retention were both consistent with last year's first quarter. U.K. specialty posted organic of 17%. benefiting from a strong start within aviation and the addition of new teams focused on North American risks. And finally, reinsurance. Gallagher Re posted 12% organic, reflecting new business wins, great retention, and a hardening property reinsurance market. Outstanding results from the Gallagher Re team. Pulling it all together, brokerage segment all in organic of 9.1%. That's a bit above the top end of our first quarter expectation and a fantastic sales quarter by the team. Next, let me provide some thoughts on the PC insurance pricing environment, starting with the primary insurance market. Overall, global first quarter renewal premiums, that's both rate and exposure combined, were up more than 9%. consistent with the 8% to 10% renewal premium change we had been reporting throughout 22. Renewal premium increases remain broad-based across nearly all of our major geographies and product lines around the globe. For example, workers' comp is up low single digits. General liability is up mid to high single digits. Umbrella and package are up in the low double digits. So most lines are trending similar to previous quarters. Two exceptions. First, public D&O, where renewal premiums are down a bit, and second, property, where renewal premium increases are accelerating. For example, fourth quarter property renewal premiums grew up 15%, and through the first three months of 23, we have seen increases of 15, 20, and 17% respectively. So our clients continue to feel cost pressures here due to rising replacement values, increasing frequency and severity of weather-related events, and hard reinsurance conditions. We are not seeing signs that these lost cost and profitability pressures are likely to abate in the near term. So as we head into our largest primary insurance property quarter, we are focused on helping our clients navigate and mitigate these premium increases. Moving to exposures, we are seeing continued strength and our customers' business activity. First quarter midterm policy endorsements, audits, and cancellations combined were better than first quarter 22 levels, greater than the eighth consecutive quarter of year-over-year increases. Shifting to reinsurance. During the heavy Japan-centric April renewals, reinsurance carriers continued to focus on increased pricing and tightening terms and conditions. This was across a broader range of territories and most all lines of business, so in even harder conditions compared to January 1st. The casually trading market saw orderly renewals and a sufficient supply of capital to fulfill the demand from underwriting enterprises. The property market continued to experience its recent challenges due to more limited underwriting capital. There were some green shoots in the ILS issuance, although pricing was typically less attractive to sedans than the traditional markets. Overall, there wasn't much new capacity entering the property market. Regardless, our teams navigated the hard market and customers again managed to secure satisfactory cover. Those interested in more detailed commentary can find our April first view market report on our website. Looking forward, there is good reason to expect a cautious underwriting stance from carriers for the foreseeable future as they contemplate recent weather events, replacement cost increases, social inflation, and ongoing geopolitical tensions into their view of lost cost trend. So we expect insurance and reinsurance pricing increases to continue throughout 23, and while it's early, likely into 24. Excuse me. We also remain optimistic on our customers' business activity during 23. We have yet to see any significant shifts in our daily indications of client business activity thus far in April. We are also seeing encouraging employment levels for our benefits clients, suggesting the economic backdrop for 23 remains broadly favorable. Recent data shows the U.S. unemployment rate declining, continued growth in non-farm payrolls, and a very wide gap between the amount of job openings and the number of people unemployed and looking for work. So I see demand for our products and services around attracting, retaining, and motivating workforces remaining strong. As we sit here today, we continue to see full year 23 brokerage segment organic in that 7% to 9% range, and that would be another fantastic year. Moving on to mergers and acquisitions. We had an active first quarter completing 10 new tuck-in brokerage mergers representing about $69 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. Also in April, we officially welcomed the former Buck colleagues. Combined with our existing employee benefits brokerage and HR consulting business, We will enhance our offerings and be better positioned to deliver superior human capital solutions for all of our clients. Moving to our pipeline, we have nearly 40 term sheets signed or being prepared, representing more than $350 million of annualized revenue. Good firms always have a choice of who to partner with, and we'll be very excited if they choose to join Gallagher. Moving on to our risk management segment, Gallagher Bassett. First quarter organic growth was 14.3%, ahead of our expectations due to continued growth from recent new business wins and some revenue from first quarter New Zealand cyclone and flooding. We also saw core new arising claims increase in the low single digits during the quarter for existing clients across both workers' comp and liability. First quarter adjusted EBITDAG margin was also strong at 19.2%. We ended up a bit ahead of our March expectations. Looking forward, we see full year 23 organic around 12% to 13% and adjusted EBITDAG margins holding up or above 19%. And that would be another excellent year. And I'll conclude with some comments regarding our bedrock culture. I'm very pleased that just a few weeks ago, we were recognized as a world's most ethical company for the 13th time. We're honored to be one of only 135 companies globally to receive this award from the Ethisphere Institute. Our 45,000 plus colleagues embrace and celebrate the unique values that we've instilled in our company. The 25 tenants articulated in the Gallagher way continue to drive our global team's success today, and we believe that our unique culture is a key differentiator and a competitive advantage. It's a strong culture of client focus. excellence, and inclusion, and it continues to drive us forward. That is the Gallagher way. Okay, I'll stop now and turn it over to Doug.

Doug? Thanks, Pat, and good afternoon, everyone. As Pat said, an excellent start to the year. Today I'll begin with some comments using both our earnings release and our CFO commentary document that we post on our website. I'll touch on organic margins and provide some modeling helpers for the remainder of 23. Then I'll finish up with my typical comments on cash, M&A capacity, and capital management. Okay, let's flip to page two of the earnings release. All-in brokerage organic of 9.1%. Call it right at the top end of the range we foreshadowed at our March 16th IR day. A nice finish from our London specialty operations and a little upside from reinsurance and benefits. One call out on that table. Contingents didn't grow organically this quarter for three reasons. First, there's a little geography between supplementals and contingents. Call that about $2 million. Second, there was a bit of positive development in Q1-22 from the prior year 21 estimates. Call that $3 million. And again, that's back in first quarter 22, causing a little difficult compare. And third, We're not expecting one of our programs to pay as large of a contingent here in 23 because of underlying loss ratio deterioration. Call that maybe towards a million. Regardless, base organic at 9.5% and all-in at 9.1%. That's a fantastic quarter by the team. Hoping to page four of their earnings release to the brokerage segment adjusted EBITDA table. We posted 40.4% for the quarter. Before FX, that's up 56 basis points. and FX adjusted up 14 basis points over first quarter 22. That's right in line with our March IR day expectations when we discussed that first quarter 22 expenses were lower than our expected run rate simply because we were still in the Omicron portion of the pandemic and that our tuck-in acquisitions are just not as seasonally weighted, but they don't roll in at 40 points of margin here in the first quarter. If you levelize for those two items, our margins expanded approximately 110 basis points. Maybe looking at it like a bridge from first quarter 22 will be helpful. Investment income gave us 90 basis points of margin expansion. The normalization of Omicron T&E expenses and inflation on all T&E cost us 80 basis points. The seasonal impact from rolling M&A uses about 40 basis points. Organic gave us 70 basis points of expansion. and some additional wages and IT investments used about 25 basis points. Follow that bridge, and the math gets you close to that 14 basis points of FX adjusted expansion in the quarter. Looking forward, it's still early, yet with a fantastic first quarter combined with Pat's upbeat commentary, makes us more bullish on hitting that full-year brokerage organic in the 7% to 9% range and posting adjusted margins up 60 to 80 basis points. Two small heads up on that. First, getting to that 7% to 9% organic for the full year might be a little lumpy over the next three quarters, given the large life case we sold in Q2 22, and then the 606 deferred revenue accounting in our fourth quarter. We discussed both of those with you last year, so there's no new news here. Just a reminder for your modeling. Second, the 60 to 80 basis points of margin expansion is before the roll-in impact of buck, which, recall, naturally runs lower margins. So when you include buck, the math would show full-year margin expansion in that 20 to 30 basis points range. So now I'm moving on to the risk management segment and the organic table at the bottom of page four. As Pat said, an excellent quarter, 14.3% organic growth. We did get a little tailwind this quarter because Omicron caused fewer claims arising in Q1-22, and we also had some New Zealand CAC claims activity. But most of this excellent result comes from strong new business wins in the second half last year. As for margins, flip to page five of the earnings race. Risk management posted adjusted Q1 EBITDA margins of 19.2%. That's up 177 basis points over last year. As we look forward, we're seeing the rest of the year organic in that 12 to 13% range and full year margins now finishing a bit above 19%. That would be the best full year adjusted margin in Gallagher Bassett's six decade history. Another demonstration of the benefits of scale, intellectual capital, technology, and operational excellence. Let's turn to page six of the earnings release. That's our corporate segment. And also when you take a look at pages three and four of the CFO commentary document. Most all of the items are right in line with our March IR Day forecast. Three call-outs on the CFO commentary document. When you see page three, you'll see a slight tick up in our expected book effective tax rate. That's entirely due to the UK rate hike to 25% that went effective April 1st. But remember, what you're seeing is a book effective tax rate. Our cash taxes paid rate is substantially lower. Call that around 10% of our adjusted combined brokerage and risk management EBITDA. That's because of the tax yield from interest, the amortization of purchase intangibles, and the incremental cash flows from our clean energy investments over the coming years. Page 5 of the CFO commentary shows those tax credits. We have over $700 million as of March 31st. And it shows that we're forecasting to use about $180 to $200 million in 23 with a step up in 24 in each later year. That's a really nice cash flow sweetener to help fund future M&A. Then if you flip back to page four of the CFO commentary document, you'll see that we had a slight beat on the corporate segment this quarter compared to our midpoint, but some timing in that beat. So you'll see full year still about the same as what we forecasted our March IR day. Moving now to page six of the CFO commentary document, that table shows our rollover M&A revenues. It shows $61 million this quarter, which is pretty close to that $63 million we estimated during our March IR day. And also looking forward, we've now included Buck in that table. But remember, you'll need to add your pick for other future M&A to these estimates. Okay, let me move to some comments on cash, capital management, and future M&A. At March 31, available cash on hand was around $1 billion, but note that about $600 million was used to buy Buck in early April, so call it $400 million. This means we estimate that we have about $2 billion more to fund M&A for the rest of this year, and our early look is another $3 billion or more in 2024, usually to fund our M&A program, utilizing only free cash and incremental debt while maintaining our strong investment grade ratings. One final reminder, recall during our March IR day, we mentioned that we would be reclassifying how we present fiduciary balances on our balance sheet and in our cash flow statement. These reclasses are purely gap geography, and we're doing so to better align our presentation with how many other brokers present their statements. You might notice some of that movement in the recast balance sheet on page 12 of the earnings release. To help you understand all the movements, there'll be a comprehensive table in our 10Q that we will file later next week. Again, all of this is to make our presentation more consistent with most of the other public brokers, and all the change is just gap geography. So those are my comments. Another terrific quarter. And looking forward, we see strong organic growth, a great pipeline of M&A, and continued opportunities for productivity improvements, all fueled by an amazing culture. I believe we are very well positioned to deliver another fantastic year. Back to you, Pat.